Max Harris: The role of corporate profits in inflation

The European Central Bank, headquartered in Frankfurt, is 'closely monitoring developments in underlying inflationary pressures that stem from both profits and wages'. Photo / AP

OPINION

Everyone’s still talking about inflation and the cost of living, even as inflation surprisingly fell last week to 6.7 per cent over the previous 12 months. But are we looking in the right place as we try to tackle inflation?

Inflation can sound like a technical topic, but it’s an issue we should all understand and be able to talk about, not just leave to economists.

There’s one major potential driver of inflation that other countries and experts have begun to take seriously, but which we have largely ignored. That driver is higher corporate profits, or increased margins, contributing to a general price rise across the economy.

On March 30, the European Central Bank (ECB) published an article online saying higher profits were influencing EU inflation. The ECB said businesses have a reasonable incentive to raise prices when they face supply chain problems, including from Covid-19 and the war in Ukraine.

But, the ECB went on, in the current moment it’s possible businesses might want to increase their margins more to recoup earlier losses from difficult Covid years. And that’s what the ECB said was happening in Europe. The ECB said it would expect profits to be dampening because of the general slowdown in the economy, but profits were rising, and the ECB was “closely monitoring developments in underlying inflationary pressures that stem from both profits and wages”.

Illustration / Emmerson

In the US, some central bankers have acknowledged a similar trend.

The Federal Reserve Bank of Kansas City in January published a piece called, “How Much Have Record Corporate Profits Contributed to Recent Inflation?” The analysis found that “markup growth was a major contributor to inflation” in 2021, with markups up by 3.4 per cent, and likely to “account for more than half of 2021 inflation”.

Then, on March 7, the most senior central banker in the United States – Federal Reserve Chair Jerome Powell – acknowledged that lower corporate profits would help to reduce inflation, when he appeared before a senate banking committee.

These central bank comments follow intense academic and policy interest in how corporate profits worldwide, led by young German economist Isabella Weber.

In a widely-read paper written with Evan Wasner in February, Weber presented evidence of “sellers’ inflation”. Weber and Wasner showed that as a result of supply shocks (such as Covid-19 transport blockages or the war in Ukraine) some businesses gained greater market power and hiked prices – and profits.

Price hikes were seen as legitimate, aided by media reporting, and businesses down the supply chain used these price hikes as a reason to increase their prices further.

Closer to home, the Australia Institute think-tank has made a similar argument in a report on the “profit-price spiral” in February, concluding that “the main driver for inflation in Australia is excess corporate profits”.

You’d think with all this international interest in corporate profits and inflation, the New Zealand Reserve Bank would be monitoring this closely, right?

In November, the Reserve Bank’s chief economist Paul Conway was asked about this by Bernard Hickey. Conway said: “Unfortunately we don’t have great data on profits. It’s a real blindspot in how we measure our economy...”

Last week, it was reported that several Treasury economists writing in their individual capacity had argued that higher demand in the economy contributed to inflation.

Supply shocks had a lower impact in New Zealand than overseas, though they still appeared to be more significant than demand and some factors were unknown.

There was no mention of the word “profits”.

It’s been left to researchers, like FIRST Union analyst Ed Miller, to do the work themselves on corporate profits. In July last year Miller compiled evidence to show corporate profits had spiked by 39 per cent in the year to March 2022, “the biggest increase we’ve ever seen”, raising questions about the contribution of profits to inflation.

Max Harris. Photo / Alex Burton

It’s time the Reserve Bank and Treasury caught up on this.

Perhaps the Reserve Bank’s data has been improved, and maybe Treasury has looked into this internally. If so, it’d be a good time to let the public know what they’ve found out.

This matters because the main tool the Reserve Bank is using, interest rates, targets high demand – and will cause damage to communities by increasing unemployment.

If some of our inflation is being driven by corporate profits, we’d think about inflation differently. And we’d need a different set of levers to bring inflation down.

This could include higher taxation of businesses or an excess profits tax, and the Commerce Commission doing more to look into market power. The next Reserve Bank Monetary Policy Statement is due next month, where the Reserve Bank usually examines “special topics”.

This could be a chance for the Reserve Bank to share updated data on corporate profits. It’s time the debate on inflation was opened up, so we can more fully understand what’s driving inflation – and what we can do to get a grip on it.

- Max Harris is a lawyer and writer. He previously worked in economic policy and is the author of the book The New Zealand Project.