Labor Share and what?

Labor Share and Potential GDP

GDI: Point of interest

I took the highest "Shares of GDI" series for "Compensation of employees" and divided it by the highest "Shares of GDI" series for "Corporate profits". The resulting graph runs from 1929 to 2014 and it all stays between 0 and 20 except during the Great Depression, when it drops down around -180, then bounces back up.

I chopped off those early years to get a better look at the rest of it:

Graph #1

Oh...

This is employee compensation as a multiple of corporate profits. In the 1950s and early 1960s -- the "Golden Age" -- compensation ran low, at about five times the profit level. Then, during the "Great Inflation" compensation increased, relative to profits. In the 1980s, compensation ran high, at about eight times the profit level. Since the early 1990s, compensation declined relative to profits, and volatility has been greater.

Graph #2: Same as Graph #1, with Trend Lines Eyeballed In

Not what you expected, is it.

Employee compensation was low in the good years. It was high in the Reagan years.

Know what I think? I think there must be more to the story than compensation and profits.


I wanted to check my trend guesstimates, so I recreated the graph with a Hodrick-Prescott calculation:

Graph #3: Data from Graph #1, plus a Hodrick-Prescott Trend (ƛ=100)

Now, that's interesting. The red line looks like a sine curve. It suggests a repeating pattern. Now that's interesting.

GDI: Corporate profits

At FRED, 25 series come up in a search for shares of gdi.

Five series come up for shares of gdi: Corporate profits. These five:

Graph #1

The highest (most all-encompassing) of the five is: Corporate profits with inventory valuation and capital consumption adjustments, domestic industries.

GDI: Compensation of employees

At FRED, 25 series come up in a search for shares of gdi.

Seven series come up for shares of gdi: compensation of employees. These seven:

Graph #1

The highest (most all-encompassing) of the seven is Compensation of employees, paid.

Compensation of Employees as a Share of Gross Domestic Income

Graph #1: Compensation of Employees as a Share of Gross Domestic Income

Falling since 1970.

It needs work

Last Sunday I showed Ed Lambert's corporate "after tax profits in real terms" on a graph with "Labor Share". Why labor share? Because Lambert says "labor share of income must be raised because increased volume of business with labor would allow for better profits."

I said the graph was "interesting. But it doesn't support the view that boosting labor share will boost profits."

The graph shows that when labor share falls slowly, business profits increase slowly. And when labor share falls rapidly, business profits increase rapidly. One has to assume, then, that when labor share increases slowly, business profits fall slowly; and when labor share increases rapidly, business profits fall rapidly. Thus, the graph does not support the view that boosting labor share will boost profits.

I don't know how that analysis sits with you, but I didn't like it much myself. As I said on Sunday,

I agree with Lambert on the labor share thing... You can't squeeze the life out of one sector of the economy and still expect the economy to be just fine. It doesn't work that way. I agree with Lambert that the fall of labor share is a problem.

Not explicit, my thought at the time was not that Lambert was wrong to say falling labor share is a problem. (I agree with him on the labor share thing.) My thought was: It's not the right graph.


Lambert says

After the 2001 recession, labor share of income began falling to never before seen lows...

What has been the result? Firms have been able to increase after tax profits in real terms to new records after the 2001 recession.

But he doesn't show a graph comparing labor share and after tax profits. So I took the bait. I took his graph of after tax profits and added labor share to it. And looking at that graph, I can only say it does not support the view that boosting labor share will boost profits.

Lambert's argument, however, is not so simple. He says firms increased profits since 2001 by finding alternative sources of income. By finding alternatives, rather than depending on labor to spend enough to boost business profits:

Firms began to open up new ways to increase profits through the channels of the Financial sector, government and foreign markets. Interest rates have been falling. Money is cheaper. Effective tax rates have been falling. Outsourcing increased. Sales in foreign countries increased. Firms became less dependent upon domestic labor’s income.

Profits went up even though sales fell, Lambert says, because financial costs went down and taxes went down for business and foreign markets expanded. His conclusion:

For me, the solution lies in making firms more dependent upon the money flows with labor... Firms will have to realize that labor share of income must be raised because increased volume of business with labor would allow for better profits.

Could be. But Lambert leaves me in exactly the same position as before: lacking a graph that shows evidence to support his argument.

Last time, I took his profits graph and added labor share myself. But that graph couldn't carry the load. I was thinking about this. And it seems to me that a better graph might be one built on Shares of Gross Domestic Income.


I went to FRED and searched for shares of gdi. FRED returned one page of results. 25 series. It's kind of a jumble for me. I'm not familiar with the way they break down the numbers into categories. So I have to look at that.

I saved the FRED page as a text file (that's a menu option in FireFox) and went through the file by hand, keeping Series ID info and deleting a lot of HTML formatting. Tedious crap.

Yeah. After I got seven of the 25 entries reformatted, I thought to check the source where FRED gets this data: BEA. Found Table 1.11: "Percentage Shares of Gross Domestic Income". That might be better. The work is done already.

Here's what I was looking for. A breakdown by category, the components of GDI:

Components of GDI. From BEA Table 1.11

For some reason (or maybe for no reason) BEA does not provide a direct link to their tables. I've got Table 1.11 on the screen now, but the URL

http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=3&isuri=1&904=2007&903=52&906=q&905=2014&910=x&911=1

gets me to their "National Data" page. From there, click "SECTION 1 - DOMESTIC PRODUCT AND INCOME" and read down the list to find Table 1.11. And then "Modify" and "Select all years" and "Refresh Table".

Could be worse. (Have you tried ONS?)

Anyway, I can look on FRED's list of 25 series for the ones that are not indented on the BEA list. The major categories, not the sub-categories.

For some reason, or maybe for no reason, the "Net Operating Surplus" series starts in 1959. The other ones all start in 1929.

Graph #1: (Stacked Graph.) Not Useful. "Net Operating Surplus" Starts Late

You can see everything drops suddenly there just before 1960. That's when "Net Operating Surplus" gets added into the mix, taking a share of the 100% total on this stacked graph. So all the other shares fall.

Couple other things to see: 1. The purple line runs very close to the blue line. On a stacked graph, that means that the purple line doesn't add much to the total. The purple line is "Subsidies". So we know that subsidies are a small part of the total. And

2. The blue line, running right close to the purple one, runs low on the graph. Near the bottom of the plot window. But after 1959, it runs between 50 and 60 percent of GDI. That's more than half the total. FRED starts the vertical axis at 50%, not at zero. The blue line looks lower than it is in fact.

That blue line is Compensation of employees.

One other thing about this graph: Compensation of employees -- that blue line -- trends down since 1970. The green and red lines appear to trend down since 1980.  Doesn't stand out on this graph, but it is there if you look: "Net operating surplus" is crowding out "Compensation of employees" and the other categories.

Net operating surplus is mostly the "surplus" of "Private enterprises". Proprietors' income and corporate profits and such.

It needs work, but I want to say this graph supports Ed Lambert's view.

Words

At work we ... // Nope.

I'm retiring at the end of this year, two, two and a half months from now. More time for writing, I hope. Anyway:

At work we have very specific terminology for the things we do. Use a piece of wood one way, it's a "scab". Use it a different way, it's a "splice". Used a third way, it's a "waler".

Our terminology is important because, as long as we're careful to use it when we talk, it's easy to convey meaning. I do drawings for a living, drawings of things to be built. I can always draw a sketch to show what I'm talking about, what my question is, or like that. But I don't need to always draw a sketch, because we have the terminology.

Words are important.


I went back to Angry Bear to read Ed Lambert's post again, then checked out Robert Waldmann's How Many Equations Should There be in Macroeconomic Models?

Who could resist a title like that??

I started getting out of my depth in the second half of it, but the part I understood I thought was great. Waldmann writes, for example,

Standard DSGE models still contain no housing sector. So the profession is attempting to understand the great recession while ignoring housing completely.

Wow!

I should say, too, that this was the easiest read I've ever had in a Waldmann post.

//

There was a comment by William Ryan on Waldmann's post. In part:

What is important to you may not be important to me depending where you stand in the profit margin department. It becomes a matter of how we see things...

I think I know what "profit margin" means. But I looked it up anyway. Profit margin is "the amount by which revenue from sales exceeds costs in a business", Google says. Profit margin is an amount (as opposed to a rate).

Yeah, profit. You spend money to make money. After the money comes in, you subtract out how much you spent, and the rest is profit.

"Profit margin" is the same as "profit" I guess, if we go by the Google definition. I'm not comfortable with that. Terminology is important. Maybe "profit" and "profit margin" are the same. I don't know. So I did a little more digging.

I found a page from Chron -- some relative of the Houston Chronicle apparently. Hearst newspapers. The page is What Is the Difference Between Profit Rate and Profit Margin Ratio? Seemed like it might be useful.

It's garbage. I want to go thru it a piece at a time. First, the opening:

Understanding the difference between profit rate and profit margin ratio is critical for a small-business owner.

The rest of that paragraph explains why it is important to you.

Not off to a good start here.

Next, the Profit Rate:

Your profit rate is the percentage of your income that is profit. You can calculate this by deducting your total expenses from your total income, and taking the amount remaining as your profit. Divide the profit by your total costs, and the result will be the rate, or percentage, of profit that you make on your sales.

"Deducting" means subtracting. So, total income - total expenses = profit
And then, profit / total costs = the rate of profit. Profit ratio. (For percentage you have to multiply the ratio by 100.)

But terminology is important. I don't care if we say "total expenses" or "total cost". But we should pick one, and stick with it. Pick and stick. So
income - expenses = profit
And then,
profit / expenses = profit rate

To make matters worse, they introduce the topic by saying

Your profit rate is the percentage of your income that is profit.

Percentage of income they say, not percentage of expenses. To figure percentage of income, you have to divide by income. But they don't want you to divide by income. They want you to divide by total expenses. To be consistent, they should have introduced the topic by saying

Your profit rate is your profit as a percentage of your costs.

I don't know if that's correct. But at least it would have been consistent.

What the Chron article is doing is like if I went to work, learned my definitions for "scab" and "splice", and then started using the two words interchangeably, as if they were the same. Oh my god, it defeats understanding! and it defeats the purpose of having a terminology.

There is a word for that: Stupid.

Next, an Example:

A home-based, small business brings in $5,000 a month in sales of dog clothing and accessories. The cost of goods sold, including the purchase of materials and wholesale products, the cost of labor to make and sell the products, and the business overheads add up to $3,500 a month. Deduct the total expenses from the total income, and the profit is $1,500 a month. To calculate the profit rate, divide $1,500 by $3,500 and the result is a profit rate of 43 percent.

Forty-three percent. Oh, that's realistic.

"Overheads" -- plural?

I hate examples that are full of words. I don't need to know it is "A home-based, small business". (And they don't need that comma.)

I need to know we're looking at "$5,000 a month in sales". I don't need to know about dog toys. Dog clothing and accessories, whatever. (Hey -- "dog clothing" is funny. But it is buried in so many mistakes that I didn't even see it till now.)

Maybe I do need to know all of

The cost of goods sold, including the purchase of materials and wholesale products, the cost of labor to make and sell the products, and the business overheads add up to $3,500 a month.

I'd be happy with just "expenses add up to $3500 a month". But expenses are technical, too. Very, very well defined by the IRS. Not clearly defined, perhaps, but defined in many, many words.

But really, the article shouldn't be explaining the tax code. So really, I just need to know we have $5000 in sales and $3500 in expenses. (I don't even need to know "a month".)

Expenses = $3500
Income = $5000

Income - Expenses = Profit
$5000 - $3500 = $1500

Profit = $1500

$1500 / $3500 = 43%

Profit Rate = 43%

Done.

Next, Profit Margin Ratio:

Profit margin ratio is the ratio of the business's gross profit in relation to sales. Using the example above, your net income is $1,500 a month. Divide this figure by the total income of $5,000 a month, and your percentage of income that constitutes profit is 30 percent. This means that the profit margin ratio is 0.30:1, or 30 percent of each dollar earned. This tells potential investors that 30 cents of every dollar you make in sales is profit, which helps identify whether your business is profitable.

... helps identify whether your business is profitable.

Yeah -- because you couldn't tell whether your business is profitable from the 43% number you got before.

Good grief.

So what else do we have here? New terminology: "gross profit" and "net income". Neither has been used before in the article. So you've got new, undefined terms. Does that help the understanding? Does it convey?

No.

"Gross profit" is the same as "net income" and both are the same as the word "profit" as used in the Example paragraph and the Profit Rate paragraph. So: Profit margin ratio is profit in relation to sales. Oh, and "sales" is the same as "income" -- but gross income, not net.

So how does "Profit Margin Ratio" differ from "Profit Rate"? The one is profit divided by income. The other is profit divided by expenses.

That's all they needed to say.

p.s.

I have no confidence that what I learned from the Chron article is right, because the article is so badly written.

I like Ed Lambert's conclusion

Jazzbumpa:

Art -

O/T here, but I want to recommend Ed Lambert's latest post at A. B.

Serious food for thought.

http://angrybearblog.com/2015/10/turner-debtdel-fallls.html

Cheers!
JzB

Dunno if there's anything to it, even after I read it once. I'll take another look now, on your time. Here's a summary of the first part of Lambert's Angry Bear post:

Adair Turner lays out an exquisite economic analysis on many layers. Yet I question him… Is it truly deleveraging debt along side fiscal consolidation that is making some economies sluggish?

I look at another cause for economic sluggishness… the fall in labor share. I see the fall in labor share as a fall in effective demand, which has lowered economic potential and the social benefits in the economy.

Every time you copy and paste a line of text from an Angry Bear post you get a line like "See more at: http://angrybearblog.com/2015/10/turner-debtdel-fallls.html#sthash.A73gaDq0.dpuf" appended to the text you copied. It's annoying, and it gets tiresome. Serious food for thought, there.

Anyway, Lambert ends this part of his post with a great conclusion:

We can say that deleveraging debt and the fall in labor share both contribute to the economic sluggishness. - See more at: http://angrybearblog.com/2015/10/turner-debtdel-fallls.html#sthash.A73gaDq0.dpuf

Deleveraging and the fall of labor share both contribute to the problem. Yes! The economy is a complex thing. Causes have consequences, and consequences become causes. It is important to point out, once in a while, that everything depends upon everything. (But what was it Schumpeter said?)

Then Lambert farts in the applesauce. Turns out, he only brought the subject up so he could talk about his pet peeve:

But since Adair Turner did not talk about the fall in labor share, I will.

The second part of Lambert's article is titled The Channels of Money Flow for Business. Lambert provides this interesting image:

Source: Edward Lambert

The picture focuses on "firms" -- the domestic nonfinancial business sector -- and shows four other sectors with which firms engage in trade: foreign, financial, labor, and government. Firms have flows of funds to and from each of these other sectors.

"After the 2001 recession," Lambert says, "labor share of income began falling...":

After the 2001 recession, labor share of income began falling to never before seen lows. Consequently relative sales to labor also decreased because labor had less income relative to production. So overall money flows between labor and firms has been growing slow. Firms have had less ability to profit from labor due to decreased overall money flows with labor. So in response, how did firms compensate for the decreased flows with labor?

Firms began to open up new ways to increase profits through the channels of the Financial sector, government and foreign markets. Interest rates have been falling. Money is cheaper. Effective tax rates have been falling. Outsourcing increased. Sales in foreign countries increased. Firms became less dependent upon domestic labor’s income.

So firms have increased money flows in other channels other than with labor. What has been the result? Firms have been able to increase after tax profits in real terms to new records after the 2001 recession.

I agree with Lambert on the labor share thing. Consumers consume. We spend most of our income. (We did, anyway, before the crisis.) So if firms wanted to boost business sales, they could get their wish by paying higher wages: Consumers would have more money, consumers would spend more, business would bring in more revenue, presto, magic, done. You can't squeeze the life out of one sector of the economy and still expect the economy to be just fine. It doesn't work that way.

I agree with Lambert that the fall of labor share is a problem. But I don't agree with his explanation of events.

He documents the claim that "after tax profits in real terms [hit] new records after the 2001 recession" by showing a graph of profit with price increases stripped away.

Why Lambert shows profit "in real terms" I don't know. Those record highs are even higher if you leave inflation in. And for crying out loud, he used the CPI in his calculation, rather than the Producer Price Index or something like.

But you can take "labor share" and add it to Lambert's profits graph, and get an interesting picture:

Graph #1: Corporate Profits (blue) and Labor Share (red)

After the 2001 recession profits started going up like crazy, and labor share started dropping like crazy. Of course. Money doesn't disappear when you spend it. It just goes into a different pocket.

Before the 2001 recession, profits increased gradually while labor share fell gradually. So money moved slowly from workers' pockets to owners' pockets before 2001, and fast after 2001.

This is interesting. But it doesn't support the view that boosting labor share will boost profits.

//

Lambert's graphic of money flow for "firms" considers both "Foreign Markets" and the "Financial Sector" to be external to firms. So I have to assume his data for firms is domestic and nonfinancial. That's fine; I just want to be clear.

If he is looking at what FRED calls domestic nonfinancial business ...

I can't find profits at FRED for business. I can only find profits for corporate business. So I want to assume that Lambert's "firms" means domestic nonfinancial corporate business. This is reasonable, because his profits graph shows corporate profits.

(I'm trying to use the right data here, to make a valid evaluation of Lambert's post.)

If he is looking at what FRED calls domestic nonfinancial corporate business, he shouldn't be showing a graph of corporate profits. He should be showing nonfinancial corporate business profits. There is a difference:

Graph #2: Corporate (blue) and Nonfinancial Corporate (red) Profits
(Lambert used the blue one.)

Funny thing, though. The assets of nonfinancial corporations are increasingly financial assets:

Graph #3: Financial Assets as a Percent of All Assets of Nonfinancial Corporations

Nonfinancial corporations have been increasing their holdings of financial assets. This means the profits of nonfinancial corporations are increasingly financial profits. You have to wonder what nonfinancial corporate profits would look like if we exclude their financial profits. This graph assumes the profit rate is the same for financial and nonfinancial assets:

Graph #4: Nonfinancial Profits of Nonfinancial Corporations (red) and Total Corporate Profits (blue)

The blue line shows total profits of corporations. The red line shows the nonfinancial profits. The space between the red and blue lines represents financial profits.

The blue line is unchanged from Graph #2. The red line is much lower now.

//

Next, take labor share and add it to the previous graph:

Graph #5: Total Profits (blue), Nonfinancial Profits (red), and Labor Share (green)

Before the 2001 recession, profits increased gradually while labor share fell gradually. After the 2001 recession profits started going up like crazy, and labor share started dropping like crazy. Money moved slowly from workers' pockets to owners' pockets before 2001, and fast after.

It is pretty easy to see the sudden increase in profits after 2001, and a matching decrease in labor share. It is also easy to see that the sudden increase in profits was mostly financial profits. Profits made at the expense of those who are in debt.

So, when Ed Lambert says

After the 2001 recession, ... relative sales to labor also decreased because labor had less income relative to production.

we know he is not quite correct. Labor had less income relative to finance, certainly. Relative to production, not so much.

But when Ed Lambert says

For me, the solution lies in making firms more dependent upon the money flows with labor. That means reversing the policies that increased profits through money channels other than with labor.

I think he is exactly right. Lambert's focus is the fall of labor share. Mine is the rise of finance. Yours may be the decline of tax rates on the wealthy and on big business. And maybe all of us want to see our trade deficit reduced. If so, all of us are calling for "making firms more dependent upon the money flows with labor."

// related post: "One for You, Three for Me"

The ultimate utopia

cochrane:

Tuesday, October 13, 2015
Open Borders
Alex Tabarrok has a very nice and very short piece at the Atlantic, The Case for Getting Rid of Borders—Completely. (HT Marginal Revolution)

In the Soviet era, there were walls and guards with guns, and we deplored that people were not allowed to cross the border. Is it that different that the guards with guns are on the other side of the walls?

If you're a liberal, you should cheer the policy with the greatest chance of elevating the world's poor and reducing global inequality. If you're a conservative, believe in the rights of individuals and freedom, don't like minimum wages, unions, protectionism, and government control, it makes little sense to switch sides on this one issue.

The nation-state has not done well lately. A time of troubles, Toynbee would say. There's no denying it.

I wouldn't dream of denying it. But I'm not one who likes change: I don't want to throw away the nation-state. I want to fix it.

//

If you take Europe as an example, and start erasing internal borders, nation-state borders -- gradually, just to improve economic conditions (sucker!) -- it turns out the economy goes to shit anyway, goes to shit in large part because of border-erasing. Specifically, because of the elimination of national money in favor of the euro. But I don't have to tell you that. You've been telling me.

When things go bad, the word comes down that to make things better they need a stronger supra-national government. The problem, they say, is that the suppression of national sovereignty was not complete enough. They need not only a unified money but also a unified fiscal -- tax policy in common throughout the continent.

You know, that could work. But I don't think we want it. Do you get much face time with the U.S. President? How about your state governor? No? You stand a much better chance of getting a word with your mayor or town supervisor. Local government is more responsive to its people. National government is already unresponsive. Supra-national government would be even less responsive. It is less responsive. They do what they want, and they tell you it's good for you.

People like cochrane seem to believe that crap.


You want a global, unified state? Ha! So did Gene Roddenberry.

So do I. But the driving force behind global unification is the desire of the wealthy few to expand markets in order to capture even more wealth. So the time is not yet right.

If we can't make the economy good with the level of government we have now, then making government more comprehensive and less responsive is not the answer.