Consumers have been relatively protected from rising input costs

A fierce debate has been raging since the release of the latest Essential Food Pricing Monitoring Report by the Competition Commission, which criticised the food industry for keeping food prices high when input costs have been declining. The finding sought to solve a problem from a consumer protection perspective, but it is perhaps useful to look at some of the key dynamics exhibited by producers over the last 10 years or so. These suggest that consumers have been relatively protected over time, particularly during the Covid-19 pandemic, while there are also economic implications of cutting prices as a function of lower input costs. For the context of this article, we assume that the findings are primarily linked to the performance of the currency and fuel price dynamics (bearing in mind that South Africa imports a lot of its inflation), and we assert that those two variables may be limited in scope.

At the height of the pandemic and coming out of it, South African producers experienced high levels of inflation, which eventually peaked at 18% in July 2022 (see chart 1). The inflation spike at the time was caused by, among others, the global economy reopening and pent-up consumer demand, supply challenges linked to climate change and Covid-19 policies, as well as the Ukraine conflict, which significantly influenced both energy and food prices. The spike in producer prices, a proxy for input costs, was vastly different from the outcomes we saw from a consumer price perspective. Consumer prices, while they increased dramatically, only peaked at 7.8% in July 2022, a vastly different outcome from producers.

Chart 1: SA producer inflation
 

Chart 2: South African Producer inflation
 

The data regarding consumer and producer prices since 2013 show that the difference between producer and consumer prices peaked in July 2022, with a differential of around 10.2 percentage points. The question we ask ourselves therefore is: what funded the significantly higher input costs (producer inflation) when consumer inflation remained significantly lower? The evidence suggests that the producers absorbed most of the costs as that is the only viable reason for how operations and supply continued despite an environment of relatively lower topline growth compared to production costs.

Chart 3: producer and consumer inflation differential
 

The second key point to establish is how often producer prices have been lower than consumer prices, which implies an environment where consumers are paying higher prices relative to the input costs of producers. Data from January 2013 show that out of the 139 observation months through to September 2024, producer prices were lower than consumer prices on 56 occasions (i.e. 40% of the time) and producer inflation has been higher than consumer inflation on 83 occasions (i.e. 60% of the time). This shows that for the most part, producers are not imposing a full pass through when input costs rise. The data show that when producers take a price “hit”, it averages at about 2.25 percentage points, while gains have averaged 0.8 of a percentage point.

Chart 4: Producer inflation passthrough
 

Chart 5: Average differential between consumer and producer inflation
 

To put this into greater perspective, listed retailers have reported selling inflation of around 4% between 2015 and 2021, significantly different from the actual input cost inflation experienced at the time.

But perhaps let’s investigate the economic implications of the reduction of prices.

The first implication is that the industry becomes less profitable as topline/revenue growth comes under pressure due to lower prices in the revenue formula. As firms become less profitable, they need to manoeuvre to manage costs for the prevailing environment. The mechanisms aren’t many, but one cost that is relatively easy to move is wages – something that has implications for employment dynamics in South Africa, a society already dealing with structurally high unemployment.

Another reason why the passthrough for industry may not be as obvious is that higher profitability allows firms to build a war chest for tough economic times. As noted above, these tough times have seen the sector opting not to pass through the full effects of higher producer inflation (i.e. during the pandemic). When firms have a sufficient capital base, they can maintain employment levels in difficult economic times despite a relatively tougher financial position.

The economy may equally suffer when the industry cuts prices. There may be an argument that lower prices free up disposal incomes, however, the key metric to consider, as mentioned above, is how lower revenue growth can result in decreasing employment and how that impacts the ability and propensity to consume. Therefore, there may be an illusionary idea that cutting prices leads to increased spending power. Yes, there are instances where cutting prices has that effect where the input and output are linearly related, such as lower petrol prices, but it may not be as simple when considering other industries and sectors. For example, some may note that taxi fares do not fall when prices fall, however, a taxi fare doesn’t only pay for fuel but also for someone’s time, the use of a vehicle, the creation of a buffer for emergency costs, as well as other maintenance costs associated with driving a vehicle.

Looking at it through a different lens, one could argue that should firms cut prices as input costs fall, so too wages should fall as a function of lower input costs for workers (i.e. it is cheaper to get to work because of cheaper fuel). However, consumers also plan for the future, create buffers for emergencies, indulge if the opportunity presents itself, etc.

The government’s fiscal position may similarly come under pressure. When looking at the debt-to-GDP ratio, the important input is nominal gross GDP, which is a function of the level of inflation. A slowing in nominal GDP growth and a worsening fiscal outlook (fiscal deterioration) would be detrimental to government expenditure on the delivery of services as well as the level of interest payments as a percentage of both GDP and revenue. This can then push South Africa into a recession, a perverse outcome in the light of the otherwise good intentions.

Producers, in summary, have often borne the brunt of rising input costs. There are arguments that perhaps this has been the result of a battle for market share in a more difficult economic environment and in the face of high levels of competition.  Perhaps it is this same competitive landscape that has served the people in the past that should be allowed to continue to do so.