Home > The Economy > Profit share hits record high, as politicians are distracted by deficit dispute

Profit share hits record high, as politicians are distracted by deficit dispute

from Dean Baker

The battle between President Obama and the Republican Congress has become a major spectator sport as we approach the end of the year. While this political dispute may provide for good entertainment, unfortunately it is having the effect of displaying the state of the economy as an issue in the public spotlight.

This is really unfortunate, because the economy can definitely use some help. Rather than offering help, the real question with the budget standoff is how much further we will impair economic growth with further cuts to the deficit. Rather than posing a problem, the deficit is a crucial support to the economy at present and it is likely to remain a crucial support for the foreseeable future.

The simple story of this downturn, and indeed for much of the last two decades, has been one of inadequate demand.  In the decades immediately after World War II, productivity growth quickly translated into wage growth, insuring that demand kept pace with productive capacity. The relationship between productivity growth and wages broke down in the 80s as a result of several policy changes, most importantly rules weakening unions, opening sectors of the economy to trade, and the deregulation of transportation, communication and other key sectors.

With more income going to profits, there was a risk that demand would lag productivity, since a smaller share of profits will be spent than wage income. In the 1990s, the gap between productivity and wages was filled by the stock bubble. When the ratio of stock prices to profits rose to more than twice their trend level, it sparked a surge in investment, and more importantly a consumption boom. Over the course of the 90s, the saving rate fell from close to 8 percent at the start of the decade (its long-term average) to just 2 percent at the peak of the bubble in 2000.

The stock bubble burst in the years 2000-2002, pushing the economy into a recession. While the official recession was short and mild, lasting just seven months in 2001, it was very difficult for the economy to recover from this bubble-induced recession. It did not begin to generate jobs again until September of 2003 and the economy did not get back to its pre-recession level of employment until January of 2005. At the time, this was the longest stretch without job growth since the Great Depression.

When the economy did finally emerge from the downturn it was on the back of the housing bubble. House prices diverged sharply from their long-term trend. Historically, nationwide house prices had just kept even with the rate of inflation. By the peak of the bubble in 2006, they had risen by more than 70 percent after adjusting for the inflation over the prior decade. This bubble led to a boom in housing construction. The $8 trillion in artificial housing wealth generated by the bubble pushed the saving rate to near zero as consumption soared.

The bursting of the bubble is the story of the downturn. There continues to be no source of demand to replace the roughly $1.2 trillion in annual demand (at 8 percent of GDP) that was generated by the bubble. In the short-term, the federal budget deficit has helped to fill this gap, but as pressure grows to reduce this deficit, there will have to be some other source of demand to replace it.

In the longer term, there really is no alternative to getting the trade deficit down, filling the gap in domestic demand with foreign demand. But this adjustment will not occur quickly, especially in a situation where most U.S. trading partners are also suffering from weak demand. This is why it is so important that the U.S. economy see wages capturing their share of productivity growth, so that the demand gap does not grow worse.

Unfortunately this does not seem to be the case. The GDP data showed the profit share rising to another record high. This confirms evidence from a variety of indices showing that wages are at best keeping pace with inflation, meaning that little or none of the gains from productivity growth are being passed on to workers.

This is a sharp divergence from the economic projections from the Congressional Budget Office and others that showed the profit share shrinking this year, with the wage share of income rising through the rest of the decade. Clearly this is not happening, which is not really a surprise with the continuing weakness of the labor market.

However this raises the question of how even the modest pace of growth of the last two years will be sustained. Plunging interest rates helped to feed demand largely through a mortgage refinancing boom, but this process is coming to an end as mortgage rates are unlikely to go still lower.

If real wages don’t start rising, it is difficult to see what can boost the economy, especially in a context where the budget deficit is shrinking, further sapping demand growth. Firms are unlikely to boost investment in this context, raising the risk of a prolonged period of severe stagnation.

If economic debates in the United States were focused on reality, this demand gap would be at the center of the discussion. Instead it is being completely ignored, just as the housing bubble was ignored in the last decade as it grew to ever more dangerous levels. This is not a good story.

See article on original website

  1. December 14, 2012 at 12:41 am

    One way to generate demand in the real economy at this time is to begin repairing and renewing crumbling infrastructure: Highways, bridges, underground water and sewer systems, etc, etc. And central banks can issue money for that purpose, debt free. That would have the effect of raising the demand for labor and higher wages.

    • December 14, 2012 at 3:58 pm

      Absolutely Helge. But the condition of being able to do this internally is for local governments to take back the right and responsibility for local people with local knowledge to do the job themselves using local or in any case nationally available materials. In the UK, since Thatcher introduced the square peg of cut and dried, minimal cost contracts into the round hole of on-going maintenance and development, fly-by-night contractors financed increasingly by foreign speculators have been able to bid down employment and quality standards and destroy the pooling of local knowledge and committed expertise in the local government’s own workforce. Same applied, of course, to our public utilities, which are now nearly all foreign owned. Rather than central banks issuing money debt free (not a good idea when it is accessible via global money markets), there is a case for local governments doing so in local money. They can know their clients and their projects better, have a more intelligible assessment problem and can create less havoc than central bankers do when they get things wrong.

  2. December 14, 2012 at 4:45 pm

    Reblogged this on Gabriel Regae comentado:
    Por um instante eu achei que ia falar de profit-sharing, participação nos lucros. Deve ser a vida pessoal invadindo meus pensamentos econômicos… Mas é um bom texto sobre a parcela dos lucros no produto.

  3. Bruce E. Woych
    December 17, 2012 at 1:30 am

    Ultimately we must face the intrinsic fact that perpetual motion as well as perpetual growth simply can not be realized, let alone sustained as any realistic model.

    The question of restructuring the infrastructure and ‘bottom up” reconstruction is a realistic plan but an unrealistic reality. Why? Because just like antiquities slash & burn agriculture: crash and burn private equity has a finance model of expeditious liquidation in aggressive and competitive motion. This mechanism is “growth oriented” to “progressively” maintain predatorial “elite” (epi-demographic) class structured advantage through monetary domination (proportionately controlled money supply) which is rapidly expanding (aka: derivatives) within the wealth & stealth classes. This monetary schism grows at the expense and strategic advantage even as it shrinks and “stagnates” as a tactical leverage over the “domestic (real) economy that is technologically asset – path dependent but only indirectly through their “allocation” of money (which has become the central peg of ALL resource allocation itself) . Controlling the asset producing technology, therefore, is the ultimate strategy of “essential asset grabbing potentials” as decreasing (real-resource) asset values increase under scarcity (both real and artificially induced); while the “pseudo-markets” pump the public with self-gratifying consumer commodity exchanges.

    So “fixing” a normative economy is a pipe-dream until the “BIG DEAL” stops destroying the OLD DEAL…and we get a handle on a PROFIT SHARING Neon-Deal for the 21st Century.

    Remember: Markets kill and Capitalism (from the Latin) is a head count!

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