Profits account for 40 percent of recent price hike

Supermarket. Source: Priit Mürk/ERR

In the first quarter of 2023, consumer prices in Estonia were 31 percent higher than in the first quarter of 2019. In addition to other factors, corporate profits contributed nearly 40 percent of the total price increase.

"Several international organizations have recently published calculations on the origins of price increases in the euro area, concluding that a significant part of recent inflation in the euro area has come from rising profits," Kaspar Oja, an economist at the Bank of Estonia (Eesti Pank), wrote in the central bank's blog. "In the first quarter of 2023, Estonian consumer prices were 31 percent higher than in the first quarter of 2019. Profits pushed up price levels by around 12 percent, or nearly 40 percent of the total price increase."

"Historically, during periods of rapid price increases, the economy has been observed to increase its markup. This is primarily attributable to activities, such as energy and agriculture, whose selling prices increased on global markets. In the remaining industries, however, markups remained largely unchanged," Oja said. "This means that prices were able to rise as fast as input costs rose. In other words, profits increased as fast as input prices rose."

20 percent of recent price increases can be attributed to firms' rising labor costs per unit of output, while 40 percent can be attributed to rising capital costs per unit of output. The remainder of inflation is primarily attributable to rising import prices. These proportions are comparable to the averages for the euro area.

Moreover, Eesti Pank's analysis demonstrates that the impact of profit growth on price increases has begun to wane. The calculations are based on economic growth (GDP) data, where first-quarter profit growth was slower than business statistics. Therefore, it is conceivable that the importance of profits was underestimated in the first quarter. Even if capital income and import prices no longer contributed to inflation, it would still be close to four percent, which is significantly higher than the historical average, due to the rapid increase in labor costs.

Comparing the price level in the first quarter of 2023 to the price level in the first quarter of 2019 prior to the pandemic outbreak, the rise in prices has been primarily driven by rising profits in the real estate, energy, financial and trade sectors. The first two activities accounted for 50 percent of the impact of capital gains growth on inflation, while all four activities accounted for nearly 75 percent of the impact. These are activities that influence the input costs of numerous firms and, consequently, the prices of a vast array of products.

"Price markups are often referred to in the case of the retail sector, where they are easiest to monitor, but the analysis shows that a large part of the price increases come from other sectors. The increase in labor costs is the main contributor to price increases directly linked to the trade sector," Oja wrote.

In addition to eroding purchasing power, rapid inflation has a negative impact on competitiveness, as rising prices exert pressure on domestic output prices. This, in turn, causes the production of exported products to become more expensive, making it more challenging for exporting companies to compete in international markets.

"Because wage negotiation takes time, capital income usually reacts fast to changes in demand, so profits fall swiftly in economic crises, but they also surge quickly in the event of unexpected demand shocks. When entry is easy, higher profits attract new enterprises and help to push down prices," Oja said.

"However, the Estonian market is limited and may not be attractive to new retailers," he went to explain.

"In the past, other nations have attempted to address this issue through stronger market intervention by competition authorities. However, this strategy may no longer be effective, as it makes the market less attractive to new entrants."

"Part of the reason for the quick price increases is that consumers lack the same level of information as businesses, and this gap should be filled by reliable analysis provided free to the public — we shouldn't be ashamed to ask why the price of one product or another has gone up so much, simply accepting the explanation that prices are going up, because everyone else is raising prices," the economist said.


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Editor: Kristina Kersa

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