An increase in gross profit at paint manufacturer Akzo Nobel of 75 percent. An average price increase of 12.1 percent at beer brewer Heineken. And an average additional 5.8 percent on everything that food manufacturer Unilever makes. The official inflation figure from Statistics Netherlands may have calmed down somewhat, but daily groceries and living costs still show a high degree of monetary depreciation.
Within the basket of goods and services that form the basis of the inflation rate, everything fluctuates. Energy prices are again significantly lower than last year (negative contribution to inflation), while many other goods and services are still considerably more expensive (positive contribution to inflation).
Inflation means that you can buy less with the same amount of money. Or that you pay more for the same amount of goods or services. A mismatch between supply and demand can drive up inflation: if people have a lot of money without production increasing, they will be willing to pay more for the same product. Conversely, lower product availability can also have an upward effect on prices. The supply of money remains the same, but what you can buy with it becomes scarce and so people are willing to pay more for the same product or service.
Companies can also increase profit margins, causing the same product to cost more without this being justified by higher costs. If this happens at a time when inflation is already high, it could happen relatively unnoticed. The consumer does not notice that little extra price increase. This has come to be called grabflation: good for the company and the shareholders, bad for the consumer.
The question that has been on economists’ minds since inflation reached record highs early last year is which of these causes contributes to what extent to overall inflation. That debate is extremely complex, if only because the data on it becomes available with a long delay. The explanation of inflation often only follows months after the emotion about the same inflation.
Two new reports recently appeared on the extent to which corporate profits contribute to inflation. The first, from the economists at Rabobank, published last week, slightly nuanced an earlier view of corporate excess profits, but maintained that corporate profits in a number of sectors (energy, for example) had contributed to higher inflation. The second, this week from the Central Planning Bureautakes a deep dive into the composition of inflation, both at the level of industry value added and at the level of consumer prices.
Long-term comparisons
The basis for the CPB analysis is a study that the IMF conducted earlier this year into the composition of inflation in the eurozone. It showed that in the period between early 2022 and early 2023, 40 percent of inflation came from imports (higher prices for goods coming from abroad) and 45 percent from higher profits. Grist to the mill of the grab-flationists.
The CPB applied the same method as the IMF, and added something crucial: time. The great value of the CPB study lies in the long-term comparison. Many studies compare current inflation with that of the previous year. The disadvantage of this is that the economy has actually been in disarray for a few years and is difficult to compare from year to year. The impact of corona, plus the lockdowns and tens of billions in government support, greatly pollute the figures for 2020 and 2021. The same, of course, applies to 2022, when the war in Ukraine broke out. It makes it extra complex to explain today’s high inflation rates.
Inflation as a measuring stick
The CPB makes it plausible that the current period of high inflation is a very exceptional one in the past two decades, namely one in which the profit margins of companies contribute to inflation to an unprecedented extent. The CPB does this by breaking down consumer inflation by component. These decompositions make it clear which category contributes to what extent to the total monetary depreciation.
The CPB recognizes four main components in consumer inflation: profit margins, imported inflation from abroad, taxes and the wage bill per unit product. The historical comparison shows that these four have been playing leapfrog in recent decades in their weighting in total inflation.
The breakdown of inflation therefore reads like a small history lesson. In each period it can be determined which was the dominant factor in the monetary depreciation. For example, in the economic boom years before the 2008 financial crisis, corporate profits were the factor that contributed most to the (then very low) inflation. During the crisis, corporate profits evaporated and it was wages that weighed most heavily (without the upward force of higher wages there would even have been deflation), followed by a period in which first foreign countries and then taxes (higher excise duties and VAT as part of the government’s austerity package) largely determined inflation.
Once the euro crisis was over around 2013 and the economy picked up again, corporate profits returned, and in 2019 it was the government’s significant increase in tax burdens (the increase in the low VAT rate) that kept inflation at the same level ( and even increased to high levels for that time). Then corona broke out, and corporate profits collapsed, while the government ensured that wages could continue to be paid with targeted subsidies. Thanks to this wage support, the Netherlands continued to spend and deflation was prevented. Inflation initially fell, but suddenly increased rapidly during the pandemic, because demand (supported by the government) exceeded supply (which was struggling with production-disrupting lockdowns and travel restrictions). More demand than supply means higher prices (at constant costs) and so corporate profit margins again became the driver of inflation.
Exceptional period
From the beginning of 2022, the world, including the Netherlands, will enter a period of unprecedented high inflation, as a result of the Russian invasion of Ukraine. Energy prices are skyrocketing as a result of the boycott of Russian oil and gas, and the inflation rate will be mainly dominated by imported inflation, especially in the first quarters of 2022. But gradually the profit margin of companies is taking over that leading role again. This will remain the case in the first two quarters of 2023, although the wage bill is now on the rise. This corresponds to the sharp increase in collective labor agreements that have now been concluded, and which set in motion the so-called wage-price spiral.
The CPB analysis therefore shows conclusively that companies’ profit margins made the largest contribution to inflation in recent quarters. But which companies, is the next question. This was already partly answered in the Rabo study and is confirmed by the CPB: four industries play the leading role: the financial sector, the government, the real estate sector and, perhaps unsurprisingly, the energy sector.
To grab or not?
The Rabo economists noted in their research that companies’ profit margins are widening, or that energy and minerals are not the only drivers. The CPB does not see this reflected in its research. In 2023, the four sectors mentioned will continue to provide the majority of the profit margins that support inflation, according to the CPB.
Has this settled the matter and can the business community, and in particular the sectors mentioned, be designated as grabbers? It’s not that simple, says the CPB. A higher profit margin is not necessarily profit inflation (the planning agency prefers to call it ‘profit inflation’). For example, an increasing profit margin does not necessarily have to lead to a price increase (after all, if costs become lower, the profit margin can increase without the price changing). The tension between supply and demand in both the goods and labor markets may also have increased profit margins. It is also possible that companies, after the difficult corona years, use the current period to restore their profit margins to ‘normal’ levels. And finally, companies can increase their profit margins because they anticipate higher costs (wages, raw materials) in the future.
In addition, earlier this year, regulator ACM concluded, against everyone’s intuition, that energy companies had not abused the Ukraine crisis to pump up profits. The profit margins were between 0 and 5 percent, meaning there were no excess profits. Even that may be statistically consistent with the CPB’s conclusions.
The quarterly figures continue to come in, and there is still no definitive answer to the extent of profit inflation. The CPB itself also recognizes this discomfort: the study at most provides more insight into the contributions to inflation, but does not demonstrate causal links. As always in economics, this requires further research.