This chart is from my “Capital and Labor: The Great Divergence” post of September 1:
In that post, I said that “Of course, it’s not surprising that corporate profits are more volatile than compensation. But there’s world of difference between periods of time when both are rising (as in 2003-2006) and those when profits are rising and compensation is not only not rising but is below that of three years ago.”
Fund manager John Hussman, in his latest newsletter, covers the same ground far more thoroughly and persuasively than I did:
To a large extent, the widening of profit margins in recent years reflects two unsustainable dynamics. One is that the increase in profits as a percent of GDP has essentially come at the expense of employees. The spike in corporate profit margins has moved hand-in-hand with the collapse in labor income. As companies cut employment dramatically in recent years, they were able to maintain relatively high levels of output, which was reflected in high productivity growth figures. At this point, however, there is little latitude to expand profit margins through further payroll cuts, and labor tensions are increasing as well. The sequential decline in measured productivity in recent quarters, and the corresponding pickup in unit labor costs, reflects the difficulty in picking much more from the bones of workers.
But if wage income is falling, how is it possible to maintain the sustained (though not growing) level of demand that is responsible for elevated corporate profits? Simple – add in a second unsustainable dynamic. Government transfer payments are now substituting for wage income to the greatest extent ever observed in history. The majority of the recent surge represents unemployment compensation.
In fact, 22 cents of every dollar of U.S. personal consumption is now financed with transfer payments. It would be absurd to imagine that this does not fall to the bottom line of corporations. In effect, the elevated level of profit margins is largely a reflection of government deficits that maintain transfer payments, and by extension, consumption demand – even in the face of wage compensation that has never been lower as a share of GDP. While we are likely to see further deficit spending in the event of a full-blown recession, which will provide at least some buffer for demand, it is doubtful that investors should bake the assumption of sustained record profit margins into their long-term valuation of stocks.
Card-carrying capitalist that he is (bear in mind that I’m a retired Wall Street analyst, which allows me to use words like these), Hussman can’t quite bring himself to state the obvious: the public sector (headed, of course, by that quasi-socialist Barack Obama) is subsidizing the private sector. Yes, we have a welfare state. But not the usual kind. It’s corporations that are on the dole. And, indirectly, it’s people like me whose income comes from corporate dividend and interest payments that are the beneficiaries of the public sector’s largesse. If government transfer payments as a percent of nominal GDP were to drop from their current 16 percent back to their pre-crisis 12 percent (which, of course, is favored by some as a way to reduce the budget deficit) , corporate profit margins would collapse, stock prices would plunge, and some corporations wouldn’t be able to fund interest payments on their bonds.
Now take a look back at Figure 1. Remember the good old days of the second Clinton administration? Prosperity was everywhere — people were lifted out of poverty is record numbers, the stock market was booming, and the budget deficit was turning into a budget surplus. This was before the housing bubble created funny money. What was different about that time? Wages income as a percent of nominal GDP was rising, breaking a downward trend that had been in place since the late 1960s.
The people who are the direct recipients of transfer payments certainly aren’t in favor of reducing them. It’s some of the people who are indirectly receiving them — through their dividend and interest payments — that advocate reducing such payments. They should be careful what they wish for.