This is Lit Review
Source: Phillips 2022, Axios.com
I want to start reviewing or summarizing not just books but individual papers, or sets of papers. For this inaugural edition of Lit Review, I want to summarize a paper by Mike Konczal and Niko Lusiani of the Roosevelt Institute. I’ve followed Konczal for some time - he is the author of Freedom from the Market: America’s Fight to Liberate Itself from the Grip of the Invisible Hand (2021).
I wanted to review a recent paper/brief that I read that tackles this question in a way that made sense to me. There is plenty of hysteria, ideology, and partisan explanations that muddy the conversation of those who are actually interested in plausible, methodologically rigourous, and empirically supported attempts to get at this question. This also continues my engagement with monopoly watching and also isn’t the first time I wrote about 2021-2022 inflation. Also check out my review two years ago on Monopoly: Life in the Age of Corporate Power (2020), by David Dayen for similar content.
This is Lit Review.
~Konczal, Mike, and Niko Lusiani. 2022. “Prices, Profits, and Power: An Analysis of 2021 Firm-Level Markups.” Roosevelt Institute (June).~
Konczal and Lusiani recently published a paper exploring the cases for and against three popular explanations as to why we are seeing a general increase in prices. The basic question explored is “why are prices rising?” The three alternative explanations are a supply side one; a demand side one; and a market power one. In order for solutions to make sense, we have to know causes and the causal nexus. And even if we don’t know the exact reason for the cause(s), if a variable is found to be causal, at the very least, then people with authority and influence can begin to have a conversation based on evidence. And Congress and the Federal Reserve should know all of the potential causes so that their toolkit is expanded and suitable for the situation at hand.
I will focus on their findings regarding market power factors. A few sentences on the other two alternative explanations. Supply side explanations for inflation refer to the idea that there isn’t enough supply for whatever reason(s)—including Russia’s illegal war and invasion of Ukraine and all of it’s direct and indirecit consequences to the supply of fossil fuels and grain—and this limited supply pushes up prices because firms are also paying higher prices for resources. Demand-side inflation refers to the idea that too much demand is pursuing supply that can’t keep up - too much money chasing too few goods. Similar sounding explanations but the causal arrow is in one, and not the other, direction.
Another paper just released, this one by the Federal Reserve Bank of San Francisco, argues that more than two-thirds of current inflation can’t be explained by demand-side explanations. They have a third factor called “ambiguous” which for them might explain as much as one-fifth of current inflation.
And while the answer is obviously a mixture of demand, supply, and market domination factors that are contributing to inflation, I want to highlight Konczal and Lusiani’s findings in terms of this third explanation as it is largely invisible in mainstream partisan and anti-government conversations. When it becomes “common sense” that we have a market power problem, we will have a healthier conversation, one more conducive to solutions.
Market power as a cause of inflation is an extremely important possible explanation. If firms have too much power, they no longer have to play by the rules of a competitive market which creates incentives to make better, safer, longer lasting products; they can just become rent seekers because they don’t have to worry about losing customers. They can set prices which is an economic, social, and political problem. Excessive profit margins can actually be a sign of monopolisitic capture; not evidence of a superstar firm creating an exceptionally fantastic product with it’s own “naturally” occuring demand. But, first we need a way of measuring markups, and at the firm-level, as far as size, seeing which firms in what industries are increasing their markups the most matters in terms of cause, too.
Konczal and Lusiani statistically examined the rate of price markups, or the increase of prices over and above costs. And the implication is that when companies/corporations are price makers instead of price takers, there might be a market power problem. So, how different was 2021 in terms of markups?
“We found that markups in the year 2021 were both the highest level on record and the largest one-year increase—over 2.5 times the increase of the next several largest annual increases. While markups averaged 1.26 between 1960 and 1980, they have been on a slow and consistent rise since then, averaging 1.56 during the 2010s. In 2021, markups suddenly increased to 1.72—that is, the average markup charged in 2021 was 72 percent above marginal cost. In other words, in 2021, we see a sharp increase in the 30-year trend of firms in the aggregate decoupling their prices from their underlying costs” (4).
They were careful to explain that higher markups don’t necessarily equate to higher profit margins. But…it turns out that in 2021, this is what we see. Net profit margin (net profit/sales) jumped to 9.5 percent in 2021 - the highest on record. Further, companies that engaged in the largest percentage of markups prior to the pandemic are the same firms (and industries) that have increased their prices the most which is, in their own words, is “suggestive of a market power explanation” (8).
The authors conclude that markups can’t only be explained by either, or a combination of, supply and demand factors but also this third factor—market power, market consolidation. They call for more regulatory scrutiny of excess profits (which are indicative of domination more than fair competition) and even an excess profits tax which disincentivizes markups.
I personally am open to an excess profits tax and I also support the idea that regulatory scrutiny be automatic, or triggered, once profits reach a certain percentage that could be agreed upon by experts in this space. There is only so much that fiscal and monetary policy can do if the political-economy is so out-of-whack and captured by corporatists, monopolists, and anti-competitive cartels. We need legislative and regulatory policy commensurate with the actual scale and scope of the problem.
This has been Lit Review.
Thanks for reading, Patrick M. Foran