Econ Notes #6: Sellers’ Inflation, Profits and Conflict, Review
Isabella M. Weber is probably the most important figure in current economics. She unites, for better or worse, several conflicts in the field: the one between ‹heterdox› and ‹orthodox› economics, the one between German, Angloamerican and other academic economics (particularly Chinese), the one between historical and ahistorical methods, the one between descriptive and policy-centered research, between empirical and theoretical, and the conflict between the sexes, or more bluntly, the conflict with misogyny in economics that became so apparent when Paul Krugman titled her idea of a partly profit-driven inflation as « truly stupid ». Krugman later apologized and revised his opinion and admitting that Weber was right - but many German economists (it is not easy explain to the uninititated the kind of brutal stupidity and patriarchy that still prevails among those), on twitter and of course in German newspapers, keep on attacking Isabella Weber.
This paper was on the top of my reading list, because again it is probably at the center of the most important economic debates right now. Its history alone would be worth recounting (but this is for another time): Building on Weber's book on « How China escaped the shock doctrine » (which I will look at later on), this paper argues methodically, by explaining a microeconomic view of the firm and their strategies (based on reports on earnings calls) and aggregating it to an explanation for certain inflation hikes. Following a first article in The Guardian in 2021, her idea attracted huge criticism from the likes of Adam Tooze and was openly debated. However, as the directors of the ECB, Isabel Schnabel and Christine Lagarde, hesitantly, and later openly embraced it and as she was invited as an advisor to the United States Congress and became a reference in applying the Gaspreisbremse/Gaspreisdeckel in Gemany, her policies had a stunning career in the last years. All of this is an example of renegade economics, of something fresh, and in its build-up very similar to Minsky's Financial Instability Hypothesis which also used a different microeconomic strategic view of the firm to explain aggregated macroeconomic crises.
Isabella M. Weber, Evan Wasner (2023): "Sellers’ Inflation, Profits and Conflict: Why can Large Firms Hike Prices in an Emergency?". Economics Department Working Paper Series. 343. S. 1-51.
This paper relaunches the term « sellers' inflation » from an obscure paper by Abba P. Lerner from the 1950s. Weber very patiently keeps renouncing the label « greedflation », as many media outlets loved to frame it after the publication of the working paper, and she insists on this more neutral term: the idea of sellers' inflation is that inflation is in large(r) parts composed by the protection of profit margins (than of wage or cost increases themselves). It is not greed for more profit, but rather the desire - or the entrepreneurial need? - to protect profit margins even in times of crises. Since large firms also compete for keeping and attracting investors who choose in regard to profit (and have maybe become pickier in this, also with rising interest rates), there is also a case to be made that firms need to protect profit margins more than before.
At the center of the argument is a reasoning of price making strategies of certain firms. In perfect competition, according to theory, all firms are « price takers » as price policies will affect their demand; but there is imperfect competition especially in the short-term (for example, because it is not easy for new players to enter the market) and in bottleneck markets, like in an ‹upstream› supply chain. Firms in those fields, e.g. energy and raw materials, are « price makers », because they can rely on a reduced demand elasticity (especially in time of retracted supply after the shutdowns of Covid-19 - but timing is crucial here as we will see later), meaning they are rather similar to oligopolies and have a certain pricing power without having to fear losing trade volumes. Very important in this regard is a sort of implicit cartel: as firms assume that their competition will use this strategy, too, they are relatively safe to stick to their decision, probably in particular in the short-term. (« Many of what we call conspiracies are the ruling class showing class solidarity », Mark Fisher) The ‹narrative› (not a word the authors use, thankfully) of rising prices is probably helping to signal this space of opportunity. The other part of the argument is the assumption that such firms (now more than before) tend to protect their profit margins even with increased costs: This is what firms explain in « earnings calls » (regular public explanations vis-a-vis the investors) explicitly, but this is also what aggregate data shows: Price hikes do not correspond directly to cost increases but they amplify these shocks by protecting profit margins which has a compound effect (« Consider a firm that produces good x at a selling price of $100 and maintains a profit margin of 10 percent, or a nominal markup above total costs of $10. Suppose an upstream shock pushes costs up by $10. If the cost increase is simply passed on, maintaining a nominal markup above total costs of $10, the price of good x would be raised to $110. But while the entirety of the cost increase was passed on, the profit margin has fallen to 9.09%. The firm therefore increases the nominal markup above total costs to $11, raising the price of good x to $111. », 10).
All of this can first explain why inflation was rising so fast and slowing down again in the short episode after 2021 and goes to show that price controls or price caps as policy regulation might be important, especially during very fast price hikes, because - and this is crucial - even a relatively short lag between an « amplifying » stage (protecting profits) and a « conflict » stage (labor fighting for higher wages) leads to long-term inequalities as these skewed distributions are never fully ‹compensated›. I suppose from this idea follow many consequences for the contested concept of inflation, because it is not monetary of supply driven alone, which probably means that monetary and demand/supply measures are never enough to capture inflation.
But it goes to show even more (even though the authors are not so explicit in these points): first, firms seem to experience a paradigm shift or strategic change to protect profits. The question that pops up in my mind: Is this not a form of « derisking » as investors, traditionally expected to receive a share of the profits in return for taking the investment risk, can safely assume to keep their profit margins even when risks hit hard? And if so, is it similar to Daniela Gabor's derisking paradigm which is primarily an explanation for monetary policies (as far as I know)? How can risk-aversion be so incentivized in an age in which it seems to be the worst meta-preference of all? Second, narratives of a supply shock, a ‹conspirational› game equilibrium, a new structure of firms (ever larger almost-monopolies) and a historical change in consumption, overlap in interesting ways. To illustrate the last point, PepsiCo CEO Laguarta is quoted:
«‹What we’re seeing across the world is much lower elasticity on the pricing that we’ve seen historically and that applies to the developing markets, Western Europe and the US. So, across the world, consumer seems to be looking at pricing a little bit differently than before.› As explanations he cites that ‘consumers are shopping faster in-store and they might be paying less attention to pricing’ (Pepsico, 2021c) – one might add as they fear contracting COVID-19 – and a special emotional attachment to familiar brands. » (17)
People do not choose according to prices as much as in earlier times, maybe they do not have the time or the mental capacity to do so. Thus, we might experience a time in which a form of stickiness and inelasticity over a broad range of fields is taking hold. Crystallizing, while simultaneously a lot of things are changing, also in the economy. So people are not only losing the fight over wages (although they have been winning some of it back in the last several months), but also the power to choose and fight over prices, in a time, when e.g. media broadcasted the stuck container ship in the Suez' canal, providing a plausible anecdote for rising prices.
Some quotes:
The theory gap of inflation (blindspot of « profit »):
« Most economists have considered the return of inflation from the perspectives of the dominant interpretations of the 1970s: Inflation originates from macro dynamics, with the (New) Keynesian interpretation positing a matter of excess aggregate demand in relation to capacity on the one hand, and the classic Monetarist postulation of too much money chasing too few goods on the other (Weber et al., 2022). […] There is no role for profits or the power of firms to set prices in this view of inflation. In fact, the post-war inflation that was driven by bottlenecks and coincided with a sharp increase in profits might be the closer historical parallel.» (1f.)
The following quotes are important assumptions. Clearly, they are much more nuanced than what media wants to see in a "greedflation":
« Firms do not lower prices, as doing so may spark a price war. Firms compete over market shares, but if they lower prices to gain territory from other firms, they must expect their competitors to respond by lowering their prices in turn. This can result in a race to the bottom which destroys profitability in the industry. » (6)
Thus, firms will first secure their market shares, their territory, only then the profits and prices.
« Firms only raise prices when they are confident that their market shares will not be harmed. […] On the other hand, without monopoly-like control over product markets granted by innovation and strong branding, firms only raise prices if they expect other firms to do the same. A widely acknowledged form this can take is through price leadership. This amounts to an established norm that other firms follow the leadership of the most powerful firm in a market. Tyson, the largest US meat processor, is an example for price leadership. President and CEO Donnie King explained on an earnings call: ‘Additionally, we took various degrees of pricing in our key categories earlier this fiscal year ... Recently, we have seen competitors followed by increasing their prices, nearing Tyson’s price gap relative to our competitors’ (Tyson, 2022b). » (6)
Also remarkable, the language of these earnings calls :
« As an example, when asked about ‘historically high price’ by one of the analysts, PepsiCo Chief Financial Officer Hugh Johnston replied that ‘the environment is well set up for pricing to be positive going forward’ despite these high levels thanks to ‘the right way to compete, which is primarily around innovation and brand building and execution’ (PepsiCo, 2021a). » (7)
More language (there are many more examples):
« The Vice Chairman and CFO of PepsiCo, Hugh Johnston, described this as
follows on an earnings call: ‘elasticities to me are basically a portfolio of risks that we try to manage rather than kind of zeroing in on a single number’ (Pepsico, 2022c), indicating that elasticities are not exogenous, fixed entities internal to consumers but dynamic and moldable. » (8)
Three stage-heuristic for a price hike after a longer term of price stability:
- The impulse stage of initial price increases in systemically significant sectors; (start of the pandemic to Q1 2021)
- The propagation and amplification of the cost shock stage (Q2 2021 to Q2 2022); and
- The conflict stage when labor tries to regain real wage losses (Q3 2022).
‹Note that this is hard to explain from a Neoclassical perspective›:
« In the context of the pre-pandemic period, several decades of near- or
below-target inflation prevailed, while profit margins increased (see Introduction). The question then emerges of why firms did not hike prices across the board before the pandemic and how they could still achieve such profit margin gains. Note that this is hard to explain from a Neoclassical perspective. »
One of the things that might be arguable in terms of data, is whether the explanations in earnings calls are truly representative of a firms strategies. At least, investors seem to believe they are. Also, the authors double-check their hypothesis with aggregate data.
Besides industries of steel/iron and wood, there is also the example of meat:
"The world’s second largest meat processor, Tyson, more than doubled its margins and profits in the second half of 2021, in no small part due to price increases they pioneered for the industry, and then continued raising prices to protect margins against falling volumes and cost pressures, for example from grain prices. Tyson changed its pricing model from annual list prices to more flexible prices and quarterly changes to ‘de-risk’ from commodity price swings (Tyson, 2021b)." (18)
Part of the reason, why it could be so flexible is that Tyson also controls subsitutes in protein consumption:
"This implied that when people had more purchasing power and bought expensive beef cuts, they bought from Tyson, but as inflation put pressure on households and they switched to cheap chicken, they were still buying from Tyson. Offering such a portfolio of close substitutes adds to the range of possibilities in strategic pricing. Like most other giant companies we studied, they found that demand elasticities are low." (18)
This is probably crucial to secure the market share even with flexible pricing.
And these concluding remarks are devastating for current monetary policy:
"The giant corporations we have surveyed in this paper express confidence on earnings calls that they are weathered against a recession. Their product portfolios are so versatile and their revenue management so perfected that they have a playbook to make sure customers stick to them through bad times. Their global reach, which makes them less dependent on any single national market, adds to their resilience. By contrast, a recent survey shows that, when expecting a recession, small business owners do not feel prepared to navigate it successfully (Shippy, 2022). Contractionary monetary policy in itself also tends to hit smaller businesses harder (Galbraith, 1957). Price takers, in contrast to price makers, cannot raise their prices when costs go up due to higher interest rate payments, and thus – unlike firms with market power – they see their profitability decline. This in turn undermines their creditworthiness and access to loans. Large firms also tend to have more financing options beyond bank loans, which can make them generally less dependent on bank rates. But the injustice of monetary policy does not stop at the discriminatory effect on small versus big businesses. Ultimately, hiking interest rates is meant to increase unemployment, which hurts workers who have already been in a defensive position in this inflation." (18)
And then the paper cuts to the point:
We are living in times of overlapping emergencies. The pandemic is not over, climate change is a reality and geopolitical tensions are mounting. It is likely that there will be more shocks to come. [...] The mere fact that a second impulse shock landed in 2022 and exacerbated already high levels of inflation – leading to the relatively long duration and significant magnitude of the COVID-19 inflation – evinces the need for states to develop tools and take effective action early on in such inflationary processes, rather than adapt the ‘wait-and-see’ approach initially
advocated by many of those on ‘team transitory’ (e.g. Krugman, 2021) until inflation becomes broad-based. (19)
The authors propose better measures:
1) Buffer stock systems:
"For commodity markets, Keynes, Kaldor and others have long argued for buffer stock systems that can dampen the violent price fluctuations inherent in these markets by inducing prices to stay within a certain corridor." (19)
The Strategic Petroleum Reserves in the US provided exactly this. The authors add that this might be counterintuitive in times of a "green transition":
"But non-linear pricing – as has been implemented for example in Germany with the so-called “gas price brake” – can create price stability for the inelastic basic demand while preserving price incentives at the margins to encourage saving." (19)
Only then can such a transition be just, they argue, "since the same communities who are hit hardest by climate change and the pollution from fossil fuels are also among the prime victims of oil price shocks. Stable fossil fuel prices can prevent profit explosions which increase the power of big oil and vested fossil fuel interests."
2) Limiting financial speculation on commodities
3) Price gouging law (prohibiting excessive pricing in emergencies), not only for consumer essentials but also for upstream commodities (Iron, fuel, wood, etc.)
4) Windfall profit taxes
5) "Finally, if all these measures fail, strategic price controls for systemically significant sectors can be a means of last resort. Where prices are administered by a handful of firms, they are easier to implement than in competitive markets." (21)