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I found this interesting. There seems to be a little bit of a long run trend upwards for profits as a share of GDP. Right now profits as a share of GDP is at a record level. The Economist seems to be claiming that this might be because globalization is creating more competition for jobs. The article also says that competition will compete away profits after a period of increases, but the long run trend still seems a little bit up. Either the trend will change and profits will fall back down to their historical level or there is a fundamental change in the economy and profits could keep going up.
Economist
There's a graph at the website.
Economist
There's a graph at the website.
Breaking records
Feb 10th 2005
From The Economist print edition
Capitalists are grabbing a rising share of national income at the expense of workers
WOODY ALLEN once quipped “If my films don't show a profit, I know I'm doing something right.” For most other people, in most other circumstances, profit is a mark of success, and in most countries corporate profits are currently booming. Last year, America's after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro area and Japan are also close to their highest for at least 25 years. UBS, a Swiss bank, estimates that in the G7 economies as a whole, the share of profits in national income has never been higher. The flip side is that labour's share of the cake has never been lower. So are current profit margins (and hence equity values) sustainable? Are they fair?
Corporate profits may be inflated in various ways. If firms made full provision for the future cost of pensions, their earnings would be smaller. And especially in America, the share of profits in national income has been bolstered by the surging profits of the financial sector which have benefited hugely from falling interest rates. Even so, the impressive efforts of American firms to boost productivity and cut costs are genuine (see article). Firms elsewhere, notably in Japan and Germany, are also restructuring aggressively. The share of profit in GDP always rises sharply after a downturn, but in the United States a bigger slice of the increase in national income this time has gone to profits than in any previous post-war recovery. Over the past three years American corporate profits have risen by 60%, wage income by only 10%.
If the share of wages in GDP continues to slide, there could be a backlash from workers who feel short-changed. Yet the chances of this are lower than before. The old divide between “them” and “us” is becoming blurred: many workers also own shares directly or through pension funds, which sooner or later will give them a slice of profits. In any case, there are good reasons to believe that profits growth will soon slow sharply and that workers will make up some of their lost ground.
An economic fallacy
The usual explanation for why profits are booming is that productivity growth has increased thanks to the computer revolution and tougher management. Thus, goes the argument, increased productivity and hence lower production costs mean fatter profit margins. History suggests otherwise. It is normal for the share of profits in national income to rise during the early stages of a technological revolution, but then those extra profits tend to be competed away. Higher profits tempt firms to cut prices to steal market share; they also increase the incentive for new firms to enter the market. The benefits of the productivity gains from railways, electricity or the car eventually went not to producers but to consumers and workers, as competition forced firms to pass cost savings on as lower prices and higher real wages. There is even greater reason for thinking that the benefits of computing technology will flow the same way, for it also increases competition in many industries by lowering barriers to entry and making it easier for consumers to compare prices on the internet.
However, there is another factor that might have raised the return on capital relative to labour in a lasting way, namely the integration of China and India into the world economy, along with their vast supply of cheap labour. To the extent that this increases the global ratio of labour to capital, it will lift the relative return to capital. Outsourcing may not have destroyed many jobs in developed economies, but the threat that firms could produce offshore helps to keep a lid on wages. As a result, the share of profits in national income could stay relatively high for a period. Labour's share would remain low, though workers may still be better off if the cake itself is growing faster. But this is not a reason to expect profits to continue to grow faster than GDP; indeed, in a competitive market profit margins will eventually narrow. Even if outsourcing reduces costs, competition will eventually force firms to reduce prices, distributing the benefits back to consumers and workers.
Stockmarket investors seem to think otherwise: current share valuations appear to assume that profits will continue to outpace GDP growth. Most analysts still expect American profits to grow by an annual 10% over the next couple of years. With nominal GDP growth of around 5%, that implies the proportion of GDP going to profits growing still larger. But this looks unlikely, and if so, share prices are overvalued. Both economic theory and historical experience argue that, in the long run, profits grow at the same pace as GDP. Such long-standing rules deserve more respect.
Feb 10th 2005
From The Economist print edition
Capitalists are grabbing a rising share of national income at the expense of workers
WOODY ALLEN once quipped “If my films don't show a profit, I know I'm doing something right.” For most other people, in most other circumstances, profit is a mark of success, and in most countries corporate profits are currently booming. Last year, America's after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro area and Japan are also close to their highest for at least 25 years. UBS, a Swiss bank, estimates that in the G7 economies as a whole, the share of profits in national income has never been higher. The flip side is that labour's share of the cake has never been lower. So are current profit margins (and hence equity values) sustainable? Are they fair?
Corporate profits may be inflated in various ways. If firms made full provision for the future cost of pensions, their earnings would be smaller. And especially in America, the share of profits in national income has been bolstered by the surging profits of the financial sector which have benefited hugely from falling interest rates. Even so, the impressive efforts of American firms to boost productivity and cut costs are genuine (see article). Firms elsewhere, notably in Japan and Germany, are also restructuring aggressively. The share of profit in GDP always rises sharply after a downturn, but in the United States a bigger slice of the increase in national income this time has gone to profits than in any previous post-war recovery. Over the past three years American corporate profits have risen by 60%, wage income by only 10%.
If the share of wages in GDP continues to slide, there could be a backlash from workers who feel short-changed. Yet the chances of this are lower than before. The old divide between “them” and “us” is becoming blurred: many workers also own shares directly or through pension funds, which sooner or later will give them a slice of profits. In any case, there are good reasons to believe that profits growth will soon slow sharply and that workers will make up some of their lost ground.
An economic fallacy
The usual explanation for why profits are booming is that productivity growth has increased thanks to the computer revolution and tougher management. Thus, goes the argument, increased productivity and hence lower production costs mean fatter profit margins. History suggests otherwise. It is normal for the share of profits in national income to rise during the early stages of a technological revolution, but then those extra profits tend to be competed away. Higher profits tempt firms to cut prices to steal market share; they also increase the incentive for new firms to enter the market. The benefits of the productivity gains from railways, electricity or the car eventually went not to producers but to consumers and workers, as competition forced firms to pass cost savings on as lower prices and higher real wages. There is even greater reason for thinking that the benefits of computing technology will flow the same way, for it also increases competition in many industries by lowering barriers to entry and making it easier for consumers to compare prices on the internet.
However, there is another factor that might have raised the return on capital relative to labour in a lasting way, namely the integration of China and India into the world economy, along with their vast supply of cheap labour. To the extent that this increases the global ratio of labour to capital, it will lift the relative return to capital. Outsourcing may not have destroyed many jobs in developed economies, but the threat that firms could produce offshore helps to keep a lid on wages. As a result, the share of profits in national income could stay relatively high for a period. Labour's share would remain low, though workers may still be better off if the cake itself is growing faster. But this is not a reason to expect profits to continue to grow faster than GDP; indeed, in a competitive market profit margins will eventually narrow. Even if outsourcing reduces costs, competition will eventually force firms to reduce prices, distributing the benefits back to consumers and workers.
Stockmarket investors seem to think otherwise: current share valuations appear to assume that profits will continue to outpace GDP growth. Most analysts still expect American profits to grow by an annual 10% over the next couple of years. With nominal GDP growth of around 5%, that implies the proportion of GDP going to profits growing still larger. But this looks unlikely, and if so, share prices are overvalued. Both economic theory and historical experience argue that, in the long run, profits grow at the same pace as GDP. Such long-standing rules deserve more respect.
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