What's behind the rising US profit share?

Diane Coyle says the fact that different countries have seen different changes in labour’s share of income in recent years – with it falling in the US but not UK - shows that “institutions are playing a big part” in driving factor shares. This is true. But it’s only part of the story.

I say so for a simple reason. Imagine aggregate wages were to fall for some reason – technical change, globalization, whatever. Would this raise the profit share?

Not necessarily. If every £1 fall in wages causes workers to cut their spending by £1, profits would also fall. In effect, what capitalists gain from the wage cut, they lose from a drop in revenues. As Michal Kalecki wrote in 1935:

One of the main features of the capitalist system is the fact that what is to the advantage of a single entrepreneur does not necessarily benefit all entrepreneurs as a class. If one entrepreneur reduces wages he is able ceteris paribus to expand production; but once all entrepreneurs do the same thing – the result will be entirely different. (Selected Essays on the Dynamics of the Capitalist Economy, p26)

A fall in wages might therefore cause a drop in economic activity rather than a rise in the profit share. To understand whether this will happen, we need to know what happens to the circular flow of income.

We can express this by re-arranging basic national accounts identities. GDP is equal to consumption, investment, government spending and net exports: Y = C + I + G + NX. It is also equal to the sum of incomes: wages, profits and taxes on production (plus depreciation):  Y = W + P + T + D. Rearranging these gives us an identity for profits:

P = (C – W) + (I – D) + (G - T) + NX.

This should be intuitive. Profits will rise (ceteris paribus): if consumption rises relative to wages (say because workers save less); if net investment rises (as Kalecki says, capitalists get what they spend); if the government borrows more; and if there’s a big trade surplus (say because import prices fall).

My table applies this framework to the US (based on tables 1.1.5 and 1.10 here*). It shows these four factors as a share of GDP in three years: 2000 (when the profit share was unusually low), 2007 and 2017.

Two big things stand out here. One is that the main counterpart to the rising profit share has been a rise in consumption relative to wages. This hasn’t happened because people have borrowed more; the savings ratio has risen slightly since 2000. More likely, I suspect, it is due to higher spending by business owners.

Also, note that net investment is much lower than in 2000. This suggests the US is in what Marglin and Bhaduri called (pdf) a stagnationist regime, in which a higher profit share is associated with lower investment.

You could interpret these two developments as signalling that profits are being sustained by short-termism – consumption rather than by investment.

Now, I know that identities don’t tell us anything about causality. These numbers are entirely consistent with Diane’s point that institutions matter. These can and do put downward pressure on wages. What happens to factor shares, however, also depends upon the behavioural responses to that incipient drop. National accounts identities help identify these responses.

This way of thinking helps explain the IMF’s point, that there’s a massive heterogeneity in developments in factor shares.

Consider, for example, two possible extremes. In one, an incipient fall in wages boosts capitalists’ confidence and hence investment. The upshot could be a boom in economic activity in which the profit share rises but in which the absolute level of wages and employment also rise: this is Marglin and Bhaduri’s exhilarationist regime.

At the other extreme, though, capitalists might respond by cutting investment whilst at the same time consumption stays weak – say because workers, fearing further cuts in wages, save more. In this case, we’ll get lower economic activity and even a fall in the profit share.

Both responses are possible, depending upon local and temporary factors such as credit constraints and animal spirits.

In this sense – and this is the virtue of Marglin and Bhaduri’s paper – general theories about factor shares are insufficient. Instead, as Edmund Burke said: “circumstances are what render every civil and political scheme beneficial or noxious to mankind.”

* I’ve lumped in the statistical discrepancy with capital consumption. Profits are actually the “net operating surplus” which includes rents and self-employment income; this is much higher than corporate profits alone.  

Comments

[Tony of CA]

Can someone please define Animal Spirits? The way folks use it in economics it sounds rather ambiguous.

[UserFriendly]

"One is that the main counterpart to the rising profit share has been a rise in consumption relative to wages. This hasn’t happened because people have borrowed more."

Actually the BEA throws too much garbage in there that shouldn't count as consumption. Government and employer payments for healthcare get added to consumption expenditure, for example.

I highly recommend this paper from the St. Louis Fed.

"In Sections 2 through 7, we have made the following claims:

• The great majority of household debt is incurred to finance asset positions, not current consumption.

• Historically, changes in household debt-income ratios have been driven more by variation in nominal income growth and interest on existing debt, than by new borrowing.

• Household debt is concentrated near the top of the income distribution; very little is owed by lower-income households.

• Consumption inequality appears to have increased in line with income inequality.

• The apparent rise in household consumption relative to income is entirely the result of third-party and imputed noncash expenditure; cash outlays for consumption by households are no higher as a share of income than they were in 1980."

https://www.stlouisfed.org/~/media/Files/PDFs/HFS/assets/2017/JW_Mason.pdf?la=en

[B.L. Zebub]

Chris,

I've been puzzling about Kalecki's price equation for a while and I've stumbled on something I'm not sure you noticed, although I suspect you may be close to. Take this bit, from Kalecki's quote:

"If one entrepreneur reduces wages he is able ceteris paribus to expand production; but once all entrepreneurs do the same thing – the result will be entirely different".

So, in Kalecki's opinion, wage suppression leads to suppressed production, yes? That is so because, following Kalecki, less consumption translates into less aggregate demand and less sales, which leads to less production and investment (again, depressing aggregate demand).

This, however, is what you found:

"[T]he main counterpart to the rising profit share has been a rise in consumption relative to wages. This hasn’t happened because people have borrowed more; the savings ratio has risen slightly since 2000. More likely, I suspect, it is due to higher spending by business owners."

But that contradicts Kalecki's claim! I might be mistaken, but Kalecki seems to take for granted that workers' consumption and capitalists' investment are the only components of aggregate demand in a closed economy. But that ignores what you yourself found: higher [consumption] by business owners. A constant -or even falling- workers' consumption may be compensated by an increasing capitalists' consumption.

I don't claim originality in making that observation. A few years back Paul Krugman made a brief comment that seems to point in the same direction:

"So am I saying that you can have full employment based on purchases of yachts, luxury cars, and the services of personal trainers and celebrity chefs? Well, yes. You don’t have to like it, but economics is not a morality play, and I’ve yet to see a macroeconomic argument about why it isn’t possible."
http://krugman.blogs.nytimes.com/2013/01/20/inequality-and-recovery/

If that objection is granted, Kalecki's omission is curious, because both Robert Malthus and Bernard Mandeville (the latter in his "The Fable of the Bees") influenced early Keynesian writers. Both Malthus and Mandeville emphasised the role of luxury consumption -non-productive, as they called it- by the upper classes.

[Robert Mitchell]

"If every £1 fall in wages causes workers to cut their spending by £1, profits would also fall."

This reasoning ignores Piketty's finding that r > g. Business owners can easily make more profit from purely financial investments than from selling goods or services in the real economy.

If you look at an insurance company's income statement, you see they make more from re-insurance and other returns on financial assets than from premiums. Same for public utilities; their investments pay out enough to cover operations and maintenance. Consumer electricity rates are explicitly decoupled from energy supply and go straight to retained earnings.

[Ahmed Fares]

@Robert Mitchell

"If you look at an insurance company's income statement, you see they make more from re-insurance and other returns on financial assets than from premiums."

Actually, they typically have higher losses than they earn on premiums. That's the business model. The losses on insurance are their cost of funds, in the same way that deposit interest is a cost of funds for a bank. Insurance companies earn money on the float between the time they receive premiums and the time they pay claims.

Insurance, like banking, is a spread business.

[E-commerce Solutions]

Well written article thanks for sharing.

[Robert Mitchell]

@Ahmed Then trying to calculate an insurance company's output using the System of National Accounts is misleading. SNA explicitly ignores capital gains; yet insurance companies' profit mostly comes from capital gains. If you use the SNA output for insurance companies, you ignore their realized profit in favor of imputed figures based on claims and premiums alone.

My point is that the figures used in this blog post don't reflect real profits. We should stop using BEA statistics in economic arguments because they ignore probably 90% of the money out there.

[Kester Pembroke]

Chris, get off your ass and do something to get George Soros as Secretary of State who supports ending the war on terror and the war on drugs. After all these years of wanting to end the war on terror Soros has never considered being the American foreign secretary.

[Kester Pembroke]

We need to support his EU Common Treasury idea. (Soros)