It has been claimed, chiefly by Democratic politicians and their supporters, that the chief cause of the spike in inflation in the latter years of the Biden administration was “price gouging.” Real economic factors played a small part in pushing prices higher: it was mostly greedy producers raising their prices simply to line their own pockets.
There are two problems here. The first is that there is no explanation why the greediness of producers was suddenly effective. Let us suppose that producers as a whole are even greedier than the legendary Ebenezer Scrooge. We have no reason to think that they only got that way in 2022. But if they were just as greedy in 2019 as in 2022, why hadn’t they already raised their prices back then?
The second problem is that this theory assumes that producers can arbitrarily set whatever price they want. But this is just not true: each producer has to compete with all other producers for the consumer’s dollar. If I am selling, for instance, gasoline, and I set my price higher than that of other gas stations, my customers will leave and get their gas elsewhere. Even if we imagine that there is collusion on the part of all gas station owners to raise prices together, that does not mean they can set the price of gasoline arbitrarily high. That is because the demand for gasoline is not fixed. In the face of high gas prices, people can carpool, or take the bus, or ride a bicycle, or put off their family trip and spend time at home, or fly instead of driving home for Christmas. This reality is what Ludwig von Mises called the “connexity of prices.”
And to the extent that a cartel of gas station owners might all be able to raise their gas price together, we encounter the same question as above: why did they wait until 2022 to do so? No one has argued that a cartel suddenly formed in 2022.
To answer that question, we sometimes find the “excuse theory.” This theory first assumes that producers always wanted to raise the prices. (And that is generally true, just as workers generally want higher wages and people selling their homes hope to get the highest offers possible.) The second assumption is that, for some obscure reason, producers were waiting for a “good excuse” to do so. This assumption is a lot more dubious than the first. After all, if I think I can sell my house for half-a-million dollars, I don’t wait for a “good excuse” before asking for that much. If you find an employer who will offer you twice your current salary, do you need an excuse to take that job? The excuse theory handles that problem by supposing that corporations are afraid of public backlash for raising prices if they don’t have such an excuse handy. (However, given that there was a public backlash and accusations of “price gouging” anyway, it seems the excuse hardly served its purpose.)
Finally, this theory contends that the supply chain interruptions caused by the pandemic and the lockdowns provided just such an excuse. The problem with this story is that it is trying to navigate too narrow a passage between Scylla and Charybdis: on the one hand, if it steers too close to the supply chain interruption side of the story, Scylla’s rocks will smash it to bits and reveal the supply-side shock as a real cause of the price increases. But if it avoids Scylla it will be sucked down by Charybdis: if the supply chain interruptions were just “an excuse,” couldn’t these clever, greedy, and diabolical producers have come up with some other excuse in 2019 to raise prices back then?
The price gouging explanation for inflation comes to ruin based on an elementary principle of social theory: one cannot explain a change in social conditions (in this case, higher prices) by pointing to a cause which has not changed (in this case, producer greed).
A More Nuanced Case
A slightly more nuanced (but still grievously mistaken) case for higher profits causing inflation is made by the Economic Policy Institute. They write that:
The price of just about everything in the U.S. economy can be broken down into the three main components of cost. These include labor costs, nonlabor inputs, and the ‘mark-up’ of profits over the first two components. . . . Since the trough of the COVID-19 recession in the second quarter of 2020, overall prices in the [nonfinancial corporate] sector have risen at an annualized rate of 6.1%—a pronounced acceleration over the 1.8% price growth that characterized the pre-pandemic business cycle of 2007–2019. Strikingly, over half of this increase (53.9%) can be attributed to fatter profit margins . . .
Let us imagine that the EPI was addressing an outbreak of wildfires, rather than inflation. If they used reasoning similar to the above, we would find an argument like this: “All wildfires on the west coast of the U.S. occur in Alaska, California, Oregon, or Washington. Recently, there were extensive wildfires in Oregon. Therefore, the cause of the recent wildfires is wildfires in Oregon.”
It is true that when a price is paid for a product, the distribution of that payment can be divided into labor costs, non-labor costs, and a return to the producer, which EPI calls the “mark-up.” (True just so long as we remember that the return to the producer might be negative. Companies do lose money and go bankrupt quite regularly.) But it would be just as silly to take a rise in one of those components as the cause of the price increase as it would be to point to wildfires in Oregon as the cause of wildfires in the west.
Something else must have caused prices to rise before corporations could grab a large share of that price increase. Otherwise, we are back with our previous puzzle: if corporations have the ability to arbitrarily raise prices in order to increase their profit margins, then why did they wait until 2022 to do so?
The EPI is using a cost-based theory of pricing. But all such theories, for example, Karl Marx’s labor theory of value, are viciously circular, as they cannot explain why the cost of the inputs to a good are what they are. Marx, for instance, had to posit that the value of a good was determined by the labor that went into making it, but not just any labor. Otherwise, producers could drive up the price of a good simply by employing more and more labor to produce it. Obviously, a theory that argues that all labor contributes to the price of a good would imply that I could get paid more for this article by typing it with my toes, since that would involve more work than typing it with my fingers. Marx (to his credit) recognized this problem and created the category of “socially useful labor” in an attempt to handle it. But “socially useful labor” is just the labor that actually makes the good more valuable: So we have moved in a circle and have not explained the source of a good’s value at all.
The effort to escape from the circularity of all cost-based theories of price is what led to the great marginal revolution in economics in the 1870s. The marginalists realized that the price a consumer will pay for a good is determined by the usefulness (the marginal utility) of acquiring the next (the marginal) unit of that good. Producers’ costs do not matter to the consumer: we don’t pay more for tomatoes raised in Patagonia simply because it is so difficult to raise them there. Of course, costs are important on the market: If a good is not useful enough to consumers that they are willing to pay the cost of producing it, then no one will make it. We don’t find solid gold bathroom cabinets for sale at Home Depot because, although many people might like to have them, they simply don’t want them enough to pay for the enormous cost of making them. To the contrary, according to a cost-based theory of price formation, we ought to find them on the shelves at our local hardware store, and happily pay the enormous price, if costs determine prices.
In other words, the economic theory EPI is using is over a century-and-a-half out of date. But, to give them their due, it is an interesting question as to why so much of the price rise in our recent inflationary episode resulted in increased corporate profits rather than, say, increased wages. If the EPI had recognized that that was actually the puzzle that needed explanation, they might have zeroed in on policies that shut down many small businesses while allowing corporate behemoths to remain open.
We don’t need an implausible theory positing that greedy corporations suddenly woke up to the fact that they could set their “mark up” however high they wanted to explain our recent episode of inflation. “Unprecedented levels of fiscal and monetary stimulus” combined with a serious supply-side shock from the pandemic fully explain the price increases we recently witnessed.
