by Nigel Gault
Profits in the U.S. economy rose at their fastest rate in 20 years in the fourth quarter of 2003. This week’s final GDP release for the fourth quarter showed pre-tax profits from current production (“economic” profits) up 29.0% year on year. That is the strongest increase since the first quarter of 1984. The profits jump reflects a combination of strengthening GDP growth (4.3% fourth quarter to fourth quarter), declining unit labor costs (down 1.7% fourth quarter to fourth quarter), and low interest rates. Extra revenues have gone straight through to the bottom line.
For the calendar year 2003, economic profits were up 18.3%, passing the $1 trillion mark for the first time ($1070 billion). The peak level of profits in the last cycle was in 1997, at $868 billion. The 1997 level was not regained until 2002 ($904 billion), but now we have moved far beyond that.
Strong productivity gains, a lack of employment growth, and rapid profits growth are all part of the same story. Companies have been able to produce more output without new hiring, and without bidding wages up. As a result, profits have soared. The share of economic profits in GDP hit 10.7% in the fourth quarter (see chart), a rate seen briefly in 1997, but before that only in the 1960s. The share will probably go higher in 2004. As the profit share of GDP has risen, so the wage and salary share has fallen from above 49% in 2000 to below 46% in the fourth quarter.
Setting aside the question of whether these income shifts are desirable on equity grounds, do they create risks for the recovery? All income ultimately accrues to households. A lack of hiring means sluggish growth in household wage and salary income. But as corporate profits and proprietors’ income grow rapidly, so the households who own these businesses (including all holders of private pension assets) benefit from increased dividends and capital gains. If the distribution of income does not matter for overall spending growth, then demand can grow just as fast whether extra output feeds wages or profits.
However, the prospective newly employed are likely to have a higher propensity to consume out of their extra income than most households, since they are much more likely to be constrained to keep their spending in line with their income. Wealthier households who benefit from profit gains may or may not raise their spending. In addition, while households as a group benefit from profit gains via pension funds, such gains are unlikely to fuel current spending. It is true that rapid profit gains will help to fuel extra investment spending, but this would probably not offset the shortfall in consumption.
There is also a confidence issue. Until the job market has clearly turned, those employed are likely to feel vulnerable to losing their jobs. The longer the interval before jobs appear, the more cautious they may become. In effect, a persistent lack of job creation would threaten to short-circuit the usual “snowball” effect, where spending, output, employment, income, and confidence all feed off each other and drive the economy forward.
Global Insight expects hiring to pick up over the course of the year. The strong growth in profits should make companies more confident about adding to their payrolls. But if the jobs drought persists, its distributional effects could eventually undermine the recovery by weakening consumer spending growth, especially in the second half of the year—beyond the “tax refund” season.
