Economic and Social Reports
Inflationary pressures, wages and profits

At 6.8% on an annual average basis, Consumer Price Index (CPI) inflation in 2022 reached a 40-year high.^Note Survey data from Statistics Canada suggest that rising prices have affected many Canadians’ ability to meet day-to-day expenses and have led to a need to adjust spending habits to cope with inflation.^Note To better understand the nature of high inflation and how it may evolve in the future, studies have looked at potential driving sources. For example, in Canada, Wang (2023) estimated the impact of import prices on inflation. Chen and Tombe (2023) examined the relative importance of supply and demand shocks in a perfectly competitive market. Faryaar et al. (2023) studied the impacts of rising markups on inflation in an imperfectly competitive market. In the United States, Stiglitz and Regmi (2022) and Jarsulic (2022) argued that the negative supply shock was the main driver of inflation but sectoral demand shifts and market power also fuelled the problem. Thus, there are different ideas in the literature on the main driver of inflation.

An important area of investigation is how labour costs (where labour costs are primarily wages and salaries, but also employers’ social contributions for employees and imputed labour income for self-employed workers) and non-labour costs (where non-labour costs are primarily corporate profits and profit income of proprietors, but also interest, depreciation, rent and indirect business taxes) are evolving relative to inflation. For example, at the beginning of 2022, businesses that expected labour shortages reported they were likely to increase wages of new and existing employees (Morissette, 2022). It is unclear to what extent increases in costs attributable to labour shortages or supply chain pressures or increased demand were passed on to consumers or absorbed by businesses. Gumiel and Hahn (2018) argued that depending on the nature of the shock, labour and non-labour costs adjust differently. The term “greedflation” has been used in the literature to describe the situation where businesses are taking the opportunity in a high inflation environment to increase their prices above their underlying costs of production to garner higher profits. Some evidence has shown that profits and profit margins have risen, but much of that has been in the oil and gas extraction, mining and quarrying, and petroleum and coal product manufacturing sectors or because of rising volumes rather than rising prices.^Note Stanford (2023, January 20) provided a different view, showing that unit non-labour costs (non-labour costs per unit of output) have risen faster than unit labour costs (labour costs per unit of output) since the first quarter of 2019 and that there has been a strong correlation between unit non-labour costs and the growth in the CPI. Economic theory does not give definitive direction on how the markups of firms (price over marginal costs) should react to a combination of demand and supply shocks. Depending on the model, increasing margins could be a part of normal profit-maximizing behaviour of firms. Faryaar et al. (2023) estimated that markups (among non-financial corporations excluding those in mining and oil and gas extraction) rose by 2.6% between the two years before the COVID-19 pandemic and the second quarter of 2022, a relatively small increase compared with the increase of inflation over the same period.

This article focuses on the relative contribution of unit labour costs and unit non-labour costs to the growth of the gross domestic product (GDP) deflator.^Note In contrast to the previous analyses that focused on one or two of the elements at a time, this article examines inflation, and labour and capital costs per unit of output under a unified framework.^Note Conceptually, the growth in the GDP deflator is different from the growth in the CPI. The CPI reflects the price of a basket of goods and services purchased by households, whereas the GDP deflator reflects a broader range of prices in the economy.^Note Despite the difference, over the period of analysis their movements are similar, with the GDP deflator rising more quickly than inflation in consumer prices because of faster growth in the price of exports (see Faryaar et al. [2023] in this volume for a chart that compares the two).

Data table for Chart 1



Data table for Chart 1
Table summary
This table displays the results of Data table for Chart 1 Gross domestic product deflator, Contribution of unit labour costs and Contribution of unit non-labour costs, calculated using percent units of measure (appearing as column headers).

	Gross domestic product deflator	Contribution of unit labour costs	Contribution of unit non-labour costs
	percent
2013	2	1	1
2014	4	1	2
2015	2	2	0
2016	3	2	1
2017	5	2	3
2018	7	3	3
2019	9	5	4
2020	9	7	2
2021	18	10	8
2022	27	14	13
Sources: Statistics Canada, authors’ calculations, Labour productivity and related measures by business sector industry and by non-commercial activity consistent with the industry accounts tables 36-10-0480-01, 36-10-0207-01, and 36-10-0104-01.

The results are presented in Chart 1. Between 2012 and 2022, the cumulative growth in the GDP deflator was 26.9%, where 13.7 percentage points of the increase came from the increase in unit labour costs and 13.3 percentage points came from unit non-labour costs. Unit labour costs contributed 50.7% of the cumulative growth in the GDP deflator, smaller than the labour share of GDP in 2019 of 57.0%.^Note

The results are similar when the focus is on the period after the start of the pandemic. Between 2019 and 2022, the cumulative growth in the GDP deflator was 16.8% (Table 1). Unit labour costs accounted for 8.1 percentage points of that growth (or 48.3%), and unit non-labour costs accounted for the remaining 8.7 percentage points (or 51.7%). In each year, the contribution of labour and non-labour costs varied. At the beginning of the pandemic in 2020, the contribution of unit non-labour costs was -1.3 percentage points, compared with 1.9 percentage points for unit labour costs. In 2021, the contribution of unit non-labour costs became more dominant, at 5.5 percentage points, compared with 2.7 percentage points. In 2022, the contributions were more equal, but the contribution of unit non-labour costs was still larger (4.1 percentage points versus 3.3 percentage points).



In summary, the contributions of labour and non-labour costs to inflation vary from year to year. They are relatively balanced over longer periods. At the beginning of the pandemic, labour costs contributed more to inflation, but non-labour costs became more important in 2021 and 2022. This is partly attributable to higher prices in the mining and oil and gas extraction industry, where prices are determined globally. Furthermore, interest rates (and the required return on capital) and depreciation have also been rising—not only profits.^Note A more comprehensive assessment can be performed if the higher growth in unit non-labour costs persists and when more detailed data are available.^Note

Authors

Hassan Faryaar and Danny Leung are with the Economic Analysis Division, Analytical Studies and Modelling Branch, at Statistics Canada.

References

Bank of Canada (2023, April 25). Selected bond yields, Bank of Canada. https://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/.

Barkai, S. (2020). Declining labor and capital shares. The Journal of Finance, 2421–2463.

Chen, Y., & Tombe, T. (2023). The Rise (And Fall?) of Inflation in Canada: A Detailed Analysis of Its Post-Pandemic Experience. Canadian Public Policy. Forthcoming.

Faryaar, H., Leung, D., & Fortier-Labonté, A. (2023). Markups and inflation: Evidence from firm-level data. Economic and Social Reports. 3(6).

Gumiel, J., & Hahn, E. (2018). The role of wages in the pick-up of inflation. Economic Bulletin Boxes, 5.

Jarsulic, M. (2022). Effective Inflation Control Requires Supply-Side Policy. Center for American Progress. Retrieved from https://www.americanprogress.org/article/effective-inflation-control-requires-supply-side-policy.

Leung, D., & Macdonald, R. (2022). Real Wages and Productivity During the COVID-19 Pandemic. Economic and Social Reports. 2(10). https://www150.statcan.gc.ca/n1/pub/36-28-0001/2022010/article/00002-eng.htm.

Morissette, R. (2022). Employer Responses to Labour Shortages. Economic and Social Reports. 2(7). https://www150.statcan.gc.ca/n1/pub/36-28-0001/2022007/article/00001-eng.htm.

Stanford, J. (2023, January 20). Profits, Not Wages, Have Driven Canadian Inflation. Commentary – Centre for Future Work. https://centreforfuturework.ca/2023/01/20/profits-not-wages-have-driven-canadian-inflation/.

Statistics Canada. (2022, June 9). Rising prices are affecting the ability to meet day-to-day expenses for most Canadians. The Daily. https://www150.statcan.gc.ca/n1/daily-quotidien/220609/dq220609a-eng.htm.

Statistics Canada. (2022, September 9). Industrial capacity utilization rates, second quarter 2022. The Daily. https://www150.statcan.gc.ca/n1/daily-quotidien/220909/dq220909c-eng.htm.

Statistics Canada. (2023, January 17). Consumer Price Index: Annual review, 2022. The Daily. https://www150.statcan.gc.ca/n1/daily-quotidien/230117/dq230117b-eng.htm.

Stiglitz, J., & Regmi, I. (2022). The Causes of and Responses to Today’s Inflation. Roosevelt Institute. Retrieved from https://rooseveltinstitute.org/publications/the-causes-of-and-responses-to-todays-inflation/.

Tombe, T. (2022, October 14). Are Rising Profits Fueling Inflation? The Hub. https://thehub.ca/2022-10-14/trevor-tombe-are-rising-profits-fueling-inflation/#:~:text=In the second quarter of,to just under 9 percent.

Wang, W. (2023). Import Prices and Inflation in Canada. Economic and Social Reports. 3(6).