Home » Business » “The Profit-Price Spiral and Inflation: How Concentration of Industry and Waning Trade Union Influence Contributed to the Phenomenon”

“The Profit-Price Spiral and Inflation: How Concentration of Industry and Waning Trade Union Influence Contributed to the Phenomenon”

Paul De Grauwe is a professor at the London School of Economics. His column appears every two weeks.

Paul De Grauwe

When inflation skyrocketed, many economists feared a wage-price spiral. This ensures that if prices rise, wages will too, forcing companies to pass on the increased wage costs in higher prices. A hellish spiral that leads to a new round of wage adjustments and price increases. That dynamic, many economists feared, would embed inflation in the economy and be difficult to combat.

The surprise is that this spiral has hardly played a role until now. In most European countries (with the exception of Belgium), real wages have fallen, in other words: wage increases have lagged behind price increases. Instead of a wage-price spiral, we have experienced a profit-price spiral. Rising energy costs have prompted many companies to increase their profit margins. They have therefore charged an extra on the increased energy costs, so that the prices of finished products have risen faster than the energy prices themselves. A new spiral that has replaced the wage-price spiral.

This is not some hysterical story from far-left economists. The European Central Bank, where economists with mainstream economic training work, released a study two weeks ago that confirmed this story. According to ECB economists, two-thirds of last year’s inflation spike was due to the profit-price spiral; only one third of the wage-price spiral. Moreover, according to the ECB economists, this phenomenon was not limited to a few sectors (such as the energy sector) but spread over almost all sectors. In 2023, agriculture, industry and the services sector have taken advantage of energy cost increases to boost their profit margins.

This is, of course, about averages. There are undoubtedly companies in all those sectors that have failed to increase their profit margins. But the average company has. This leads to the question of how such a thing was possible. Here’s an attempted answer.

A first element in the answer is the changed balance of power between employers (shareholders) and employees in both the US and the EU. Since the 1980s, we have observed an increasing concentration of business. This phenomenon was extensively mapped out with figures by two Flemish economists, Jan De Loecker and Jan Eeckhout, among others. At the same time, we observe a waning influence of the trade unions. This shift in power from workers to employers has allowed profit margins to rise and the share of wages in GDP to fall in most countries.

Against this historical backdrop, we can understand recent inflation developments. The energy shock of 2021-22 created a window of opportunity to boost profit margins. Normally it is not so simple: if company A increases its profit margin and company B does not follow, the first company risks losing market share. However, the huge increase in energy costs acted as a whistle for all companies to increase their profit margins. If they all did this together, the negative market share effect would also disappear. This mechanism was facilitated because most sectors were more concentrated than before.

Inflation has thus exposed a struggle for a country’s economic value. And that battle seems to be turning out in favor of business and shareholders.

What can be done about this? The ECB continues its policy of pushing down aggregate demand for goods and services through interest rate hikes, in order to nip inflation in the bud. She will succeed. But there is a cost involved: a recession with the associated misery cannot be ruled out.

The ECB does not have the resources to address the causes of the profit-price spiral. The increased concentration of industry can only be tackled by a vigorous competition policy. This means that the government is drastically curbing price agreements, restricting mergers and acquisitions and possibly forcing groups that are too large to split up. But here’s where the shoe pinches. The political will to do so has eroded over the years. Competition policy hardly appears anywhere in political party programs anymore.

2023-05-08 17:36:00
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