Official figures show that, in the final quarter of last year, the share of profits in GDP rose sharply, from 19 to 19.9 per cent. This is not exceptionally high; it’s not only below the 25 per cent peak seen in 1997, but even below the 21.1 per cent average since current data began in 1955. Nevertheless, history suggests it could be the start of a big upturn.
The last three recoveries from recession – in the late 70s, early 80s and early 90s - all saw big rises in the profit share. There are basically two reasons for this, both of which could recur this time.
One is that labour productivity rises simply because firms respond to increased demand by working staff harder rather than by merely taking more on. After a long stagnation in labour productivity, this seems to be happening; in Q4, total hours worked rose by only 0.4 per cent whilst GDP grew by 0.7 per cent, implying a 0.3 per cent rise in productivity.
Secondly, recessions leave a legacy of high unemployment, and this holds wages down, allowing firms to grab more of the gains of higher output. In this context, the fact that unemployment has already fallen a lot doesn’t mean much. There are almost as many people out of the labour force who want to work as there are officially unemployed: 2.3 million against 2.34 million. And this desire to work is no mere idle preference; in the last 10 years, 484,000 people have moved from “inactivity” into work every three months. In this context, it’s not so surprising that there’s little sign of any rise in wage inflation: in the year to the fourth quarter, average wages rose 1.1 per cent – less than they grew in 2012.
Of course, a squeeze on wages is not good for profits if it merely leads to lower consumer spending. But there might be a powerful offset to this. The Bank of England expects business investment to rise 43 per cent in the next three years. Because one firm’s capital spending is another’s orders, this means rising profits. As the great Polish economist Michal Kalecki wrote in the 1930s, “capitalists get what they spend.”
In previous economic upturns, it was quite common for profits to rise half as much again as GDP, even over periods as long as five years. This would suggest that domestically-generated aggregate profits could easily grow by more than seven per cent a year over the next five years.
Granted, much could go wrong here. It might be that the financial crisis has done much more harm to productivity growth than anyone thinks. Maybe we won’t get the good cyclical upturn in output that generates rising productivity and profits – perhaps because of the ongoing stagnation in the euro area or because the dearth of profitable investment opportunities means the Bank is too optimistic about capital spending.
However, if this is anything like a normal economic upturn, it might prove to be rather better for investors than you might think.
