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Philip Cross: Higher profits are not driving inflation

·4 min read
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The Ontario NDP framed its latest attack on the private provision of some health-care services by claiming it would raise costs by layering profits on top of other input costs. This reflects a fundamental misunderstanding of the role profits play in our economy, something that is endemic to the public sector from which the left primarily draws its misguided understanding of how the economy works.

Profits are the reward earned for satisfying customer demands while keeping costs — and therefore prices — as low as possible. Market competition ensures that, even with a profit margin, the efficiencies achieved by the private sector lower overall costs while delivering a wide range of new products. In his book The Dawn of Innovation, Charles Morris recounts how the so-called “robber barons” in the 19th-century U.S. made their fortunes by lowering the costs and prices of products for consumers. John Rockefeller “won his markets by concentrating fanatically on reducing costs and increasing efficiency.” Cornelius Vanderbilt built his fortune by slashing the cost of ocean steamships running from New York to Nicaragua and then to the California Gold Rush. Andrew Carnegie undercut competitors by masterfully accounting for the internal costs of steel-making. Matt Ridley in How Innovation Works describes how Henry Ford “had a relentless genius for cost control” that allowed him to dramatically lower the cost of automobiles.

Business firms have a focus on lowering costs that governments do not understand let alone replicate. One sawmill operator boasted that “we can use every bit of the tree except for the smell,” just as meatpackers use “every bit of the pig except the squeal.” Robert Kraft, owner of the New England Patriots, sometimes drops by the team weight room to turn off TVs not being used or to flick off the building lights when the team practises outdoors. The public sector not only does not have this mentality, it is contemptuous of such frugality because it is able to pass on higher costs to the taxpayer.

Government leaders used to share the private sector’s cost consciousness. Former U.S. president Calvin Coolidge proclaimed, “I am for economy. After that I am for more economy.” Coolidge meant what he said, decreeing his administration would issue one pencil at a time to each bureaucrat, who had to return the stub if not entirely used up. C.D. Howe, Canada’s minister of munitions and supply during the Second World War, made the federal government more efficient by bringing in corporate executives (the so-called “dollar-a-year men,” because that is what they were paid) to run government operations like a business.

Compare NASA’s wasteful and extravagant approach to space exploration with the innovative approach of entrepreneurs Elon Musk and Jeff Bezos who introduced reusable rockets and capsules. Bezos calculated that using a space rocket only once cost $400 million, but a reusable rocket slashed the cost to $40 million or less. Reducing the cost of getting into space by a factor of 10 opens up the potential of using space for manufacturing, research and tourism, even with the addition of a profit margin. The difference in mentality is clear. The public sector treats the public purse as a bottomless pit that renders efficiency unimportant, while the private sector relentlessly finds ways to raise efficiency, lower costs and still make a profit.

The narrative that higher profits have fuelled the surge of inflation over the past year holds no more water than the notion that an unexplained and co-ordinated outburst of greed caused inflation, rather than an over-abundance of fiscal and monetary stimulus. Over the past year when inflation took off, corporate profits rose a total of 7.5 per cent, less than the 10.6 increase in wages and salaries or the 15.8 per cent hike in indirect taxes, according GDP data from Statcan. It is higher costs that are fuelling higher prices, not higher profits.

The sectoral breakdown of profits confirms that retail profits are not benefiting from inflation. The profits of food and beverage stores plunged 30 per cent in the past year, while general merchandise stores (such as Canadian Tire) saw profits fall 40 per cent. Even the booming real estate industry has seen profits fall sharply from their peak as housing demand wilts in the face of rising interest rates.

Instead of treating more private-sector provision of health care as a cost, it should be regarded as a way of introducing greater efficiency, more innovation, and lower costs for the taxpayer. Margaret Thatcher’s innovation of more privatization became a key component in dampening inflation in the 1980s. More privatization today can help cool the current burst of inflation while lowering the expense of government after the excesses indulged in during the pandemic.

Philip Cross is a Senior Fellow at the Macdonald-Laurier Institute.