Unemployment weakens governments. Inflation kills them. That’s what a government official from Brazil once told me. But in rich countries including the United States, the politically destructive power of inflation had been forgotten. Standard policy tools left us unprepared and the Biden administration was slow to fight back. The re-election of Donald Trump should serve as a warning to democratic governments.
In this age of overlapping emergencies — hurricanes, an Avian flu outbreak, two regional wars — threats to supply chains are becoming commonplace. Each threat brings the risk of inflation and its power to destabilize governments, including our own. With such emergencies being the new normal, if we learned anything from last week’s earthquake election result, it’s that we need new means of protecting our society and democracy.
Among the biggest problems that need fixing: Many business sectors today are dominated by large corporations that can profit from these one-time events.
Using A.I. and natural language processing in an upcoming paper, several co-authors and I analyzed more than 130,000 earnings calls of publicly listed U.S. companies and found that businesses can coordinate price hikes around cost shocks. This enabled companies, by and large, to pass on or amplify the impact of the initial cost increase in response to shocks in the wake of Covid-19 and the war in Ukraine.
In other words, the sudden news of cost shocks, like the onset of a pandemic and war, grants companies more freedom to coordinate price hikes across sectors because they realize that their rivals are very likely going to do the same.
Skeptics of this idea often counter that corporate concentration was already high before the pandemic, yet those same powerful businesses kept prices stable for many years, despite close-to-zero interest rates. That’s because under normal circumstances, a company that decides to increase prices without knowing that its competitors would follow suit risks losing business to rivals. This was the world we were living in before the pandemic. Globalization had created the most efficient, just-in-time production networks the world has seen and, for the most part, even giant companies kept prices stable under the pressure of competition.
But when supply bottlenecks occur, the clockwork stops. Every producer is naturally limited in how many products it can produce. This means that even if a company increases prices, competitors cannot easily ramp up their supply to take its business. Plus, everyone in the business sector understands the natural reaction to a shock is to raise prices. Jacking up prices is now a safe choice and has become the rational thing to do for profit-maximizing businesses.
In the wake of Covid, most companies managed to pass on their higher costs to the consumer and defend their margins, while some even increased them. But even if they simply keep their profit margins in response to a cost shock, their profits increase. Think of how the broker’s fee is higher for a more expensive house even if the percentage terms are the same. Corporate leaders know this to be the case. That’s why we found that when cost shocks are large and hit the whole economy, executives sound quite upbeat about them.
Massive shocks can be even better news for the sectors directly hit. Take oil. When demand collapsed overnight because people stayed home during the shutdowns, fossil fuel companies, suddenly faced with an unprecedented collapse in demand, closed some of their highest-cost oil fields and refineries. When demand recovered, the result was a shortage that led to record-high margins. In another forthcoming paper, my co-authors and I estimate that in 2022, U.S. shareholders in publicly listed oil and gas companies had claims on $301 billion in net income, a more than sixfold increase compared to the average of the four years before the pandemic. Oil and gas profits also exceeded the U.S. investments of $267 billion in the low-carbon economy that year.
Oil is inherently a boom-bust sector, but we cannot afford such extraordinary profit spikes in times of emergency. They prop up a sector that needs to be phased out to mitigate climate change. They also exacerbate inequality. As our new research shows, at the peak of the fossil fuel price spike in 2022, the wealthiest 1 percent claimed through shareholdings and private company ownership 51 percent of oil and gas profits. The less affluent faced higher inflation and only got a small slice of the oversized oil and gas profits pie.
Working people suffer through no fault of their own. Even if their wages eventually catch up, they are squeezed and feel cheated in the first place. This is why sellers’ inflation deepens economic inequality and political polarization, which are already threatening democracy.
President Biden mobilized a few unconventional measures to fight inflation, including an antitrust renewal to address outsize corporate power and increasing oil supply by drawing down the Strategic Petroleum Reserve. These actions were an important departure from old orthodoxies, but were ad hoc and retroactive. The main policy tool remained increasing interest rates. Sharp rate increases deepened the housing crisis, exacerbated the debt crisis for developing countries and increased the costs of investments urgently needed to address the climate crisis.
Economic stabilization used to be part of the disaster preparedness toolbox. It is time we add it back in. Just as it was recognized that some banks were too big to fail after the global financial crisis, we have to recognize that some other sectors are “too essential to fail.” In essential sectors, we need to move from a pure efficiency logic to strategic redundancies. This requires policy interventions.
Ports and other critical infrastructure should have spare capacity and a well-paid work force large enough to ramp up activity when needed. The Strategic Petroleum Reserve, a publicly owned buffer stock of oil, should be employed systematically to buy when prices collapse and sell when prices explode to avoid price extremes. It should buy oil on the open market when demand is falling short, thus preventing prices from collapsing, and sell oil when there is a threat of short supply, thus preventing prices from exploding. Such countercyclical purchases and sales by buffer stocks in commodity markets operate on the same logic as central banks’ open market operations in money markets.
It is not enough to release oil when prices spiral upward. As we have learned during the pandemic, a collapse in prices can create a sudden reduction in production capacity that breeds price spikes when demand picks back up.
Another lesson is that where markets are global, it is a good idea to coordinate stabilizing measures internationally — as the International Energy Agency did for its member states. And where futures markets exist, buffer stocks can buy futures when prices fall and sell when they rise for stabilization.
Countercyclical price stabilization through buffer stocks is important beyond oil. We also need it for critical minerals to encourage investments in the green supply chain and for food staples like grains, to avoid violent commodity price fluctuations in the wake of extreme weather events.
In addition to buffering essentials, we need policies that align public and private interests with resilience. As long as corporations see profits go up thanks to threats of shortages in times of disaster, we cannot assume that they prepare for emergencies in the best interest of the public. Price-gouging laws and windfall-profit taxes are relevant policy tools here.
Of course, the main task remains tackling the root causes of the emergencies. But this is a momentous task, especially in our climate change era, and in the interim a systemic set of buffers, regulations and emergency legislation is necessary. Without this economic disaster preparedness, people’s livelihoods and the outcome of elections remain at the whim of the next shock.
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