Earlier this week, I suggested the purported wage-price spiral which many argue is driving inflation across developed markets may actually be a price-wage dynamic.
The thesis is simple enough. The pandemic and subsequent policy response in rich nations created a unique macro environment which afforded corporates unprecedented latitude to raise prices. That pricing power was reflected in margins, but it eventually manifested in wages too. It wasn’t completely lost on workers that when they weren’t working, they were paying more for their own output.
Over time, this revelation has prompted lamentations for “Greedflation,” which I’ve discussed here on innumerable occasions, but only recently using that term. SocGen’s Albert Edwards has warned that Greedflation in the context of already restive electorates could mean the end of capitalism as we know it.
As it turns out, the ECB is concerned about the price-wage dynamic too. The figure below strongly suggests inflation in 2022 was indeed driven by corporate greed, although the ECB was more diplomatic about it. (The word “greed” doesn’t show up in their analysis.)
“Most recently, the effect of profits on domestic price pressures has been exceptional from a historical perspective,” the bank’s economists said, referencing the visual. “While, on average, from 1999 to 2022 unit profits contributed around one-third to the GDP deflator, over 2022 they contributed an average of two-thirds.”
Edwards commented on the paper, which he apparently noticed after Tracy Alloway flagged it, likely on Twitter. (I’m always amused by these feedback loops. They sometimes make me wonder if I should engage more on social media. But, as regular readers know, I find social media wholly intolerable. I’m not especially “old,” but I suppose I’m an “old soul,” as they say. I still read physical books and wait to read The New Yorker until it’s delivered to me in the mail, as opposed to using the app, where the latest stories are immediately available.)
“I am not in favor of price controls having seen how price and income policies of the 1970s failed,” Albert said Thursday. “But something must and will eventually be done if corporates do not begin to demonstrate ‘restraint’.”
Of course, the C-suite isn’t famous for “restraint” when it comes to the pursuit of profits. As Edwards surely knows, the unrestrained pursuit of profits, very often at the expense of workers, became capitalism’s raison d’être beginning in the mid-80s, when capitalism became shareholder capitalism. “Restraint” in the context of corporates and profitability is an oxymoron — a non sequitur. We worship profits as a god.
The ECB did a good job of summarizing the prevailing state of affairs:
[F]irms have an incentive to try to minimize their share of the burden by raising their prices in order to protect their profit margins. Producers in some sectors might even try to increase their margins over and above what would be justified by higher input costs to also fully recoup previous real income losses from the various shocks of the past three years. Another motivation could be the attempt to build buffers in an environment of high uncertainty.
Likewise, workers want to minimize their share of the burden by adjusting their wage claims to recoup the real wage losses resulting from higher prices. While price adjustments of firms can happen relatively quickly, wage-setting is usually staggered… and often requires a long negotiation process.
That latter point speaks to the negative operating leverage thesis favored by so many US equity bears. Pricing power is waning, but labor costs are still rising. Presumably, that’ll erode margins, earnings growth will turn negative and share prices will adjust accordingly. But companies will fight it. Because that’s what management is expected to do. It’s not about workers. It’s about shareholders.
The ECB continued:
Many companies are apparently able to expand their profit margins without facing significant losses of market shares. Why is that? The first reason is demand outpacing supply in many sectors: Surging demand for certain goods and services after the pandemic met the widespread supply constraints of firms that are finding it difficult to get sufficient raw materials, intermediate goods, equipment and workers. High input prices (for example for energy) also made it easier for firms to increase their profit margins, because they make it harder to tell whether higher prices are caused by higher costs or higher margins. And since companies aim to recoup their real income losses whenever possible, the high inflation environment can provide a further opportunity to do so.
This isn’t surprising. One more time: Western democracies have decided that capitalism and the unrestrained pursuit of profits is more than just the best “-ism” in a long list of imperfect secular religions we’ve devised. It’s that, but it’s also the only viable model, we’re told, by the capitalists. Never mind the fact that parts of Europe have thrived under what, in the US, are cartoonishly mischaracterized as Venezuela-style setups.
The ECB offered a rather stark warning. “How to allocate… losses is at the heart of recent negotiations between firms and workers,” the bank’s staff wrote. “If both sides try to unilaterally offset any real income losses, this could trigger successive wage and price increases, and create risks of an upward spiral that could make everyone poorer.”
If you ask Edwards, the current plan for dealing with the situation isn’t likely to work. “Central banks bludgeoning the consumer over the head with interest rate hikes to crush demand as a vicarious way to squeeze corporate margins is no longer politically acceptable in the current environment in my opinion,” he said Thursday.
Any thoughts on what I recall was Hyman Minsky’s idea of the government becoming the employer of last resort?
I have thought about this idea and think its worthwhile.
Simply taxing share buy-backs to put them on a level playing field with dividends would make a substantial difference. Since the only money going to buy-backs (and dividends for that matter) is income which the corporation can’t find a more productive way to redeploy, it won’t weaken corporations themselves at all. Instead, they’ll be incentivized to either reinvest their capital (which would at least partially include reinvesting in workers’ salaries); elsewise, they can continue to return capital to shareholders via buy-backs. In the latter case, government revenues grow, which can then be redistributed to the workers who aren’t being adequately compensated by buy-back funding corporations.
Thank you, WMD, your last sentence gave me my morning’s macro laugh.
The premise of greedflation reminds me of the Lamar Jackson controversy. Ostensibly, every NFL team is competing with one another for talent. In reality, they’re all on the same team.
Stamping out anticompetitive practices seems in order, though there doesn’t appear to be much stomach for it.
I despise social media, but I immediately read every New Yorker article online.
People need to be willing to change their spending habits or companies will continue to raise prices until their profits fall. I have noticed in my grocery shopping that the large name brands such as Coke, Pepsi, all large snack brands, all large cereal brands have raised their prices well in excess of inflation or their rise in costs. The store brands and the smaller brands (a lot of these are actually good quality) have raised their prices more in line with inflation and in some cases less. I really started paying more attention to my shopping habits in the last year, and I have actually cut my grocery bill by smarter shopping. But I also have to do more work (not much) in selecting products and do some more preparing of my own food. I own a house, so my payments have not gone up. But car insurance has skyrocketed if you remain with your current provider. but if you switch, you can get rates that are 20% lower as a teaser rate. Then they will jack it up the following year. then switch again. same thing for cell phone, streaming services. have to be willing to switch to get better pricing, and then switch again when you come off the teaser rate. If you want to travel, you are probably out of luck. I don’t understand why people are willing to pay so much, but that’s just the way it is. anywhere anyone wants to go is very expensive. you can probably find some out of the way places for much cheaper but there is probably a reason people don’t go there. and people could cut down on their gasoline cost by just slowing down to the speed limit and keeping tires inflated. can reduce gas usage by 30% just by changing driving habits.