One of the paradoxes of economics is that although profits are the motive for much economic activity, macroeconomists rarely discuss them. They should, because in the US the picture is grim.
Figures from the Federal Reserve allow us to put together a measure of the profit rate since 1952. They show that the pre-tax profits of non-financial companies last year were just 7.4 per cent of non-financial assets (measured at historic cost). This was only half the rate firms enjoyed in the mid-1950s. And even before the pandemic, the profit rate had been trending down for decades: it was lower in 2019 than it was in the 1970s, for example.
This long downtrend explains a big fact – that trend economic growth has slowed. In the 10 years to the end of 2019 real GDP per head grew by only 1.6 per cent per year – and that was a recovery from a deep recession. That compares to average growth of 2.5 per cent per year between 1953 and 1973. Quite simply, if profit rates are lower firms have less incentive to invest and innovate – which means economies stagnate.
You might find these facts puzzling in light of talk that monopoly power and the share of profits in US GDP have risen in recent years. But there’s no great paradox. As Jan Eeckhout and Jan De Loecker have shown, it is only a minority of firms that have enjoyed increase mark-ups since the 1980s. And a higher share of profits in GDP is entirely compatible with a falling profit rate if the capital stock grows faster than output.
Yes, giant firms such as Apple (US:AAPL), Amazon (US:AMZN) and Microsoft (US:MSFT) are enjoying great profits. But much of corporate America is in a bad way. That’s why just five companies now account for over 20 per cent of the S&P 500.
From this perspective, the pandemic might – just might – be a solution, as it could raise the profit rate in two ways.
First, the recovery from the pandemic – aided by President Biden’s $1.9 trillion fiscal boost – will raise aggregate demand and hence profits: the OECD expects GDP growth of 6.5 per cent this year, the strongest growth since 1984.
Secondly, the pandemic is reducing the denominator of the profit rate, the capital stock. Non-residential capital spending fell 4 per cent in volume terms last year, and S&P report that the number of large firms going bankrupt rose over 8 per cent, suggesting that the degree of capital scrapping has increased.
Higher profits, spread over less capital, can yield a big rise in profit rates. And indeed, we’re already seeing the start of this. Fed figures show that the profit rate rose from 5.7 to eight per cent between the second and fourth quarters of last year.
But we’ve seen this before. After the recessions of 1990-91, 2001 (a mild recession for output but nasty one for profits) and 2007-09 profit rates bounced back sharply. But on all three occasions they failed to return to the peaks of the 1950s and subsequently fell back again. History could well repeat itself, especially if this upturn does lead to higher inflation and interest rates.
Profits are of course essential for the health of capitalism. By this metric, American capitalism is less healthy than it used to be – and is likely to remain so.
