How company profits are keeping prices high

When major oil companies announced record earnings in February, even US President Joe Biden was appalled. The White House said it was "outrageous" that ExxonMobil had raked in a profit of $56 billion (€51 billion) in 2022 as consumers were grappling with inflation rates not seen in decades.

Top policymakers in Europe have also weighed in on the issue, imposing windfall taxes on energy firms. Even though price pressures have eased lately from their record levels, the eurozone is still reeling from elevated inflation levels. Consumer prices in the common currency area rose 6.9% in March from a year earlier, keeping inflation at more than three times the European Central Bank's target of 2%.

What is causing inflation?

The reopening of the economy after the COVID-19 pandemic resulted in pent-up demand even as supply disruptions caused by lockdowns persisted. The high demand coupled with supply troubles fueled inflation. Consumer prices climbed further after Russia's invasion of Ukraine which sent energy and food prices soaring. 

While the impact of the reopening has largely faded out and supply bottlenecks have eased, inflation still remains stubbornly high.

Policymakers are concerned that increased profit margins may have a big role to play.

Speaking at a conference in Frankfurt last week, Fabio Panetta, a member of the ECB's executive board, put up a remarkable chart. It showed how companies' profits in the eurozone rose faster than wages.

"Opportunistic behavior by firms could also delay the fall in core inflation," Panetta said. "We should monitor the risk that a profit-price spiral could make core inflation stickier," he added with an apparent wordplay on the much dreaded wage-price spiral.

According to a Reuters report, consumer goods companies in Europe boosted operating margins to an average of 10.7% in 2022, up by a quarter over 2019, before the pandemic.

"Companies in certain sectors have been able to take advantage of the state of emergency of pandemic and war to raise prices in ways that are not possible in normal times. When prices rise more than costs, profit margins increase," Isabella Weber of the University of Massachusetts Amherst told DW.

Ulrich Kater, chief economist at Deka Bank, says it was the fog of uncertainty during the pandemic and war that led companies to hike prices.

"You want to implement a safety margin so that you are not buried by the cost increases afterward," he told DW.

Wage growth trails rise in profits

In the United States, companies are now recording the highest profits since the end of World War II. That is according to a recent study by Weber, who also masterminded the German cap on energy prices.

In Europe, "the effect of profits on domestic price pressures has been exceptional from a historical perspective," economists at the ECB wrote in a blog in March. Profit growth outstripped wage growth especially in agriculture, manufacturing, trade, transportation and food and mining and utilities, according to ECB calculations.

With an eye on recent profits driving up inflation, Weber said supply-chain disruptions have altered competition dynamics. Usually, consumers can switch to other suppliers if a company hikes prices to maximize profits, Weber explains, but "if all competitors know that the competition cannot serve their own customer base, a price increase does not threaten the loss of market share as it would otherwise."

Will inflation be lower in the future?

The ECB expects high inflation to eventually taper off in the eurozone. It expects price increases to come down to 2% annually by 2025.

"The fact that profits have risen more than wages so far doesn't mean that has to be the course going forward," Kater said.

For Weber, companies' ability to set prices is alarming and it needs to be checked. She said laws that limit excessive price increases by corporates, such as the proposed revamping of a price gouging law in New York, could be a part of the solution. The rules prohibit companies from taking advantage of a crisis to charge excessive prices for essentials.

Additionally, antitrust authorities would have to check for price manipulation if suspicions of market dominance were to manifest, Kater adds.

On Wednesday, the German government opted to strengthen its antitrust agency. Robert Habeck, the economy minister, had initiated the move last year after fuel prices had remained stubbornly high.

Mathis Richtmann is a business journalist with Deutsche Welle. 

Disclaimer: This article first appeared on DW, and is published by special syndication arrangement.