Wages or profits? What’s to blame for sky-high inflation?

As the cost-of-living crisis takes a turn for the worse, debate is raging about the role corporate profits have played in delivering the highest inflation rate in three decades.

As covered previously by The New Daily, analysis by the Australia Institute stated massive profits posted by big business since COVID have driven prices higher for families nationwide.

Union leaders have seized on the research, using it to rebut claims from business groups and the federal opposition that wages growth is to blame for higher prices.

Australian Council of Trade Unions secretary Sally McManus fired the latest salvo on Wednesday after the RBA admitted a recent minimum wage hike helped spark a surprise rate hike in June.

“Workers are bearing the brunt of inflation and the increasing interest rates,” Ms McManus said.

“It doesn’t matter how much evidence there is that factors like overseas supply issues and profits are part of causing inflation – not the low paid – big business and their cheer squad will always campaign for lower wages.”

But while there’s widespread agreement among economists that wages growth, to date, hasn’t caused the inflation crisis, there are numerous critics of the idea that profits are at fault.

That chorus, which last week included Treasury and the RBA, argue the research conflates windfall mining exports with local price pain felt by families at the checkout and petrol pump.

Inflation blame game

Debate stirred again this week when the OECD weighed in, suggesting that aggregate data shows both profits and wages have played a role in rising prices over the past 12 months.

Their analysis found that unit profits were rising particularly quickly in Australia early last year as inflation shot up, while both wages and profits were rising late last year as price growth peaked.

Case closed, right? Well, no – it’s much more complicated than that, as the OECD admits.

“A key policy issue is whether the observed aggregate increase in unit profits reflects a generalised lack of competitive pressures throughout the economy, or specific factors that have contributed to strong profit growth in a few sectors or in a subset of firms,” its researchers said.

First, it’s important to understand the metric used by the OECD for its analysis isn’t the typical inflation data we’re used to hearing about, which is drawn from the Consumer Price Index (CPI).

Instead, the analysis draws from what’s known as the GDP deflator, which uses production data to track price changes across the economy, and breaks it down into the income streams – namely profits and wages.

These figures help economists understand how key business inputs like labour and capital are combining to produce goods and services, which are then valued at your local store with prices.

When revenue is generated, the theory is that both labour (in wages) and capital (in profit) get a return for their production.

As the graph above shows, the OECD found profits were a key driver of the GDP deflator in early 2022, with contributions from rising labour costs playing a larger role later on in 2022.

But keep in mind that these are aggregate measures – what’s being captured here is not a decision by an individual firm to expand its profit margins at the expense of their customers.

Rather, as Treasury economist Sarah Hunter explained to Senate Estimates last week, Australia’s very large (and profitable) mining sector is dominating the profit side of the ledger.

“The mining sector is a much larger share of production in the Australian economy than it is of consumption,” she said.

Reserve Bank governor Philip Lowe later said that once resources are removed from the figures, profit margins haven’t expanded “systematically” and don’t explain rising inflation.

“When we look at the aggregate data, the share of national income that is going to profits, if we put aside the resources sector, really hasn’t changed,” he said.

“There are certainly some firms where profit margins are rising, but there are other firms where profit margins are under pressure.”

Crucially, the OECD also recognised the role of mining profits in pushing up the GDP deflator in its report this week, saying it has likely been a major factor in exporting nations such as Australia.

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