Corporate profits

I got an email this morning pointing me to an entry at the Washington Monthly weblog, which essentially excerpted a longer post by Brad Delong. The heart of the argument is a graph, showing how corporate profits are going up, as a share of GDP, even as labour compensation is going down. Here it is:

It's interesting that the compensation line has been drawn underneath the corporate profits line, because a glance at the left-hand and right-hand scales will show that compensation is still more than five times greater than corporate profits on an absolute basis.

It's also interesting to note the conclusions being drawn from this graph – essentially, that the economic recovery is not helping real people, with the benefits going instead to MegaCorp. I would read it very differently.

Firstly, look at the long decline in corporate profits during the stock-market boom from 1997 to 2000. A company with $1 at the end of its fiscal year has two choices. On the one hand, it can declare it to be profit, pay tax on it, and then distribute the remainder to its stockholders in the form of a dividend. On the other hand, it can take that dollar and reinvest it somehow – in equipment, or R&D, or advertising, or acquiring rival companies, or even giving its workers pay rises.

During the stock market boom, almost no one valued stocks based on their dividend yield: actually returning profits to shareholders was seen as hopelessly old-fashioned and a sign that the CEO wasn't really on board when it came to the new economy paradigm. (Microsoft, it's worth noting, has never paid a penny in dividends, despite sitting on more than $50 billion in cash which it simply doesn't know what else to do with.) Profits weren't important: a rising stock price was. And so companies made sure that they minimised their profits (and taxes) while trumpeting the fact that they were spending lots of money on whatever the flavour of the month was on the stock market that week.

The stock market, of course, loved highly-paid "knowledge professionals" who were expert at, say, turning a large manufacturing company into a lean brand-management shop which outsourced all the real work. Technology salaries went through the roof, and in general, the more you were earning, the bigger your pay rises would be. Labour compensation naturally started rising, but it was just as much a consequence of the rich getting richer as it was anything to do with the increase in total employment.

Fast-forward to recession, stock-market crash, and falling employment levels. A lot of the people being fired were pretty high up the food chain: computer programmers, investment bankers, advertising professionals. At the same time, the Bush Administration started enacting very corporation-friendly tax cuts, and stock-market investors started looking at profitability again.

The consequences were entirely predictable. First of all, companies cut back severely on any kind of discretionary investment, concentrating instead on the bottom line. Profits, naturally, started increasing, even as rising unemployment meant that wages and salaries were going nowhere. Then, when the economy started picking up again, it was suddenly the low-cost workers who were most in demand, rather than the high-cost workers whom everybody had wanted in the boom years. Most of the current increase in employment is concentrated in the very low-wage sectors: hourly workers, burger flippers, and the like.

As the economic boom continues, things will start changing. Already the stock market is looking reasonably healthy, and companies are likely to start hiring more people on six-figure salaries, even as real wages start rising again. Corporate profits won't be declared any more, since that's the most wasteful thing to do with them: rather, CEOs will reinvest them, increasing GDP growth even as it will bring the top line of this graph back down towards its historical mean. Meanwhile, labour compensation in total will be growing even faster than real wages, due to increased employment and the fact that most of the cheapest workers have already been hired.

I think, then, that the graph shows pretty much what you'd want to see in a country coming out of recession: a corporate emphasis on making money by hiring low-cost workers. That's both the best way to jump-start the stock market, and the best way to increase total employment. Once things start ticking over nicely again, then you can start going back to creating high-value-added jobs. It's a simple matter of sequencing, is all.

Posted by Felix at 13:55 EST

Comments

My explanation would be that wages are sticky and profits aren't. But could be wrong.

Posted by: charles at 8:04 EST, June 27, 2004

I actually read the original paper from the UMass econ department on which these posts are based- it was in a macro class at NYU's MBA. bottom line reading from NYU's free market econ dept: the UMass guys are a bunch of pinkos with an agenda, and their conclusions aren't supported by the facts. oh, and that since most corporate profits eventually get returned to citizens (as dividends or capital gains), it really doesn't matter if wages increase or not.

Posted by: jake at 8:11 EST, June 29, 2004

Of course, the citizens who receive stock-market dividends and/or capital gains are generally not a broad cross-section of the labour market.

Posted by: Felix at 23:48 EST, June 29, 2004

yeah- people (ok, it was me, since i was raised by communists) pointed that out, but the prof said that stock is owned more widely than i thought, and that because people who own stock must eventually spend that money, die (and therefore pass it on to people who will spend it), it really does trickle all the way down. i know- i wasn't satisfied either.

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