Profits don’t cause high inflation

09 March 2023

This opinion article by Business Council chief economist Stephen Walters was published in The Australian Financial Review on Thursday, 9 March 2023 

With inflation running at its highest level in decades, many thousands of Australians feel that life is getting harder. Everything from mortgage repayments to grocery bills seems to be growing. In this context, there’s no surprise that people are looking for answers.

The discussion about the causes of this inflation pressure is being hijacked, but the answers actually aren’t that  hard to find. In fact, they’re published regularly in the official statistics.

It’s convenient to point the blame at successful businesses, but the inconvenient truth is that inflation reflects very strong demand and constrained supply. Call me an economist, but it really is that simple.

There’s no denying corporate profits in some sectors are elevated.

But, it’s because commodity prices received by our world-class miners – who pay some of the highest wages in the country - have been at record highs.

We should welcome this – the budget certainly does.

In reality, the profit share of the economy outside mining - in other words, how much of the economic pie is made up by profits - continues to hover near record lows.

Claims that the squeeze on households is driven by price gouging or profiteering simply don’t stack up.

How is it that high prices for our exported iron ore are lifting measured prices in Australia, outside indirect impacts through higher national income?

Retail shoppers don’t lift a lump of iron ore off the supermarket shelf and take it home. Iron ore is not in the CPI basket.

High inflation is not uniquely an Australian phenomenon - prices are rising here for the same reasons they are rising around the world. In fact, inflation here is less acute than for those in the US and UK, where it pierced 9 per cent. Quarterly inflation here got to nearly 8 per cent – the highest in 33 years – but last week’s data showed it receding. We should welcome that, too.

Demand in the economy exceeds supply here for a few reasons, starting with substantial fiscal and monetary support delivered during the pandemic. Households are still sitting on cash reserves of $360 billion built up during COVID. There was huge pent-up demand during COVID, too, particularly for holidays and travel. The jobless rate last year was the lowest since Whitlam was Prime Minister.

On the supply side, the east coast floods destroyed food crops, leading to shortages. Natural disasters impacted labour markets, particularly for tradies. Many rushed north to help with the rebuild, pushing up labour costs, as did broader skill shortages. Job vacancies are almost double the pre-COVID level. There also were supply disruptions encountered during the pandemic, which are unwinding, albeit slowly. And, of course, there is the war in Ukraine, which lifted food, energy and fertiliser prices.

This all help explains why we still pay close to $2 a litre for petrol, and why you can’t find a chippy to fix the kids’ cubby house. Food and petrol together make up a fifth of the basket of goods measured for the consumer price index. Another large component is housing, where rents are soaring, for a combination of factors, including an acute shortage of housing.

Demonising companies for making profits may feel good for some, but no-one should want unsuccessful firms.

You can’t have it both ways. We can’t deliver higher living standards, full employment, decarbonisation and higher wages while denigrating companies and working to curtail the success needed to fund all this.

A no profit economy would be the low road to slower growth, lower wages, fewer jobs and falling living standards.

A telling statistic from the National Accounts was that private business investment fell last quarter, while productivity is languishing. Our economic dynamism is in retreat. Investment as a share of GDP is at recession-like lows. This is alarming. We need to turn the declines in productivity, investment and dynamism around … fast.

Companies employ six in seven Australians – anti-business rhetoric doesn’t help anyone. Nor does the fact that other countries are massively subsidising the energy transition, while we’ve suffered a decade of embarrassing policy failure. That loud sucking sound you hear is investment going to the US. Australia now invests more in the US than the US invests here. Europe and the Middle East are following the US on energy investment subsidies, while we squabble.

The Business Council has long advocated for a more competitive tax system, so companies have a better chance to compete. We must start to level the playing field. A 20 per cent investment allowance, for example, would lower the after-tax cost of capital for Australian companies. Our members tell us this would be a big win.

It wasn’t long ago that RBA Governor Phil Lowe was asking companies to lift their prices and pay Australians more. That was when inflation was low, persistently below the RBA’s target. Phil wanted wages growth with a “3” in front of it. Implicit in the governor’s plea was faster productivity growth – that’s difficult without a fully formed reform agenda.

At least private sector wages growth has accelerated – it now starts with a “3” and those getting a pay rise last quarter got a 4 per cent bump. Moreover, the National Accounts showed that wages paid in the economy – which also accounts for rising employment and hours worked – grew last year at the fastest rate since 2007. That healthy increase was facilitated by successful companies.

Those demonising corporate Australia can’t have it both ways – wanting higher wages for workers, which companies are paying, while saying firms aren’t doing their bit for national prosperity. Many of these businesses, in fact, will be central to decarbonising our economy. The investment task on this transition is mammoth, and decades long. We need our companies to succeed and be profitable.

It’s great to be debating important national policy issues. But a slanging match divorced from facts is not the way to go.

Stephen Walters is the Business Council of Australia's Chief Economist 


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