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Healthy capitalism

Created:

6 October 2008

Written by:

Chris Dillow

In one important sense, capitalism is in good shape. By capitalism I don't mean a free market economy or - of course - the financial system. Instead, I'm thinking in the Marxist sense; capitalism as a system for extracting surplus from workers.

And in this sense, capitalism is thriving because profits in the non-financial economy are okay. In the US, latest Federal Reserve data show that companies' returns on tangible assets are well above their 20-year average. Things aren't quite so rosy in the UK. But, even here, non-oil profits relative to the capital stock or gross domestic product (GDP) are higher now than they were in the mid-90s. And in the first half of this year, non-financial companies had a a huge financial surplus (an excess of retained profits over capital spending), equivalent to 3.5 per cent of GDP.

All this isn't merely the product of a long boom that's now over. It's also due to a structural factor that's still in place - a massive increase in the global supply of labour caused by India and China's industrialisation has tilted the balance of class power from workers to capitalists.

This matters, and not just because it's a counterweight to some of the more apocalyptic talk. In the long run, there has been a correlation between profit rates and share valuations; high profits usually mean high valuations. The current contrast between decent profits and low valuations might, therefore, be a buying opportunity.

Also, profits are a major driving force of economic growth. Low profits cause cuts in jobs and capital spending, and high profits mean rises in these. And, ordinarily, banks are more willing to lend to profitable firms than to less profitable ones.

Decent aggregate profitability is therefore a powerful support for economic growth.

Granted, this won't be enough to stop a rising number of companies going bust; aggregate figures aren't true for every single firm. Nor will it be enough to stop a recession here or in the US.

But it could well be enough to ensure that the recessions will be relatively mild.

Usually, even mild recessions are bad for stock markets. But given their current febrile state, such an outcome might prove to be a huge relief.