What inflation in 2022 will tell us about capitalism

By John Authers,

In 2021, inflation returned. After a year of debate, no one can deny it anymore. Next year, we’ll find out if he’s here to stay and how much bitter economic medicine will be needed to quell him.

Opinions are more divided than ever on this vital question. Optimists still maintain that while inflation turned out to be more than a transitory hitch, it will soon fade away. Whether they are right depends on the outcome of some of capitalism’s deepest conflicts.

A number of factors will indeed combine to bring inflation down next year. Used car prices have doubled and gasoline prices rose 50% last year. This will not happen again. The bottlenecks in world trade have already started to ease somewhat. And central banks have ample room to tighten monetary policy; So far, there has been no attempt to reduce demand by raising the price of silver or reducing its supply.

Read also | What 2021 has taught us about inflation

Encouragingly, the bond market expects inflation to barely exceed 2% in five years and the Fed’s interest rates won’t even rise that high. Consumer expectations are not very different. If they were to change and take root, then inflation would be difficult to dislodge. But for now, investors believe the price increases can and will be brought under control relatively painlessly.

Nonetheless, persistently higher inflation remains a possibility. Whether this happens will depend on two fundamental questions that have long plagued capitalism: Will labor gain a greater share at the expense of capital? And, if so, will companies absorb higher labor costs or pass them on to customers?

Labor for capital

Since the 1980s, capitalism has evolved to control inflation. The risk now is that capitalism will engage in regime change.

Labor’s share of GDP remained stable at just over 60% for the five decades following World War II. But it began to decline sharply after the dot-com bubble burst in 2000 and continued to decline after the 2008 financial crisis. As Ellen Zentner, chief economist at Morgan Stanley put it, the historically “unprecedented fall” “Labor share in GDP” marks a break in the fundamental structure of the economy.

The growing powerlessness of unions has made it more difficult for workers to bargain collectively. Demographics have also diminished their bargaining power. While the baby boom generation was of working age, the labor supply was plentiful. The ability of companies to outsource production to countries with lower payrolls, particularly China, has further held back wages, as has the influx of migrants from Mexico.

What was already a bad deal for the lowest paid turned terrible in the years following the 2008 financial crisis, as companies increasingly resorted to part-time workers who received fewer benefits and more. could be made redundant at lower cost. For several years under President Barack Obama, the wages of part-time workers were far behind those of full-time workers, and also behind inflation:

This malaise led to populist anger and the rise of President Donald Trump. Over the past year, however, the pandemic appears to have turned the job market upside down. In the wake of virus-related closings, job postings have reached near record highs as companies have tried and failed to fill low-paying jobs.

Low-skilled, undereducated and poorly paid people gained more bargaining power and used it. Now they are getting the best salary deals in a generation; their wages are rising faster than for the well paid and expensive to educate. The growth in wages of women and non-whites has exceeded that of men and whites.

Unfortunately for them, another trend has also been reversed. The extra wages they negotiated are nowhere near enough to cover the rapid rise in inflation. Data produced by the Federal Reserve Bank of Atlanta shows a sharp decline in real wages.

This gives workers even more pressure to push for higher wages next year, which would be crucial for built-in inflation. It was data like this that prompted Federal Reserve Chief Jerome Powell to say at the last central bank meeting of the year: “The job market is in many ways warmer than it is. it never was in the last expansion.

Who pays?

If the capitalists are forced to pay their workers a larger share of their income, they have two alternatives. One is to take the hit themselves, leave the prices unchanged, and settle for a tighter profit margin. The other is to pass wage increases on to consumers by raising prices, if they can.

Will they and do they have the power to do it? As Morgan Stanley’s Zentner puts it, this is the “needle point” time for the Federal Reserve, which aims to balance full employment with price stability. If companies decide to take the blow, the acceleration of wages should not be reflected in the rise in prices.

Until the last decade or so, history has provided clear indications. Over time, profit margins have been an almost perfectly cyclical mean reversion phenomenon. Margins improve when times are good and decline during recessions as companies choose to take some of the brunt of the economic downturn on their own.

But something has changed since the financial crisis. The margins of S&P 500 companies rebounded quickly after 2008, helped by stagnating wages. On the eve of the pandemic, margins had avoided a significant drop for a decade and reached a record high.

Since the pandemic, margins have moved further away from the traditional model, experiencing a slight decline (thanks to massive layoffs at the start) and now returning to reach a level of profitability never seen before.

At this point, however, companies need to recruit more people to increase production. And it looks like they won’t be able to do that unless they raise wages.

Executives assure investors that they are confident in their pricing power and Wall Street predicts that margins are expected to rise further next year. This is prompting complaints from politicians, who suggest that the concentration of heavy industry, thanks to mergers and acquisitions of recent decades, has left companies with the discretion to charge the prices they want.

This argument, long the stuff of academic papers and Davos panels, will come to a head next year. In recent decades, the balance of capitalism has tilted sharply in favor of capital. In particular, this had the effect of controlling inflation. Now, after a once-in-a-generation pandemic disrupted labor markets, workers, especially the lowest-paid, appear to be regaining their strength.

The story of inflation in 2022 will also be the story of whether the regime of capitalism is really changing and returning to an arguably healthier equilibrium. We should be watching prices not only for their impact on the economy, but for what they tell us about the future of our societies.

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