Ignoring the role of profits makes inflation analyses a lot weaker
Washington Post columnist Catherine Rampell wrote last week that those pointing to the role of fatter profit margins in driving price inflation are engaged in “conspiracy theories,” and argued that the conspiracy theorists are distracting attention from things that could really lead to lower inflation: faster immigration and removing import tariffs. It’s a pretty unconvincing column all around.
First, the alleged inflation cures that attention is being pulled away from are really weak tea. The case for faster immigration helping to quell inflation runs through its effect on labor markets. If faster immigration increases labor supply this could in theory dampen wage growth. But wage growth has not been the source of the current inflation. And recent readings on wage growth have it roughly consistent with relatively normal rates of inflation. Putting further downward pressure on wage growth that is already lagging far behind inflation would just increase the burden of adjustment to more normal inflation that will be borne by workers.
The case for tariff removal being a major tool to rein in inflation is even worse.
For one, it’s obvious as day that the Trump-era tariffs that have caused so much consternation—whatever their other virtues or vices—had nothing to do with the current inflation. They were put in place far before early 2021 when inflation began. Of course, even though they had nothing to do with the rise in inflation, their removal could, in theory, provide a one-off decline in the price level. But the magnitude of this potential effect is very small.
The best rough-and-ready estimate for what removing Trump-era tariffs would do to consumer prices can be obtained by simply dividing the post-2017 increase in total tariff revenue by personal consumption expenditures. Doing this exercise gives you a number in the neighborhood of 0.3 percentage points: Inflation would move from the current 8.1% to 7.8%. There are plenty of reasons, moreover, to think that the effect would be smaller or completely undetectable (mostly because the effect of tariff removal is far from guaranteed to show up as a lower overall price level as opposed to exchange rate adjustments or increases in prices for exportable goods).
Claims that tariff removal could do much more than this have been based on highly opaque models. The description of how these models lead to a 0.3 percentage point decline to somehow be amplified enough to pull down inflation by more than a percentage point invokes claims that tariff declines spark larger price declines when imported goods are in close competition with domestic output. But here’s where the huge increase in profit margins in recent months is informative: How can profit margins be rising so fast if there is any robust competition right now in goods markets? The epic supply-chain snarls of recent months have forced potential goods buyers to endure strangely long wait times and face much higher prices. The idea that these conditions are consistent with having a wide range of competing products to choose from and that this fierce competition will in turn amplify the effects of tariff removal doesn’t sound realistic at all.
Given the weakness of both the proposed faster immigration and tariff removal ideas for restraining inflation, the claim that focusing on anything else is a policy disaster is really unconvincing.
And the “other thing” often been focused on in recent debates over inflation—the extraordinary rise in profits that has coincided with the price spike—is a real and important phenomenon that should grab our attention. For example, the rise in unit profits has mechanically contributed about half of the total rise in prices since the pandemic recovery began. This is, by an order of magnitude, far bigger than any contribution of fast wage growth or tariff removal. This rise in profits tells us all sorts of important things about the inflation of the past year.
For one, it reminds us that one person’s cost is another’s income.
As a nation, the mechanical effects of inflation don’t make us poorer. Higher prices in a given sector mean higher potential incomes for capital owners and workers in that sector. In the current recovery, the higher revenue generated by higher prices, however, has overwhelmingly gone to the capital owners and not the workers. In short, the most important angles of inflation (like so many other economic phenomena) are distributional, so asking why corporate profits are spiking while inflation-adjusted wages are falling is a perfectly fine question.
For another, higher inflation going hand in hand with high-profit shares is not, as Rampell claims, just the same old, same old of business cycles. In fact, it is far more common in a tightening economy (one characterized by falling unemployment) to see inflation nudging up as real (inflation-adjusted) wages rise and the profit share of income falls. The fact that today’s pattern is entirely the opposite of the norm in most business cycles really should give some pause to those claiming that there is no story here except the familiar one of aggregate demand racing ahead of supply.
Finally, the idea that corporations are always looking for profits and this should never attract the attention of policymakers seems wrong to me. One analog to the current situation is when policymakers weigh in to restrain profit-making through price increases following natural disasters. If a storm wrecks a town’s ability to supply safe municipal water and a grocery store with bottled water in inventory begins selling it for $20 a bottle, there are a number of existing price-gouging statutes that are often invoked to stop this. Part of the rationale for these kinds of anti-price-gouging measures is simple morality, and so its applicability to the current situation is pretty subjective. But part of why policymakers are comfortable weighing into situations like that is they’re quite sure the huge profit margins being earned by the only grocery store with bottled water after a hurricane are not useful.
High profit margins can be useful when they provide market signals about where economic resources should be deployed in the long run to meet the needs of a changing economy. But nobody thinks there should be a long-run shift of labor and capital into producing more bottled water nationwide in the situation where a hurricane has knocked out a town’s water supply, so putting a cap on the profitability of selling it during a short-term emergency like that does no harm.
Much about the current situation is not like the aftermath of a hurricane, but it’s certainly fair to ask if today’s sky-high profit margins are useful or not. I tend to think the allocation of production and consumption post-pandemic is going to look mostly like it did before, so I don’t see these high-profit margins as usefully signaling where economic resources should be deployed. So measures to cap them (say, an excess profits tax) would be perfectly reasonable.
I’m pretty pessimistic that policymakers can move nimbly enough to put a cap on excess profits that will restrain inflation in the near term. I’m also pretty sure the huge profit spike is mostly behind and that most sources of inflationary pressure will start to normalize in the second half of 2022. But, as a simple matter of fact, the rise in profits has been historic and has explained far, far more of the rise in prices over the past year than labor costs or import tariffs, and this makes it odd indeed to label calls to address this as “conspiracy theories.”
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