Sunday, June 5, 2011

"What the hell kind of recession is that?"

While the bulk of the population suffers, corporate profits have soared, Jazzabumpa writes. BING! and I'm off.

This is "Corporate Profits After Tax" from FRED:

Graph #1

Up, up and away. Not sure what Jazz refers to as "profits have soared". Maybe the recent rebound from the depths of recession? Maybe the more-than-doubling that occurred in the mid-2000s? Maybe just the general uptrend? One or both of the more recent two, I suspect.

But Graph #1 provides no context.
// And now I will lead you astray.
Below is corporate profits relative to GDP:

Graph #2

Wartime profits at a high level, but falling into the early 1950s... Then rough stability until around 1980... Followed by a decline until about 1986-87... Then a significant upward trend from a low of 3% to a peak of over 10%, followed by a painful moment during the recent recession, and a quick bounce back up to 9½%.

Hm. Not at all what I expected to see. But it has been a long time since I looked at corporate profits.

I am not pleased with the context I put profits in, for Graph #2. GDP is the "size" of the economy and everything gets compared to it. So I did the quick-and-dirty thing, and used GDP for the context. But that ain't right.

Profits were up over 6% of GDP in the mid-1950s and mid-'60s, when the economy was very good. Profits were up over 6% of GDP in the mid-'70s, when the economy was not very good. And profits went up over 6% of GDP by the mid-'90s, when the economy was just so-so. So is 6% profit good? or bad? or indifferent?

In the second half of the '90s, when the economy gave its best performance in a long time, profits fell. But when the economy was good, profits should have been rising.

Then again, profits reached a new high in the mid-2000s. Unemployment should have reached an all-time low. Yet that is not what happened.

None of this makes sense. When the economy is good, profits should be good. And when profits are good, the economy should be good.

Here's the trouble: GDP is exactly the wrong context for profits. What the graph shows, more clearly than most graphs, is the denominator effect. When the economy grows, the expanding denominator makes the trend line fall. When the economy does poorly, a shrinking denominator makes the trend line rise.

The graph doesn't show the changes in profit; it shows the effect of changes in GDP. The graph is junk.

Adam Smith had an interesting observation about profits:

The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. They are regulated altogether by the value of the stock employed, and are greater or smaller in proportion to the extent of this stock.
The Wealth of Nations, Book One, Chapter VI: "Of the Component Parts of the Price of Commodities"

The proper context against which to look at corporate profit, according to Adam Smith, is the investment required to generate that profit. Not GDP.

1 comment:

Jazzbumpa said...

"profits have soared"

Yes the rebound from the depths, in the latest jobless non-recovery; though the other two aspects are relevant to the larger perspective.

But your second graph is not garbage. The context is relevant. It's just that with any time series ratio, you need to be very careful about what conclusions you draw.

One could posit that in normal times, the profit/GDP ratio runs between 3 (or 4) and about 7% - sort of a Hauser's canard - er, tautology . . . I mean Law analog.

What this suggests is that the last decade really is extraordinary. Putting graph 1 on a log scale would be interesting.

But the truth is that Corporate profits really have soared while the rest of us have suffered. Indeed, there is a huge shift, starting in the mid 80's, of all times. And there is your great stagnation.

The corollaries are the slow, steady decline in median income, and the decline in wealth capture by the working class.

You can look at an observable phenomenon in a variety of contexts. This one tells a rather interesting story, and is actually a rather nice piece of work.

The next thing to look at might be how all that profit is distributed among sectors.