No More Learning

The crux of inflation is not that prices rise in general, but that they rise dif- ferentially. Inflation is never a uniform process. Although most prices tend to rise during inflation, they never rise at the same rate. There is always a spread, with some prices rising faster and others more slowly. From this viewpoint, the engine of inflation is a redistributional struggle fought through rising prices. The overall level of inflation is merely the surface consequence of that struggle.
So in the end, Milton Friedman is right - but only in part. Inflation is always and everywhere a monetary phenomenon; but it is also always and everywhere a redistributional phenomenon. 16
15 Note that the equivalence of the two definitions breaks down once we admit that commodi- ties cannot be aggregated into an overall 'quantity' (Chapter 8). However, since economists are generally indifferent to this impossibility, we don't press it in this chapter.
16 The following is a technical note for those interested in the fine print. Mainstream econo- mists would readily admit that in reality prices do not all change at the same rate, and that relative price variations may even be positively correlated with the rate of inflation (see for instance Parks 1978). But these relative variations, they would add, neither cause inflation nor bear on its consequences.
First, in a competitive market relative price variations reflect changes in consumer preferences (marginal utility) and technology (marginal productivity), and in that sense
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Redistribution
The difference between the two views is decisive. For those who see inflation as an aggregate 'nominal' process of 'too-much-money-chasing-too-few- commodities', indeed there is little reason to look any further into the so- called 'real' world of distribution. The only relevant questions are, first, how much money is created and, second, how increased liquidity is 'transmitted' to higher prices.
But if inflation is merely the aggregate appearance of an underlying redis- tributional conflict, the way to understand it is to begin from that very struggle. From this perspective, there are two important questions: (1) who are the winners and losers in the struggle; and (2) what is the broader char- acter of that struggle? We deal with each question in turn.
Winners and losers
Inflation redistributes income in many different ways, of which we highlight two: redistribution between workers and capitalists, and redistribution between small and large firms. 17
Workers and capitalists
Figure 16. 2 contrasts the redistribution between workers and capitalists with the rate of wholesale price inflation in the United States over the past half- century (the insert in the top-left corner shows the period since 1985 and will be examined later). The distribution of income denotes the ratio between the
have little to do with overall inflation. Second, 'disequilibrium' prices - namely, those that do not reflect the underlying logic of utility and productivity - may exist, but only temporarily. Soon enough, the market would force them back to their 'proper' equilibrium levels. And finally, during inflation deviations from equilibrium prices arise mostly from misguided expectations and therefore are never systematic in their pattern. These devia- tions could make some 'agents' richer and others poorer, but only by fluke. Disequilibrium prices could also arise from 'government intervention' and 'monopoly practices' (mainly by labour unions), but the redistributional effect is nullified once agents become aware of these 'imperfections' and 'discount' them into their demand and supply. Moreover, regardless of their redistributional impact, these 'imperfections' cannot translate into inflation unless validated by increases in overall liquidity.
Unfortunately, this line of defence is persuasive only to those who erect it. First, marginal utility and productivity are never observable, so there is no way to know the 'equilibrium' price that equates them. Second, equilibrium prices, as their name suggests, hold only in equilibrium. But since we never know whether we are in equilibrium or disequilibrium, we never know which prices are 'out of line'. Finally, it is unclear why we should assume that inflation does not systematically redistribute income. To argue that market forces prevent such systematic redistribution may be a meaningful explanation for an observed outcome. But shouldn't we first establish that this is indeed the outcome?
17 Inflation is also related to the distribution of assets, a topic to which we return later in the chapter.
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Corporate Earnings per Share / Wage Rate * (Index, right)
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? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? Figure 16. 2
US inflation and capital-labour redistribution
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* Corporate earnings per share are for the S&P 500. The wage rate is the average hourly earnings in the goods producing private sector till 1963 and in the private sector afterwards.
Source: Standard & Poor's through Global Insight (series code: EARN500NS for S&P 500 earn- ings per share); U. S. Department of Commerce and U. S. Bureau of Labor Statistics through Global Insight (series codes: AHPGP and AHPEAP for the wage rate; WPINS for the wholesale price index).
earnings per share of the Standard & Poor's 500 (S&P 500) and the average hourly wage in the private sector. The specific focus on earnings per share and the wage rate is intended to emphasize the income of individual owners - the owner of capital and the owner of labour power, respectively.
Now, if mainstream economics is right and inflation is 'neutral', its ups and downs shouldn't correlate with the distribution of income between workers and capitalists. The wheel of fortune would oscillate between the two groups as they alter their prices and wages at different rates. But since these are relative price changes, there is no reason for them to be systematically related to the overall nominal rate of inflation.
Unfortunately, that is not what we see in the chart. Instead of a random pattern, the data show the two series to be tightly and persistently correlated. When inflation accelerates, income is redistributed in favour of capitalists; and when inflation decelerates, the process inverts to benefit workers at the expense of capitalists. Obviously, this isn't exactly the evidence neutrality buffs would marshal to prove their point.
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Now, at first sight it seems that the correlation has loosened a bit in recent years. But this is an optical illusion. Notice that the fluctuations in the income ratio have trended upwards, particularly since the late 1980s. The main reason is that, unlike workers, the S&P 500 have gone global, drawing an increasing proportion of their profits from overseas operations (as illustrated in Figure 15. 6). This global diversification caused the levels of the two series to diverge. 18
Remarkably, though, even in this period of heightened capital flows and soaring foreign earnings, the fluctuations of distribution and inflation continue to move in tandem. The insert in the top-left corner of Figure 16. 2 recalibrates the left-hand axis, showing that the correlation remains as posi- tive and tight as before. 19
Small and large firms
The second redistribution through inflation is between small and large firms. Given our focus on external depth, the interesting question for us concerns the earnings-per-employee ratio: can dominant capital leverage inflation in order to increase its own earnings per employee faster than the average?
The neutrality theory of inflation would say no. Relative 'pricing power' - assuming such power exists - is a 'real' variable. This relative power may rise or fall, but there is no reason for it to change with 'nominal' inflation, and even less reason for the change to be related to firm size. And yet, here, too, reality disrespects the theory. It turns out that US inflation has systematically and persistently redistributed earnings from small to large firms.
In this illustration we use the Fortune 500 group of companies as our proxy for dominant capital and focus specifically on net profit. 20 Differential profit per employee is defined as the ratio between net profit per employee in the Fortune 500 group and in the business sector, respectively. However, as we already mentioned, Fortune stopped publishing the number of employees after 1993, so we end up with only a partial series. Fortunately, there is a close substitute: the differential markup. This indicator measures the ratio between the net profit share of sales in the Fortune 500 group and in the business sector, respectively. Over the period between 1950 and 1993, the annual oscil- lations of these two differential indicators looked like carbon copies of one another, with a correlation coefficient of 0. 86. Assuming that this correlation
18 Notice that the peaks of the income ratio in Figure 16. 2 coincide with the peaks in the foreign-to-total profit ratio in Figure 15. 6.
19 For a similarly tight correlation using monthly rather than annual data since 1999, see Nitzan and Bichler (2006a: p. 22, Figure 4). In principle, the analysis could benefit from matching the international sources of profits with the corresponding national rates of infla- tion. However, given the convergence of global inflation rates since the 1990s, the insight added by this exercise is likely to be limited.
20 A more complete analysis of capitalist income would consider corporate interest payments as well as net profit.
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continued after 1993 makes the differential markup a nearly perfect proxy of differential profit per employee. 21
Figure 16.
3 contrasts the differential markup of the Fortune 500 with the annual rate of wholesale price inflation. The figure demonstrates the greater
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US inflation and differential accumulation
* The markup is the per cent of net profit in sales. The Fortune 500 markup is the per cent of after tax profit in sales revenues. The business sector markup is computed by dividing total corporate profit after tax with IVA and CCA (from the national income accounts) by total business receipts (from the IRS). The Differential Markup is given by dividing the Fortune 500 markup by the business sector markup.
Note: Until 1993, the Fortune 500 list included only industrial corporations (firms deriving at least half their sales revenues from manufacturing or mining). From 1994 onward, the list includes all corporations. For 1992-3, data for Fortune 500 companies are reported without SFAS 106 special charges.
Source: U. S. Department of Commerce through Global Insight (series codes: ZAECON for total corporate profit after tax with IVA and CCA; WPINS for the wholesale price index); U. S. Internal Revenue Service; Fortune.
21 The reason for the tight match is simple to explain. The markup is given by the following expression:
markup = profit = profit per employee markup = sales = sales per employee
As noted earlier in the chapter, differential sales per employee have changed very gradu- ally and only by a little (increasing by 20 per cent over the period 1950-93). This relative stability causes fluctuations in the differential markup to be more or less fully expressed as fluctuations in differential profit per employee.
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'elemental power' of dominant capital. Over the past half-century, the differ- ential markup averaged 1. 6, while differential profit per employee (which is not shown here) averaged 2. These numbers mean that the largest firms marked up their sales by 60 per cent more than the business average and that they earned twice as much profit per employee.
For our purpose, though, the crucial point lies in the dynamics. Over time, the relative profit power of dominant capital tended to fluctuate; and as the data clearly show, these fluctuations have been positively and tightly corre- lated with the rate of inflation: dominant capital tended to beat the average when inflation rose and trail it when inflation fell. 22
Further analysis in Nitzan (1992, pp. 418-22, Figures 9. 15a-9. 15h) demon- strates that the link between inflation and differential depth is positively related to firm size. The analysis disaggregates US-based corporations into eight groups ranked by assets size, showing that the larger the firm, the greater and more systematic its differential gains from inflation.
This systematic correlation is all the more remarkable given the prevalent practice of markup pricing discussed in Chapter 12. Much of the literature about this practice is concerned with the way firms 'respond' to and 'transmit' cost signals. 23 Now, if firms merely responded to and passed on cost increases, their differential markup position would have remained the same and there would be no redistribution. Figure 16. 3, though, shows that redistribution is incessant, so there must be more to markup pricing than passive reaction.
At the very least, some firms - most notably the largest - must be more 'responsive' than others; their more agile reaction, particularly during infla- tion, helps them beat the average and redistribute income in their favour. But the more plausible explanation is that these firms do not simply react passively; they take the initiative. They actively raise their prices, markup and profit per employee faster than the average, and as the ensuing redistibutional struggle unfolds inflation is ratcheted higher.
Patterns
All in all, then, it is clear that US inflation hasn't been 'neutral' in the least. On the contrary, it has been associated with a systematic redistribution of income from workers to firms and from small firms to large firms. That in itself is already a good enough reason to doubt conventional inflation theory. But what is really remarkable here is that the direction of these two corre- lations has remained the same for half a century or more.
This point can hardly be overstated. Redistribution is a matter of power, and power can shift over time. So even if we accept that 'inflation is always and everywhere a redistributional phenomenon', still there is no inherent
22 For evidence and analysis of the same process in Israel and South Africa, see Nitzan and Bichler (2000; 2001).
23 For a critical discussion of markup theories of inflation, see Nitzan (1992: Ch. 4).
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