During the past two years, many of us suspected that the price increases were not only the result of higher energy and raw material prices, but also that some producers, suppliers and service providers raised their costs: either to make up for losses during the closures due to the coronavirus, or because , in order to increase the financial reserves for the worse times to come – write in their analysis the economists of ING, who already warned in the first stage of the rise in inflation that it will not be temporary.
The minutes of the February meeting of the European Central Bank (ECB) revealed for the first time that inflation has elements that are not linked to higher costs. The minutes said that profit growth remained very strong, suggesting that the pass-through of higher costs to higher selling prices remains strong. Therefore, the ECB emphasized that the evolution of profits and profit margins requires continuous monitoring and further analysis, on a par with the evolution of wages.
ING reminds that ECB analyzes are reported to show that profit margins in the Eurozone have increased rather than decreased. Consequently, in the euro area since 2021
the largest part of domestic price pressure was not caused by labor costs and taxes, but by profits.
The picture is similar in Germany: if the companies had simply passed on the higher producer prices, profits would hardly have increased, writes ING. In practice, however, starting from the second half of 2021, a significant part of the price increase can be explained by higher corporate profits. Official company profit data are not available, so they base their analysis on gross value added reduced by employee compensation as a surrogate, since gross value added results from employee compensation and company profit (and is already indirectly adjusted by the prices of input goods). At the same time, however, the gross added value also includes the depreciation of machines and investments, which are difficult to quantify.
The application of the above-mentioned methodology shows that the share of profit within the total gross added value has increased significantly in some sectors in the last three years.
According to the bank’s analysts, this suggests that German companies may further stimulate inflation.
In the construction sector, for example, the share of profit within gross value added increased by 22% between the fourth quarter of 2019 and the fourth quarter of 2022. In the trade, transport and hospitality sector, this value was 19%, while in agriculture it increased by 14%.
Margins have also grown significantly in the last three years, they point out. In particular, the margins of companies operating in the agricultural, construction, retail, transport and hospitality sectors increased significantly. While margins increased by 14% overall between the fourth quarter of 2019 and the fourth quarter of 2022, they increased by 63% in agriculture, 48% in construction, and 25% in trade, transportation and hospitality. In contrast, the margin in financial and insurance activities increased by only 0.2% and in information and communication by 4%.
In many sectors, higher margins were driven by profits – not employee compensation. While the 14% increase in the margin in the entire economy between the fourth quarter of 2019 and the fourth quarter of 2022 can be explained almost equally by the increase in employee incomes and profits, the increase in the margin in the agricultural sector, the construction industry, and the trade, transport and hospitality sector it can primarily be explained by the increase in profits, so it is not due to higher energy and raw material prices.
However, inflation in Germany and the euro area is no longer the result of a mere supply shock
– warns ING. On the contrary: over the past year, inflation started more and more from the side of demand. Not only are higher energy and raw material prices passed on to consumers, but the widening of profit margins in some sectors also contributes to inflationary pressure.
Whether this is “inflation of greed” in the purest sense of the word or other reasons are behind it, we cannot fully know – they write. However, according to them, it is clear that since both the profit-price and price-wage spirals are currently strengthening, core inflation remains stubbornly high, the ECB will continue to raise interest rates, at least until the summer, before keeping interest rates high for a while.
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