“Australia
isn’t experiencing a wage-price spiral, it’s at the beginning of
a price-profit spiral,” said Australia Institute chief economist,
Dr Richard Denniss.
“The
national accounts show it is rising profits, not rising costs, that
are driving Australia’s inflation. While workers are being asked to
make sacrifices in the name of controlling inflation, the data makes
clear that it is the corporate sector that needs to tighten its
belt.”
The
report points out that wage growth was at record low levels, while
the profit share was at a near-record share of GDP.”
[The Guardian,
18 July 2022]
The
Australia Institute,
Are
wages or profits driving Australia’s inflation? An analysis of the
National Accounts,
July
2022, excerpts:
Introduction
In
recent months the role of wages in driving inflation has been
frequently discussed, with many commentators expressing concern that
Australia risks a ‘wage price spiral’.
For
example:
“Aggressive
wages growth will only spur further inflation growth.”
— Andrew
Mackellar, CEO of the Australian Chamber of Commerce and Industry
“We
are now at risk of a wages and inflation and interest rates death
spiral.”
— Innes
Willox, CEO of Australian Industry Group
“In
the current circumstances, there is a clear risk that a high increase
in wages without improved workplace productivity would fuel inflation
and increase the likelihood of a steeper rise in interest rates to
the detriment of growth and job creation.”
— Innes
Willox, CEO of Australian Industry Group
The
fear that wage growth has, or could, play a significant role in
Australia’s inflation typically ignores the fact that, as shown in
Figure 1, real wage growth is at historically low levels and has been
for some time.
While
wage growth clearly has not been the driving force of recent
increases in Australian inflation, or indeed inflation around the
world, the continuing impact of COVID 19 and the sharp increase in
global energy prices associated with Russia’s invasion of the
Ukraine clearly
have.
What
causes inflation?
Inflation
refers to an overall increase in the level of prices in an economy.
According to the International Monetary Fund:
Inflation
is the rate of increase in prices over a given period of time.
Inflation is typically a broad measure, such as the overall increase
in prices or the increase in the cost of living in a country.
While
much is made of the link between increases in the costs of inputs
(such as the price of oil) and increases in prices (such as the price
of petrol) in fact many firms have a high degree of discretion about
how much, if any, of an increase in costs they will pass on in the
form of higher prices.
In
short, if firms choose to absorb all of an increase in cost rather
than increase prices the cost increases will lead to a reduction in
profit not an increase in prices. Similarly, if firms pass on price
increases that are more than enough to cover an increase in their
production costs then profits will rise. In turn, macroeconomic data
on economy-wide changes in prices and the share of GDP flowing to
workers and profits can shed light on both the underlying sources of
inflation and the distributional consequences of firms’ responses
to rising production costs.
While
spokespeople for large companies often suggest they have ‘no
choice’ but to increase their prices when their costs increase not
only do they have the choice to accept lower profits, a closer
examination of their language makes clear that they face a range of
choices.
For
example, in attempting to explain how he had ‘no choice’ but to
increase prices in his stores in early 2002, Gerry Harvey, the
Executive Chairman of the retail chain Harvey Norman, actually made
clear the range of choices he did face:
If
a guy down the road drops the price, we drop the price,
If
we drop the price, they drop the price.
But
if it’s costing you all 10 per cent more than it was yesterday,
they’re all going to put up their prices (because) they’ve got no
choice.
Mr
Harvey makes clear that his company is willing and able to choose to
lower prices to match his competitors pricing, even in the absence of
a change in cost. He also makes clear that he expects other firms not
to absorb any increase in costs and that his firm and his competitors
are all likely to increase their prices if costs increase by 10
percent, but it is not clear by how much his firm, or others, would
chooses to increase their prices by.
Intriguingly,
he ends this explanation by saying firms have no choice, even though
all firms have different costs structures and his opening statement
is that he would lower his price to match a cheaper offer by a
competitor.
As
all firms have slightly different cost structures, contract terms for
inputs, bottoming costs and exposures to market rents it is
inconceivable that all firms in any industry would experience
identical changes in price and, in turn, the choices firms make about
their price setting in response to changes in cost reflect both their
current rates of profit and their willingness to gain or lose market
share…..
In
short, while in the long run firms must set prices sufficient to
cover their costs of production, there is no direct link between
costs of production and prices beyond the desire of firms to
maintain, or increase, their profits. While firms in new industries
seeking rapid growth often deliberately set their prices below their
costs in, companies like Santos are currently enjoying a significant
increase in price that is entirely unrelated to their cost of
production.
Given
that profits currently account for a record share of GDP there is
simply no truth behind the assertion that the Australian corporate
sector has ‘no choice’ but to pass on cost increases in full in
the form of higher prices. Indeed, the rising profit share of GDP
suggests that Australian firms have, for some time, been choosing to
increase their prices faster than their costs have been rising. By
definition this causes higher inflation…..
The
European Central Bank’s analysis of the role of profits in driving
inflation
In
a recent speech, Isabel Schnabel, a member of the board of the
European Central Bank, said
“profits have recently been a key contributor to total domestic
inflation” ……
Ms
Schnabel went on to state that:
many
firms have been able to expand their unit profits in an environment
of global excess demand despite rising energy prices… The
resilience of profits is particularly evident in those sectors most
heavily exposed to global conditions, such as the industry and
agricultural sector.
And:
To
put it more provocatively, many euro area firms, though by no means
all, have gained from the recent surge in inflation. The fortunes of
businesses and households have diverged outside of the euro area,
too, with corporate profits in many advanced economies surging over
the past few quarters.
Poorer
households are often hit particularly hard – not only do they
suffer from historically high inflation reducing their real incomes,
they also do not benefit from higher profits through stock holdings
or other types of participation.…..
Australian
results
The
methodology used by the ECB to decompose recent shifts in price
levels and attribute them to shifts in wages, profits and taxes can
be applied to Australian data to show the contribution of each to
inflation.
The
Australia Institute applied the ECB method to annual data for the
financial years 2005 to 2021 and quarterly data for June 2021 to
March 2022 (the most recent quarter for which data is available).
Annual data was used where possible to minimise the volatility in the
underlying data caused by COVID-19 support payments affecting tax and
subsidies.
The
Australian data provides even more stark results than the ECB’s.
Figure 5 shows that unit labour costs played almost no role in
inflation (as measured by the GDP deflator) over the period 2013 to
2021 and had typically contributed less than half of the GDP deflator
prior to 2013.
For
the three quarters of data available for 2021–22, encompassing the
current uptick in the CPI, labour costs have played an insignificant
role, accounting for only 0.6 percentage points of the 4.1 percentage
point increase in the GDP deflator (15 percent of the total).
Meanwhile
profits have accounted for 2.5 percentage points of the increase in
the GDP deflator (about 60 percent of the total).…..
Read
the full 15 page report here.
Billionaire
business owners and industry lobbyists have other ways of saying our profits are more important than people without ever mentioning the word. Here is a recent example.
ABC
News,
17
July 2022:
Head
of the Victorian Chamber of Commerce and Industry, Paul Guerra,
welcomed the announcement but said the government must ensure it
keeps the balance between supporting people in need and running the
economy into debt.
"The
federal government has told us the pandemic is not over," Mr
Guerra said.
"The
current wave seems to be stronger than we might have all first
thought so we think it's a good thing that support is being provided
there for those who are in need.
"That
said, we'd like to make sure they come off as soon as the current
risk is over so we can accelerate our way as we recover out of
COVID."
BACKGROUND
Across
the board record profit taking is not just an Australian phenomenon….
Political economist Assistant Professor Isabella M. Weber speaking on U.S. NPR radio program "All Things Considered", 13 February 2022:
Companies
always want to maximize profits, right? In the current context, they
suddenly cannot deliver as much anymore as they used to. And this
creates an opening where they can say, well, we are facing increasing
costs. We are facing all these issues. So we can explain to our
customers that we are raising our prices. No one knows how much
exactly these prices should be increased. And everybody has some sort
of an understanding that, oh, yeah, there are issues, so, yes, of
course companies are increasing prices in ways in which they could
not justify in normal times.
But
this does not mean that the actual amount of price increase is
justified by the increase in costs. And as a matter of fact, what we
have seen is that profits are skyrocketing, which means that
companies have increased prices by more than cost. In the earnings
reports, companies have bragged about how they have managed to be
ahead of the inflation curve, how they have managed to jack up prices
more than their costs and as a result have delivered these record
profits. [my yellow highlighting]