I had just finished a meal at a Western restaurant in Jalan Song when I noticed something odd about the receipt. A bit more expensive than usual.
To see just how rapid inflation is now, duck into the eateries in the city. It’s not the prices on the menu so much that’ll shock you. It’s the fact that the prices were scrawled in pen on stickers slapped on the menu. Those stickers are a tell-tale sign that prices are going up at such a rapid-fire clip that the staff is struggling to print new menus fast enough. Rewriting prices on old menus is easier and cheaper, too.
In media coverage of today’s rising prices in general, this has become a prevailing narrative: businesses are passing their rising costs onto consumers. But this isn’t an explanation. It’s just repeating the thing to be explained. Why are costs going up? You’re right back where you started.
While superficially plausible, this gets the economics of prices the wrong way round. Of course, costs are prices, too. A business’ “costs” are the prices it pays for factors of production (land, labour, and capital goods). So, in a bigger picture, this theory posits that “factor prices determine product prices”.
But this is the exact opposite of how an economy actually works. It is anticipated product prices determine factor prices: prices that determine costs, not the other way around. And that ultimately consumer preferences determine all prices.
In many cases people blame businesses for “price gouging” to fatten their profits. Greedy. But blaming rising prices on profit-seeking is like blaming a plane crash on gravity.
Just imagine police officers arriving at Wisma Saberkas to investigate the death of someone who fell from the building. An officer approaches the crowd surrounding the mangled body and asks, “Does anyone here know what caused this person to fall?” A young man proudly answers, “I do! Gravity!”
I told this story to a group of university students many years ago; they rightly laughed at this explanation’s absurdity. And they, no less rightly, remain unimpressed with the “gravity” explanation even after I noted the indisputable fact that, in the absence of gravity, the person now splattered dead on Wisma Saberkas’s pavement would still be alive. The students understood that the actual cause of this death is something that changed – say, a decision to commit suicide, or a snapped cable on window-washing scaffolding – to enable ever-present gravity to pull the person fatally to the ground.
The same logic applies to inflation. To truly explain inflation we must identify something that changed – something that changed both to incite sellers to charge higher prices and, more importantly, to enable buyers to pay these higher prices. That something clearly isn’t “greed”. Therefore, the only plausible explanation of inflation is excessive growth in the money supply – which, as it happens, we’ve lately had a great deal of.
I am aware of the fact that businesses are always seeking profit and are always ready to raise prices if that is what will maximise profits. If businesses can preserve profits by raising prices now that their costs are higher, why wouldn’t they have increased profits by raising prices before when their costs were lower?
Customers don’t care about business costs. They care about value. Based on the value they expect from a product, there is a limited price range they’d be willing to pay for any given amount of it. That translates into the market demand for the product: the quantity of a product that would be bought at any given price point. The value of, and demand for, a product does not fluctuate with its production costs.
Even businesses don’t (or at least shouldn’t) really care about past costs when it comes to pricing. Past costs are sunk. Whatever was spent to produce it, at any given moment a business has a given inventory. Its best interest is to price that inventory so as to maximise revenue given current demand.
Based on that definite demand, raising prices past a certain point will result in less revenue, regardless of past costs. If the most revenue they can hope for is less than their past expenditure, that’s just the way things turned out. They can learn from that error and from those losses by spending less and/or differently in the future. But they cannot change the past or defy the economic reality of the present.
What consumers are willing to pay for goods and services determines what entrepreneurs are willing to pay for land, labour, and capital goods. For example, suppose that tomorrow the government decides to tax the sale of ink for ballpoint pens at RM1,000 per mL, would pen makers be able to carry on as usual and pass this increased cost on to consumers?
Would consumers be willing to pay RM1,000.25 for a pen? Of course not. Anticipated consumer demand is a limit on what producers will pay for inputs. More expensive inputs do not mean consumers are ready to pay a higher price for outputs.
So if “cost passing” isn’t what’s driving up prices, what is? Like I always said, again, the excessive growth of money supply by the central bank. I suspect that many businesses will be able to get away with increased prices because of this. Even if their stated intention is to ‘pass on’ or share costs with their customers, the increased demand from the money that has been injected into the economy over the past couple years is what really makes their price increases both necessary and feasible.
Extra money enables customers to bid up the prices charged by their suppliers, who in turn use the extra money to bid up the prices charged by their suppliers, and so on. That is how new money raises prices across the board (although, unevenly) as it circulates through the economy.
To an extent, industry analysts are right to blame rising restaurant prices on supply constraints. The war in Ukraine, lockdowns, trade restrictions and so on. But they are wrong to characterise it as a matter of “passing on” or “recouping” costs. Rather, it is a matter of greater scarcity translating of certain goods and thus higher prices. When there’s less of something, its price tends to go up.
Again, this phenomenon is not “passing on costs.” It is the rippling repercussions of economic destruction and impoverishment. The word “passing” implies that consumers are impoverished while producers are not. But that is not the case. Diminished production and greater scarcity impoverish everyone involved.
Overall, it is misleading to call that “inflation,” although both academia and the media tend to lump all price increases together under that term. For any given increase in prices, part of it may be caused by monetary expansion, and another might be due to supply constraints. Personally, I think it would be clearer to call only the former, and not the latter, “inflation”.
The views expressed here are those of the columnist and do not necessarily represent the views of New Sarawak Tribune.