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Economic Monthly Report

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Corporate profits have own dynamic

Thu, Jun 18 2009, 14:23 GMT
by La Caixa Economic Research Dept.

La Caixa

Since the end of Seventies or the beginning of the Eighties the proportion of income applied as return on capital has increased both in the United States and the European Union. Nor was Spain left outside this dynamic. This was a world-wide trend that went beyond the cyclical fluctuations of the economies. What lay behind this trend? The factors operating in the distribution of product between wages and profits are technological innovation and globalization, while the evidence related to institutional changes (labour deregulation, level of trade union membership and the state of wage negotiations) is less conclusive.

With regard to technological progress, it is felt that this began to change in character and rate in the Eighties, mainly from the impact of the new information and knowledge technologies. The effect of these became clearly evident as of the mid-Nineties. These technological changes tend to strengthen the capital factor to the extent that rapid innovation generates transitory extraordinary income up to the point where new products or processes are imitated or copied by new competitors and prices come down. Furthermore, technological change increases relative demand from that segment of the population that is highly-skilled. Given that in nearly all industrialized countries the proportion of highly-skilled workers around 1980 was relatively low, the process of innovation raised the proportion of income going into these wages while the bulk of workers became relatively less in demand.

At the same time, globalization of the economy has reinforced the change in distribution between wages and profits. The move into world trade by countries that traditionally were excluded (the so-called emerging economies led by China) is tending to bring about a decrease in the share of labour in the income of countries where there is abundant capital, a situation to be found in the advanced industrialized countries.

The tendency to growth of profits coincided with an extraordinary period of increases in prosperity and world employment. The present economic recession has meant a difficult trial for these trends. To begin with, corporate profits are going through a giddy fall due to their sharp cyclical nature. That is to say, when demand drops sharply, the different speed of adjustment between product prices and production costs (especially wage costs), brings about a rapid reduction in profits. In the United States, total corporate profits dropped 24% annual at the end of 2008. The collapse was still sharper for listed companies due to the bigger relative weight of the financial sector. Between the second quarter of 2007 and the fourth quarter of 2008 the gains of companies listed in the S&P 500 index showed a drop of 82%, although it is true that in the summer of 2007 profits stood at exceptionally high levels.

As the recessive stage is overcome and the mechanisms of technical change and globalization are again operating normally, the above trends will likely return. This would be an advantageous situation given that, when all is said and done, the maxim cited by former German chancellor Helmut Schmidt remains valid: «today’s profits are tomorrow’s investment and the jobs of the day after».

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Published on  Thu, Jun 18 2009, 14:45 GMT