Buying Power Disparities and Corporate Profits

The Economist wrote yesterday about the prospects for corporate profits in 2008:

The big question is not whether 2008 profit estimates will have to be revised down; they almost certainly will. It is whether this shift marks a short-term cyclical setback or something more structural as profits retreat from the 40-year-high share of economic output that they notched up in 2006.

The optimists argued that profits could stay high because the balance of power had moved in favour of capital and away from labour, thanks to the globalisation of the workforce. But perhaps profits had been boosted by accommodating monetary policy, a credit boom and the associated surge in asset prices. In other words, financial services may have dragged the rest of corporate America up. If the credit crunch has a long-lasting effect, the banks may end up dragging corporate America back down again.

This imbalance of earnings between capital and labor is going to be corrected eventually. Since the 1970's, the proportion of income that is earned by the labor force has been declining. Corporate profits are taking an ever higher chunk of the GDP in most developed countries.

The sound idea of Henry Ford, that workers should be able to afford the things they are producing has been completely neglected. The fundamental unsustainability of this disparity has been masked by ever growing levels of consumer debt.

Now we are seeing the results of this unsustainable development. The average American consumer is now at the end of his ability to go any further into debt. American levels of consumption have not been truly affordable in years, which has been reflected in the huge current account deficit. Now the American current account deficit is starting to morph into a significant capital account deficit. The capital account deficit for the third quarter (published Dec 17) is probably going to be huge, in the tens of billions of dollars, due to the loss of credit since August.

A reduction of western over-consumption is probably unavoidable. It might even be considered a welcome development for ecological sustainability, but the level of compensation for workers in the developing world has to pick up quickly so that they can absorb a significant part of the existing production without too much panicky destruction of productive capacity that would be caused by a rapid deflationary wipe-out of fictitious capital.

There are two possibilities. Either the proportion of global GDP that is earned by the workforce is increased through wage negotiations, or there will be a significant deflationary trend that will take care of it.

Buying power disparities will be corrected through either wage adjustments or price adjustments, or a combination of both. Protracted abuse of under-paid workforce will eventually result in a loss of wellbeing for all of us.