March 27, 2008 (Profits Byte)"The profit share is likely to be lower at the peak of this cycle than the 90s peak."
The profit share of corporate income fell by 1.6 percentage points in 2007, making 2006 the peak profit year of the last business cycle. Nominal profits in both the financial and non-financial sectors fell by 3.7 percent. It is important to recognize that National Income Accounting profit numbers differ substantially from profits reported on financial statements because they do not deduct write-downs for losses on loans. These write-downs will show up in the national accounts as lower profits in future years, due to less interest being collected than would be the case if the loans had not gone bad. This means that financial sector profits are likely to decline as a share of total profits in future years.
In 2006, the profit share of income in the corporate sector was 22.9 percent, up slightly from the 22.2 percent share in 1997, the peak of the last cycle. This increase is likely to prove illusory. Profits tend to be revised downward with comprehensive revisions, due to the accounting of stock options. Since the revisions are especially large following large gains in the stock market, it is likely that the 2006 data will be revised below the share reported for 1997 in subsequent data revisions.
The massive write-downs of bad debt also imply that much of the financial sector profit in recent years was illusory. Banks and other financial institutions booked fees and interest payments on loans that will eventually go bad, leaving them with large losses. The fees and initial interest payments appear in the profit data immediately, however the losses will only show up gradually through years of lower interest payments than the banks would have received if the loans had not gone bad.
In effect the housing bubble led to a huge exaggeration of both the profit share of income and financial sector’s share of corporate profit. With the collapse of the bubble, both will be substantially lower in the years ahead.
Since the last decade did not led to any redistribution of labor income to profits, it is worth examining the basis for the extraordinary gap between productivity growth and wage growth over this period. In the decade from 1997 to 2007, non-farm productivity growth averaged 2.63 percent annually, while the average hourly wage for production workers rose at a 0.79 percent annual rate, a gap of 1.84 percentage points.
|Productivity (non-farm business)||2.63 percent annually|
|Productivity (total economy)||2.21 percent annually|
|Minus gap between gross and net output||0.19 pp|
|Minus gap between CPI and output deflator||0.16 pp|
|Equals “Usable Productivity”||1.78 percent annually|
Much of this gap turns out to be attributable to measurement issues as shown in the table. Annual productivity growth for the whole economy was just 2.21 percent. The depreciation share rose of output rose by 0.19 pp annually, and the difference between the consumer price index and the output deflator was 0.16 pp. Adjusting for these measurement issues leaves an annual rate of “usable productivity” growth of 1.78 percent.
This 1.78 percent is the amount that the average workers’ income would have increased each year without redistribution. Adjusting for the growing share of health care costs in compensation, average hourly compensation for production workers rose by 1.02 pp leaving a gap of 0.76 pp. This is the income that was shifted to higher paid workers such as doctors, lawyers, and hedge fund managers over this decade.
This analysis suggests that redistribution was somewhat less than is often believed, and that it went to very high paid workers, not corporate profits. It also suggests that the uptick in productivity growth with the IT boom is much less impressive than is generally realized, with “usable productivity” growth still a full pp lower than in the 1947-73 golden age.