Margins and Wages: In a Consumer Driven Economy You Can't Have One Without the Other

Consumer spending drives the economies of the US and most developed

countries. Credible statistics place the percentage economic activity attributable to consumer spending at between 40% and 70%.

US 'real' unemployment is at @9%, broader gauges of unemployment (which include those no longer seeking work or underemployed) are closer to 20%, and wages have been flat, on an inflation adjusted basis, for approximately 30 years. It is little wonder, then, that the economic recovery has been uneven, halting and is even now could be faltering. The chain of causation seems clear: if many of those consumers have not realized wage increases for most of their working lives, if between 10 and 20% of them are not working at all, and if the credit markets will no longer lend to them due to the financial crisis, a consumer-driven economy is simply running out of demand.

On the other side of the ledger, corporate margins and profits are closing in on historic highs. There is nothing overtly wrong with this, except for the fact that the system, as currently constituted, is sowing the seeds of its own destruction. You can not continue to extract extraordinary profits if you are doing so at the expense of the people you need to pay for current and future growth. Forget the morality (though there is much that should be said about that); this process is, quite simply, economically unsustainable.

As The Economist comments, something is going to have to give if the economy is to grow: either margins and (probably) executive compensation are going to have to shrink in order to provide adequate buying power to the consuming public or we are headed for another economic crisis. JL:

"BCA Research has some remarkable statistics in its research note on profit margins (no link available, I'm afraid). Since 1990, real domestic corporate profits in America have risen 200%, while real compensation for corporate employees has increased just 20% and real median family incomes are up just 2% (is this the American dream?). Since 2000, the relevant statistics are 80%, 8% and minus 5% respectively.

Profit margins in the non-financial sector as measured by ebitd (earnings before interest, tax and depreciation) are as high as they have been at any moment in the last 50 years. there was a big drop in margins in the 1970s as wage and commodity costs soared and it has only been in the past decade that profits have returned to 1960s level. what was remarkable about the 2007-2008 subprime crisis is the speed with which margins have rebounded.

BCA cites a number of factors to explain the rebound from aggressive cost-cutting, the use of technology, to a sharp rise in overseas margins arising from a weaker dollar and some "tax-planning" measures that routed profits to low-tax countries. On the basis of this analysis BCA concludes that it will be extremely hard for margins to rise further from current levels. Yet the trend in margins tends to follow the economic cycle, so it would be unusual for margins to weaken sharply in the absence of a marked slowdown in the pace of economic growth.
Of course, a slowdown in growth might be just what's occurring at the moment.

So why haven't workers got more of the pie? The conventional economic assumption is that compensation should keep pace with productivity. But the productivity gains have accrued to employers not employees. However BCA find that if you compared compensation with corporate prices (which companies get from selling their goods), the fit is much closer than with the consumer price index. Corporate prices have risen slowly because they are dominated by capital goods, where technology and China have kept the lid on increases. The consumer price index, by contrast, contains a lot more services where international competition is more constrained. I am not sure that this explanation is entirely satisfying - companies sell services too.

For the lowest-paid workers, things have been getting worse not better as they spend more of their incomes on food and energy, where inflation over the last year has been particularly strong. The divergent trend between profits and incomes brings us to the Marxist question of whether demand eventually collapses because workers cannot afford to buy the goods that capitalists produce. This crisis was averted in the 1990s and 2000s because consumers borrowed money to maintain spending - an option that is no longer very popular. So if the economy is to prosper in the next few years, it seems likely that the workers will have to get a better deal - and profit margins will have to take a hit.