The Wal-Mart Effect Updated

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When the American economy was humming along and consumers were spending money liberally during the second half of the 1990s, economists tried their darnedest to figure out why prices weren’t rising very rapidly. While some attributed the phenomenon to productivity gains from technological innovation, McKinsey, the global consulting company, coined the phrase The Wal-Mart Effect to explain how the giant retailer’s intense focus on keeping operating costs low and passing the savings on to consumers accounted for much of the restraint in prices.

Warren Buffett boiled that notion down to a simple formulation: Wal-Mart, not some technology giant like Microsoft, was the most important contributor to the vitality of the economy at the time.

The economic picture is quite different today, but Wal-Mart’s role is no less central. As retailers like Linens ‘n Things and Circuit City head into bankruptcy and even slick operators like Target warn of a steep drop in consumer demand, customers are heading to Wal-Mart for savings. The Bentonville, Ark., based chain recently reported third quarter sales up 7.5 percent, including a surprising 3 percent gain in stores opened for more than a year.

Retail analysts tell us that many of those stores going bust right now, like Linens ‘n Things, expanded too rapidly during the good times. But Wal-Mart’s march across the United States was as energetic as other retailers’. The difference is that Wal-Mart expanded without ever losing its focus on operating efficiently, nor ever eschewed its custom of passing savings along to consumers. That’s because Wal-Mart, which produced huge savings when it revolutionized the distribution and delivery of goods to stores on a massive scale starting in the 1970s, has never forgotten the lessons that it learned during its early years. I remember in the midst of a steep recession in 1982 traveling the back roads of Arkansas to visit Wal-Mart stores and a distribution center as a young financial reporter and asking myself, “Can this really be the future of retailing?” Twenty-five years later, in the midst of another steep downturn, the answer to that question is obvious.

Still, the Wal-Mart Effect circa 2008 is different in several crucial ways. Two years ago, for instance, Wal-Mart saw an opportunity because of rising prescription drug prices, and it kicked off a campaign to sell generic drugs for $4 for a 30-day prescription. The move, which the company eventually expanded to all of its pharmacies, sparked a pricing war around the country as big pharmacy chains slashed their own prices on generics. Wal-Mart estimates that Rx customers at its stores alone have saved more than $1 billion.

That might be chump change, however, compared to what’s happening in the grocery business. Once primarily a general merchandise discounter, Wal-Mart embarked on rapid expansion of stores selling groceries when it noticed that local supermarket chains were taking a bigger and bigger bite out of consumers’ pocketbooks—in some markets doubling their profit margins during the 1990s. Today, Wal-Mart operates some 2,500 stores selling food items, and food prices at Wal-Mart’s stores are typically from 10 percent to 25 percent lower than at competitor stores, depending on the food category. Even if you don’t shop at Wal-Mart you’re likely to save five percent on your food costs when the retailer enters your market. Those savings add up, particularly for low-income households, who recognize a 6.5 percent increase in income from the savings of shopping at a big-box grocery store.

But Wal-Mart’s march into food retailing also raised the ire of powerful food unions and helped to make the chain a persistent target of labor and its political supporters. The fragmented grocery business in the U.S., where no national retailer before Wal-Mart played a significant role, is one of the few mass market sectors in which organized labor is still a force, composing about 20 percent of the workforce, compared to just five percent of general merchandise workers (Few of Wal-Mart’s general merchandise competitors, like Target or Kohl’s or Kmart, are unionized). Grocery unions have watched Wal-Mart’s entry into their business with growing alarm, which reached a crescendo during the 2004 Los Angeles area supermarket workers strike, when Democratic presidential candidate John Kerry visited the picket lines in support of workers. Although Wal-Mart was not even operating in that market, just the sight of the company rolling out its combined food/mass merchandise stores elsewhere was enough to prompt a face-off between unions and supermarkets over wages and benefits.

That battle, with Wal-Mart as the subtext during a presidential campaign, helped to galvanize every anti-Wal-Mart constituency. A disparate group united in their single-minded loathing of the chain, they ranged from anti-globalists who blame Wal-Mart for the decline in American manufacturing (as if, if Wal-Mart didn’t exist, no other retailer would have figured out consumers might be interested in buying clothes imported from overseas that cost less), to anti-sprawl activists who blame Wal-Mart for the decline of urban downtown shopping, to rural chambers of commerce, who blame Wal-Mart for the decline of Main Street shopping, to feminists who are rankled that Wal-Mart won’t force its pharmacy employees who object to the morning-after pill to dispense it (instead, those employees are allowed to pass the customer on to another Wal-Mart associate).

Members of Wal-Mart’s founding family, the descendants of Sam Walton, have also angered activists and made the business a target because they have used their fortune to support conservative and free-market causes, especially the choice movement in public education (from 2000 through 2004 Walton family members helped fund research into school choice here at the Manhattan Institute). Apparently, it’s one thing to use the family fortune to back anti-smoking initiatives in the developing world, like New York Mayor Bloomberg’s foundation has done, or to advocate for the rights of prostitutes in Africa, as George Soros’ Open Society has done, but quite another to promote free-market principles here in the U.S.

Still, despite the unique ability of Wal-Mart to drive a certain type of activist into a frenzy, consumers have mostly just yawned at the anti-Wal-Mart hysteria. Its stores remain the overwhelming shopping favorite of more Americans than any other retailer. Moreover, even in those days when unemployment in America hovered below five percent, thousands of people lined up to apply for a job when Wal-Mart opened a new store.

Wal-Mart’s contribution to American economic progress has been recognized among a diverse ideological group of economists. Most representative, perhaps, is a paper by Jason Furman, one of President-elect Obama’s economic advisors, entitled “Wal-Mart: A Progressive Success Story.” Furman acknowledges that productivity is the main engine of economic progress and that Wal-Mart has pushed much of the retail sector to follow it along a path of lower prices, benefiting low income households the most. Along the way Furman demolishes many of the typical criticisms of Wal-Mart. He notes, for instance, that calls by activists that Wal-Mart pay its entry level workers more fail to acknowledge that Wal-Mart’s overall margin of profits-to-revenues is small, as are its profits-per-worker, and that other retailers with higher salary scales serve a different, more upscale customer. Furman also disputes the notion that Wal-Mart benefits from “corporate welfare” because some of its workers (4.5 percent to be precise) are on Medicaid, noting that for entry level workers, the choice of Medicaid over a company-sponsored plan that requires co-pays simply makes economic sense, and that the benefits of the program accrue to the worker, not Wal-Mart.

Furman’s principal criticism of Wal-Mart is that as a company that serves millions of low-income households and employs so many entry-level workers, it should be doing more to advocate on the national stage for policies to help those at the bottom of the income scale, from expanding the earned income tax credit to lobbying for ways to expand health care coverage in the U.S.

Still, it’s difficult to gauge how the Wal-Mart sector, that is, the segment of retailing that includes the chain itself and every other operator forced to compete with it, will fare in the new politics of Washington. Early in the presidential campaign Obama was vying with John Edwards for the title of Wal-Mart basher, but as the campaign evolved during the financial crisis, that sort of talk evaporated.

But there is much that could be done in Washington to undermine the progressive success story that is Wal-Mart, from rising tariffs and other protectionist measures that would increase the cost of imported goods, to passage of the misnamed Employee Free Choice Act, which could set off a series of labor-management battles and prompt Wal-Mart and its competitors to rethink some of their expansion plans in the face of potentially higher employee costs. That would be the wrong kind of Wal-Mart Effect.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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