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A level Economics: UK's inflation is due to rise in corporate profit-taking

Figures give fuel to claims that profiteering has played a big part in the UK’s high levels of inflation writes Phillip Inman in The Guardian 


British companies have boosted their profitability, according to the latest official figures, insulating themselves against cost pressures and fuelling claims that profiteering has played a big part in the UK’s inflation story.

In a week when Joe Biden said he was only winning the war against inflation in the US because corporate profits were declining, figures released on Thursday by the Office for National Statistics showed UK business profits increased in the first quarter of 2023.

Manufacturing firms increased their net rate of return to 8.8% in the first quarter, from 8.4% in the fourth quarter of 2022. Services companies, which account for about three-quarters of economic activity, increased their net rate of return to 16.1%, an increase of 0.4 percentage points from the last three months of 2022.

The rate of return is a measure of profitability that shows the margin between operating profits and the cost of assets used to generate those profits. Unions have accused firms of putting up prices by more than the rise in their costs, a trend nicknamed greedflation.

It is a hot topic because the Bank of England has consistently said the small ups and downs registered by the ONS in its calculations of corporate profitability show little evidence of profiteering. It has repeatedly urged workers to restrain wage demands and played down the need to tell companies to restrain price rises.

On the other side of the argument stand a growing number of academics, thinktanks and unions.

The TUC general secretary, Paul Novak, said he was shocked by the ONS figures, which he claimed showed “a culture of entitlement is alive and well” among the large corporations that he said were mostly to blame for higher prices.

Sharon Graham, the head of the Unite union, arguably credited with doing more than anyone in the UK to promote research into corporate profits, said companies were exploiting a crisis.

Philip King, a former government adviser and small business commissioner until 2021, said many small and medium-sized companies would wonder what the fuss was about. He said it was clear from the figures that “companies are maintaining their profitability despite the difficult trading conditions they have faced”, and it was large businesses that would be to blame. These “typically have more flexibility when it comes to increasing prices and cutting costs”, he said.

The International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD) and many leading academics say steady profit margins show businesses are doing better than any other participants in the economy, in particular workers.

An OECD report last month found average profit margins in the UK increased by almost a quarter between the end of 2019 and early 2023. Stefano Scarpetta, a director of the OECD, said it was “somewhat unusual that in a period of slowdown in economic activity we see profit picking up”.

George Dibb, an economist at the IPPR thinktank, said the Bank of England was “plain wrong” to consider steady profit margins a non-story.

On closer inspection the headline average is if anything worse than it first appears. Overall, the net rate of return for all non-financial businesses – a measure that excludes banks and insurance companies but includes North Sea oil and gas firms – increased from 9.8% in the last quarter of 2022 to 9.9% in the first quarter. That shows margins remained consistent through one of the worst winters for cost of living rises and cuts in disposable incomes for several generations.

However, excluding North Sea oil and gas firms, which showed a slump in profitability in the first quarter as energy prices fell from their peaks, dragging down the average, the level of profitability for most firms jumped from 9.6% in the last quarter of 2022 to 10.6% in the first quarter of 2023.

Richard Murphy, a professor of accounting at the University of Sheffield, said low wage rises in most sectors outside financial services meant large companies were probably doing much better than smaller ones.

Murphy said half of all UK company profits were generated by small and medium-sized companies and the other half by a few thousand larger firms.

Another interest rate rise is expected next month and the main reason given by the Bank will be that wages are rising too quickly, not that profits are rising too quickly. It is a stance that is going to become increasingly contentious.

A Level Economics 86: Zero or Low Inflation?

Governments target low levels of inflation instead of aiming for zero inflation (no inflation) for several reasons:

1. Price Stability: Low levels of inflation provide a degree of price stability, allowing businesses and individuals to plan and make economic decisions with more certainty. Moderate inflation encourages spending and investment, as consumers and businesses are motivated to avoid holding onto cash that loses value over time.

2. Avoiding Deflationary Spirals: Targeting a low, positive rate of inflation helps prevent deflation, which can be harmful to the economy. Deflation can lead to falling demand, reduced business profits, and negative expectations about the future, triggering a deflationary spiral that can be difficult to reverse.

3. Interest Rate Management: Having a small positive inflation rate allows central banks to use interest rates more effectively to control economic conditions. When inflation is too low or negative, central banks may reach the "zero lower bound," limiting their ability to further lower interest rates during economic downturns.

4. Nominal Wage Flexibility: Moderate inflation helps facilitate nominal wage adjustments in the labor market. Wages are typically sticky downward, meaning that employees are reluctant to accept nominal wage cuts. With moderate inflation, real wages (wages adjusted for inflation) can adjust downward more smoothly without actual cuts in nominal wages, allowing labor markets to respond to changes in economic conditions.

5. Balancing Debt Burdens: Low inflation helps reduce the real burden of debt. In economies with significant public and private debt, moderate inflation allows debtors to pay back loans with money that has lower purchasing power, easing the overall debt burden.

Winners of Low Inflation:

1. Savers and Lenders: Savers and lenders benefit from low inflation as the real value of their savings and lending returns is better preserved. They avoid the erosion of purchasing power that occurs during periods of high inflation.

2. Debtors: Borrowers benefit from low inflation as it reduces the real burden of their debts. They can pay back loans with money that is worth less in real terms, effectively reducing the real cost of borrowing.

Losers of Low Inflation:

1. Fixed-Income Earners: Individuals with fixed incomes, such as retirees living off pension funds, may struggle to maintain their purchasing power during periods of low inflation. Their incomes do not keep pace with rising prices.

2. Central Banks in Deflationary Situations: When inflation is too low or negative, central banks may face challenges in stimulating the economy through conventional monetary policy tools. This can limit their ability to address economic downturns effectively.

3. Economies in Deflationary Spirals: Low inflation can increase the risk of deflationary spirals, which negatively affect businesses and consumers. Falling prices can lead to postponed spending and reduced investment, perpetuating economic stagnation.

In summary, governments target low levels of inflation to maintain price stability, avoid deflationary risks, and enable more effective monetary policy management. While low inflation benefits savers and lenders and reduces the real burden of debt, it may adversely affect fixed-income earners and pose challenges for central banks and economies experiencing deflationary pressures. Striking a balance between price stability and supporting economic growth is essential for achieving sustainable economic performance.

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Yes,in theory, zero inflation would offer more price stability than a low level of inflation. With zero inflation, the general price level of goods and services would remain constant over time, providing the most stable prices for consumers and businesses. However, achieving and maintaining exactly zero inflation can be challenging and may not always be the most desirable target for central banks and governments. Here's why:

1. Deflation Risk: The pursuit of zero inflation can increase the risk of deflation, which is a sustained decrease in the general price level. Deflation can be harmful to the economy, as it can lead to falling demand, reduced business profits, and negative expectations about the future. Deflationary spirals can be challenging to reverse and can result in economic stagnation.

2. Nominal Wage Stickiness: Wages in the labor market are often sticky downward, meaning that employees are reluctant to accept nominal wage cuts. In a scenario of zero inflation, real wages (nominal wages adjusted for inflation) could be more rigid and unable to adjust downward. This may lead to higher unemployment, as businesses may not be able to adjust labor costs efficiently during economic downturns.

3. Interest Rate Management: In a low-inflation or deflationary environment, central banks may face difficulties in using interest rate policy effectively. Interest rates already near or at zero, known as the "zero lower bound," can limit the central bank's ability to further lower rates to stimulate economic activity during downturns.

4. Avoiding Economic Stagnation: A small positive rate of inflation, often targeted by central banks (e.g., 2% inflation target), can provide some buffer against deflation and help avoid stagnation. Moderate inflation encourages spending and investment, as consumers and businesses are motivated to avoid holding onto cash that loses value over time.

5. Monetary Policy Flexibility: A low, positive rate of inflation allows central banks to use interest rates more effectively to manage economic conditions. They can implement conventional monetary policy tools to adjust interest rates in response to changes in the economy.

In practice, many central banks aim for a low, positive rate of inflation rather than zero inflation. They typically target inflation rates around 2%, which allows for some price stability while providing a buffer against deflationary risks. A moderate and stable rate of inflation can facilitate nominal wage adjustments, allow for more flexible interest rate management, and avoid the adverse effects of deflation. Striking a balance between price stability and supporting economic growth is a key consideration for monetary policy and inflation targeting.

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The definition of "low inflation" is not fixed and can vary depending on the context and the specific economic conditions of a country. It is not a scientific term with a standard numerical value universally applicable to all economies. Instead, what constitutes "low inflation" is often a normative judgment made by policymakers and economists based on the desired economic outcomes and the prevailing economic circumstances.

Subjectivity of Low Inflation: What may be considered low inflation in one country or at a particular time may not be deemed as such in another context. Policymakers, central banks, and economists typically consider various factors, such as historical inflation trends, long-term economic growth objectives, and the overall stability of prices, when determining the target level of inflation.

Examples of Target Inflation Rates:

1. United States: The Federal Reserve, the central bank of the United States, has a dual mandate of promoting maximum employment and stable prices. It has typically targeted an inflation rate of around 2% as conducive to economic growth and stability.

2. European Central Bank (ECB): The ECB, responsible for monetary policy in the Eurozone, aims to maintain inflation below, but close to, 2% over the medium term. This target is based on the belief that a moderate level of inflation is beneficial for economic activity and helps avoid deflationary risks.

3. Japan: The Bank of Japan (BOJ) has had difficulty achieving its target of 2% inflation amid decades of deflationary pressures. In response, the BOJ has implemented aggressive monetary policies to combat deflation and boost inflation expectations.

Evaluating the Normative Nature of Low Inflation: The normative nature of low inflation means that there is ongoing debate and differing viewpoints on what the ideal inflation rate should be. Some arguments in favor of low inflation include:

1. Price Stability: Low inflation contributes to price stability, making it easier for households and businesses to plan and make economic decisions without significant concerns about rapidly changing prices.

2. Wage and Price Stability: A moderate and stable inflation rate allows for nominal wages and prices to adjust more smoothly, facilitating labor market flexibility and resource allocation.

3. Avoiding Deflation: A target for low inflation helps avoid deflationary pressures, which can be harmful to economic growth and can lead to negative expectations and delayed spending.

On the other hand, some economists and policymakers argue that there are potential drawbacks to persistently low inflation:

1. Deflationary Risks: If inflation consistently falls too close to zero or turns negative, it can increase the risk of deflationary spirals, leading to economic stagnation and challenges in policymaking.

2. Monetary Policy Constraints: Extremely low inflation can reduce the effectiveness of conventional monetary policy tools, such as lowering interest rates, especially when interest rates are already close to zero (zero lower bound).

3. Real Debt Burden: Very low inflation can increase the real burden of debt, making it more challenging for borrowers to service their debts.

In conclusion, the definition of "low inflation" is subjective and varies across countries and economic circumstances. It is typically a normative judgment based on the desired economic outcomes and the prevailing economic conditions. While low inflation is generally viewed as conducive to economic stability, there are ongoing debates on the ideal inflation rate and the potential drawbacks of persistently low inflation, such as deflationary risks and limitations in monetary policy effectiveness. Striking the right balance between price stability and supporting economic growth remains a key challenge for policymakers.

A Level Economics 24: Migration and Labour Markets

Migration can have significant impacts on labor markets, both in the origin and destination countries. Here are some key effects of migration on labor markets:

1. Labor Supply:

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   • Increase in Available Workers: Migration can increase the overall labor supply in destination countries. Migrant workers bring additional skills, qualifications, and labor resources that can fill gaps in specific sectors or occupations facing labor shortages.
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   • Impact on Wages: The increase in labor supply due to migration can affect wages, particularly in sectors with a high concentration of migrant workers. If the labor supply increases more rapidly than the demand for labor, it can put downward pressure on wages in those sectors.
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   • Complementarity and Substitutability: Migrant workers may possess skills and qualifications that complement the existing workforce, leading to improved productivity and specialization. Conversely, they may also be seen as substitutes for native workers in certain occupations, leading to increased competition for jobs.

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3. Labor Demand:

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   • Fill Skill and Labor Gaps: Migration can help address skill and labor shortages in certain industries or occupations. Migrant workers can contribute to meeting the demand for labor in sectors where there is a lack of local workers with the required skills or willingness to work in those roles.
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   • Sectoral Effects: Migration patterns can influence the composition of labor demand in different sectors. For example, sectors such as construction, agriculture, and healthcare often rely on migrant labor to meet seasonal or specific industry demands.
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   • Entrepreneurship and Innovation: Migrant workers may bring entrepreneurial skills, innovative ideas, and cultural diversity to the labor market, contributing to economic growth and fostering business development.

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5. Wage Differentials and Remittances:

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   • Wage Differentials: Migration can contribute to reducing wage differentials between origin and destination countries. Migrant workers often earn higher wages in destination countries compared to what they would have earned in their home countries, which can help bridge income gaps and improve living standards.
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   • Remittances: Migrant workers frequently send remittances, which are monetary transfers sent back to their home countries. Remittances can have positive effects on the labor markets of origin countries by increasing household incomes, stimulating local consumption, and potentially supporting investment in education, housing, or small businesses.

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7. Skill Drain and Brain Gain:

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   • Skill Drain: The emigration of highly skilled workers from origin countries, often referred to as brain drain, can lead to skill shortages and loss of human capital in those countries. This can negatively impact labor markets and hinder economic development in the origin countries.
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   • Brain Gain: On the other hand, migration can also result in brain gain for destination countries. Highly skilled migrants can contribute their expertise, knowledge, and innovation to local industries, research institutions, and the overall economy, leading to positive labor market outcomes.

It's important to note that the impacts of migration on labor markets can vary depending on factors such as the scale and composition of migration, labor market institutions, policy frameworks, and the social and economic context of both origin and destination countries. Careful management and policies that consider the needs and challenges of both native and migrant workers are essential to harness the potential benefits of migration while addressing any associated concerns or disruptions in labor markets.