One is that we're seeing one of the few benefits of low investment. The current recession is quite unlike the recession of the early 90s and slowdown of 2001-02. In the run-up to those, firms invested heavily and this reduced profit rates when demand faltered. This is partly because the denominator in the profit rate (the capital stock) was high, and partly because such investment led to stronger competition between firms. However, in the years before this recession, companies held back their capital spending. There has therefore been much less over-accumulation, and so less downward pressure on profits.
You could regard this as one of the merits of companies focusing on "shareholder value". Insofar as this stopped bosses going on vainglorious expansion plans, it has helped protect profit rates in the downturn.
To see the second reason why profits have held we must remember some simple accounting identities. GDP is the sum of consumer spending (C), investment (I), government spending (G) and net trade (NX). It is also the sum of wages (W), other incomes such as from rent and self-employment (O), taxes on production (T) and profits (P). Rearranging this gives us an identity for profits and other incomes:
P + O = (C –W) + I + (G – T) + NX
Now, in the last two years net exports have fallen, which has tended to depress profits. But the other three terms on the right hand side of this equation have increased. Consumer spending has risen faster than wages, by £5.4bn in nominal terms; investment in capital and inventories has risen £4.1bn, and government consumption has risen £2.6bn more than taxes.
All of which is a way of saying that profits have held up because we haven't seen significant deleveraging by working households or governments. For both, their spending has risen faster than incomes.
Which brings me to my concern. What happens if (G – T) falls as the public finances "improve", and/or if consumer spending grows more slowly than wages, if households use rising incomes to reduce debt? Then, by identity, there will be downward pressure on profits. This would be increased if firms' focus on shareholder value continues to limit capital spending; one firm's spending, remember, is another's revenue and profit.
Of course, some of the pain of lower consumer and government spending will fall upon foreigners as UK imports fall. But it's unlikely that all of it will. And that means profits will take a hit.
The message here is simple, and bleak. Households can improve their balance sheets, the government can improve its, and profits can grow nicely. But it’s very unlikely that all three can happen at the same time.
