BoC’s inflation fight faces a new hurdle: getting businesses’ pricing power back to normal

Over the past two years, Peter Neal has watched the input costs for his snack food company rise incessantly. And every three to six months his team at Neal Brothers Foods has sent cost increase requests along to retailers, such as Loblaws and Metro, asking them to raise the shelf prices for the company’s products, or to absorb the higher costs themselves.

In normal times, “we could go two, three years or more without a cost increase on a bag of chips, for example, or a jar of salsa,” said Mr. Neal, who co-founded the company with his brother 35 years ago.

“In the last couple years it’s been sometimes quarterly, it’s been certainly every six months, and it hasn’t gone up five or 10 per cent … it has been sometimes 30, 40 per cent.”

Neal Brothers is hardly unique in raising prices more frequently, and by larger amounts, than normal. Hit by rising agriculture commodity, transportation and labour costs, food suppliers have been quick to pass these increases along to the next link in the supply chain. And while food prices – which were up 10.4 per cent year-over-year in January – dominate public conversations about inflation, hyperactive price changes have become the norm across a wide range of industries.

The unusual combination of supply-side shocks and robust consumer demand has short-circuited price-setting behaviour over the past two years. This has sparked a debate about how much inflation has been driven by corporate profits – so-called “greedflation” – as opposed to other economic forces.

Bank of Canada officials have tended to play down the role of profit in driving inflation. But they have begun arguing that companies need to return to more competitive price-setting behavior to get inflation under control.

“That process of normalization is one of those key things that we’re watching to evaluate whether we’ve raised interest rates enough to get inflation back to target,” Bank of Canada Governor Tiff Macklem told the House of Commons finance committee last month. “And if we don’t see it continue to normalize, we will need to do more.”

The change in price-setting behaviour in 2021 and 2022 caught economists and central bankers by surprise.

Companies typically respond to increases in the cost of goods by passing a bit along to customers, and absorbing the rest in their profit margins. Starting around the middle of 2021, businesses began passing a larger portion of their rising input costs through to end consumers, and doing so more rapidly than usual.

For companies, that meant preserving, even growing their profit margins in the face of repeated supply shocks. For consumers, it meant that surging oil prices or container shipping rates quickly ended up on their bills at the checkout counter.

This has led to accusations of price gouging, mainly from NDP politicians. Both the Competition Bureau and the House of Commons agriculture committee have launched investigations into food price inflation. The Competition Bureau also joined an international working group last year investigating potential collusion in global supply chains.

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Many economists tend to interpret the economywide shift in pricing behaviour as a response to strong consumer demand coming out of COVID-19 lockdowns, weaker competitive pressures, and a general sense of disorientation amid high inflation.

“The bulk of the inflation came from the supply shocks, and the capacity of consumers to weather higher prices because of the large income transfers and government support programs during the pandemic,” said Craig Alexander, a former chief economist with Deloitte. “But it created a window of opportunity for firms to have more pricing power than they had before.”

With everyone raising prices, businesses did not have to worry as much about losing customers to competitors. Moreover, high inflation made it difficult for shoppers to tell whether a given price was reasonable.

“Consumers didn’t shop around as much when they were suddenly faced with a higher price,” Mr. Alexander said. “Businesses could articulate that costs have gone up because of the pandemic, and the consumer had no line of sight to whether that statement was accurate or not.”

With consumer demand expected to fall in the coming quarters, the window for aggressive pricing strategies appears to be closing. At the same time, many cost pressures, such as shipping rates and oil prices, have fallen since last summer – although labour costs keep rising quickly.

Bank of Canada business surveys have found that a growing number of companies expect their price growth to slow in the next 12 months. And many survey respondents said they’re once again tracking competitors’ pricing, and waiting for cost increases to be realized before raising prices.

Still, it could be a long and bumpy road back to normal. Loblaw Cos. Ltd. chief executive Galen Weston, for instance, said on an earnings call last week that his company was sitting on over 1,000 requests from suppliers for “significant cost increases.”

“We continue to believe that these inflationary pressures are temporary and that they will ease with time, but predicting how long that will take is proving extremely challenging,” Mr. Weston said, adding that his company would “push back on unjustified cost increases from suppliers.”

Mr. Neal said his company still has cost increase requests sitting with retailers. But he disputed the idea that they were unjustified, noting that a spike in tomato prices caused by drought in California, among other cost pressures, has squeezed his company’s margins.

“When [the price of] those tomatoes have increased by 40 per cent … I don’t want a jar of salsa going from $4.99 to $6.99 or $7.99, but there’s nothing else you can do. And for a retailer to turn around and say we’re money hungry is really difficult to take,” Mr. Neal said.

The experience of the past two years has left a number of politically charged questions in its wake. Did oversized profits drive inflation? Did corporate concentration add to the problem?

In Canada, non-financial-sector corporate profits were up 12.5 per cent last year compared to 2021, and up 32 per cent compared to 2019. Likewise, profit margins, which collapsed early in the pandemic, have rebounded strongly and are above pre-pandemic levels.

This has led some Canadian economists, notably Jim Stanford, director of the Centre for Future Work, to argue that profit was the key driver of inflation. He points to 15 industries – including oil and gas, and food retail – which saw large growth in profits and also experienced some of the highest rates of inflation.

Other economists aren’t convinced profits are to blame for inflation. Much of the increase in profitability occurred in a handful of sectors that benefited from surging global commodity prices. This was particularly true of energy and mining companies, which saw windfall profits as oil and metal prices surged in 2022.

“There’s no question they’re making more money and their margins have risen,” said former Bank of Canada deputy Gov. Lawrence Schembri, who retired from the central bank in June and is now a senior fellow at the Fraser Institute. “But it’s hard to know how much of the increase in the final good is really driven by higher margins. You see oil company profits, but they’re just selling their oil at global prices.”

Profit margins at food and beverage stores grew from 1.57 per cent in 2019 to 2.6 per cent in 2022, according to Statistics Canada data. By contrast, profit margins at oil and gas extraction and support services companies grew from 2.5 per cent in 2019 to 18 per cent in 2022.

To some extent, the debate is a moral one. Jurek Konieczny, an economics professor at Wilfrid Laurier University, said that the term “greedflation” is a political statement more than an economic one. “I see no reason for a firm not to maximize profits, when the economic situation changes,” he said.

Mr. Stanford agreed that “greedflation” is not a particularly useful word. At the same time, he advocated for various market interventions – including windfall profit taxes, rent controls and energy price caps – that would curb corporate profits.

“Greed is a normal feature of a profit maximizing capitalist economy … But when we see it in operation so ruthlessly at a moment of social and economic crisis, it is naturally going to cause us to ask some fundamental questions. Is a company’s right to set a price at whatever a market can bear beyond reproach?” he said.

The atypical pricing dynamics of 2021 and 2022 have increased interest in questions related to corporate concentration and competition.

Economists don’t typically think about inflation in terms of competition. Customers in highly concentrated markets usually pay more than those in more competitive markets – but that’s an issue of price levels, not the pace at which prices increase over time.

A recent paper by Federal Reserve Bank of Boston economists complicates this idea. They found the increase in corporate concentration in the United States since 2005 likely magnified the 2021 and 2022 supply shocks. They estimated that a 50-per-cent increase in industry concentration leads to a 25-per-cent increase in the pass-through of input costs.

Public policy changes aimed at increasing competition – such as stricter rules related to corporate mergers – take time to change the composition of the market. That suggests they wouldn’t be effective at combatting today’s high inflation, Mr. Alexander said. But they may be worth pursuing in their own right.

“If the current inflation shock increases awareness of the fact that Canadians pay more because we have very concentrated markets in many areas, and that leads to a change in competition policy … that could be one silver lining out of the recent inflation shock,” Mr. Alexander said.