Where Have All the Profits Gone?

Popular Economics Weekly

I first wrote about the reasons for the huge stock selloff in early February when the DOW plunged more than 1,000 points in one day. It seems to be repeating itself this week, with the DOW losing almost as much over the past 2 days when the economic news was good—GDP growth averaged 2.3 percent in 2017, and both the manufacturing and service sectors are booming. Then why the selloff with new tax cuts that will put more money into people’s (and corporate) pockets as well?

The short answer is investors fear inflation and higher interest rates will kick in later this year with continued growth and a very tight labor market. But the longer answer is that investors are looking at the wrong economic model, if they believe inflation is about to rise even when it isn’t. Nor are interest rates rising, which is another indicator of incipient inflation with the 10-year Treasury security yield declining of late and still below 3 percent.


Graph: Econoday

Core inflation with the PCE consumption index did rise 0.3 percent in January, but not enough to lift the year-on-year rate which holds at an as-expected 1.5 percent. Total prices, reflecting a rise in gas, rose 0.4 percent with this year-on-year rate also unchanged, at 1.7 percent. 

That is barely a hint of inflation, folks, and certainly no reason for the Fed to move up its interest rate forecast, even with the good economic news. Then why the inflation fears? It’s really the Fed Governors, which are usually bankers, which means they listen mostly to business economists. Whereas, they should be listening to macroeconomists such as Nobelist Paul Krugman or the IMF’s Olivier Blanchard, that study what is behind the larger picture of national and international economic growth.

Macroeconomists look at aggregate demand, which is the sum of activity in the private and public sectors to predict economic growth. And they see weak demand, because average household incomes haven’t risen faster than inflation over the past 30 years.

In other words, average real household incomes have literally not grown at all when inflation is factored in. This has been happening since the 1980s when trickle-down economics came into vogue, which said that the owners of capital and industry should receive the lion’s share of national income (via lower taxes and regulations), and that would create more jobs and growth for everyone.

This is also when labor laws were weakened that has resulted in 25 red states having right to work laws that mean members of a union don’t have to pay union dues, if they don’t like their policies. Yet they enjoy the benefits. This has weakened the bargaining power of ordinary workers, needless to say. Several states like Wisconsin even ban most public service employees of the state from collective bargaining. So their salaries have actually declined, rather than grown.

Therefore, better-paying jobs and higher growth never materialized. This is something conservative economists don’t want to believe, because it means government regulations are needed to tame the greed of corporate and hedge fund managers who do very little to boost aggregate demand, so that very little trickles down to the 80 percent of our workforce that earns wages and salaries. And they are the drivers of real economic growth.

Shouldn’t the new Republican tax bill that repatriates overseas profits and lowers the corporate tax rate be helpful? Not really, because history shows most of those increased profits buy back stock to enrich their shareholders and corporate CEOs, rather than ‘trickle down’ to substantial pay raises.

The New York Times reported that historically, American companies had paid out profits with a quarterly check, known as a dividend. But after the S.E.C. changed its rule in 1982, companies started using more of their profits to buy their own shares, in the process giving their shareholders a bigger piece of the company.

“Buybacks soon soared,” reported the Times. “That was about 5 percent less than those companies spent on new plants, research and development and other investments. By contrast, 20 years ago, companies spent four times as much on such investments as they did on buybacks.”

And hedge fund managers are still taxed at the lower capital gains tax for carried trades on the 20 percent they earn from any profits their hedge funds earn, rather than at the higher personal income tax rate.

Unfortunately, this means the siphoning of profits to nonproductive uses will continue, and stagnation of household incomes will depress any potential for higher growth and wages.

Harlan Green © 2018

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

About populareconomicsblog

Harlan Green is editor/publisher of PopularEconomics.com, and content provider of 3 weekly columns to various blogs--Popular Economics Weekly and The Huffington Post
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