“The Culprits Behind Greedflation”
We all know the story of Robin Hood. Steal from the rich and give to the poor. The unprecedented levels of inflation in 2021-2022 however, may be telling a different story–one of corporate greed and exploitation–and one which has passed under the radar seemingly unnoticed by many.
We may all have an idea of where inflation is coming from: supply chain disruptions simultaneously met with overwhelming demand. Research into industry dynamics provides a third explanation for the burning hole in your pocket: Market power. Corporations are supposedly raising prices as a result of rising costs in raw materials and energy. Meanwhile we are witnessing the largest corporate profit margins since 1950. Are these profits excessive and are elevated markups really justified or are they simply a sign of greed and exploitation by large corporations taking advantage of the information asymmetry present between producers and consumers?
In an inflationary environment, “consumers lose track of how much is reasonable to pay” presenting companies with a pretext to slowly raise prices under the guise of rising costs. This concept of so-called ‘Greedflation’ has been getting more attention lately.
“In other words, in 2021, we see a sharp increase in the 30-year trend of firms in the aggregate decoupling their prices from their underlying costs.”
An analysis by the Roosevelt Institute titled “Prices, Profits, and Power: An Analysis of 2021 Firm-Level Markups,” by Mike Konczal and Niko Lusiani, illustrates the trend of rising markups (the difference between the selling price and marginal cost, i.e. the cost of producing one additional unit) since 1980. 2021 marked the largest increase in markups in a single year and also recorded the highest all-time level in markups. However, this does not necessarily reflect an increase in market power. Markups could be increased simply to cover increasing overhead costs. The paper reveals that while overhead costs have indeed gone up, both markups and net profit margins have gone up by a greater amount, signaling greater market power.
“The more concentrated the economy is, the more ability the dominant firms have to turn … shocks into higher prices”
The research department at the Federal Reserve Bank of Boston, in a paper on the “Cost-Price Relationships in a Concentrated Economy,” reports a linkage between the recent acceleration of market concentration and the inflationary pressures of the last two years. More specifically, industry concentration points to a greater pass-through of cost shocks into prices because firms find themselves in a dominant position that allows them to “set pricing strategies upward during the shifting demand and supply dynamics.”
“It is an economy in which a handful of giant corporations control sector after sector after sector and can control the pricing that goes on.” says U.S. Senator Bernard Sanders (I-VT).
These pricing strategies are exacerbated by investors in a price-profit spiral. Companies respond to incentives of shareholders to increase their prices to meet short-term earnings expectations, and these earnings are subsequently spent on share repurchases and dividend payouts. Maximizing shareholder value may be benefiting high-ranking corporate executives, “but what is good for shareholders, we see time and again, is not necessarily good for the economy or good for consumers or good for workers.” says Robert Reich, professor of public policy at the University of California, Berkeley.
A 2018 IMF Working Paper titled “Global Market Power and its Macroeconomic Implications” asserts that “firms have lower incentives to invest in innovation as their market position strengthens,” signaling that markups are not only hurting consumers in the short run but also affecting long-term economic prosperity. The marginal relation between markups and innovation initially increases, but higher levels of market concentration are eventually associated with a negative rate of investment.
Nonetheless, critics have questioned whether market power truly is to blame for rising prices and point out that correlation does not necessarily imply causation. Inflation could instead be driving higher profits. Moreover, if market concentration was driving inflation, then why didn’t it happen sooner? “Were corporations not greedy in the 2010s? What changed in March 2021 such that corporations suddenly became greedy?” says Michael Faulkender, associate dean and professor of finance at the University of Maryland, in his statement at a senate hearing earlier this year.
Similarly, Sen. Chuck Grassley (R-IA) characterizes corporate greed as a complete misdiagnosis of inflation and rejects the theory of ‘Greedflation’ altogether. He argues that it has been used as a scapegoat by US policymakers that enacted the American Rescue plan stimulating too much demand in the economy. Shifting the blame to the private sector could have repercussions comparable to those of the 1970s price controls and windfall profit tax that only “made things worse by shortening supply.”
Still, proponents of the Greedflation theory support a windfall tax to deter excess profits in certain industries. Congressional Democrats, including Sen. Elizabeth Warren (D-MA), introduced the ‘Price Gouging Prevention Act of 2022’, prohibiting the practice of price gouging during “abnormal market disruption”.
“Profits are good … but in these times it is wrong to receive extraordinary record profits benefiting from war and on the back of consumers.”
The European Commission issued a similar statement at the 2022 State of the Union Address by President von der Leyen. They, too are proposing a cap on company revenues in the energy sector.