The cost of everything is skyrocketing: from everyday items like gas and groceries to private goods like cars and houses. Gas prices are at an all-time high, and the cost of food and essential items is rising at a rate that is hard to keep up with. It’s a change that’s compelling everyone, especially low income households, to re-evaluate their budget and become extra cautious of their spendings. We are experiencing a rise in prices faster than at any other point in four decades. Lawmakers, economists and politicians around the world are scrambling for explanations; so what is happening? These inflation spikes have presented major policy challenges. Everyone has their preferred story about what went wrong and what policies would bring our economy back in line.
On one side, we have Economics 101 – Supply and demand. The initial waves of consumer price increases arrived as the COVID-19 pandemic disrupted global supply chains and the unprecedented influx of stimulus bills prompted too much demand for too little supply, throwing the supply-demand equilibrium into chaos. Russia’s invasion of Ukraine led to another wave of disruptions, particularly in energy and food. On the other side, the White House and progressive organizations assert that increasingly dominant corporations are using the pandemic as an excuse to profiteer, that is, big companies have seized on inflation as an opportunity to increase prices more than they otherwise could. Proponents of the theory call this: ‘greedflation’. What’s happening is not that simple. A pandemic, a trade war, a land war, huge government spending, and a global economy that has become more integrated might be too complex to explain.
To understand this, it’s helpful to break it down into three questions: Are large corporations really charging more than necessary? If so, is that primary to a four-decade high inflation rate? And is this happening because large companies now have more market power than they did decades ago?
The price of most things in the U.S. economy can be broken down into the three main components of cost - labour costs, nonlabor inputs, and the “mark-up” of profits over the first two components. Since the trough of the COVID-19 recession in the second quarter of 2020, overall prices in the non-financial corporate sector have risen at an annual rate of 6.1%. Strikingly, over half of this increase (53.9%) can be attributed to larger profit margins, with labour costs contributing less than 8% of this increase. This is not normal. From 1979 to 2019, profits only contributed about 11% to price growth and costs over 60%, as shown in the Figure below.
Thus, there is no doubt that across the economy, profit margins surged during the pandemic and remained elevated. This disproportionate share of corporate profit in price growth in the current recovery has led to the claims that the increasing concentration of market power with large corporations is driving inflation. However, it’s not proof that profits are driving inflation.
Firstly, the increase in market power has not happened recently enough to make it the root cause of inflation. Secondly, we also see that this jump in profit’s share of the economy is only about the same size as the jump after the Great Recession when inflation was low. So, it doesn’t seem likely that an increase in monopoly power since early 2020 is likely to be a big part of the inflationary surge. Also, for this theory to fit, we’d have to see continuing increases in monopoly power in 2021 and 2022. Economists who study monopoly power do not see much of an increase since Covid. More recent developments have also weakened the greedflation hypothesis. Inflation has remained high: 8.6% over the past year, according to a federal report. However, the stock market has plummeted; the S&P 500 was more than 20% below its January peak. And earning calls have disappointed investors so far this year. If the pursuit of profits were driving more inflation, one would not expect to see that. Such theories based on a lack of evidence become very expensive as they are encouraging democrats to pursue policies that could be actively harmful. These include a proposed tax on windfall oil profits which would likely reduce oil production exactly when we want the output to increase. It pushes democrats’ governance toward questionable policies. Lashing out at corporations by any means available will not bring down inflation because even if greedflation explains some of our problems, it does not offer a way out. Market concentration is a persistent problem, yet we have had close to no inflation for two decades. So, it’s not possible that market concentration suddenly explains inflation. Moreover, most research on how market concentration affects companies’ “pass-through” of suddenly higher costs has found that fiercely competitive industries raise prices more than those that only a few companies dominate because they have thin margins and would otherwise lose money. The never-seen-before rise in inflation is neither just because of ‘greedflation’ nor just because of an overheating labour market. Greedflation could be driving higher prices in some places because companies are always greedy, meaning they always hope to maximize profits. However, their ability to raise prices and make money is determined by demand and supply, which have been chaotic and unpredictable lately. The relationship between profits, inflation and market power will be tough for economists to nail down because the discipline has never had to incorporate so many factors simultaneously, with little historical precedence. The bottom line is that the supply chain bottlenecks, overheating labour market, increasing aggregate demand coupled with lack of productive capacity and price gouging are all playing a role in the unprecedented challenges we are facing today.