Is ‘Greedflation’ Rewriting Economics, or Do Old Rules Still Apply?

There are few good things about living through a period with the highest inflation in four decades, but here’s one: It’s a chance to re-examine what happens in an economy that’s gone haywire.

Since prices started to escalate a year ago, politicians and economists have seized on inflation to tell their preferred story about what went wrong, and what policies would bring it back into line. Some say it’s very straightforward: Supply and demand, Economics 101.

“There’s simply a lot of cash out there,” said Joe Brusuelas, chief economist for the accounting firm RSM US, referring to the several trillion dollars in pandemic stimulus that’s filtered into the economy since early 2020. “The competition for those goods is up and that’s sending prices up, whether we’re talking about getting a Nissan Sentra or a seat on an American Airlines flight.”

The White House and progressive organizations, however, say wait a minute: This time is different. In a time of extraordinary disruption, they contend, increasingly dominant corporations are taking the opportunity to jack up prices more than they otherwise could, which is squeezing consumers and supercharging inflation. Or “greedflation,” as the hypothesis has come to be known.

The argument comports with the Biden administration’s focus on the ills of economic concentration. Congressional Democrats have run with the idea, introducing bills that would impose a temporary “excess profits tax” on companies that charge prices they deem unreasonably high, or simply ban those high prices altogether. Critics, including the nation’s largest business lobby, deride these efforts as based on a “conspiracy theory” and a “flimsy argument.”

So what’s really going on?

It’s hard to tease out. A pandemic, a trade war, a land war, huge government spending, and a global economy that’s become vastly more integrated might be too complex for traditional macroeconomic theory to explain. Josh Bivens, research director at the left-leaning Economic Policy Institute, thinks that’s a good reason to revisit what the discipline thought it had figured out.

“When I hear stories about an overheating labor market, I don’t think about falling real wages, and yet we have falling real wages,” Dr. Bivens said. Nor is the rise in profits typical when unemployment is so low. “The idea that ‘there’s nothing to see here’ — there’s everything to see here! It’s totally different.”

When thinking about greedflation, it’s helpful to break it down into three questions: Are companies charging more than necessary to cover their rising costs? If so, is that enough to meaningfully accelerate inflation? And is all this happening because large companies have market power they didn’t decades ago?

Productive Profits, or Gouging?

There is not much disagreement that many companies have marked up goods in excess of their own rising costs. This is especially evident in industries like shipping, which had record profits as soaring demand for goods filled up boats, driving up costs for all traded goods. Across the economy, profit margins surged during the pandemic and remained elevated.

When all prices are rising, consumers lose track of how much is reasonable to pay.

“In the inflationary environment, everybody knows that prices are increasing,” said Z. John Zhang, a professor of marketing at the Wharton School at the University of Pennsylvania who has studied pricing strategy. “Obviously that’s a great opportunity for every firm to realign their prices as much as they can. You’re not going to have an opportunity again like this for a long time.”

The real disagreement is over whether higher profits are natural and good.

Basic economic theory teaches that charging what the market can bear will prompt companies to produce more, constraining prices and ensuring that more people have access to the good that’s in short supply. Say you make empanadas, and enough people want to buy them that you can charge $5 each even though they cost only $3 to produce. That might allow you to invest in another oven so you can make more empanadas — perhaps so many that you can lower the price to $4 and sell enough that your net income still goes up.

Here’s the problem: What if there’s a waiting list for new ovens because of a strike at the oven factory, and you’re already running three shifts? You can’t make more empanadas, but their popularity has risen to the point where you would charge $6. People might buy calzones instead, but eventually the oven shortage makes all kinds of baked goods hard to find. In that situation, you make a tidy margin without doing much work, and your consumers lose out.

This has happened in the real world. Consider the supply of fertilizer, which shrank when Russia’s invasion of Ukraine prompted sanctions on the chemicals needed to make it. Fertilizer companies reported their best profits in years, even as they struggle to expand supply. The same is true of oil. Drillers haven’t wanted to expand production because the last time they did so, they wound up in a glut. Ramping up production is expensive, and investors are demanding profitability, so supply has lagged while drivers pay dearly.

Even if high prices aren’t able to increase supply and the shortage remains, an Economics 101 class might still teach that price is the best way to allocate scarce resources — or at least, that it’s better than the government price controls or rationing. As a consequence, less wealthy people may simply have no access to empanadas. Michael Faulkender, a finance professor at the University of Maryland, says that’s just how capitalism works.

“With a price adjustment, people who have substitutes or maybe can do with less of it will choose to consume less of it, and you have the allocation of goods for which there is a shortage go to the highest-value usage,” Dr. Faulkender said. “Every good in our society is based on pricing. People who make more money are able to consume more.”

Sorting Chickens and Eggs

The question of whether profit margins are speeding inflation is harder to figure out.

Economists have run some numbers on how much other variables might have contributed to inflation. The Federal Reserve Bank of San Francisco found that fiscal stimulus programs accounted for 3 percentage points, for example, while the St. Louis Fed estimated that manufacturing sector inflation would have been 20 percentage points lower without supply chain bottlenecks. Dr. Bivens, of the Economic Policy Institute, performed a simple calculation of the share of price increases attributable to labor costs, other inputs, and profits over time, and found that profit’s contribution had risen significantly since the beginning of 2020 as compared with the previous four decades.

That’s an interesting fact, but it’s not proof that profits are driving inflation. It’s possible that causality runs the other way — inflation drives higher profits, as companies hide price increases amid broader rises in costs. The St. Louis Fed’s Ana Maria Santacreu, who did the manufacturing inflation analysis, said that it would be very hard to pin down.

“It would be interesting to get data on profit margins by industry and correlate those with inflation by industry,” she said. “But I still think it is difficult to capture any causal relationship.”

Concentration’s Double Edge

If you think that’s complicated, try establishing whether market power is playing a role in any of this.

It is well established that the American economy has grown more concentrated. On a fundamental level, domination by a few companies may have made supply chains more brittle. If there are two empanada factories and one of them has a Covid-19 outbreak, that in itself creates a more serious shortage than it would if there were 10 factories.

“Concentration has affected prices during the pandemic, even setting aside any potentially nefarious actions on the part of leaders,” said Heather Boushey, a member of President Biden’s Council of Economic Advisers.

But most of the public argument has been about whether companies with more market share have been affecting prices once goods are finished and delivered. And that’s where many economists become skeptical, noting that if these increasingly powerful corporations had so much leverage, they would have used it before the pandemic.

“Market concentration is a longstanding problem, yet we’ve had close to no inflation for two decades,” said David Autor, an economics professor at the Massachusetts Institute of Technology. “So it cannot be that market concentration suddenly explains inflation.”

In addition, most research on how market concentration affects companies’ “pass through” of suddenly higher costs has found that fiercely competitive industries raise prices more than those that are dominated by only a few companies, because they have thin margins and would lose money if they didn’t. That’s one consequence of oligopolists’ pricing power: They can give up some profits when they choose to.

But again, these are strange times, and it’s fair to ask whether that dynamic might have changed. Nobody is arguing that companies got more concentrated during the pandemic — only that the existing lack of competition may have interacted with inflation in a way that channeled corporate power differently.

For example, one reason rising concentration didn’t translate into higher prices in the decades before the pandemic appears to have been that corporations widened their margins by squeezing suppliers and resisting wage increases. Federal income supports during the pandemic gave workers more bargaining power, while costs for items from cardboard to diesel rose. That would have shrunk markups — unless companies channeled their leverage over consumers by raising prices instead.

The Search for Answers

The relationship of profits, inflation and market power will be tough for economists to nail down. High-quality government data will take time to produce. Moreover, it requires a melding of micro- and macroeconomic disciplines that haven’t had to synthesize so many factors simultaneously, with little historical precedent.

Lindsay Owens, an economic sociologist who runs the progressive Groundwork Collaborative and has championed the greedflation argument, emphasizes how different the economy looked during America’s last bout with inflation: Labor was far more powerful, and investors less so.

“It’s not surprising to me that a field that’s spent 50 years studying the ’70s didn’t think a lot about pricing and market power, because that wasn’t as prevalent during their last moment to study it,” Dr. Owens said.

Moreover, the field of industrial organization hasn’t agreed on a reliable gauge for industries’ competitiveness. Even measuring profit margins, especially for particular goods, isn’t foolproof.

In late May, economists at the Federal Reserve Bank of Boston released a preliminary paper finding that even before the pandemic, more concentrated industries were able to pass along a higher share of their own cost increases. But critics pointed out that it counted only public companies and omitted the retail sector, which would probably play an important role.

As more evidence accumulates, we might find that the pandemic affected various industries in different ways, even across disparate geographies. Jan De Loecker, a professor at KU Leuven in Belgium who was a co-author of a seminal paper on the pernicious effects of rising market concentration, doubts that concentration worsens price increases across the board.

“Just think about U.S. health care and the oil market — the stories there are so radically different,” Dr. De Loecker said. “But inflation is a basket of goods that consumers draw from. So the idea that there’s one story that explains rising prices in both is not a good way to think about it.”

For now, the stakes are more about the public understanding of inflation, rather than government intervening to keep empanada prices low. The price-gouging bills in Congress don’t have the votes to pass, and the White House hasn’t endorsed them.

Bharat Ramamurti, deputy director of the National Economic Council, said the White House’s argument that market concentration may fuel inflation only added urgency to its antitrust agenda, from the Federal Trade Commission to the Department of Agriculture. Given that fighting inflation is mostly up to the Federal Reserve, increasing competition could be one of the few useful tools at the White House’s disposal, even if only over the longer term.

“There are folks out there, even though this is a time of great uncertainty, who are taking the hard-line opposite position, which is that it is ridiculous to say that concentration plays any role in inflation,” Mr. Ramamurti said. “And I think that is hard to defend.”