Is ‘Greedflation’ Rewriting Economics, or Do Old
Rules Still Apply?
Economists and politicians are debating whether
monopolistic companies are fueling inflation in ways that confound longstanding
theory.
By Lydia
DePillis
June 3,
2022
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 re-examine 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’s 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’s 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,” Dr. 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 like 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.”
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,” Dr. 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. Dr. 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. The St. Louis
Fed’s Ana Maria Santacreu, who did the manufacturing inflation analysis, said
that it would be very hard to pin down.
“It would
be interesting to get data on profit margins by industry and correlate those
with inflation by industry,” she said. “But I still think it is difficult to
capture any causal relationship.”
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 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.
What is
inflation? Inflation is a loss of purchasing power over time, meaning your
dollar will not go as far tomorrow as it did today. It is typically expressed
as the annual change in prices for everyday goods and services such as food,
furniture, apparel, transportation and toys.
What causes
inflation? It can be the result of rising consumer demand. But inflation can
also rise and fall based on developments that have little to do with economic
conditions, such as limited oil production and supply chain problems.
Is
inflation bad? It depends on the circumstances. Fast price increases spell
trouble, but moderate price gains can lead to higher wages and job growth.
How does
inflation affect the poor? Inflation can be especially hard to shoulder for
poor households because they spend a bigger chunk of their budgets on
necessities like food, housing and gas.
Can
inflation affect the stock market? Rapid inflation typically spells trouble for
stocks. Financial assets in general have historically fared badly during
inflation booms, while tangible assets like houses have held their value
better.
“Market
concentration is a longstanding 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.
But again,
these are strange times, and it’s fair to ask whether that dynamic might have
changed. Nobody is arguing that companies got more concentrated during the
pandemic — only that the existing lack of competition may have interacted with
inflation in a way that channeled corporate power differently.
For
example, one reason rising concentration didn’t translate into higher prices in
the decades before the pandemic appears to have been that corporations widened
their margins by squeezing suppliers and resisting wage increases. Federal
income supports during the pandemic gave workers more bargaining power, while costs
for items from cardboard to diesel rose. That would have shrunk markups —
unless companies channeled their leverage over consumers by raising prices
instead.
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,” Dr. 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.
In late
May, economists at the Federal Reserve Bank of Boston released a preliminary
paper finding that even before the pandemic, more concentrated industries were
able to pass along a higher share of their own cost increases. But critics
pointed out that it counted only public companies and omitted the retail
sector, which would probably play an important role.
As more
evidence accumulates, we might find that the pandemic affected various
industries in different ways, even across disparate geographies. Jan De
Loecker, a professor at KU Leuven in Belgium who was a co-author of a seminal
paper on the pernicious effects of rising market concentration, doubts that
concentration worsens price increases across the board.
“Just think
about U.S. health care and the oil market — the stories there are so radically
different,” Dr. De Loecker said. “But inflation is a basket of goods that
consumers draw from. So the idea that there’s one story that explains rising
prices in both is not a good way to think about it.”
For now,
the stakes are more about the public understanding of inflation, rather than
government intervening to keep empanada prices low. The price-gouging bills in
Congress don’t have the votes to pass, and the White House hasn’t endorsed
them.
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,” Mr. Ramamurti said. “And I
think that is hard to defend.”
Lydia
DePillis covers the changing American economy and what it means for real people.
@lydiadepillis
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