Around a decade ago, I wrote a college English paper on the topic of inflation. I went into my research with the assumption that inflation is primarily caused by greedy businesses raising prices faster than wages, and at the time I though my research supported this assumption. I was wrong, but I did not realize this until several years later, when I was discussing my research with a friend over email, and he asked me some questions I had not considered. When I did the math, it proved my original assumption wrong.
For the paper, I looked at inflation over the 50 year period from 1960 to 2010. Now I don't recall all of the exact details, and I don't have the time or energy to search my archives for the original paper, but a few figures were hard to forget. Average inflation from 1960 to 2010 was 659%. That means that prices increased by 6.59 times over those 50 years. Housing prices increased by somewhere in the neighborhood of 1,000% (a little more, I think), and car prices increased by somewhere in the neighborhood of 800% to 900%. That's 10 times and 8-9 times.
I did some math on these figures, and they seemed to match up with some claims by others that greed driven inflation caused prices to increase, and businesses just deliberately lagged on wages, so that they would come out ahead. I don't recall the exact value, but wages during that time period increased by significantly less. A smoking gun? I thought so. Now, I did find some evidence that some of the inflation was caused by government regulation, so in the paper I accused businesses of taking advantage of regulation to justify bigger price increases than the actual cost of the regulation. Again, the numbers seemed to support my claims. I'm pretty sure I got an A on the paper. It was a little controversial, but the professor graded based on my English writing skills and not the subject matter or opinions.
As mentioned above, several years later I was discussing this with a friend over email. He wondered exactly how much role the government regulation played. We both agreed that government regulation couldn't have contributed much, probably not more than a few percent. At the same time, he wanted to know why houses and cars had inflation so much more than the average, and the obvious answer was regulatory costs. During that time period, building codes grew quite substantially, and regulations around selling and buying homes grew a lot as well. Similarly, this was the time period where all of the safety and emissions regulations for cars were put in place. But could regulation alone really explain such a huge difference?
So I did the math. Say regulatory costs increase prices for something by an average of 2% per year. Over the course of 50 years, that's a 269% cost increase for producing that thing! 2% doesn't seem like much, but when you compound it over time, it adds up fast. Of course, we don't have new building codes or car manufacturing regulations coming out every year, so this surely can't explain all of the difference. This is true, but the 2% is an average. Emissions requirements for new vehicles increased prices by far more than a measly 2%. Each new safety regulation added significantly more than 2% to the price of new cars. Periodic large regulatory cost increases can increase prices at least as fast as constant small ones. A 15% increase each decade adds up to a 201% increase over 50 years. When you intersperse that with multiple 2% to 5% increases every 3 to 5 years, that can easily add up to enough to explain the difference, and building codes are even worse, because they typically have a bigger impact.
Ok, so regulation can explain the difference between average inflation and the much higher inflation for houses and cars. Those are only two products though. Surely it doesn't play a big role in average inflation? Unfortunately, this is also wrong. It's easy to miss the impact of multi-stage supply lines, which are hit by regulatory costs at every stage.
Consider this: A car dealership gets hit with a new regulation requiring them to record some additional data about each sale or repair. That data takes extra time to collect and extra space (physical or digital) to store. Maybe that increases operating costs by a couple of percent per transaction. So they must pass that cost onto customers (businesses can't take loses, therefore it is necessary that every cost be passed on to customers or be recovered by paying less for labor). But also the manufacturer gets hit with a new safety regulation that costs an additional 2% (pretty low end for safety regulations). That cost gets passed to the dealership, which passes it to the customer. So now we've got a 4.04% total increase. (Cost increases like this tend to compound, rather than adding.) But wait, the steel mill supplying the manufacturer also gets a 2% increase, because of some additional regulation, and so that regulatory cost "trickles down" to the customer, compounding for a total of 6.12% inflation. The steel mill isn't where the raw material originates though. They are getting scrap steel from garbage dumps, recycling collectors, and scrap yards, who also got hit by a 2% regulatory cost increase requiring them to pay more for their electricity to meet new EPA requirements, and if they are smelting raw ore, the mining companies were probably impacted by the same regulation. Now we are up to 8.24%. There can also be cycles in here that cause additional compounding steps, for example, the mining company, the scrap companies, and the steel mills are also all using steel products, so their cost of operation increases a bit more than the 2%, any time they have to repair or replace steel equipment.
Now, this is a contrived example. Odds of all of these getting hit all in the same year are pretty low. At the same time, 2% is a really low estimate for cost of new regulations for any of these. Not only would most of these regulations increase prices by more like 5% to 15%, government regulations rarely affect only one element of a business's operations. One safety regulation might only cost 5%, but the bill with that regulation is going to have another two or three, each also adding 5% or more, because "Well, now that we are thinking about auto manufacturing, we might as well look at everything about it." Additionally though, some regulations affect all industries. For example, any new vehicle regulation is going to impact over-land shipping costs, and practically everything depends on transportation infrastructure in the developed world. Fuel regulations also impact transportation costs heavily. And there are tons of cycles in here as well. If gas prices go up by 10%, prices for everything at the supermarket are going to increase by at least 5% to cover that, and now I'm paying more, so I have to ask for a raise to cover the increase in cost-of-living, and that will eventually trickle back to the supermarket prices adding an additional fraction of a percent to prices. Anything that impacts electricity prices (basically and EPA regulation) will raise costs for every company that uses electricity, and businesses can't take losses, so that means prices increases across the board.
Between 1960 and 2010, we had a lot of significant increases in regulatory costs in industries that impact all other industries. Gasoline and diesel fuel were significantly more heavily regulated. Vehicle manufacturing was more heavily regulated. Electrical power generation was more heavily regulated. Even communications (from post office to every kind of electronic communication) saw heavy regulatory increases. And housing costs do broadly affect the economy, so the very heavy regulatory increases in housing costs did contribute significantly to all of the other inflation.
When you put this all together, most industries saw significant cost increases due to regulation between 1960 and 2010, every single year, even when the new regulations didn't target them specifically. The average annual regulatory cost increase to produce average inflation of 659% over 50 years is a mere 3.84%. (You can calculate this including the compounding effect with 1.0384^50. The 1.0384 is equal to 100% (the original cost) plus 3.84% (the average increase), and the 50 is the number of years.)
The truth is, it's actually surprising that average inflation was so low, despite the constant barrage of regulatory cost increases. It's not just easily believable that most of the inflation was directly caused by regulatory cost increases, it's actually feasible that almost all of it was caused by rampantly growing regulation. (Only "almost" because increasing government debt also causes inflation very directly. That's a topic for another article though.) And cars and houses increased in price faster because they were more frequent direct targets of the additional regulation.
Sadly, it really is that simple. I was wrong. Inflation wasn't and isn't driven by greedy businesses. It's mainly driven by constantly growing government regulation, slowly suffocating the economy.
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