Buying local – when might it make sense?

To the standard competitive market-oriented mindset, the “buy local” campaigns that one observes in many places just don’t make much sense. Why would anyone limit her options when deciding what to buy?

George J. Mailath, Andrew Postlewaite, and Larry Samuelson have a working paper out this month just on this topic. They point out first that one can easily find reasons for people to willingly stick with buy local programs. Such programs build community spirit; they have environmental benefits by reducing transportation costs; they allow buyers to more easily influence the conditions under which the products they are buying are made and so ensure fair treatment of workers. It may even be that buying local provides a public good in the form of a vibrant and diverse business district.

But can we find a benefit to buy local programs if we rule out all such explanations and rely on a model full of selfish individuals who do not care about the environment, conditions of production, or the public good aspect of a healthy local business district?

This paper says yes. It considers a model with firms that produce goods for sale and whose owners are the ones buying these goods. But the paper does not assume that the goods are sold on perfectly competitive markets. Instead, they are sold under conditions of monopolistic competition. This means that each good is considered different enough from the others that its producer has some monopoly power, meaning that s/he can charge more for her/his good than its marginal cost of production.

(For non-economists: the marginal cost of a unit of a good is the extra cost incurred to make that unit. You find it by subtracting from the total cost of producing all the units of the good including the last one the total cost of the units except the last one. Perfectly competitive markets are supposed to result in the price of each good equalling its marginal cost.)

So why would a reciprocal arrangement like “I’ll buy from you expecting you’ll buy from me”, which is what “buy local” boils down to, make sense in a world of selfish agents? The simple answer offered in this paper is that when A buys from B, a local producer, instead of a remote producer C who might offer a lower price, A may motivate B to buy from A instead of remote producer D. This way, A and B are giving each other a measure of monopolistic profits.

This could make sense, from the bean-counting point of view, the costs of buying somewhat sub-optimal goods because they were produced locally cannot be too large, or the locals will defect and buy from far away. As the paper puts it, “communities connected by common interests, culture, or physical proximity are ideal candidates for successful buy local arrangements.”

A critic of mainstream economics might say “bah, humbug” at this point. But notice that, even as the authors are prominent economists who would not be called non-mainstream by any reasonable observer, they are far from defaulting to the supposedly knee-jerk modeling of the economy as a bunch of perfectly competitive markets that some (many?) critics of economics paint the field as doing. Instead, they show one of many ways that non-competitive markets can be analyzed formally to reach insights about behaviors, such as buying locally, that cannot easily come out of an off-the-shelf competitive market model.