The ongoing bout of inflation and the resultant cost of living crisis has been an unkind one. Some of the economic powerhouses in the world are undergoing or about to enter a recession, people are losing jobs, wealth disparities are getting bigger and to make matters worse, households are struggling to even provide themselves with meals twice a day.
The situation is so extraordinary this time around that going for a ‘dream home’ is sounding like a fantasy for common people. For experts and analysts, the situation has become a perfect case study of what happens in an out-of-control economy.
Joe Brusuelas, the chief economist for the accounting company RSM US, referred to the several trillion dollars in pandemic stimulus that had trickled into the economy since early 2020 by saying, “There’s just a lot of cash out there.”
“Whether we’re talking about purchasing a Nissan Sentra or a seat on an American Airlines aircraft, prices are increasing as a result of increased competition for those items,” the expert commented further.
However, the White House and progressive groups argue this logic. They claim that during this period of extreme economic upheaval, increasingly powerful firms are taking advantage of the chance to raise prices even higher than they would otherwise be able to, putting pressure on consumers and escalating inflation. Or, as the theory is now known, “greedflation.”
The claim is consistent with the Biden administration’s emphasis on the adverse effects of economic concentration. The proposal has gained traction among congressional Democrats, who have introduced legislation that would either outright outlaw high pricing or temporarily apply an “excess profits tax” on businesses that they judge to be charging excessive rates. These initiatives are criticized as being founded on a “conspiracy theory” and a “flimsy logic,” according to the nation’s top business group.
What exactly is happening?
It’s challenging to elicit. Traditional macroeconomic theory may find it difficult to explain a pandemic, a trade war, a land war, massive government spending, and an extensively linked global economy. In the opinion of Josh Bivens, that is a definite cause to reexamine what the field believed it had found the head of research at the Economic Policy Institute.
“I don’t think about dropping real wages when I hear stories about an overheated labour market, yet we have falling real wages,” Josh Bivens remarked.
Moreover, growth in profits at a time of such low unemployment is not expected.
It’s helpful to divide the concept of reflation into three questions. Are businesses overcharging customers to compensate for their rising expenses? If so, would a meaningful inflation increase result from that? And is this all taking place because big businesses today have more market clout than they had decades ago?
Productive gains or price gouging?
There is little debate that many businesses have marked up products more than their rising costs. This is particularly clear in sectors like shipping, which saw record profits as increasing demand for products filled ships, raising the cost of all traded items. As a result, profit margins increased throughout the COVID and the period after. Consumers also lose track of how much it is appropriate to pay when all prices are rising.
Everyone is aware that prices are rising in an inflationary climate, according to Z. John Zhang, a professor of marketing at the University of Pennsylvania’s Wharton School. That’s a fantastic chance for any company to realign their rates as much as possible. Unfortunately, for a very long time, this opportunity won’t present itself again. The real difference of opinion is whether or not more profits are excellent and natural.
According to fundamental economic theory, setting prices as high as the market will encourage businesses to produce more, lowering costs and ensuring more people can access the scarce item. For example, if you create empanadas, there is enough demand for them to sell them for $5 each, even though it only costs you $3. Therefore, you could buy a second oven and produce more empanadas, perhaps enough to raise the price to $4 while still selling enough to increase your net income.
The issue is that you are already working three shifts. What if a waiting list for new ovens is due to a strike at the oven factory? Even though you are out of empanadas, you would charge $6 because of how well-liked they are now. People might opt to purchase calzones instead, but eventually, the need for ovens makes it challenging to find all types of baked foods. In that case, you profit handsomely while your customers suffer.
Real-life incidents like this have occurred. Take the fertilizer supply, which decreased due to the restrictions on the chemicals required to produce it after the Ukraine war. Even as they strive to increase reserves, fertilizer businesses recorded their most substantial earnings in years. Oil is the same way. Drillers have been reluctant to increase production since the last time they did so, a glut resulted. Since increasing production is expensive and investors seek profitability, the supply has lagged, and drivers suffer.
Even if high prices cannot boost supply and the shortage persists, an ‘Economics 101’ course may suggest that pricing is the most effective way to distribute limited resources, or at the very least, that it is preferable to price restrictions or rationing. As a result, those who are less privileged could not have access to empanadas at all. According to University of Maryland finance professor Michael Faulkender, capitalism operates naturally in this manner.
The allocation of items for which there is a shortage goes to the highest-value consumption, according to Michael Faulkender.
Pricing determines the value of every good in our society. People who earn more money can buy more things.
Sorting eggs and chickens
It is more difficult to determine whether profit margins are accelerating inflation.
Researchers have calculated the potential contribution of various factors to inflation. For example, the St. Louis Fed projected that manufacturing sector inflation would have been 20% lower without supply chain bottlenecks. At the same time, the Federal Reserve Bank of San Francisco determined that fiscal stimulus initiatives contributed three percentage points.
In a straightforward calculation of the share of price increases over time attributable to labour costs, other inputs, and profits, Bivens of the Economic Policy Institute discovered that the contribution of profits had increased significantly since the start of 2020 compared to the preceding four decades.
Although that is a fascinating fact, it does not prove that profits are what is causing inflation. Instead, inflation may produce more enormous profits because businesses conceal pricing increases.
Dangers of wealth concentration
There is no doubt that the American economy has become more centralized. Fundamentally, supply chains may have become more fragile due to a few corporations’ dominance. There will be a greater scarcity if there are just two empanada factories and one has a COVID-19 pandemic than if there are ten factories.
Even putting away any possibly evil deeds on the part of leaders, concentration has affected prices throughout the pandemic, according to Heather Boushey, a member of President Joe Biden’s Council of Economic Advisers.
However, the main topic of debate has been whether or not businesses with a larger market share impact prices once items are produced and delivered. Many economists express scepticism at this point because they believe they would have used it if these firms had had significant leverage before the pandemic.
Market concentration is a long-standing issue, yet there has been little inflation in the past 20 years, according to Massachusetts Institute of Technology professor of economics David Autor.
Additionally, the majority of studies on how market concentration affects companies’ “pass-through” of unexpectedly higher costs have discovered that fiercely competitive industries raise prices more than those that are dominated by a small number of firms because they have slim profit margins and would incur a loss if they didn’t.
Seeking solutions
It will take time for economists to pinpoint the exact relationship between earnings, inflation, and market dominance. It will take some time to produce high-quality government data.
Additionally, it necessitates blending microeconomic and macroeconomic disciplines, which have yet to consider so many variables simultaneously.
Lindsay Owens, an economic sociologist and founder of the progressive Groundwork Collaborative, highlights how the economy differed during America’s first fight with inflation. Labour was far more robust, and investors were less so. As a result, Lindsay Owens has championed the “greedflation” theory.
He noted, “A field that has spent 50 years studying the ’70s didn’t think a lot about pricing and market power is not unexpected to me, because that was less prevalent during their last chance to learn it.”
In addition, there is no widely accepted indicator of an industry’s competitiveness in an industrial organization. Even calculating profit margins is only sometimes accurate, especially for certain commodities.
The White House’s claim that market concentration may cause inflation has only increased the urgency of its antitrust agenda, according to Bharat Ramamurti, deputy director of the National Economic Council, which includes the Federal Trade Commission and the Department of Agriculture. Increasing competition may be one of the only effective measures available to the White House, even if only in the long run, given that the Federal Reserve is responsible mainly for combating inflation.
Even though there is a lot of uncertainty right now, Bharat Ramamurti noted that some people are embracing the hard-line opposing stance, which holds that it is absurd to claim that concentration has anything to do with inflation. And it isn’t easy to defend that.
In conclusion, while the causes of inflation are complex and multifaceted, the concept of “greedflation” and the role of corporate greed in driving inflation have recently gained attention. While some argue that rising profits are a natural response to market demand and supply chain disruptions, others believe that the concentration of market power among a few large corporations has led to higher prices and reduced competition.
While economists continue to study the relationship between earnings, inflation, and market dominance, increasing competition through antitrust measures may be one effective solution to combat inflation in the long run. Regardless of the approach taken, it is essential to scrutinize and address the root causes of inflation to ensure a fair and equitable economy for all.