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Research from the OECD shows businesses have been the big beneficiaries of inflation so far, but the tables may be starting to turn.
Key points:
- OECD research shows that unit profits made up a greater share of price increases than unit labour costs during the pandemic
- Labour costs started accelerating last year and the OECD warns they are now rising with profits
- The employee share of national income remains near historical lows with the profit share near highs
In its latest Economic Outlook, published this week, the Organisation of Economic Cooperation and Development devoted a section of the report to look at which sector has contributed most to inflation — workers, businesses or governments.
The research uses the same methodology as a paper published earlier this year by left-of-centre think tank the Australia Institute, which argued that businesses were mostly to blame for Australia's high inflation rates.
However, this research comes from the Paris-based developed economy think tank currently led by former Liberal finance minister Mathias Cormann.
Its conclusions for Australia are broadly similar, showing that unit profits accounted for a large proportion of price rises over 2021 and early 2022, with unit labour costs only starting to capture a significant share of price increases towards the end of last year.
However, as with the Australia Institute research, which was criticised by the Reserve Bank amongst others, economists have urged caution in interpreting these results.
"That tells you more about who benefits or not from inflation, and not what caused the inflation," explained Professor Chris Edmond, who teaches economics at the University of Melbourne.
And, for resource exporting economies like Australia, the use of the GDP deflator as the inflation measure, rather than the Consumer Price Index, tends to capture the big swings in export prices that boost profits here, but not domestic prices to the same extent.
"Our GDP deflator is quite sensitive to changes in iron ore and coal prices," explained Monash University economics lecturer Dr Zac Gross.
"So, you can see very large swings in the GDP deflator based on what happens overseas in commodity markets, driven by demand from, say, China."
The OECD found this in its research.
"A significant part of the unit profits contribution has stemmed from profits in the energy and agriculture sectors, well above their share of the overall economy, but there have also been increases in profit contributions in manufacturing and services," the report noted.
"A large part of the higher unit profits contribution originates from mining and utilities, even in commodity-importing economies."
The OECD did note with some concern that both profits and labour costs were climbing for much of the period, particularly last year, in a way that had not been seen since the stagflationary period of the 1970s.
However, it also noted that wage pressures were nowhere near the levels seen during that era.
"The recent period – so far at least – is unlike the 1970s in that GDP inflation was generally much higher in the 1970s, notably on account of stronger increases in unit labour costs," the OECD observed.
The organisation also noted the unusually large direct effect on inflation from government COVID subsidies and their withdrawal.
"While it is usually stable and small, the contribution from unit taxes was particularly volatile following the COVID-19 shock, reflecting pandemic-related subsidies that have subsequently been phased out and changes in the composition of expenditure, particularly household consumption," the report added.
'Generational project' to unwind business gains
However, while many economists argue the data provides no evidence that corporate profits have caused inflation, Professor Edmond said there is little doubt business owners (including shareholders) have been both recent and longer term beneficiaries from receiving a rising share of national income.
"The profit share, or the non-labour share, of income has been rising in many countries for a long period of time, since the 1980s basically, in most countries," he told ABC News.
"The non-resources rise in Australia has been perhaps more modest until relatively recently."
Previous research from the Reserve Bank suggested that, outside resources, financial corporations and real estate had been the main sectors that had seen a notable shift upwards in their share of national income, as the employee share fell from highs above 60 per cent for much of the 1970s to lows below 50 per cent in recent years.
Professor Edmond said that, to reverse that longer term trend, you would need to start seeing real pay rises that were above labour productivity growth.
In normal times, with inflation averaging 2.5 per cent and productivity growth of 1-1.5 per cent, that would mean annual pay increases of at least 4 per cent over many years to restore labour's share of national income to historical averages.
"I would be very sympathetic to a view that said, 'that's what we need'," he said.
"It's very, very challenging to try and do that simultaneously with while we're living through an inflationary blip, right?
"Precisely because the concern that a period of higher-than-normal nominal wage growth might feed through to prices and make it harder for inflation to be controlled, and mean that real interest rates need to stay high for a longer period than normal is not a ridiculous concern.
"I think of that as almost a generational project."
However, the March quarter National Accounts released earlier this week showed that pay rises were accelerating and outstripping productivity, which fell.
Combined with a slide in commodity prices from recent peaks, that is likely to see the distribution of national income tilt slightly back towards workers compared to business owners, albeit still well below historical averages.
Unfortunately, this recent shift is more indicative of a turn in the business cycle, as rate hikes started biting hard across much of the economy.
"The profit share is like a leading indicator of the business cycle," Professor Edmond observed.
"It tends to be rising relatively rapidly early in a boom, and then it tends to be falling. It's a leading indicator of the economy beginning to turn around and perhaps slow down.
"The recent accounts are kind of broadly consistent with that."
Ultimately, that will not be good news for anyone if workers simply end up with a growing share of a shrinking economic pie.