All About Inflation
A combination of pandemic-era supply chain issues and corporate price gouging is creating the highest inflation numbers in decades. With prices rising ever-higher, resolving this issue is critical for the economic well-being of America.
The biggest story in economics right now is, undoubtedly, the dual problem of inflation and shortages. With inflation running at four-decade highs and many store shelves running empty, these intertwined issues have taken over America (and, to some extent, the entire world). After a significant drop in 2020, annual inflation spiked up to around 5% in May of 2021. As 2022 began, inflation spiked again to our current rate of 7.5% year-over-year. High inflation is a significant problem for every American, as it saps the value of their wages away. Identifying the causes behind price increases, and how we can stop them, are critical issues for our economy.
The two primary reasons for the current inflation situation are supply chain issues and price gouging. Most Americans are by now aware of the significant issues in international shipping and logistics. Scenes of dozens of giant cargo ships lined up along coastlines were common throughout 2021, and ships still have to wait weeks in queue to unload. But what led to this and other problems in getting goods into customers hands? In the beginning of the pandemic, there was a sharp drop-off in spending as people hunkered down into quarantine. Companies then cut back production anticipating a prolonged recession (or shut down due to coronavirus restrictions). By the end of 2020, though, consumer spending started to rebound. Inventories soon emptied, and firms had to ramp up production way faster than they expected. The shift in spending from services (which had all shut down) to goods also meant that demand for manufactured products was much higher than usual. Producers also had to deal with customers (both households and other companies) who were eager to spend much more since they had cut back earlier in the year. This basic mechanism—suppliers on their back foot as demand soared—sparked the supply chain crisis, but other issues aggravated it.
Since America imports an extreme share of its manufactured goods, those products need to be shipped internationally. Global logistics relies on huge cargo ships full of metal shipping containers, which suffered a unique crisis in 2020. As the pandemic hit, ships were recalled and containers were left behind. Unfortunately, many containers were stuck in import locations like the United States. As exporters, such as China, reopened production, the containers they needed were halfway around the world. Even though the number of containers was adequate, there were shortages in the places that needed them most. As a result, prices for containerized shipping skyrocketed, and any goods shipped internationally became much more costly. Cargo ships also faced problems at ports. In recent decades, ships have grown larger and larger, so they can only unload at the small number of ports large enough to handle them; case in point, the twin ports of Los Angeles and Long Beach handle 40% of all US imports. Even worse, decades of underinvestment and organizational issues left American ports fragile and prone to congestion. The executives of international logistics decided to fit all their goods through a very small and worn-down funnel, and the results have been disastrous for supply chains.
Labor shortages have also amplified supply issues. The trucking industry, in particular, has seen significant shortages in drivers. For decades, the industry has cut or stagnated driver pay and increasingly classified them as contractors rather than employees. Unionization in the industry has fallen off a cliff. While many drivers can still make salaries above $50,000 (if they’re not misclassified as an independent contractor), they must work significant overtime to get there—in a job that is relatively inhospitable. These declining labor conditions have created a situation where turnover in trucking has reached almost 100% per year. Maintaining staffing with that level of quits is near-impossible.
Broader labor issues have contributed to the shortages. After many businesses laid off employees or went bankrupt in 2020, rehiring has consistently lagged behind consumer demand. Conversely, many workers temporarily stopped looking for work at the height of the recession. Workers soon started returning to the labor force, but it's hard to overcome that economic inertia; many people chose to permanently retire, as well. The continuing pandemic has elevated the amount of workers out sick. These trends were especially prevalent during the omicron wave, where increased infections led to massive staff shortages. These economic-wide issues compounded into a shortage of our most crucial input: labor. Supply chains were hampered as a result.
The supply chain crisis has enabled the second major cause of inflation: market manipulation. Since the pandemic, we have seen powerful corporations exploit their economic influence to markup prices and pad out their bottom line. The shipping industry is especially prone to this exploitation. Around 80% of ocean freight is controlled by just three shipping alliances. There are just seven major railroad companies in the US, and, at the local level, duopolies and monopolies are common. This level of consolidation breeds price gouging and monopolistic practices. Thes industries have seen their prices soar, and it is hard to imagine that none of this markup is profiteering.
In a more broader sense, it seems companies across the economy are exploiting circumstances to increase their profits. Corporate profit margins are now at 70-year highs. This creates a curious contradiction. Corporations are saying they are desperate and need to raise prices, but their profitability is exploding to levels not seen in our lifetimes. The apparent contradiction disappears when you realize that inflation is being used as a cover for price gouging. It’s true that expenses are rising, but corporations are raising prices faster than costs so they can skim extra profits off the top of inflation.
Digging into inflation data, some of the items with the highest price increases have clear ties to monopolistic practices. By far, the biggest inflation has occurred in petroleum products. This inflation is easily explained by manipulation. Oil production is heavily controlled by OPEC, a cartel that conspires to maximize the profits of its members. In 2020, OPEC instituted a cut in oil production. Since then, the cartel has suppressed production even as demand grows. The end result is much higher prices. Energy companies in the United States have also taken advantage of this situation. After years of near-recklessly investing in new fracking ventures, the industry has refused to expand production in the past few years. Even as energy prices rise (which creates greater profit opportunities for production growth and which precipitated investment in previous years), companies have kept production mostly flat. Deals made with financiers on Wall Street are a major factor; investors' desire for high profits are an explicit reason for this policy. Frackers can rake in revenue by keeping supply low, and so they are.
Meat prices have been another major cause of inflation. Here, too, market manipulation is present. The beef meatpacking industry is controlled by just four corporations who command an 80% market share. In the past few years, the price consumers pay for beef has skyrocketed, but the ranchers raising cattle have not seen their revenues increase. The difference is instead being pocketed by the meatpackers. One of the corporations, JBS Foods, had to settle a price gouging lawsuit just a few weeks ago. The plaintiffs alleged that JBS had conspired to suppress beef production to raise prices—clear market manipulation by an oligopolistic firm. Other markets, such as chicken and pork, face similar oligopolies in their meatpacking sectors; heavy consolidation is a big reason why meat prices have risen so much.
These two forces, supply chain backlogs and price gouging, are the root causes of inflation in the United States. The backlog that began because of the pandemic caused shortages and delays, and profiteering corporations exploited the situation once it arose. Given the complexities of global logistics, the supply chain backups are likely to last longer than initially predicted. Corporate attempts to price gouge will also prolong the issue. There will also be an inertia effect; companies will start to expect continued price increases and build inflation into their business plans. Regular markups will become routine—if the inflationary cycle is not stopped.
There is an alternative explanation for inflation being pushed by politicians and pundits. In this contrasting view, it is not the decentralized forces of supply chains and price gouging generating price increase; rather, actions by central governments created the problem. They allege that massive fiscal stimulus packages and excessive monetary policy created our current inflationary environment. This hypothesis makes intuitive sense, but evidence disproves it. Countries like Germany and Japan had much larger stimulus packages than the United States (relative to the size of their economies) but saw lower inflation. Looking internationally, there is a weak correlation between stimulus spending and the increase in inflation.
If you dig into the specific components of inflation, it is easy to see that supply chain and price gouging factors are predominant. The Bureau of Labor Statistics releases detailed breakdowns of inflation by specific categories. This data allows us to see which items are really driving inflation. The following are the components that saw annual inflation greater than the overall inflation figure of 7.5%: Meat products, fuel oil, motor fuel, electricity, utility gas service, new vehicles, and used cars and trucks. These are the items that are driving inflation (as they are the only ones above the weighted average), and we know the reasons for these increases. Meat products were price gouged by monopolistic meatpackers. Oil and gas production was suppressed by OPEC and profiteering frackers. Vehicles are in short supply primarily because of a supply chain backup in semiconductors. Government stimulus and low interest rates did not create these dramatic price increases; the failures and manipulation of the private economy did.
None of this is to say that stimulus measures had no effect on inflation. By their very nature, stimulus packages and expansionary monetary policy put upward pressure on prices. It is also fair to say that the Federal Reserve and Biden administration have been too slow to react to inflation. However, stimulus alone is not the reason we have over 7% inflation. Considering the effect of supply chain problems and corporate price gouging (especially on the items driving inflation the most), government policy likely accounts for just a small component of our annual inflation—especially because the last COVID package passed almost a year ago, and most of the stimulus came in 2020. It is simply a fact that supply chains have faced massive backlogs in the past two years, and this hiccup was not government-made; the pandemic did that. We would see higher costs regardless of what the government did. Critics of the government also have to account for what would have happened if stimulus measures were weak. The unemployment rates around 20% and the massive spikes in poverty and hunger our country saw in 2020 were categorically unsustainable. A recession that was prolonged would have created a multi-year humanitarian crisis. Government intervention ended these catastrophes, and anyone saying the stimulus was too much has to understand that they would just be trading slightly lower prices for significantly higher financial struggles.
No matter the exact causes, inflation needs to be dealt with. The Federal Reserve is best-equipped to rein in prices. Ending their expansionary policy and gradually raising interest rates is the best policy going forward, and the Fed has already started on this process. In the next few months, Fed officials can decide how aggressive their rate hikes should be to bring down inflation without hurting employment numbers and production. Given that their target interest rate is still near zero, the Federal Reserve has a lot of room to maneuver. These monetary measures will curb inflation at least somewhat. Unfortunately, the root causes of inflation will remain. Until the supply chain crisis—and the opportunist price gouging based on the backlog—subsides, inflation will remain above-average. The Fed’s policy can bring down demand, which alleviates some of the pressure on supply chains, but it cannot magically sort out logistics delays and production backlogs.
The federal government should pursue two other policies to bring down inflation. The first is investment into infrastructure and domestic production. Infrastructure improvements in ports and other transportation mechanisms will bring down the costs of logistics and expand capacity at congestion points. Bringing more production back to the US creates redundancies so that there are more items to go around (a surplus instead of shortage) and less layers of logistics that items need to get through (sidestepping many of the issues in international shipping). Congress is preparing legislation that tackles some of these issues. Again, though, this policy will not bring immediate relief. These are long-term investments that will take time to implement. They will create massive cost-savings in the long-run and help prevent future crises, but they will not resolve our current situation.
The second major policy would be to use antitrust powers to threaten price gouging companies. The Biden administration is already doing this, which is a positive development. Using antitrust, the administration could penalize companies like the meatpacking giants who engage in manipulative behavior. Undoing high-profile price gouging would bring prices down for the specific industry affected, and the threat of antitrust would make other executives think twice before pursuing price gouging behavior. This policy is more geared towards short-term progress, but it will not be a silver bullet; supply chain issues will still exist. Nevertheless, it will help Americans’ budgets tremendously.
Economists predict inflation to moderate as 2022 progresses; business leaders also expect supply issues to subside this year. Especially as OPEC opens up oil production, inflation should gradually wind down in the next few months (although the economic effects of the Ukraine crisis could change conditions drastically). It will likely stay well above 2% into 2023, but consumers will feel some relief. Unfortunately, there are no quick fixes to inflation—outside of deliberately crashing the economy, which is undesirable. However, there are policies that we can and should pursue. The one thing our country cannot do, is nothing.
Katharine Sciackitano is a a third-year Economics major in the College of Arts and Sciences. She serves as a Managing Editor for the Agora.
Image courtesy James Marvin Phelps, Creative Commons.