Challenging the Consensus on Profits and Inflation

A pedestrian walks past the Reserve Bank of Australia (RBA) building in Sydney, Tuesday, February 4, 2020.
AAP Image/Joel Carrett


The Australia Institute’s research on corporate profits – rather than wages – driving inflation has challenged one of the sacred tenets of Australian economic management, leading to pushback from the likes of pro-business media outlets and the Federal Treasury.

The Institute’s research found that corporate profits had contributed far more than wage rises to the rapid rise in inflation between 2019 and 2022.

This research represented a significant divergence from a decades-old consensus. As such, it was extremely unpopular with the Reserve Bank of Australia (RBA)—whose entire strategy for addressing inflation it called into question.

Ultimately, though, reality cares little for ideology, and as the RBA’s efforts to curb inflation in the second half of 2022 and the first half of 2023 proved ineffective, a significant serving of humble pie was on the menu for those who criticised the research and policy conclusions.

Our Research On The Link Between Profits And Inflation

The Australia Institute published its first discussion paper on the causes of the cost-of-living crisis in July 2022, around the same time that inflation began on what would prove to be a long upward trajectory. This initial paper found that labour costs had played an insignificant role in driving this initial rise in inflation: they accounted for only 15% of economy-wide price increases. Profits, meanwhile, accounted for 60% of those increases.

While this initial paper received some media coverage, there was little wider controversy.

By early 2023, however, the cost of living had risen, and the RBA’s traditional method of controlling inflation—repeated interest rate rises for those with mortgages —was proving ineffective. In April 2022, the RBA’s target cash rate was 0.1%.

By the end of the year, the RBA had lifted rates eight times, and the rate stood at 3.1%.

They went on to increase rates four more times in the first half of 2023, and by July of that year, the official interest rate stood at 4.1%: a total increase of 4% in just over a year. Despite these drastic measures, however, inflation remained stubbornly high.

It was in this climate that the Institute’s Centre for Future Work published Profit-Price Spiral: The Truth Behind Australia’s Inflation. This in-depth examination of the link between inflation and corporate profits was released In February 2023.

The Institute’s research captured the full attention of the media, business lobby groups, the RBA and the Treasury.

Having previously refused to address the issue of skyrocketing corporate profits at all, the RBA settled on a new narrative to explain the findings: that the rise in corporate profits was essentially confined to the resources sector, and that record resources profits only affected the resources sector.

Governor Lowe said as much during an appearance at the Senate Economics Legislation Committee on 31 May 2023: “When we look at the aggregate data, the share of national income that is going to profits, if we put aside the resources sector, really hasn’t changed.”

Again, the Australia Institute’s research found otherwise. The month before Dr Lowe’s estimates appearance, in April 2023, the Institute’s Centre for Future Work published Profits and Inflation in Mining and Non-Mining Sectors, a briefing paper by Greg Jericho and Jim Stanford.

The paper found that while the mining sector had indeed experienced an immense rise in profits—some 89% between the end of 2019 and the end of 2022 without any appreciable increase in output, largely due to the war in Ukraine—it wasn’t alone. When the mining sector is factored out of the equation, corporate profits increased 27% over the same period. Wages, meanwhile, grew only 14%—hardly the dreaded wage-price spiral.

The Response To Our Research

A casual reader might expect that research into a new way to address a stubborn problem might be welcomed by the RBA, especially when that problem was having a direct and adverse impact on the day-to-day lives of millions of Australians.

Instead, the RBA and its supporters responded with ridicule and hostility.

Or Profit-Price Spiral paper was dismissed out of hand as “silly” in an AFR piece published in late February. It is worth noting that none of the hostile coverage engaged with the substance of the research.

However, despite the critical domestic reception, powerful support came from an unexpected quarter. In early June 2023 the OECD, led by former Morrison government finance minister Mathias Cormann, published its first Economic Outlook of 2023.

Taking a similar methodological approach to the Institute’s research, the OECD analysed the role of profits and labour costs in inflation in multiple economies around the world, including Australia’s.

The OECD’s findings, which were widely reported, were consistent with the Australia Institute’s findings and largely ended the controversy around this research.

Even the RBA started to change its tune: in his appearance before the Senate committee, Lowe conceded, “Wages have not been a driver of inflation,” and also, “There is no sign that higher prices lead to higher wages, leading to higher prices and so on… that is not happening.”

Profit-driven inflation isn’t a phenomenon specific to Australia. Similar research into the link between corporate profits and inflation has been conducted worldwide by bodies as diverse as economics faculties, unions and the European Central Bank.

The dogged insistence on sticking to conventional wisdom, however, does seem more pronounced in Australia than overseas.

It has taken the voices of the OECD and other centrist organisations to convince the RBA of the link between profits and inflation when the evidence of that link has been sitting in front of them for at least a year.

Dismissing inconvenient research that challenges the economic orthodoxy is both short-sighted and destructive.

Ultimately, even big business suffers from a situation where a large number of Australians can barely pay their rent or mortgage.

The Australia Institute’s purpose is “research that matters”, and the way in which our work has reshaped the debate on inflation is a perfect example of this purpose in action.

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