CCPA Senior Economist David Macdonald breaks down the numbers by creating a new methodology, which shows that corporate profits are eating up the vast majority of the extra inflation dollars, far outpacing increased labour costs or other expenses.
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Executive summary
This report creates a new dataset to better understand what is driving inflation in Canada—workers’ wages, corporate profits, and specific industries. Right now, we largely rely on the Consumer Price Index (CPI) to track inflation. It’s good at telling us which prices are going up or down but does a poor job of telling us why. This paper adopts a GDP deflation approach, which can separate inflation into three broad categories: profits, wages and other. We can also perform this disaggregation down to the industry level.
What this new approach tells us is different from current inflation headlines. Inflationary price increases aren’t ending up in workers’ pockets, they are ending up in corporate profits—particularly in oil, gas and mining.
Cumulatively between the third quarter of 2020 and the third quarter of 2022, business prices have risen by 19%. In dollar terms, $72 billion more was sent to the corporate sector in the third quarter of 2022 compared to third quarter of 2020, due to higher prices alone:
- Of that $72 billion, $30 billion ended up as corporate profits.
- Put another way, 41 cents of every dollar spent in higher prices between July and September of 2022 (Q3) was converted into $30 billion in corporate profits.
- A third of that $72 billion—$24 billion—ended up as higher labour compensation without higher output, either through higher wages or more workers required to accomplish the same task.
- The remaining 25% of inflation—$18 billion—ended up as “other costs.”
By far, the largest beneficiary of inflation has been the oil and gas extraction and mining industries:
- Of that $72 billion more in inflation, $18 billion of it ended up in mining and oil and gas extraction. These are inflation dollars only and removes the impact of higher levels of production that can also increase wages and profits.
- Of those $18 billion in inflation dollars flowing to oil, gas and mining, basically all of it ended up on the profits side. Only $656 million ended up in higher worker compensation.
- In a broader sense, 25 cents out of every extra dollar spent on inflation is going straight to higher oil, gas and mining profits.
The second largest industry for receipt of inflation dollars was manufacturing: 13% of every inflation dollar is flowing to this industry, two thirds ($6.6 billion) of which is ending up as profits and one third of which is ending up as higher labour compensation ($3 billion). Manufacturing includes oil refining of crude into gasoline and diesel.
The finance and insurance industries represent the next largest inflation category: Finance and insurance received $7.6 billion of the $72 billion in extra inflationary dollars paid to the business sector in the third quarter of 2022.
Out of the $72 billion in inflation dollars paid in the third quarter of 2022, $29 billion ended up in only three industries: oil/gas/mining, manufacturing and finance/insurance and 40% of all higher prices ended up as profit in just those three industries.
In the 2022 federal budget, a new corporate surtax was applied to the banking and insurance industries, one of the three industries that have been taking over half of every inflationary dollar spent and declaring it as profit. However, this surtax has yet to be applied to the other two industries—oil, gas and mining and manufacturing, including refining—that have been converting inflationary benefits into corporate profits. Companies profiting from inflation are the best candidates for a surtax because these profits are pure rent seeking without productive merit. The proceeds for a corporate surtax can be recycled to help consumers, particularly lower-income households who have to pay those higher prices.
Introduction
There has been plenty of interest in this historic period of inflation in Canada and around the world. The public and the rate-setting Bank of Canada are generally focused on the Consumer Price Index (CPI) as the measure of inflation. There are various versions of the CPI that include or exclude key commodities, like food and energy prices, to get to core inflation or the three versions that the Bank of Canada follows, which attempt to exclude some of the CPI volatility to get to a better underlying inflation figure.
As noted above, the benefit of the GDP deflation approach is that the value-added approach can separate inflation into three broad categories: profits, wages and other. We can also perform this disaggregation down to the industry level.
The GDP deflation approach tracks the nominal “value-added” by each industry instead of a final price. If an industry only passes on its higher input costs as higher prices but doesn’t change the amount of product sold, then there is no change in its contribution to GDP and it isn’t the industry responsible for those higher prices. Its value added has remained unchanged.
Businesses often complain about higher input costs causing them to increase their prices, but this skates around the fact that one business’ input costs is another business’ prices (which sold them their inputs). Energy plays a key role as one of those driving input costs, but Canada is a net exporter of crude oil and generally exports as much as it imports in refined petroleum (like gasoline and diesel).8 It is possible that management costs increased substantially without adding to output and is, therefore, inflationary. Had those management costs not materialized, prices may have been lower or more money could have gone to corporate profits.
Finance, insurance and holding companies saw the second highest inflationary increase in labour compensation, amounting to $3.4 billion by the third quarter of 2022. Professional, scientific and technical services were third, with an inflationary increase in labour compensation of $3.3 billion compared to two years earlier.
As with analysis of profits above, it would be interesting to drill further down to determine which sub-components of various industries are seeing higher growth in worker compensation compared to output. But, like the profit figures, we can only get hints of what might be driving it without knowing how much is due to higher production and how much is inflationary.
Inflation drivers over the past three recessions
There are common trends in recessions when it comes to profits and wages: profits drop faster than wages but rebound much faster. The data set for this paper only goes back to 1988. However, within this period, there are three recessions to examine: the 1990–91 recession, the global financial crisis (GFC) and the pandemic recession. This section looks at the GDP deflator for the business sector, which is broken down by profits and worker compensation across these three recessions.
At almost every quarter, corporate profits during the pandemic recession and recovery were contributing more to inflation than in any other recession. The profits percentage point contribution to inflation peaks at over 15 percentage points four quarters after the pandemic hits.
During both the 2008–09 global financial crisis and the 2020–21 pandemic recession there was plenty of inflation that went to corporate profits, but during the 1990–91 recession there was almost no inflation pressure from corporate profits. Put another way, during the global financial crisis and pandemic recoveries, profits rose much faster than output (real GDP) in the business sector.
Figure 6 is on the same scale as Figure 5 to highlight how labour compensation is much less important in explaining inflation, regardless of any recessionary period. During the global financial crisis of 2008–09, wages played a particularly unimportant role in driving inflation for the business sector; when profits were driving inflation (at the fourth and fifth quarter after the recession started) wages actually became deflationary.
In the first year-and-a-half of the pandemic, workers’ compensation was adding less to inflation than during the global financial crisis. However, by the third quarter of 2021 (R+6Q), workers’ compensation pressure on inflation exceeded the other two recessions. Again, workers’ compensation was a far less important contributor to inflation in the business sector than profit, but it was still higher, reflecting a tight labour market following the pandemic re-opening.
Conclusion and policy recommendations
Canada needs a new dataset that combines the unit cost of labour and unit profits of the business sector as a whole and by industry in order to glean deeper insight into where inflation dollars go. To properly understand inflation, the focus needs to be broadened from the change in the retail price of goods and services sold to consumers to include the entirety of the business sector. Policy-makers need to understand the changes in the intermediate prices all the way up the supply chain to better understand the change in the final retail price. Inflation, as judged by the GDP deflator for the business sector, allows us to do that.
Unfortunately, the synthesization of two broad data series from Statistics Canada isn’t ideal, as discussed in the methodology section. A properly constructed series on unit costs for labour and profits—including the components that make “other costs” like net interest, depreciation, indirect taxes and subsidies—is critical for further study. Given the turmoil that inflation is causing in Canada, Statistics Canada should endeavour to produce such a series on the business sector in the aggregate and at the subsector level, or three-digit NAICS, as is available in the United States. This would allow a better understanding, for example, of the causes of higher grocery store prices9 vs. higher gas station prices, which are otherwise grouped together in a broad “retail trade” category.10
Since 2020, inflation dollars have gone more to corporate profits than to labour compensation. On the corporate profits side, only three industries—oil and gas, mining, manufacturing and financial services/insurance captured almost all of the inflation dollars. On the labour side, the largest inflationary industry was construction, where there seems to be an explosion of management costs related to residential construction.
Inflation places a heavy burden on Canadians and most of it is ending up in corporate profits. The surge in international prices of oil, gas and refined petroleum products, such as gasoline and diesel, has driven inflation as well as profits for Canadian corporations operating in these sectors. The reasons for these higher profits have nothing to do with Canadian companies—they were driven by international events like Russia’s illegal war in Ukraine.
In the 2022 federal budget, a new corporate surtax was applied to the banking and insurance industries, one of the three industries that have been taking 40% of every inflationary dollar spent and declaring it as profit. However, this surtax has yet to be applied to the other two industries—oil, gas and mining and manufacturing, including refining—that have been converting inflationary spending into corporate profits. Companies profiting from inflation are one of the best candidates for a surtax because these profits are pure rent seeking without productive merit. The proceeds for a corporate surtax can be recycled to help consumers, particularly lower-income households that have to pay those higher prices.
Despite the clear harm that rampant inflation is causing Canada’s economy and the macroeconomic disruption it entails, there is too little focus on the causes: mainly, high oil and transport fuel prices for Canadians. Natural gas and electricity companies are not allowed to profit off of Canadians like oil companies are due the recognized deleterious effect of high prices for these inputs. The Atlantic provinces and Quebec regulate gasoline prices to consumers, which at least examines allowable margins for wholesalers and retailers, even though it doesn’t protect consumers from feedstock price increases.
