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The shrinking pie

The most obvious reason for my surprise is that labour productivity has fallen. Total hours worked in the three months ending in February were 1.4 per cent up on the previous three months whereas GDP grew only 0.5 per cent, according to NIESR, implying that productivity fell by 0.9 per cent. If workers are producing less, we'd expect them to earn less.

But they are also producing less for their employers. Lower real wages don't mean higher profits. Real wages are falling not because companies are taking a bigger share of the pie, but because the pie is shrinking.

This is especially so because many companies face two other squeezes on their profits. One is that sterling's fall has raised the cost of raw materials and imports. Import prices are 9.9 per cent up on a year ago, and manufacturers are paying 17.9 per cent more for their materials than they were a year ago. Yes, the weak pound means that exporters can pass these higher costs on to their customers. But only around 15 per cent of non-financial businesses do any exporting at all, according to the ONS.

A second pressure is the rise of very small businesses, which are nibbling away at corporate profits: think of micro breweries, farmers' markets, pop-up shops and the like. Since 2010, the share of GDP going to the self-employed has risen (albeit because there are more of them, rather than because they're making big money). This means less for workers and employers in the corporate sector.

One big fact tells us that employers aren't taking a bigger share of the pie. It's that the share of profits in UK GDP has been stable in recent years. At the end of 2016 it was 20.9 per cent. That's less than in 2014-15 and slightly below the average since 1955 (when current data began).

You might object to this by pointing to official figures last week. These showed that the gross return on capital for non-oil, non-financial companies has risen to close to its highest rate since 2000.

Such numbers, however, raise a question: if companies are making high returns on capital, why aren't they increasing that capital? Why is business investment falling?

The answer, I suspect, is that these figures paint too healthy a picture of companies' fortunes. For one thing, the profit rate has been boosted by companies increasing the ratio of labour to capital: employing more workers raises the ratio of output to capital and hence returns on capital while reducing labour productivity. And for another these numbers measure the capital stock at replacement cost. This means that falls in the relative price of capital goods mechanically raise the measured profit rate. Whether this means companies are actually better off is, however, debatable.

My point here is a troubling one for investors. The fall in real wages does not mean profits are doing well. Instead, the fall is bad for us all.