By Gareth Vaughan
If you're looking for profit-led inflation you should probe consumer facing industries rather than look across the whole economy, says UBS chief economist Paul Donovan.
Speaking in the Of Interest podcast, the London-based Donovan says profit-led inflation, whereby companies are able to expand profit margins and convince customers it's fair to do so, is the third wave of inflation experienced in developed economies since the Covid-19 pandemic. It follows a demand shock as developed country economies reopened and consumers had a "stockpile of savings" they spent on durable goods such as furniture, electronics and cars, and an energy supply shock after Russia invaded Ukraine, when energy prices surged and demand reduced.
"What it [profit-led inflation] has really done is prolong the inflation. If we had not had the war in Ukraine I don't think we'd have got the profit-led inflation because Ukraine has been an important part of the story that companies have told to convince people to accept higher prices. I think if we hadn't had the war in Ukraine we would be sitting here talking about falling prices today," Donovan says.
"Right now we're starting to see profit-led inflation be challenged in a number of countries. But I'd say that it has probably accounted for about half of the inflation that we've experienced over the last six-to-eight months."
Lobby group Business NZ issued a report it commissioned from consultants this week on profit-led inflation, or "greedflation" as it put it, saying it was "an imported narrative not supported by the evidence." Looking at data from 14 industries over the three years to December 2022, the report said 71% of price increases came from input costs, 15% labour costs and 14% gross profit increases.
Donovan says three years is too long of a period to look at for profit-led inflation, and you wouldn't expect to see it across the economy as a whole.
"I think this is one of the problems with a lot of the analysis that we've seen on profit-led inflation. There is this assumption that every company is raising profit margins and that absolutely isn't the case, it's a subset of companies that raise margins. And so if you look at economy-wide data you're going to find less evidence of profit-led inflation," says Donovan.
"In the case of New Zealand, if you're going to get profit-led inflation coming through, you don't look at the entire economy, you look at the consumer facing sectors [such as retail, restaurants, clothing brands or food brands], and see what's happening with margins there. That's the critical story."
In the podcast he also talks about how to spot profit-led inflation, consumers' naive views about what causes inflation, why he doesn't like the greedflation term, why central bankers should talk more about profit-led inflation, why it took off in the wake of Covid-19, and the role of social media.
"Two things made profit-led inflation easier this time. Consumers did have more savings, sort of a windfall of savings during the pandemic. No one's going to describe the pandemic as a lottery win but it was a bit like that. You got a sudden influx of cash that you weren't expecting to have. So that meant that people perhaps became a little bit more indifferent to prices," says Donovan.
*Donovan published a report on profit-led inflation earlier this year which we covered here.
**And you can find all episodes of the Of Interest podcast here.
31 Comments
That over-and-above-basics 'money' those people chose to 'spend' (if they didn't, there would be no 'profit' made) was debt, issued on the basis of the continued RE ponzi, wasn't it?
Thanks for the interview/article, it adds to the debate - but there is one possibility it doesn't contemplate; could it be that folk have been covid-shocked out of their continued-BAU assumptions? Maybe they're partying because they realise that the chances of there being no tomorrow, are increasing?
A lobby group commissions a report with findings that are favorable to their members? How convenient. "Here's our wage bill, here's our invoices from suppliers, here's our shelf prices over the year". Nothing to see here.
What about supplier rebates? Charge the retailer xx% more on invoice, and then send a cash payment at the end of the year based on accumulated spend. E.g. $0 - 100k: 5%. $100k - $500k: 7% etc.
The issue with supermarkets deducting the rebate off the invoice amount was raised in the ComCom report (p 363) last year, so backdoor rebates are happening and may only be visible from a full audit of supermarket bank accounts.
https://comcom.govt.nz/__data/assets/pdf_file/0024/278403/Market-Study-…
What annoys me is the common post covid strategy of over zealous " profit theft" by companies in order to instantly get their books back into profit and offset the loss!
This is specifically common with monopolies and duopolies like Air NZ, Supermarkets.. fuel companies...
These wankers could have spread the losses.
So the only winners are the greedy shareholders .
All so-called free-marketry ends in less and less monopolies.
Joe's corner hardware store is absolutely allowed to bid against a hardware chain. But he can't undercut, therefore is out of business, therefore the chain get his old customers.
We got peddled a fable, by a vested-interest cohort.
Oil companies are taking less than 80c/L now to refine the oil, deliver it, and make their profits. The crude oil itself is 38c on top. The rest is tax, about $1.10/L
https://www.interest.co.nz/charts/commodities/oil-and-petrol
Shopping around will make a difference. But the costs we impose on ourselves in tax is still the biggest portion of what we pay, and that is even after the suspension of some of the tax. It is hard to make the case it is 'greed' by oil companies.
Construction was all greed.
Labour prices sky-rocketed.
Popular FB pages had builders saying 'not getting out for less than $100 per hour'.
Trades didn't bother to turn up on sites especially on Monday's and left early on Fridays.
Cost of finance to complete was greater so house costs go up.
Plumber charging $100/h as part of a commercial contract.
Nice work Gareth. That Business NZ greedflation report compared 2019 and 2022 and concluded that margins had not increased across key industries. They very conveniently left out 2020 and 2021 when construction, wholesale and retail (our biggest price setters by far) all saw big increases in profit margins. CPI would have been 1.5 to 2 percentage points lower in 2021 if they had kept their margins at their previous (very healthy) levels.
The consultants (Sense) also decided not to use the level two business data, which is where you can separate out retail from accommodation / food. Obviously lower margin in accommodation / food (no tourists) offset the higher margins in retail. Again, seems rather convenient.
Amazes me that even this paper thin analysis shows that the contribution of imported input costs dominates our inflation story, with wages and profits responsible for a much lower (and broadly equal) share. Yet, we attempt to wrestle down prices by trying to make more people unemployed. What a stupid way to run an economy.
Noone seems to mention the - cannot quote the % - increase in freight costs post COVID, but was it not $1,800 to about $18,000 a container from China, which face it with Vietnam, Japan Pakistan is where a lot of our imports come from. I remember an article by the Mobray family who pondered on buying their own ship, but suspected Unions on the US coast would be very slow to dock and unload it.
While no doubt there was probably profiteering going on, these ships generally stop at a few ports on their run. In normal times they'd be in and out of a port within 48 hours. During Covid, each port could be upwards of 1 week. The Emma Mærsk for example carries 13 crew with capacity up to 20. So you have all these time related costs combined with reduced revenue.
We had a shipment due into Auckland that were just dumped in Brisbane by the ship because they couldn't be arsed coming to NZ.
Whilst I generally agree with all the points made in this article, its credibility is somewhat dented for me when Paul Donovan says that but for the Ukraine war "we would be sitting here talking about falling prices today". Since when do prices ever fall after a period of inflation? Very rarely.
Perhaps Donovan might agree with the 79% of economists polled by University of Chicago who disagreed or strongly disagreed that market power was a significant factor in higher US inflation.
https://www.waikato.ac.nz/news-opinion/media/2023/it-might-be-tempting-…
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