There are many reasons being floated around for why inflation has spiked in 2021 and 2022. I have blogged on the possibilities of unemployment benefits and expansionary monetary policy, as well as the supply chain crisis. There is another theory making its rounds in political discourse: corporate greed.
During a House of Representatives hearing last Wednesday, Representative Katie Porter (D-CA) grilled macroeconomist Michael Konczal of the Roosevelt Institute. Part of Porter's tirade was pulling out an enlarged chart from the Left-leaning Economic Policy Institute. According to this chart (see below), corporate profits are responsible for about half of the inflation spike. A day later, Whoopi Goldberg chided the media for not reporting on the supposed cause of inflation: corporate profits.
The high level of profit margin presents a "chicken versus egg" debate. The New York Federal Reserve Bank found a relationship between the producer price index and profit margin, which suggests correlation. Interestingly enough, the Bank points out that "the relationship between inflation and profit growth is not unusual in the historical context."
Even with correlation, you need to ascribe a causal mechanism in order to explain the correlation. Did the inflation come first and the corporations raise their prices in response? Or did the corporate profit margins trigger the inflation? If the former is correct, that would mean corporations were responding to market forces. If it is the latter, that would suggest "greedflation." While the Federal Reserve Bank of New York remained agnostic as to the correlation mentioned in the previous paragraph, I have some reasons to question the theory that corporate profits caused inflation.
1) Let's get at the intuition of the price-gouging behind the "greedflation" because it does not make sense. To pose the rhetorical question presented by the Mises Institute:
Why, then, has inflation only recently exploded after 40 years of calm, now clipping at better than four times the Federal Reserve's target annual rate of two percent?
It is not as if people were naturally benevolent throughout history and the pandemic magically turned people greedy. People have always been self-interested creatures; it is a natural part of the human condition. Part of the theory of the firm, which is a part of numerous economic schools of theory, states that the main reason a [for-profit] firm primarily exists and make decisions to seek profit. Firms are greedy in the sense that they exist to maximize their own profit. To quote Adam Smith from the Wealth of Nations, "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest."
Standard microeconomic theory teaches that firms cannot charge whatever they want. If they charge too much, fewer people will buy their goods or services, and they will incur losses. For firms, profit maximization is finding that sweet spot between charging as much as they can while still brining in the optimal amount of revenue. As political commentator Hannah Cox brings up, what is problematic with the mainstream Left is that "these people have no idea how markets work or what conditions actually create prosperity." I know there are some on the Left that still recognize such economic realities as markets or prices, but the political rhetoric that is permeating more on the Left shows that such individuals become fewer as the mainstream Left embraces class warfare more and more.
2) The Producer Price Index (PPI), which measures production costs for businesses, has been on average higher than the Consumer Price Index (CPI). How can producer prices increase more than consumer prices? The Mises Institute rightfully distinguishes between corporations and businesses. According to a 2019 report from the Small Business Administration (SBA), small businesses account for 44 percent of the GDP. Small businesses have a harder time bearing the cost of external events than corporations. Rather than being motivated by avarice, small businesses are increasing their costs because they are responding to market forces.
3) Professors from Brandeis University and New York University published a CNN article showing why it is not "greedflation." They found a more plausible factor contributing to the high level of inflation: the labor shortage. Not only is unemployment under 4 percent, but there are nearly two vacancies for each person searching for a job. Wages and salaries increased to bring in more workers. On top of that, firms were still hiring workers. Since labor compensation is typically the largest cost for a firm, it eats away at profit. If the labor market tightness continues, we will continue to see labor cost inflation.
4) If greed causes inflation, then it would stand to reason that greedier countries would have higher rates of inflation. The American Institute for Economic Research (AIER) does something interesting. AIER takes 2021 data to compare the inflation rates of multiple countries with their rankings on the Charities Aid Foundation (CAF) World Giving Index. As you can see with the chart below, there is a lack of correlation between inflation and the CAF's metric of measuring greed.
5) To quote Wharton School Professor Z. John Zhang, who is a Director at the premier business school: "If there is any truth to greedflation, it's that businesses are eager to pass along their increased cost to consumers because consumers are more receptive right now to price hikes...but that doesn't mean that firms are manipulating the markets through collusion."
I would ask why consumers are more receptive to price increases. Catherine Rampell at the Washington Post brought up many points that I did in September 2021 that point to significantly more plausible culprits to the unusually high levels of inflation in the United States.
- The Federal Reserve maintained low interest rates while increasing money supply by 40 percent since the beginning of 2020 (Federal Reserve). Having more dollars chase the same amount of goods and services increases prices.
- Expansionary monetary policy was combined with expansionary fiscal policy in the form of stimulus payments that boosted consumer demand, thereby increasing consumer prices.
- In the meantime, labor shortages, supply shocks, and COVID-related disruptions limited the supply, which also drives up prices.
- Companies cannot produce fast enough and the government has induced people to want to consume more, which means consumers are willing to pay more.
The list above is a brief summary of how the United States Congress and the Federal Reserve contributed to rising prices without getting into other such plausible causes of inflation as China's COVID-related restrictions, how the war in Ukraine affected inflation in 2022, or any other market-specific trends that arose as a result of the pandemic. What I hope to discuss in further detail in a future post is how the government played its role in unusually high inflation rates. What I will say in the meantime is this: It might be a convenient scapegoat during an election season, but there is not much basis that corporations are the cause, let alone a primary cause, of the rising inflation.
11-7-2022 Addendum: A good colleague of mine read this piece and asked what was wrong with the EPI's chart I posted at the beginning. My short answer was that there was not a correlative impact on inflation. Below is data from the Federal Reserve Bank of St. Louis (FRED) on the corporate profits after tax as a percentage of GDP. See the more variable nature of the chart.
Here is the Bureau of Labor of Statistics data for the CPI for All Urban Consumers (CPI-U). This is a much more gradual increase, with 2021-22 being a notable exception. If corporate profits were historically responsible for major spikes in inflation, we would have seen more inflation spikes since 1950. Since this is not the case, corporate profits do not have a correlative impact, never mind a causal impact.
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