Jobless hope for profits

I have pointed out elsewhere that there are more people out of work than headline figures suggest, and that this fact could force down real wages even further in the next 12 months. For investors, however, there’s an upside to this – lower real wages could mean a rising profit share and hence decent profit growth even if the economy grows only slowly.

History suggests this usually happens. Since the data on economic inactivity began in 1993, there has been a good correlation (0.51) between a wide measure of unemployment – the unemployed plus “inactive” who want a job as a percentage of the working age population – and the non-oil profit share four quarters later. High rates of joblessness, such as in the early 90s, led to high profit shares. And lower rates, in the mid-00s, led to lower profit shares.

There’s a simple reason for this. In conventional economic terms, an excess supply of labour bids down its price, increasing consumer surplus for its purchasers. Or in Marxian terms, mass unemployment shifts bargaining power from workers to capitalists.

If the post-1993 relationship between my measure of joblessness and the future profit share continues to hold, we should see a rise in the profit share of around a percentage point in the next 12 months. This would mean that if money GDP rises four per cent (say, one per cent real growth and three per cent inflation) we should see a rise in nominal non-oil profits of 10 per cent.

There are, though (at least) two risks to this.

One lies in the circular flow of income. If households reduce spending as their real wages fall, companies will be no better off; what they save through the back door in lower wage costs, they’ll lose through the front door in lower revenues.

However, consumption smoothing theory predicts that spending should fall less than wages, especially if consumers expect the fall in the latter to be only temporary. Instead, they should respond by reducing savings or by borrowing more. And, in fact, the latest Bank of England data suggests that consumer borrowing – perhaps helped by the Funding for Lending Scheme – might be picking up. Yes, there is a possibility that households will deleverage. But this is more likely to happen when real wages and incomes rise, not fall. Insofar as spending holds up as wages fall, profits should benefit.

The second danger is that labour productivity might continue to drop as real wages do so. Now, there are countless reasons why productivity has been weak: credit constraints have slowed down the rate of entry and exit; capital spending and technical progress have slowed; firms have invested in R&D which hasn’t yet raised output, and so on. But it’s possible that at least two factors behind the fall might recede: companies that have been hoarding labour might either sack staff or utilize them more fully as the economy recovers; and loss-making “zombie firms” which have struggled on because of the forbearance of banks or optimism of their owners could finally close. Either of these would tend to raise productivity and profits.

Overall, then, I suspect that this year might be a better one for corporate profits than for workers.

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