Maybe It Was Corporate Greed?
One of the principles I said would guide this newsletter is that I would admit when I was wrong. It’s that time again.
A while back, when discussing inflation I wrote:
Not all of the increase in prices can be chalked up to greedy monopolies, however. The dynamics of supply and demand would lead us to expect some price increases. The pandemic put a hard speed limit on service based markets. Unable to go do stuff, Americans chose to buy more stuff. The shift from spending on services to spending on stuff changes the supply and demand intersection. Given the pandemic, with all its work stoppages and supply chain disruptions, it was difficult for companies to produce more stuff. So, when people who were spending some of their money on services shifted that spending to buying stuff, the amount of demand for stuff increased while the supply couldn’t. More people wanting the same amount of stuff naturally leads to higher prices.
And, despite inflation, this is what is happening. People are buying more stuff. The rate of increase in stuff bought is higher than the rate of inflation, which means that despite higher prices, people are still buying more than they used to. If the supply of stuff can’t keep up, then this has to lead to some price increases.
For several months after this I kept saying, especially my more progressive friends, that this was the most likely explanation. People, unable to go do things, were buying more stuff at the same time businesses didn’t have as much stuff to sell due to supply chain problems. Once supply chains were smoothed out again inflation would probably go away. I was on team transitory inflation, and I predicted that “inflation problems will go away by spring”. Around April/May I thought this had happened. I figured we had seen the inflation peak, and were headed back down to more normal pricing dynamics. But, inflation stayed really high for several more months until it finally didn’t change between June and July.
I was super confused by this because the inflation problems had largely gone away by spring, but inflation hadn’t. Business inventories were going back up fast, because supply chains were smoothing out.
Retail inventories were doing even better.
People had started to spend less, meaning lower demand at the same time inventories were increasing.
This was even more important because the money people were spending had started to shift—fairly quickly—away from stuff, where the supply chain issues had been most important,
toward services, where supply chains didn’t matter quite as much.
Plus, this evened out demand, meaning the excess demand that required price increases wasn’t there.
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On top of this port congestion had largely been alleviated, and shipping rates were way down, and still falling fast.
Wages, which had been rising fast, were no longer keeping up with inflation—nowhere near in fact.
Wages were really the biggest reason we saw inflation in the 70s and 80s. People expected inflation to keep going for a long time, so they would demand big raises (there was once a time when workers had enough competitive power to do this). Companies expected inflation to keep going for a long time, so they would grant big raises, then raise prices to cover the cost. This would lead to workers demanding another raise. It’s called a wage-price spiral, but we haven’t seen that at all during this current inflationary period. Inflation expectations have actually been much lower than inflation, and trending down.
Some people blamed the high gas prices in the spring, but this didn’t make any sense either. What I find to be one of the most helpful ways to think about gas prices is by measuring how many minutes the average worker has to work to buy a gallon of gas. Since the “inflation adjusted price” of anything isn’t really a clear concept for a lot of folks, the number of minutes of work needed to pay for a gallon of gas is often more useful.
Because of wage growth the number of minutes needed to buy a gallon of gas hasn’t been particularly high compared to recent history. And, more to the point, gas prices being higher in the past didn’t lead to high inflation. So, I just never bought the argument that gas prices were forcing businesses to charge more for their stuff.
All the major signs that I could find were pointing to disinflation, or possibly even some amount of deflation back in the spring, but this never happened. The missing piece of the puzzle, the one that could make all these pieces fall into place—that is, the causes of inflation abating without inflation abating—was if the margin between the falling causes of inflation and inflation itself was being eaten up in corporate profits.
Well, on Friday we finally got second quarter corporate profit numbers.
The most shocking thing to me about these second quarter profit numbers is that in both before and after tax measurements the increase in profits in the last three months is roughly the same size as the increase in profits for the entire decade of the 1990s!
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Look, a lot of stuff goes into this—the internet wasn’t really a thing in the 90s, there is a lot more globalized trade, other nations have developed far more, etc.—but even in the pre great recession boom this would have been a gargantuan jump.
As I wrote way back when I was wrong about this, CEOs were bragging about their monopoly power to charge higher prices, and then blame those prices on inflation (maybe I should have believed what they were saying). This pricing power is keeping inflation higher than it should be, and the margin is substantially going toward corporate profits.
The only silver lining I can think of to all of this data is if corporations were trying to save up some cash to move jobs back to the United States. Just-In-Time supply chain management has had its flaws massively exposed by Covid. Experts in infectious diseases warn that Covid type infectious outbreaks are more and more likely as human populations grow and increasingly interact with each other and encroach on the habitat of wildlife. If a manufacturing hub, like China, is going to shut down entire cities to fight infections, businesses need more slack in their supply chains to manage this risk. So far, over half a million jobs have been brought back to the United States since the beginning of the pandemic.
This is a great trend for American workers, and the recent Inflation Reduction Act and CHIPS and Science Act will both help too. But I’m skeptical that such a small percentage of workforce reshoring can really explain the margins we’re seeing corporations take. Businesses can depreciate the costs of any capital investments they make in the United States anyway, so higher current profits aren’t needed to justify these projects. Huge projects are more concerned with future profitability.
So, how does this problem get fixed? Well, since my training is in tax economics my default thought process leads me to taxes. The good news is, whether you think the biggest part of the problem is a huge supply and demand shift (like I did back when I first wrote about this), or whether you think a significant part the problem is corporate greed/monopoly power, the answer is the same: a windfall profits tax.
A windfall profits tax is just an extra tax on corporations that gets triggered when Congress decides profits are growing faster than would be expected in a healthy functioning market. They could write a law that puts the trigger at a percentage growth, or dollar growth, or has no trigger at all and is just a one-time event.
If the problem is market dynamics, and not greed, then a windfall profits tax reduces the incentive of corporations to extract as much as possible out of advantageous changes in market dynamics. If the problem is greed from corporations a windfall profits tax reduces the reward for being greedy. If Congress were to tax 100% of windfall profits (to be clear, I’m not suggesting this, just using it as an example) these incentives aren’t reduced, they are entirely eliminated.
The bottom line here is the same theme you probably get tired of reading from me: free markets and competitive markets are not the same thing. In a free market corporations can capture enough market power to raise prices, pin it on a scapegoat, and shatter profit records. In a competitive market this isn’t really possible. Capitalism relies on competitive markets, not free markets.
It would sure be nice if we had more capitalism.
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Good read and I appreciate the FRED charts you included, but I think you missed an important one, M2. Both M2 and Corporate Profits After Tax jumped by about 50% from pre-pandemic levels. Wouldn’t one expect higher corporate profits (and inflation) be correlated with money supply? After all the value of a widget or service is not determined by input costs (materials and labor) but by the price a consumer is willing to pay?