EcoTV Week

Pricing power: the return, and soon the end?

04/27/2023

The current inflationary situation is unprecedented in many respects. Indeed, some of its strength lies in the ability of firms to pass on the rise in their production costs in their selling prices. This is known as pricing power. And it allows companies to preserve their margins in a difficult environment.

Transcript

The current inflationary situation is unprecedented in many respects. Indeed, some of its strength lies in the ability of firms to pass on the rise in their production costs in their selling prices. This is known as pricing power. And it allows companies to preserve their margins in a difficult environment.

Such pricing power is unusual. The qualifier that has traditionally been associated with it has been ‘weak’ or ‘non-existent’, owing to the intensity of competition and the need for most companies to preserve their market shares rather than their margins. But since 2021, the surge in inflation amid rising energy and commodity prices, a strong rebound in post-Covid demand, and supply constraints appears as a game changer. In this particular context, firms have regained pricing power.

The ECB pays close attention to this issue, to see how important this role of margins is and fuels inflation. According to his calculations, in the fourth quarter of 2022, unit profit margins accounted for about half of the 6% year-on-year increase in the GDP deflator, with the other half coming from the rise in unit labour costs. For the whole of 2022, the estimated average contribution reaches even two-thirds, which is much more than the average contribution of one-third between 1999 and 2021.

There is a positive consequence: protecting margins supports investment and employment, which is good for growth. But it also, and above all, has the negative effect of fuelling inflation, through rising selling prices and wage claims, in response to inflation. The risk is that margins, prices and wages will end up in a negative upward spiral. This calls for further monetary tightening. Growth is doubly constrained by inflation and rising rates. And corporate margins should also end up suffering.

Looking ahead to the coming quarters, however, the environment should become less inflationary. Lower commodity prices, growth and supply difficulties should moderate corporate pricing power. This is already apparent in the input and output price components of the surveys, which are declining sharply in manufacturing and, to a lesser extent, in services at this time. This should lead to a fall in inflation.

THE ECONOMISTS WHO PARTICIPATED IN THIS ARTICLE