The increase in energy costs was a whistle-blower for all companies to increase their profit margins

Paul de Grauwe is Professor at the London School of Economics. His column appears every two weeks.

When inflation rose too high, many economists feared a wage and price spiral. This ensures that if prices rise, wages will also rise, forcing firms to pass on increased wage costs at higher prices. An infernal spiral leads to a new round of wage adjustments and price increases. Many economists fear that this dynamic will make inflation more entrenched in the economy and more difficult to combat.

Surprisingly, this spiral hasn’t played any role yet. In most European countries (except Belgium), real wages have fallen, in other words: wage increases lagged behind price increases. Instead of a spiral of wages and price, we have witnessed a spiral of profit and price. Rising energy costs have prompted many companies to increase their profit margins. Thus, they charged extra for the increased energy costs, so that the prices of finished products rose faster than the prices of energy itself. A new spiral has replaced the spiral of wages and prices.

This is not a hysterical story from far-left economists. The European Central Bank, where economists with mainstream economics training work, released a study two weeks ago that corroborated this story. According to economists from the European Central Bank, two-thirds of the rise in inflation last year was due to the profit and price spiral. Only a third of the wage spiral – price. Moreover, according to ECB economists, this phenomenon has not been limited to a few sectors (such as the energy sector) but has spread to almost all sectors. In 2023, agriculture, industry and the service sector have benefited from energy cost increases to boost their profit margins.

This is of course about averages. There are undoubtedly companies in all of these sectors that have failed to increase their profit margins. But the average company has it. This leads us to ask how this thing was possible. Here is an attempt at an answer.

The first element of the answer is the changing balance of power between employers (shareholders) and employees in both the US and the EU. Since the 1980s, we have noticed an increase in business concentration. This phenomenon has been extensively charted in numbers by two Flemish economists, Jan de Lucker and Jan Eckhot, among others. At the same time, we note the waning influence of trade unions. This shift in power from workers to employers has allowed for higher profit margins and a lower share of wages in GDP in most countries.

Against this historical background, we can understand recent inflationary developments. Created energy shock in 2021-22 window of opportunity To enhance profit margins. Usually it’s not so simple: if Company A increases its profit margin and Company B does not follow, Company A risks losing market share. However, the massive increase in energy costs has been a whistle-blower for all companies to increase their profit margins. If they all do this together, the negative market share effect will also disappear. This mechanism has been facilitated because most sectors are more focused than before.

Thus, inflation revealed a struggle for the economic value of the country. It seems that this battle is in favor of businessmen and shareholders.

What can be done about it? The European Central Bank continues its policy of lowering aggregate demand for goods and services by raising interest rates, in order to nip inflation in the bud. You will succeed. But there is a cost involved: recession with misery cannot be ruled out.

The ECB does not have the resources to address the causes of the profit and price spiral. The increasing concentration of the industry can only be addressed through a vigorous competition policy. This means that the government is aggressively reining in price agreements, restricting mergers and acquisitions and possibly forcing very large groups to split up. But here’s where the shoe pinches. The political will to do so has eroded over the years. Competition politics does not appear anywhere in the platforms of political parties anymore.