(Bloomberg Opinion) -- On Tuesday Senator Elizabeth Warren offered Federal Reserve Chair Jerome Powell an impromptu lesson in what she termed “Econ 101.” Through a series of leading questions, she argued that lack of competition was a major factor behind the rise in prices that Americans have experienced over the last year.
It’s a claim Warren has made before. As an example, she pointed to the fact that grocery-store profits have swelled during the pandemic — something that, she said, shouldn’t happen in competitive markets.
In economic terms, this misses the mark. In any real-world market, a temporary surge in demand will tend lead to a temporary rise in profits. This is true even if sellers keep their prices the same: Increased sales volume, with the same workforce and other overhead costs, will lead to increased profits.
Economics also suggests that those higher profits would induce businesses to try to hire more workers, stock more inventory and, eventually, open more stores. The first two are precisely what happened in the U.S. economy in the last year, and are why both job openings and port traffic rose in 2021.
And it’s competition between retailers, for workers and inventory, that’s led to record growth in wages and soaring commodities costs. If lack of competition were the problem, then higher demand at retailers would not flow through to higher demand for wholesalers.
Indeed, it’s precisely by restricting sales that monopolists are able to obtain permanently higher profit margins. Restriction is the opposite of what the economy has seen.
This isn’t the first time Democrats have cited corporate greed as a reason for rising prices. At a hearing last year, Senator Sherrod Brown blamed inflation on corporations that would rather pass costs on to consumers than cut into profits. President Joe Biden’s administration, meanwhile, has blamed rising gas prices on OPEC and collusion among U.S. refiners, while ignoring its own efforts to discourage fracking — the single biggest factor keeping oil prices down over the last decade.
Individually, these efforts often end up being little more than a nuisance to industry. Nothing has come of the administration’s investigation of oil refiners, for instance. Collectively, however, these efforts create two major problems.
First, there is the climate of uncertainty that actually depresses supply. When senators incorrectly draw a line from elevated profits to malfeasance, they discourage investment.
Having seen the pressure that current demand puts on supply, firms could invest in excess capacity. That investment would then be rewarded with higher sales during the next demand surge, and ideally higher profits. But firms may hesitate to make those investments if they fear they will bring congressional scrutiny.
Second, and more important, these efforts distract from the central role that overall demand plays in inflation — and allow politicians to avoid coming to grips with the new reality. For years it has been clear that the U.S. economy is operating below capacity, and that more spending could be met with more supply. Those days are coming to an end.
This is a good thing — that tightening of capacity that has created an unprecedented surge in job openings and bargaining power for workers. It comes with a price for Democrats, however: If inflation is not transitory, then what happens to their plans for even greater spending? That’s the kind of economics question Warren should have asked Powell.
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- John Authers on the inflationary headwinds facing the U.S. economy in 2022
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a Bloomberg Opinion columnist. He was formerly vice president for federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina. He is also co-founder of the economics blog Modeled Behavior.
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