No, profits aren’t ‘driving’ inflation

What has caused inflation?

Another report from the Australia Institute has sheeted home blame to corporate profits, particularly in mining.

Profits surged by 90 per cent in the mining sector between the end of 2019 and end of 2022, the institute said in a report released today.

The report intended to double down on the institute’s argument that above-target inflation is caused by companies making too much money.

But there’s an obvious question.

How much do mining products feature in the consumer price index, which measures inflation?

Iron ore, which has been the runaway economic success story on the west coast since the early days of lockdowns, is almost entirely exported.

In Western Australia, the high iron ore price has been a phenomenal win for the budget.

Royalties from the steel-making commodity have been running between $7 billion and $8 billion more than their level six years ago.

That will help build a new Women and Babies Hospital, and plenty more.

Gas and coal do affect energy prices for Australian consumers, although both are also largely exported.

Electricity prices were 4 per cent higher in December 2022 compared to three years earlier, according to the Australian Bureau of Statistics, while gas was up 17 per cent.

The two items account for only 3.2 per cent of the CPI basket, according to the ABS.

No doubt those price rises hurt households, but there are plenty of other products becoming more expensive, too.

Rents, transport, food and beverages, and recreation have been where consumers have felt the pinch most, according to the ABS data.

It would be wrong to attribute higher costs in those sectors to the profits of an iron ore miner or metallurgical coal company.

Most resources companies are exporters, which means Australia's trading partners are footing the bill when their revenue rockets, not everyday Australians.

The prices of coal and gas are set on world markets, with Australian companies pocketing whatever cash they can get when the going is good.

The huge lifts in commodity prices have driven export revenue and helped government budgets.

In December, the Australia Institute estimated that higher prices for thermal coal and metallurgical coal drove industry’s profits north by up to $45 billion, with around $28 billion of extra tax revenue going to governments.

Then there’s petrol, which is mostly imported.

The price of oil, used to make petrol, is effectively set by foreign governments through OPEC.

All of that suggests that resources industry profits aren’t the cause of inflation, although in some cases, they are a consequence of it.

Beyond mining, the crucial hole in the Australia Institute’s argument is that both workers and companies earned a similar share of the benefit from GDP growth across the year, ABS data shows.

A change of heart

Casual observers may have whiplash from watching the economic debate change over recent years. 

It was only three or four years ago that the idea of governments running much higher budget deficits to stimulate employment was rapidly gaining traction in some quarters, with inflation risk not given further thought.

Pre-pandemic, the Australia Institute argued in a 2019 report to drive the unemployment rate below 5 per cent on the basis that it wouldn’t increase inflation.

The institute criticised the mainstream view in economics that pushing unemployment too low is generally linked to accelerating price pressure.

Australia Institute executive director Richard Denniss added to this campaign in an opinion piece in late 2020.

“The answer is as economically simple as it is politically inconvenient,” he wrote. 

“[W]ith high unemployment and no risk of inflation on the horizon, the Australian government, like Donald Trump’s administration, and any country that issues its own currency, can literally spend as much as it wants right now.”

About a year later, inflation resurfaced, more than just a theoretical problem.

One more year after that, and price rises were running at greater than 8 per cent annually, shredding wage growth for most workers and kneecapping anyone with cash sitting in the bank.

That came as unemployment pushed 48-year lows, with WA reporting more job vacancies than people looking for work.

The low unemployment, huge need for workers and continued growth of GDP all suggest strong demand was a critical factor in inflation.

Undoubtedly, having the lowest interest rates in the country’s history and huge government stimulus packages were big contributing factors in driving demand.

Inflation was also heading upwards in other countries before the Ukraine War, indicating the tragic invasion was not the sole, or major, cause of price rises.

Now, after having declared “there’s no risk of inflation on the horizon”, the institute has said businesses are responsible.

That line of thinking is effectively arguing that companies suddenly became significantly more greedy between the end of 2020 - when the institute thought inflation would not become a problem - and now.

More likely is that the institute was off the mark in thinking the economy could be stimulated unceasingly without negative consequences.

It ought to be self-evident that businesses will be the first winners in a demand-driven inflation outbreak.

Economists like to say wages are sticky, which means they don’t adjust very quickly.

Any worker negotiating an enterprise bargaining agreement with the state government would probably agree.

The slow adjustment means workers feel the pain of inflation first, and it takes longer for their incomes to rise to compensate them.

But just because some businesses have been early winners does not mean they will be long term winners; or that corporations are the cause of inflation.

The Australia Institute has got cause and effect backwards. 

If Australia is going to get inflation under control for the long term, we need to be clear about the real causes, even if it is politically inconvenient.