How retailers are profiting from inflation question gains new urgency from FTC report

Profits and inflation surged together in the aftermath of the pandemic, leading many market commentators to pin the blame for inflation on corporate greed fueled by fiscal stimulus.

Other economists and corporations fired back, arguing that companies are designed to be profit-maximizing and that to assume a new level of avarice on the part of the private sector was both unlikely and naive.

The Federal Reserve views higher profits as a consequence of market conditions following the pandemic rather than a cause of them, with Fed chair Jerome Powell arguing in 2023 that “higher margins are what happens when you have an imbalance between supply and demand.”

But the Federal Trade Commission (FTC) is not so convinced about whether profit-maximization is a cause or effect of inflation, noting some weird dynamics in the increasingly concentrated grocery sector that the agency says deserve further analysis.

In a new report, the agency observed that retail grocery revenues increased to more than 6 percent above costs in 2021 and more than 7 percent in 2023, “substantially higher” than their most recent high-point of 5.6 percent in 2015. The calculation controls for fixed and labor costs.

“This profit trend casts doubt on assertions that rising prices at the grocery store are simply moving in lockstep with retailers’ own rising costs,” the agency said in its report, urging “further inquiry by the Commission and policymakers.”

Economists have noted similar dynamics of margin expansion in downstream industries over the last few years resulting in new market equilibriums with adjusted levels of output. One notable example has been in the automotive sector.

“Auto manufacturers’ profit margins continued to exceed their suppliers’ in the third quarter,” consultants for Bain and Company wrote in a November analysis, describing the same downstream margin expansion as supplier costs held mostly steady.

“[Equipment manufacturers] were able to ride out the supply shortage [in the chip sector] by focusing production on the highest-margin models and raising prices, but suppliers had no such strategic options,” they said.

Perhaps the most sweeping argument that margin expansion flipped over the course of the pandemic from being a result of inflation to one of its self-sustaining drivers has come from University of Massachusetts Amherst economists Isabella Weber and Evan Wasner.

They characterized the pandemic inflation as “a sellers’ inflation” deriving from the ability of firms with a lot of market power in concentrated industries to simply raise their prices.

“This requires an implicit agreement which can be coordinated by sector-wide cost shocks and supply bottlenecks,” they wrote, effectively saying that supply shocks can act as cover for cartel-like price coordination among competitors.

Such a process can even lead to “self-sustaining inflationary spirals under certain conditions,” they argued, though a definitive picture of such a spiral has yet to emerge.

Federal Reserve economists have made similar arguments to Weber and Wasner themselves, noting that markups grew by 3.4 percent over 2021 while PCE inflation was 5.8 percent, implying that markups could “account for more than half of inflation” during that year.

“Such high markup growth is especially striking given that markup growth contributed almost nothing to inflation in the decade leading up to the COVID-19 pandemic,” Kansas City Fed researchers wrote in a theory-heavy paper.

While the Fed researchers admitted the causal effect of profits on inflation, they concluded that the boosted markups were more likely associated with anticipated cost increases rather than an increase in monopoly power.

But the new report on the grocery business from the FTC offers a different picture, one that displays concentrated downstream retail power flexing its muscles over the supply chains that terminate in their stores to boost profits.

“Some firms seem to have used rising costs as an opportunity to further hike prices to increase their profits, and profits remain elevated even as supply chain pressures have eased.

Larger retailers and wholesalers with considerable leverage over their suppliers were able to take more aggressive action to protect themselves,” FTC researchers concluded.

The report notes that the grocery sector has undergone “significant consolidation over time,” with the four biggest companies accounting for more than 30 percent of the sales in 2019, as compared to half of that 30 years earlier.

It also calls out big grocery retailers for implementing “policies that imposed strict delivery requirements on their upstream suppliers and threatened fines for noncompliance. Walmart even tightened the delivery requirements its suppliers had to meet to avoid fines as the pandemic went on.”

Author Adam Kaat, who works as a supply chain manager in the aerospace industry and wrote two books based on his time working in various jobs at a Whole Foods during the height of the pandemic, criticized these policies as “absurd” and “bullshit” in an interview with The Hill.

“That’s not going to help anybody. That’s also going to drive the cost on the items, definitely. That’s going to affect poor people the most,” he said, adding that he didn’t see any such policy during his time at Whole Foods.

Supply chain pressures have largely gone away as production and logistics pipelines have normalized, and inflation has also fallen precipitously over the last year and a half, with the core PCE price index dropping to a 2.8-percent annual increase.

However, profits are still way above their accustomed levels, hitting an all-time high of $2.8 trillion in the fourth quarter, according to Commerce Department data released Thursday. Profit margins expanded for a second consecutive quarter, up 3 percentage points to 12.2 percent of GDP, according to a calculation by financial firm EY-Parthenon.

Economists are backing up the FTC report, saying that expanded margins raise an important question about competition.

“The interesting question is whether the margins are going back down now, with the supply chain pretty much back to normal. I am not sure that they have, and that would suggest a real issue of inadequate competition,” Dean Baker of the Center for Economic Policy Research told The Hill.

While further research will reveal more about the interplay between fiscal policy, profit margins, and private-sector market power in the aftermath of the pandemic, the FTC is cautioning that the effects of boosted profits at the grocery store are still having an economic effect.

“As supply chains normalize, some of these symptoms may subside, but the underlying issues remain,” the agency said, noting that margins are still “quite elevated.”