The claims by business leaders that record-high profits have not contributed to recent inflation are wrong, according to a new paper from the Australia Institute.
Dr Jim Stanford, director of the Australia Institute's Centre for Future Work, says enormous price increases for fossil fuel products early in the pandemic were the single biggest cause of the initial acceleration of inflation in Australia.
He argues those price increases not only generated unprecedented profits in the mining sector but also pushed higher costs into other sectors of the economy.
He has also hit back at recent comments from Reserve Bank governor Philip Lowe.
Last week, Dr Lowe said it was wrong to suggest that inflation in Australia had been driven by ever-widening profit margins because, if you excluded the resources sector, the share of profits in national income had hardly changed in recent years.
But Dr Stanford says it does not make sense to exclude the resources sector from analyses of Australia's economy, given its central place in Australia's economic development strategy.
"For the first time, in 2022, mining profits accounted for over half of all corporate operating profits in the entire economy," he argues.
"When analysts suggest that mining profits should be excluded from consideration of the role of profits in broader macroeconomic conditions (including inflation), they in effect are proposing to exclude most profits in Australia."
Reserve Bank has problems with the argument
In February, Dr Stanford published a research report that considered how excess business profit-taking had contributed to recent inflation in Australia.
The paper concluded 69 per cent of excess inflation between December 2019 and September 2022, over and above the Reserve Bank's 2.5 per cent inflation target, had been manifested in higher corporate profits.
However, the Reserve Bank took issue with the work.
A freedom of information request shows RBA officials discussed Dr Stanford's paper internally, on the morning it was reported by the media, and they found some problems with the paper's methodology.
Assistant governor Luci Ellis took part in those internal discussions.
Then last week, in a speech to the National Press Club, RBA governor Philip Lowe drew attention to the argument about profits and inflation so he could dismiss some aspects of the debate.
"In terms of price-setting, the experience differs across firms and industries," Dr Lowe said in his speech.
"However, at the aggregate level, the share of profits in national income — excluding the resources sector, where prices are set in global markets — has not changed very much over recent time."
He included the below graph in his slides accompanying his speech.
"A reasonable interpretation of this is that, while firms on average have been able to pass on higher costs and maintain profit margins, inflation has not been driven by ever-widening profit margins," he said.
Then, in the Q and A section of his Press Club speech, when he was asked about the Australia Institute's report again, Dr Lowe had another crack at it.
"As I said in my prepared remarks, rising profits are not the source of the inflation pressures we have," he said.
"Outside the resources sector, the share of national income that goes to profits is basically unchanged.
"I think what's been happening is demand is strong enough to allow firms to pass on the higher input costs into prices, so the firms have not suffered a decline in their profits as their costs have gone up, with the exception of the construction sector.
"But most sectors have been able to pass on the higher input costs into higher prices and have kept their profit margins the same.
"So rising profits as a share of national income is not the source of inflation; it's the supply-side issues and the strong demand in parts of the economy because of the pandemic response.
"That's our interpretation of the data, and we've looked at this very carefully."
A problem with the RBA's problem with the argument
But Dr Stanford has hit back at those comments from last week from Mr Lowe.
In a new paper, written with colleague Greg Jericho, Dr Stanford provides more details to show how profits, wages, and inflation have behaved during the pandemic.
It notes Australia's mining sector has generated unprecedented windfall profits in the past two years, as the result of dramatically higher prices for fossil fuel energy — petroleum, gas, and coal — and other minerals.
"The scale of these profits is enormous," the paper finds.
"For the first time in 2022, mining profits accounted for over half of all corporate operating profits in the entire economy (making up 51.5 per cent of profits for the year as a whole).
"The dramatic expansion in the share of nominal GDP arising from the mining sector is almost completely due to inflating prices, not growth in real output.
"There has been hardly any change in real value added from the mining sector in the last three years: real value added of the sector grew less than 1 per cent in that time. In contrast, nominal value added shot up by 80 per cent – and profits even faster."
The paper says those enormous increases in prices were charged to purchasers (including in Australia) for petroleum, gas, and coal products, and that is "clearly visible" in the producer price indices constructed by the Bureau of Statistics to measure inflation in costs of inputs purchased by various industries.
For example, between March 2021 and September 2022, the prices paid by manufacturers for coal and petroleum soared by between 75 and 85 per cent, and prices for gas and electricity rose much faster than other input costs.
See the graphic below.
"Therefore, it is clear that products sold by the mining sector have had a dramatic impact in overall cost pressures facing other industries," the paper says.
The paper also shows that, since March 2021, inflation in consumer energy products — such as electricity, home heating, and automotive fuels — has been far worse than the overall rise in consumer prices.
Automotive fuel prices have increased by a cumulative 38 per cent since early 2021, more than three times faster than the overall CPI.
Gas and home fuel prices have increased almost twice as fast as the overall CPI, and home electricity prices have risen 50 per cent more than the overall CPI.
"This makes it all the more surprising that central bank officials could decide that mining profits (swollen by dramatic energy price increases) are somehow irrelevant to monetary policy and anti-inflation strategy," the paper argues.
"Energy products have made a disproportionate contribution to rising consumer prices in Australia throughout the post-COVID inflation episode.
"Clearly, for monetary policy purposes, the mining sector cannot be treated as some kind of 'exception.' Its surging prices (and resulting profits) were the biggest single cause of accelerating inflation over the last two years.
"The consequences of this linkage for inflation, macroeconomic performance, and income distribution should be acknowledged and taken into account in the design of anti-inflation remedies."
It's not just the mining sector
Dr Stanford argues that it is also wrong to say that profits in the non-mining sectors of the economy have been insignificant.
He says profits in industries such as wholesale trade, manufacturing, professional and technical services, and transportation have been relatively large in the pandemic era.
But he also acknowledges some industries have experienced flat or declining profitability. Dr Stanford cites the hospitality and arts and recreation sectors as particularly hard hit by the initial lockdowns and yet to fully recover.
"This variability of profits across industries is consistent with international research indicating that initial inflationary surges were concentrated in sectors with particular market power and strategic linkages to the rest of the economy," the paper observes.
Concerns with the analysis
Dr Stanford's methodology is not without its critics, beyond the Reserve Bank.
Saul Eslake, the principal of Corinna Economic Advisory, says he thinks inflation in the COVID era can be better explained by global factors.
"The first thing I'd say is the increase in inflation is global," Mr Eslake tells the ABC.
"From one perspective, you could say the increase in inflation is the result of a collision between demand, that has been driven by an extraordinary amount of fiscal and monetary policy stimulus … and the supply side, where many production chains were hampered by a combination of COVID, and the war in Ukraine, and the [move to bring supply chains back onshore].
"JobKeeper finished in March 2021, so it would be wrong to blame that, but it would be fairer to be critical of all central banks for keeping monetary policy too easy for too long, with the benefit of hindsight."
Mr Eslake does not deny that increased profits by energy companies have fed into inflationary dynamics, but they were taking profits handed to them by the global situation, especially the war in Ukraine.
"No Australian energy company made the conscious decision to raise the price of coal or gas in order to boost its profits," he says.
"The global market did that and those companies took those profits. Is that 'causing' inflation, or is it a symptom of the inflation that's been caused by other factors? That would be my view.
"You'd be right to say that higher prices for energy and transport fed through into higher prices for a whole lot of other things, but you've got to recognise that the starting point for all of that was global factors, not conscious decisions by those companies to raise prices."
Mr Eslake's views are shared by many other economists in Australia.
In Europe, some concerns with equity
But over in Europe, central bankers are grappling with similar problems and they are confronting the power struggle over inflation head-on.
Last month, the president of the European Central Bank, Christine Lagarde, did raise the issue of profits, saying firms and workers must share the burden fairly of the hit to incomes from rising energy costs.
"So far, real wages have decreased substantially, while firms' profit margins have expanded in many sectors," she said.
Andrew Bailey, the Bank of England governor, also pleaded with companies to assume that inflation would be falling this year and to keep that in mind when they set their prices over coming months.
While Fabio Panetta, a member of the executive board of the European Central Bank, argued governments should be prepared to step in where necessary to prevent corporate profiteering, since their fiscal support programs had helped to keep profits high in recent years.
"If there is a sector in particular where market power is abused or there is insufficient competition, then there should be competition policies that should intervene," Mr Panetta said.
"It should be clear to producers that strategies based on high prices that increase profits and inflation may turn out to be costly for them."
Despite strongly rejecting that rising corporate profits are to blame for the bulk of inflation, even the Reserve Bank of Australia has consciously flipped its economic language to talk about the dangers posed by a potential of a "prices-wages spiral", when conventional economic textbooks refer to a wage-price spiral.
In doing so, the RBA has been clear that this is because it is an initial spike in consumer prices that is driving demands for higher wages, rather than the other way around.
