March 29, 2001 (Profits Byte)

The capital share of corporate GDP (profits plus net interest generated in the corporate sector) rose slightly in 2000 compared with 1999, from 15.9 to 16.1 percent. The profit share alone increased by an almost identical amount, rising from 13.0 percent to 13.1 percent. This increase incurred in spite of a sharp drop of 6.8 percent (24.7 percent at an annual rate) in profits in the 4th quarter of the year. The increase in the capital share puts it near its peaklevel for the post-war period, which was reached at the height of the Vietnam war in 1965, and then nearly matched with a 16.7 percent share in 1997.

The sharp drop in the profitss in the fourth quarter is by far the most striking feature of this report. The falloff in profits in the last six months has been somewhat concealed by the fact that corporations typically make year-over-year comparisons in their quarterly reports. Because profits rose rapidly in the first and second quarters of 2000, the fourth quarter figures for 2000 are not very different on average than they were for the fourth quarter of 1999. (Comparing fourth quarter results, corporate profits, net of interest, were actually up slightly in nominal terms, increasing 2.4 percent from the fourth quarter of 1999 to the fourth quarter of 2000.)

However, for purposes of the economy, the quarter-to-quarter change in profits has the most importance. The decline in profits in the fourth quarter will force firms to change their behavior. In the first half of 2000 they were borrowing money at annual rate of more than $540 billion to finance both investment and large stock purchases (share buybacks and new stock purchases). This pace of borrowing would have been unsustainable in any case, but the sharp decline in profits at the end of the year is forcing a cutback in both stock acquisition and investment.

The 4th quarter decline was steepest in the non-financial sector and was especially sharp in manufacturing (profits of financial firms actually rose slightly.) Profits in the non-financial sector as a whole fell by 12.5 percent, or 41.5 percent at an annual rate. In the manufacturing sector alone, profits dropped by 21.4 percent in the fourth quarter, which translates into an annualized rate of decline of more than 60 percent. The fourth quarter drop in manufacturing followed a third quarter decline of 4.8 percent.

The drop in before tax corporate profits was partially offset by a sharper fall-off in tax payments, so that after-tax profits fell by only 4.8 percent. While the drop in the tax payments is helpful to corporate balance sheets, it may lead to somewhat of a shortfall in budget projections.

Corporate tax payments were 6.0 percent below their pace for fiscal 2000 in the fourth quarter of 2000, the first quarter of fiscal year 2001. The Congressional Budget Office projected that corporate tax payments would be 4 percent higher in 2001 than 2000. It would take a sharp upturn in profits in the near future to reach the CBO figure.

While the impact on the economy may prove painful -- a cutback in investment and a sharp drop in stock prices -- the decline in profits in the last quarter of 2000 was predictable. Profit shares had reached historically high levels. This was primarily due to the fact that there had been a significant shift of income from wages to profits in the middle years of the decade. The drop in oil prices in 1998 and 1999 also allowed workers to get real wage increases that did not come at the expense of corporate profits. However, with the low unemployment rate of the late nineties, it was virtually inevitable that the wage share would begin to stabilize and possible even rise somewhat back towards its historic levels. In addition, firms are apparently finding themselves unable to fully pass along higher energy prices, now that the 98-99 decline is being reversed.