The ongoing discussion on the factors driving inflation has intensified in recent months.
In the beginning, when inflation had spiked, there was broad agreement that this was due to supply considerations, as Covid-19 had disrupted the operations of firms across the world and raised costs. Then, the Ukraine war added to these problems, particularly in Europe, which had to radically change its energy provision to more costly sources. At the same time, many economists from the neoliberal spectrum were arguing that the main reason for inflation was the fiscal support that governments provided to households, as this kept demand high while supply had fallen.
With the gradual readjustment of global supply chains and progressive reduction in energy costs, combined with the elimination of Government support measures related to the pandemic and the impact of monetary policy tightening, many assumed that inflation would fall sharply. However, while inflation is declining, it remains very stubbornly high.
The notion of ‘greedflation’
Enter the new theory – greedflation, a term denoting price hikes imposed by corporations to leverage the current inflationary climate and inflate their profits, regardless of actual cost pressures.
It started with left-leaning economists such as Robert Reich, who noted how, while costs were declining, firms were not passing on these savings but instead were widening their profit margins. Gradually, the evidence for this grew and started to convince even more traditional economists, notably the European Central Bank’s President, Christine Lagarde. In a session with the European Parliament’s economic committee last June, she noted that increased corporate profits were worsening inflation and called for better data on profit margins and closer scrutiny from competition authorities.
Of course, the notion of greedflation is being strongly contested by neoliberal economists. The Economist argued recently that greedflation is a nonsense idea and that the cause of inflation is that governments were too generous in forking out assistance during the pandemic.
Yet the evidence is steadily increasing that corporate profits are rising in many countries while wages remain compressed.
Malta’s inflation should be steadily declining? Why isn’t this the case?
Interestingly, the Central Bank of Malta appears to be taking a stand for the notion of greedflation explaining why inflation in Malta is appearing to be persistent. In fact, Maltese firms were shielded entirely from the energy shock and today benefit from the lowest energy and fuel prices in Europe, and so one would expect Malta’s inflation to be steadily declining. Yet, after months in which our country’s inflation was lower than that in Europe, the data seem to show that, if one excludes energy and fuel prices, inflation in Malta is, in fact, exceeding that in Europe.
In In its most recent economic outlook the Central Bank of Malta has, in fact, pointed out that, since 2022, inflation persistence has increased and that this occurred for both goods and services. Basically, what this means is that, once prices rise, this rate of increase is persisting for much longer than it used to do in previous years. Something appears to have changed in Malta’s inflationary process.
In a recent article, Alexander Demarco, Deputy Governor of the Central Bank of Malta, noted that “the fact that HICP (Harmonised Index of Consumer Prices) inflation has been so high and prolonged suggests that, apart from rising costs, inflation could be also driven by other factors, such as profit mark-up adjustments, as wage inflation both in Malta and the Euro area remained on average relatively benign after 2019, and well below overall HICP inflation.”
Demarco argues that, “at a sectoral level, agriculture & fishing, manufacturing, real estate, and wholesale & retail trades, together with accommodation and food services (hotels and restaurants) reported an increase in their profit mark-up in 2022. These were also sectors whose output price increased at a higher rate than the overall average”. For instance, the wholesale & retail trades, transport and accommodation and food services sectors reported a 20.6% profit mark up over costs in 2022, up from 17.4% in 2019.
Firms are not justified in raising their prices further
In a more recent article, Demarco argues that, in light of these increases in profit margins, firms are not justified in raising their prices further now that workers are rightfully demanding better wages. He writes that, even if wages were to rise by 4.1%, firms would still have the same profit margin they had in 2019 (that is, before the pandemic and the Ukraine war). If, instead, they opt to raise prices in reaction, they would be keeping inflation higher just to keep on making more profits than they used to make before.
In the most recent Outlook for the Maltese Economy, the Central Bank of Malta economists noted that “profit margins in the industrial sector have reached historical highs” and that “in the services sector, the increase in profit margins in 2021 and 2022 may reflect a normalisation in profit margins following the sharp declines experienced in 2020 as a result of the COVID-19 pandemic. However, profit margins in this sector exceeded those in 2019. We observe a broad improvement in profit margins across all sub-sectors of the services sector, which reverses the trend decline in profit margins that occurred between 2015 and 2019.”
All this suggests that developments in profit margins could play an important role in driving price inflation in the coming months. It is important that firms realise that, after having been shielded from the huge shocks faced by their counterparts abroad, they must exercise caution not to reduce Malta’s competitiveness at this crucial juncture. Higher profits should be the result of higher efficiency or the introduction of new technologies rather than an increase in mark-ups. The latter route is likely to result in lower demand, especially in light of weakening foreign demand, and could lead to a reduction in the country’s economic prospects.
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