Economics
Profits up ... Wages down

Dean Baker ... Profit share hits record high ... If economic debates in the US were focused on reality, the demand gap would be at the centre of the discussion.

Burgess COMMENTARY
I seem to have read this same story a hundred times in the past couple of years ... but nothing seems to change.

When I was a corporate executive ... budget manager, controller, CFO and similar posts ... one of my contributions to corporate performance was the design and implementation of the accounting systems so that all the decision makers would have the metrics they needed to make the right decisions for their areas of responsibility and to have the right incentives in place so that people were motivated to work in ways that contributed to the organization's profit performance.

In society the metrics that are available and the metrics the media talk about are not at all helpful. I think it is fair to say that money profit and GDP growth are the two measures that get talked about the most in relation to economic performance and economic health.

The media also talks about jobs ... or unemployment. I sense that the media thinks that this is something that will improve when there is more profit and more GDP growth ... and that is about as far as it goes.

I have rarely heard the media talk about the role productivity has played in creating unemployment. I have rarely heard analysts talking about the relationship between more profit and less jobs.

Based on my corporate experience, I have often observed that it is easy to make more profit ... 'Fire an American and hire a Chinaman'. If profit is the determining metric, then there is going to be a migration from high wage areas to low wage areas. Companies are going to move their manufacturing operations from the US to China ... and their operations in China may well get sub-contracted or moved to other countries where labor costs are even lower.

More profit for investors is offset by less money for labor. This is a dangerous 'race to the bottom'

Economic policy making that has GDP growth as its goal is also very dangerous. GDP growth makes it much easier to sell more 'stuff' and make more profit. Maybe in the process there might be some job creation, but when the policy is to promote consumption then it is likely that the job growth is going to be in low wage locations. GDP as a measure of economic performance and economic health is useless.

Society needs better metrics along the lines of TrueValueMetrics (TVM). Society needs economic activity that is valuadd rather than value destruction. If the economic activity can also make profit and have positive cash flow, that is an added benefit, but the driver of decision making should be the ability of the economic activity to produce valuadd.

There are many new metrics in play at the present time. Triple Bottom Line is one of these, where profit, people and planet are all taken into consideration. I like the idea, but it cannot get traction in its present form. The money profit accounting systems are everywhere, and the conversation about profit is the basis for all the decision making in capital markets. As far as I know people accounting and planet accounting do not exist in a useful form ... and the conversation about people and profit is only going on among a very small group of people. most of whom are far removed from the corporate 'C' level executives who make decisions and the capital market investors who provide funds for corporate decisions.

The TVM intiative aims to modernize double entry accountancy invented more than 400 years ago and the basis for modern money profit GAAP accounting so that it can be used everywhere as value accountancy which takes into account the money profit dimension of economic activity as well as people impact and planet impact. The key is that there may not be mention of profit without the related mention of people and planet.

The TVM framework is accountancy, not statistics. Because of this, many of the concepts that make money profit accountancy so efficient for reporting business performance can also be used for valuadd.

If we start to measure the right things, then the decision making will change so that we get the right results. This is what TVM is all about.
Peter Burgess

Profit share hits record high ... If economic debates in the US were focused on reality, the demand gap would be at the centre of the discussion.

IMAGE When the economy did finally emerge from the downturn it was on the 'back of the housing bubble' [GALLO/GETTY]

The battle between President Obama and the Republican Congress has become a major spectator sport as we approach the end of the year. While this political dispute may provide for good entertainment, unfortunately it is having the effect of displaying the state of the economy as an issue in the public spotlight.

This is really unfortunate, because the economy can definitely use some help. Rather than offering help, the real question with the budget standoff is how much further we will impair economic growth with further cuts to the deficit. Rather than posing a problem, the deficit is a crucial support to the economy at present and it is likely to remain a crucial support for the foreseeable future.

The simple story of this downturn, and indeed for much of the last two decades, has been one of inadequate demand. In the decades immediately following World War II, productivity growth quickly translated into wage growth, ensuring that demand kept pace with productive capacity. The relationship between productivity growth and wages broke down in the 80s as a result of several policy changes, most importantly rules weakening unions, opening sectors of the economy to trade, and the deregulation of transportation, communication and other key sectors.

Consumption boom

With more income going to profits, there was a risk that demand would lag productivity, since a smaller share of profits will be spent than wage income. In the 1990s, the gap between productivity and wages was filled by the stock bubble. When the ratio of stock prices to profits rose to more than twice their trend level, it sparked a surge in investment, and more importantly a consumption boom. Over the course of the 90s, the saving rate fell from close to 8 per cent at the start of the decade (its long-term average) to just 2 per cent at the peak of the bubble in 2000.

The stock bubble burst in the years 2000-2002, pushing the economy into a recession. While the official recession was short and mild, lasting just seven months in 2001, it was very difficult for the economy to recover from this bubble-induced recession. It did not begin to generate jobs again until September of 2003 and the economy did not get back to its pre-recession level of employment until January of 2005. At the time, this was the longest stretch without job growth since the Great Depression.

When the economy did finally emerge from the downturn it was on the back of the housing bubble. House prices diverged sharply from their long-term trend. Historically, nationwide house prices had just kept even with the rate of inflation. By the peak of the bubble in 2006, they had risen by more than 70 per cent after adjusting for the inflation over the prior decade. This bubble led to a boom in housing construction. The $8 trillion in artificial housing wealth generated by the bubble pushed the saving rate to near zero as consumption soared.

The bursting of the bubble is the story of the downturn. There continues to be no source of demand to replace the roughly $1.2 trillion in annual demand (at 8 per cent of GDP) that was generated by the bubble. In the short-term, the federal budget deficit has helped to fill this gap, but as pressure grows to reduce this deficit, there will have to be some other source of demand to replace it.

In the long-term, there really is no alternative to getting the trade deficit down, filling the gap in domestic demand with foreign demand. But this adjustment will not occur quickly, especially in a situation where most US trading partners are also suffering from weak demand. This is why it is so important that the US economy see wages capturing their share of productivity growth, so that the demand gap does not grow worse.

Economic projections

Unfortunately, this does not seem to be the case. The GDP data showed the profit share rising to another record high. This confirms evidence from a variety of indices showing that wages are at best keeping pace with inflation, meaning that little or none of the gains from productivity growth are being passed on to workers.

This is a sharp divergence from the economic projections from the Congressional Budget Office and others which showed the profit share shrinking this year, with the wage share of income rising through the rest of the decade. Clearly this is not happening, which is not really a surprise with the continuing weakness of the labour market.

However, this raises the question of how even the modest pace of growth of the last two years will be sustained. Plunging interest rates helped to feed demand largely through a mortgage refinancing boom, but this process is coming to an end as mortgage rates are unlikely to go still lower.

If real wages don't start rising, it is difficult to see what can boost the economy, especially in a context where the budget deficit is shrinking, further sapping demand growth. Firms are unlikely to boost investment in this context, raising the risk of a prolonged period of severe stagnation.

If economic debates in the United States were focused on reality, this demand gap would be at the centre of the discussion. Instead it is being completely ignored, just as the housing bubble was ignored in the last decade as it grew to ever more dangerous levels. This is not a good story.

Dean Baker is a US macroeconomist and co-founder of the Centre for Economic and Policy Research.

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.