Everyone is talking about the cost of living, and it’s not hard to see why. A typical trip to the supermarket will cost about 8% more today than it did a year ago. Unsurprisingly, there’s a lot of argument about who, if anyone, is to blame for this, and what governments and the Reserve Bank can to do to help.
If we think, as commentators including Reserve Bank governor Philip Lowe would like us to do, in terms of a wage price spiral, it’s obvious that wages have not been driving the process so far. Real wages have fallen back to levels last seen in 2012. Despite this, Lowe and the RBA would like to hold wages down, in order to achieve a rapid reduction in inflation to the preferred range of 2-3%.
There are a couple of problems here. First, if wages aren’t driving inflation, it seems as if profits must be. But why is this? The term “greedflation” has been widely used, but it doesn’t seem that Australia’s corporate leaders are any more (or less) greedy than they were a few years ago, when inflation was running below 2%.
A more plausible explanation relates to what Rod Sims and other experts like Ross Garnaut have said; that Australia has a high degree of market concentration in many areas, notably supermarkets. Despite some limited competition from independent grocers and Aldi, Coles and Woolworths dominate the market. They have increased their margins substantially since the beginning of the pandemic.
Coles and Woolworths offer a curious double defence of their increased margins. On the one hand, reasonably enough, they observe that the prices they pay to their suppliers have increased. These increases, it seems must be passed on in full. On the other hand, they point to a variety of vaguely described reductions in their own operational costs, such as the end of costs related to Covid restrictions. Not mentioned is the fact that wages have barely moved, so that operating costs have fallen in real terms.
In a normal market, when all firms can achieve cost reductions, competition ensures that these reductions are passed on to consumers. These competitive forces are much less effective in an oligopoly or duopoly market, so the cost reductions can be captured as higher profit margins.
But the question arises again: why now? Oligopoly and duopoly were the rule before the pandemic when inflation was low. At an inquiry held by the House of Representatives standing committee on economics earlier this year, my colleague Flavio Menezes and I offered a partial explanation. Oligopolistic companies did not start the inflation but they did amplify it.
During the lockdown phase of the pandemic, households built up savings as a result of government aid and the simple fact that lots of avenues for spending were cut off. Once the restrictions were lifted, households started spending. It’s unsurprising that, when demand increases, prices rise. But, as we showed, firms with market power will increase their prices more than those in competitive industries.
On the other side of the coin, the combination of market concentration and slow-moving wage bargaining has made it easy for employers to hold wage growth well below the rate of inflation. Even where generous sounding wage increases, like the recent 8.6% increase in the minimum wage have been achieved, they have barely allowed wages to catch up with prices.
If governments really cared about the impact of the cost of living, they would support wage increases sufficient to maintain living standards, rather than fiddling with a few particularly noticeable prices, such as those for energy. In the longer term, a focus on promoting competition and an increase in home construction would resolve some of the biggest pressures on costs.
It is possible that the long-term rate of inflation might settle about 4%, instead of the Reserve Bank’s current target of 2-3%. But there is nothing magic about this target. It was picked arbitrarily in the early 1990s, for reasons that are no longer relevant. The low target has proved problematic at times. In particular, when interest rates were cut to zero during the lockdowns, monetary policy would have been more effective if inflation had been a little higher.
The Reserve Bank bitterly resists any such suggestion, because it would lose “credibility” as a result. Rather than focusing exclusively on inflation (the “cost of living”) it should pay a little more attention to the other two elements of its legal mandate: full employment and the living standards of the Australian people. And the government should get on with the business of tackling market concentration, which is not only fanning the flames of inflation but is allowing companies to reap record profits while workers and their families struggle to get by.
