There\u2019s a big risk we\u2019ll fail to learn a vital lesson from our worst inflation outbreak in decades. If inflation is such a scourge that we must pay a terrible price to get it back under control, why do we do so little to stop big companies from acquiring the power to raise their prices by more than needed to cover their rising costs?<\/p>\n
Economists are far more comfortable thinking about inflation at the top, macro level than the bottom, micro level. At the top, inflation is caused by aggregate (total) demand for goods and services growing faster that aggregate supply \u2013 the economy\u2019s ability to produce those goods and services.<\/p>\n
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<\/span>Credit:<\/span> <\/cite><\/p>\n We know from Reserve Bank figuring that more than half the price rise we\u2019ve seen has come from temporary disruptions to the supply of production inputs, caused by the pandemic and the Ukraine war.<\/p>\n But, the Reserve insists, prices have also risen because demand\u2019s been stronger than it should have been. Why? Because in our efforts to hold the economy together during the pandemic, we applied far more economic stimulus than was needed.<\/p>\n Economists \u2013 even those who stuffed up the stimulus \u2013 are comfortable with this explanation because it puts the blame on government. The model of the economy they carry in their heads tells them the market usually works fine, whereas it\u2019s government intervention in the market that usually causes the problems.<\/p>\n So, you can see why economists were so discombobulated when one of the world\u2019s top macroeconomists, Olivier Blanchard, tweeted about \u201ca point which is often lost in discussions of inflation\u201d. \u201cInflation,\u201d he wrote, \u201cis fundamentally the outcome of the distributional conflict between firms, workers and taxpayers.\u201d<\/p>\n \u2018Economists are infinitely more reticent in urging businesses to go easy with their price rises.\u2019<\/p>\n He\u2019s saying economists need to look at the more fundamental, bottom-up factors driving inflation. Is worsening inflation caused by workers and their unions successfully demanding real wage rises higher than the increasing productivity of their labour justifies?<\/p>\n Or is the strength of competition insufficient to do what the mental model promises: prevent firms from raising their prices beyond what\u2019s needed to cover their higher costs (including a \u201cnormal\u201d return \u2013 profit \u2013 on the capital invested by their owners)?<\/p>\n The strange fact is that economists and econocrats have a long history of lecturing workers and unions on the need for wage restraint. Reserve Bank governor Dr Philip Lowe has been saying workers must be \u201cflexible\u201d and accept wage rises far less than the rise in consumer prices. That is, take a big pay cut in real terms.<\/p>\n But economists are infinitely more reticent in urging businesses to go easy with their price rises. I suspect this is partly because of the biases hidden in their mental model, but mainly because they know their employer, or the big-business lobby, or its media cheer squad, or all the business people on the Reserve\u2019s board, would tear into them for daring to say such a thing.<\/p>\n Olivier Blanchard: \u201cInflation is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers.\u201d<\/span>Credit:<\/span>Stephen Jaffe<\/cite><\/p>\n Similarly, economists have insisted the Australian Bureau of Statistics publish any number of different measures of wage growth, but few measures of profit growth.<\/p>\n Last month, Dr Jim Stanford, of the Australia Institute, sought to even things up a bit by publishing figures that broke the inflation rate up into the bit caused by rising wages and the bit caused by rising profits.<\/p>\n He found that \u201cexcess corporate profits account for 69 per cent of additional inflation beyond the Reserve Bank\u2019s target\u201d, whereas rising labour costs per unit of production (that is, after adjusting for the productivity of labour) account for just 18 per cent.<\/p>\n What? Huh? Never seen an exercise like that before. How\u2019d he cook that up? The business lobby went on the attack and the business press consulted a few economists who lazily dismissed it as nonsense.<\/p>\n But though it\u2019s unfamiliar, it\u2019s not as weird as you may think. Stanford was copying the method used by some crowd called the European Central Bank. What would they know?<\/p>\n Well, OK. But how can you take the rise in the prices of products over a period and \u201cdecompose\u201d it (break it down) into the bit caused by rising wage costs and the bit caused by rising profits?<\/p>\n By taking advantage of the fact that, every time we measure the growth in gross domestic product in the \u201cnational accounts\u201d, we measure it three different ways.<\/p>\n First, the growth in the nation\u2019s expenditure<\/em> on goods and services. Second, the growth in the nation\u2019s income<\/em> from wages, profits and other odds and sods. Third, the growth in the production<\/em> of goods or services by each of our 19 different private and public sector industries.<\/p>\n In principle, each way you measure it gives you the same figure for GDP. Then you use a \u201cdeflator\u201d to divide the growth in nominal GDP between the bit caused by higher prices and the bit caused by higher quantities \u2013 the \u201creal\u201d bit.<\/p>\n So, it\u2019s quite legitimate to take this measure of inflation and break it up between higher wages and higher profits (leaving the bit caused by changes in taxes and subsidies).<\/p>\n Actually, the stats bureau\u2019s been doing this exercise for wages (\u201cnominal unit labour costs\u201d) for decades, but not doing it for profits (because no one\u2019s been keen to know the results).<\/p>\n Note that the \u201cGDP deflator\u201d is a quite different measure of inflation to the one we usually focus on: the index of consumer prices.<\/p>\n<\/p>\n