In confusing times, profits do not predict a recovery
Among the many puzzling phenomena of the post-crisis world, one of the oddest is the astonishing rebound in American corporate profits. For bulls of the US, this is prima facie evidence that the US recovery is stronger than it looks. Well, maybe.
The central problem is lack of clarity. It is still unclear, for instance, how far the rebound has been due to restocking. And while productivity seems to have risen, some of that will be due to unsustainable lay-offs.
So let us instead try to put those profits in their historical context. The result makes the rebound look more puzzling still.
A word first on procedure. Over time, as the consultant Andrew Smithers has pointed out, there is no use looking at earnings as published by companies themselves. Accounting conventions have changed too much, as have the dodges employed by companies to get around them.
That leaves us government data. In the US case, these have the added advantage of being primarily domestic. So we can compare profits and wages directly over time, without the disturbing effect of production being switched to cheaper locations overseas.
The key measure, I would argue, is profits as a proportion of output. We can trace this back as far as the Great Depression, when US corporates plunged into collective loss.
There followed a steady climb to the super-profitable war years, with the profit share of gross domestic product peaking in 1951 at 14.7 per cent (pre-tax profit, unadjusted).
Then came a steady decline to the mid-1980s, with a nadir of 5.5 per cent reached in 1986. This was followed by a slow and modest recovery until the period 2001-06, during which the figure shot from 6.9 per cent to 13.6 per cent – only just below the previous high.
In the crisis it fell back, but only to 9.3 per cent in the period 2008-09. Considering that this was the deepest recession since the war – and that the postwar average figure is 9.6 per cent – that was not bad going.
Better yet was the sequel; for by the end of this year’s second quarter, the annualised figure was back up at 12.3 per cent.
One of the conclusions we should draw from this is that the profit share is not merely a function of the economic cycle. This is borne out by the fact that in the sharpest economic recovery of the postwar period, 1983-85, the figure stayed well below its long-run average.
Rather, it represents a division of the pie between capital and labour. That owes something to the bargaining power of the two parties – to the strength of organised labour, for instance.
Equally important is the internal working of the market. When a company becomes super-profitable, it aims to expand. That involves hiring labour away from the competition, thus driving the wage share up and the profit share down.
In the frictionless world of investment banking that happens instantaneously, as it is doing right now. In the stickier conditions of ordinary corporations, it is a lot slower and less predictable.
If we compare profits directly with wages, the results are more extreme. As a share of the pie – profits plus wages – profits hit a wartime peak of 25 per cent. The present figure is 25.8 per cent, only just off the 2006 peak of 26.6 per cent.
This is odd in two respects. Outside the 1930s, there is nothing in the record to compare with the rate of climb in the profit share between 2001 and 2006. And nowhere is there a rebound comparable to that of the past 18 months.
On the first point, the obvious answer may be the best. The depressing effect of Chinese and Indian wages, though not directly present in the figures I am using, is no doubt operating at a distance. This would be consistent with the widespread sense that the living standards of middle America have been going nowhere in recent years.
The profit rebound is another matter. Leaving aside the disruptive effect of the banks, pre-tax profits from non-financial corporations are now running 8 per cent below their 2006 peak, having been down 37 per cent for the whole of last year. But the wage bill for those companies is in effect unchanged from 2006 – specifically, 0.2 per cent higher.
To summarise all that, the domestic profit share of US corporations is back at record levels in spite of the financial crisis. That level has not proved sustainable in the past, nor is there any reason to suppose it is now.
And while the causes of the rebound are mysterious, it cannot be taken as the harbinger of roaring recovery. Nothing in the post-crisis world is that simple – not even profits.
tony.jackson@ft.com
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