There are few good things about living through a period with the highest inflation in four decades, but here’s one: It’s a chance to reexamine what happens in an economy that’s gone haywire.
Since prices started to escalate a year ago, politicians and economists have seized on inflation to tell their preferred story about what went wrong and what policies would bring it back into line. Some say it’s very straightforward: Supply and demand, Economics 101.
“There’s simply a lot of cash out there,” said Joe Brusuelas, chief economist for the accounting firm RSM US, referring to the several trillion dollars in pandemic stimulus that has filtered into the economy since early 2020. “The competition for those goods is up, and that’s sending prices up, whether we’re talking about getting a Nissan Sentra or a seat on an American Airlines flight.”
The White House and progressive organizations, however, say wait a minute: This time is different. In a time of extraordinary disruption, they contend, increasingly dominant corporations are taking the opportunity to jack up prices more than they otherwise could, which is squeezing consumers and supercharging inflation. Or “greedflation,” as the hypothesis has come to be known.
The argument comports with the Biden administration’s focus on the ills of economic concentration. Congressional Democrats have run with the idea, introducing bills that would impose a temporary “excess profits tax” on companies that charge prices they deem unreasonably high, or simply ban those high prices altogether. Critics, including the nation’s largest business lobby, deride these efforts as based on a “conspiracy theory” and a “flimsy argument.”
So what’s really going on?
It’s hard to tease out. A pandemic, a trade war, a land war, huge government spending and a global economy that has become vastly more integrated might be too complex for traditional macroeconomic theory to explain. Josh Bivens, research director at the left-leaning Economic Policy Institute, thinks that’s a good reason to revisit what the discipline thought it had figured out.
“When I hear stories about an overheating labor market, I don’t think about falling real wages, and yet we have falling real wages,” Bivens said. Nor is the rise in profits typical when unemployment is so low. “The idea that ‘There’s nothing to see here’ — there’s everything to see here! It’s totally different.”
When thinking about greedflation, it’s helpful to break it down into three questions: Are companies charging more than necessary to cover their rising costs? If so, is that enough to meaningfully accelerate inflation? And is all this happening because large companies have market power they didn’t decades ago?
Productive Profits, or Gouging?
There is not much disagreement that many companies have marked up goods in excess of their own rising costs. This is especially evident in industries such as shipping, which had record profits as soaring demand for goods filled up boats, driving up costs for all traded goods. Across the economy, profit margins surged during the pandemic and remained elevated.
When all prices are rising, consumers lose track of how much is reasonable to pay.
“In the inflationary environment, everybody knows that prices are increasing,” said Z. John Zhang, a professor of marketing at the Wharton School at the University of Pennsylvania who has studied pricing strategy. “Obviously, that’s a great opportunity for every firm to realign their prices as much as they can. You’re not going to have an opportunity again like this for a long time.”
The real disagreement is over whether higher profits are natural and good.
Basic economic theory teaches that charging what the market can bear will prompt companies to produce more, constraining prices and ensuring that more people have access to the good that’s in short supply. Say you make empanadas, and enough people want to buy them that you can charge $5 each even though they cost only $3 to produce. That might allow you to invest in another oven so you can make more empanadas — perhaps so many that you can lower the price to $4 and sell enough that your net income still goes up.
Here’s the problem: What if there’s a waiting list for new ovens because of a strike at the oven factory, and you’re already running three shifts? You can’t make more empanadas, but their popularity has risen to the point where you would charge $6. People might buy calzones instead, but eventually the oven shortage makes all kinds of baked goods hard to find. In that situation, you make a tidy margin without doing much work, and your consumers lose out.
This has happened in the real world. Consider the supply of fertilizer, which shrank when Russia’s invasion of Ukraine prompted sanctions on the chemicals needed to make it. Fertilizer companies reported their best profits in years, even as they struggle to expand supply. The same is true of oil. Drillers haven’t wanted to expand production because the last time they did so, they wound up in a glut. Ramping up production is expensive, and investors are demanding profitability, so supply has lagged while drivers pay dearly.
Even if high prices aren’t able to increase supply and the shortage remains, an Economics 101 class might still teach that price is the best way to allocate scarce resources — or at least, that it’s better than the government price controls or rationing. As a consequence, less-wealthy people may simply have no access to empanadas. Michael Faulkender, a finance professor at the University of Maryland, says that’s just how capitalism works.
“With a price adjustment, people who have substitutes or maybe can do with less of it will choose to consume less of it, and you have the allocation of goods for which there is a shortage go to the highest-value usage,” Faulkender said. “Every good in our society is based on pricing. People who make more money are able to consume more.”
Sorting Chickens and Eggs
The question of whether profit margins are speeding inflation is harder to figure out.
Economists have run some numbers on how much other variables might have contributed to inflation. The Federal Reserve Bank of San Francisco found that fiscal stimulus programs accounted for 3 percentage points, for example, while the St. Louis Fed estimated that manufacturing sector inflation would have been 20 percentage points lower without supply chain bottlenecks. Bivens, of the Economic Policy Institute, performed a simple calculation of the share of price increases attributable to labor costs, other inputs and profits over time, and found that profit’s contribution had risen significantly since the beginning of 2020 as compared with the previous four decades.
That’s an interesting fact, but it’s not proof that profits are driving inflation. It’s possible that causality runs the other way — inflation drives higher profits, as companies hide price increases amid broader rises in costs.
Concentration’s Double Edge
If you think that’s complicated, try establishing whether market power is playing a role in any of this.
It is well established that the American economy has grown more concentrated. On a fundamental level, domination by a few companies may have made supply chains more brittle. If there are two empanada factories and one of them has a COVID-19 outbreak, that in itself creates a more serious shortage than it would if there were 10 factories.
“Concentration has affected prices during the pandemic, even setting aside any potentially nefarious actions on the part of leaders,” said Heather Boushey, a member of President Joe Biden’s Council of Economic Advisers.
But most of the public argument has been about whether companies with more market share have been affecting prices once goods are finished and delivered. And that’s where many economists become skeptical, noting that if these increasingly powerful corporations had so much leverage, they would have used it before the pandemic.
“Market concentration is a long-standing problem, yet we’ve had close to no inflation for two decades,” said David Autor, an economics professor at the Massachusetts Institute of Technology. “So it cannot be that market concentration suddenly explains inflation.”
In addition, 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 are dominated by only a few companies, because they have thin margins and would lose money if they didn’t. That’s one consequence of oligopolists’ pricing power: They can give up some profits when they choose to.
The Search for Answers
The relationship of profits, inflation and market power will be tough for economists to nail down. High-quality government data will take time to produce. Moreover, it requires a melding of micro- and macroeconomic disciplines that haven’t had to synthesize so many factors simultaneously, with little historical precedent.
Lindsay Owens, an economic sociologist who runs the progressive Groundwork Collaborative and has championed the greedflation argument, emphasizes how different the economy looked during America’s last bout with inflation: Labor was far more powerful, and investors less so.
“It’s not surprising to me that a field that’s spent 50 years studying the ’70s didn’t think a lot about pricing and market power, because that wasn’t as prevalent during their last moment to study it,” Owens said.
Moreover, the field of industrial organization hasn’t agreed on a reliable gauge for industries’ competitiveness. Even measuring profit margins, especially for particular goods, isn’t foolproof.
Bharat Ramamurti, deputy director of the National Economic Council, said the White House’s argument that market concentration may fuel inflation only added urgency to its antitrust agenda, from the Federal Trade Commission to the Department of Agriculture. Given that fighting inflation is mostly up to the Federal Reserve, increasing competition could be one of the few useful tools at the White House’s disposal, even if only over the longer term.
“There are folks out there, even though this is a time of great uncertainty, who are taking the hard-line opposite position, which is that it is ridiculous to say that concentration plays any role in inflation,” Ramamurti said. “And I think that is hard to defend.”
(This article originally appeared in The New York Times)