A “profit push” explanation for the current inflation
According to the US inflation calculator, the inflation rate in the US averaged below 2 percent a year from 2012 through 2020. Then it shot up to seven percent in calendar year 2021 and so far in 2022 is running at a 7.9 percent annual rate. Why? It depends on who is talking. If you listen to right wing idiots, it’s because President Biden has cancelled the Keystone Oil Pipeline. If you listen to many mainstream economists, it’s because of supply – chain disruptions. If you listen to Republicans in Congress, it’s because the Biden Administration is running astronomical deficits. Finally, if you check out public opinion polls, it’s because corporations are greedy and are jacking up prices.
This is the kind of issue, I LIVED FOR when I was a professor. I would get quotes from people representing the different “sides” and I’d try to give the students the BEST POSSIBLE arguments for each position and then let them go at it. I did that because my job as a faculty member was to get students to think for themselves and in my view the best way to do that is make students consider arguments they disagree with and then come up with reasons to support their positions. I also told students that it was important to realize that people can change their minds when they think something through so there was no reason to be afraid to try out an idea.
But I am not in the classroom any more. Instead, I am a concerned citizen who knows enough economics to understand when an argument is nonsense and when it is convincing. In the commentary I delivered on March 18, I presented my case for the following conclusion: In the context of an inflation surge that began in calendar year 2021 as the economy started to recover from the brief but quite deep COVID-created recession many businesses began taking advantage of the situation to raise prices more than their costs. Many were rewarded with record-setting profits in 2021 and that process continues today.
First, let’s dispense with true idiocy. There are people out there blaming the gigantic increase in oil prices on the fact that Joe Biden refused to permit the Keystone XL Pipeline extension construction to continue. The reason this is idiocy is that the pipeline would not bring a drop of oil to market until 2023 if it had been allowed to be built to completion. In addition, it would not have increased production in the United States but it would have increased American exports of oil elsewhere. (Yes, the war in Ukraine has disrupted supplies of oil but that cannot explain the price hikes before the war began!)
Supply chain disruptions are a good explanation for the initial months of the inflationary surges. According to an interesting article on the Renewing America website, “…the story of … disruptions in 2021 is complex. As COVID-19 vaccines became widely available in the United States and the economy reopened, consumer demand recovered strongly. …Companies --- which for decades had been disciplined by the market into creating “just-in-time” supply chains and holding little inventory – scrambled to keep up. At the same time, companies in critical sectors such as warehousing struggled to attract and retain workers. These factors, combined with years of underinvestment in U.S. infrastructure, saw goods-laden containers piling up at major ports and ships waiting for weeks to dock. As a result, shoppers around the country saw sparse shelves and higher prices.” [Anshu Siripurapu, “What Happened to Supply Chains in 2021?” December 13, 2021 available at https://www.cfr.org/article/what-happened-supply-chains-2021.]
In other words, the initial bouts of inflation were the result of consumer demand recovering after that very deep dive in early 2020. Let’s remember what happened beginning in March of 2020. [In what follows, I am taking data from the Federal Reserve Bank of St. Louis data base, known as FRED.]. In just two months from the end of February to the end of April, Consumer Spending in the US fell NINETEEN PERCENT. [Those are nominal dollars. For the FRED diagram see https://fred.stlouisfed.org/series/PCE. In real terms the fall was “only” 18 percent.]. To give an idea of how precipitous this fall was, it too FIVE YEARS from January of 2015 to January of 2020 for consumption expenditures to rise nineteen percent.
The result of the decline in consumer spending was a precipitous fall in investment (about 16 percent). The fall in GDP was nine percent. This was the most precipitous decline in economic activity ever recorded. In the Great Depression, it took almost a year for the GDP to fall that much (though in the end after three years it had fallen 30 percent!)
The result could have been obviously predicted by any first-year business major. Businesses were caught with skyrocketing inventories. They cut back spending for new inventory $242 billion by June of 2020. This meant they had to scramble to rebuild those inventories once consumer spending started to pick up. That coupled with supply chain disruptions (semi-conductors, etc.) fueled the initial increase in inflation.
So now the question remains --- is the continuation of inflation just the result of the temporary supply-chain disruptions or is there something to either the critique of deficit spending or the belief that in markets dominated by a few giants, businesses are taking advantage of the inflation in input prices (including wage increases) and raising prices much more than are warranted by their increase in costs.
First of all, the deficit spending argument is nonsense. Yes, the federal government spent a lot of money counteracting the COVID-19 recession of 2020 and did so without raising taxes. (And these bills were passed virtually unanimously in Congress and signed by Republican President Trump!). As a result, the federal deficit ballooned to almost 15 percent of GDP (after being in the neighborhood of 2 – 3 percent of GDP the previous years). But as the economy started to recover, the federal deficit as a percentage of GDP fell throughout 2021.
[For a diagram of that data from the FRED database see https://fred.stlouisfed.org/series/FYFSGDA188S]
According to the latest data from the Federal Government, the deficit fell to 12.8 percent of GDP in fiscal 2021 and is projected to fall below eight percent of GDP in the current fiscal year (which began in October). For that information see https://www.usgovernmentspending.com/federal_deficit_percent_gdp
In other words, while inflation is rising, the impact of the federal government’s deficit is falling. Politicians and journalists and economists-of-hire can scream bloody murder about federal government profligacy but the deficit in 2021 and 2022 cannot be blamed for the rising inflation in those years.
[By the way, I have said this over and over again but it bears repeating. The total number of the deficit ($XXX trillion) is meaningless. To measure its impact, one has to measure it as a percentage of GDP. It’s the same principle used in measuring the success of a business. Total profits in dollars tell you nothing. You need to know your rate on the capital invested or (sometimes) on the total value of sales.]
This brings me to the conclusion that I reach: Public opinion is correct --- corporations have been able to take advantage of the current inflation to (for many of them) inflate their profit margins – participating in what the great economist (and my collaborator on a textbook) Howard Sherman calls “profit-push” inflation.
In a fascinating and detailed article in Fortune, Megan Leonhardt asked the question: “Is inflation really this bad, or are greedy companies profiting off the pandemic?” [The article appeared on February 19, 2022 and is available at https://fortune.com/2022/02/19/inflation-profits-prices-companies-pandemic/
The evidence presented makes it clear that in industry after industry, the prices charged by many of our largest companies have risen much more than their costs and the general rate of inflation.
I’ll show a handful of examples but the entire article is worth reading:
“…a sampling of national average prices for 18 key products from Fortune 500–ranked consumer goods and food manufacturers January 2021 to 2022 found that 11 products saw inflation-beating price increases.” These include Kellogg cereals, Kimberly-Clark Kleenex and Diapers, and Duncan Hines Yellow Cake Mix.
For a second example, consider the fact that the consumer price index for meats, poultry and fish rose 12% over the past year, JBS steak rose 34%, Tyson chicken bites rose 27% and Tyson chicken breasts rose 18%.
How does “profit push” inflation work? Most American industries are dominated by a few giants. For example, the four major meat companies in the U.S.—Cargill, Tyson Foods, JBS, and National Beef Packing—control 55% to 85% of the hog, cattle, and chicken markets. Think of the big names in Gasoline at the pump (and the smaller named companies buy all their gas from one of the giants). Think of the handful of giant distillers who sell beer or the giants of the tobacco industry. Or think of the handful of automobile companies.
These industries are organized as OLIGOPOLIES – a few giants compete. They compete with advertising, with slight differences in the products, but one thing they don’t compete with is price. Instead, they practice a policy known as “price leadership” where a few giants set prices and most of their competitors follow through. It is because of that (unofficial) collusion in price setting (official collusion is still illegal under anti-trust laws!) that periods of inflation usually involve giants hiking their prices to stay ahead of inflation.
The evidence presented in the Fortune article is convincing to me. The public is right, even as too many economists accuse ordinary citizens of being too quick to blame “greedy corporations” for price hikes. Giant firms in industries with few competitors are ratcheting up their prices because the general level of inflation gives them cover.
Further proof is in profit statistics. According to a CNBC report, “….operating margins have remained close to a record 13% through most of 2021 because corporations, while faced with higher costs, were able to raise prices.” [Bob Pisani, “Profits for S&P 500 companies rose 22% in the fourth quarter and nearly 50% in 2021, estimates show,” CNBC, January 13, 2022, available at: https://www.cnbc.com/2022/01/13/profits-for-sp-500-companies-rose-22percent-in-the-fourth-quarter-and-nearly-50percent-in-2021-estimates-show.html]
There has been a proposal in Congress for an excess profits tax. The revenue raised should be returned to individuals as a rebate on their payroll taxes. Note I wrote payroll taxes. A significant number of people with low incomes pay no income taxes but every wage earner pays payroll taxes. Rebating a percentage of payroll taxes from the revenue raised by an excess profits tax would permit the social security and Medicare trust funds to continue receiving the revenues they need but would cut the net tax burden on low and moderate wage workers by returning some of their tax payments.
[And by the way, excess profits taxes are not some wacky out of this world idea. The US imposed excess profits taxes during both World War II and the Korean War … as I have argued many times, the fight against the Coronavirus is equally as important as those wars were.]
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies
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