Corporate profits

Corporate profits and aggregate demand

I’ve heard Tyler Cowen allude to it before and Eli Dourado makes it’s explicit

My first proof [that the short run is over] is business profits. They are at an all-time high, about two and a half times higher in nominal terms than they were in the late 1990s, our last real boom…

If you think unemployment is high because demand is low and the business is therefore unprofitable, you are empirically wrong. Business is very profitable, but they have learned to do without so much work.

What Eli calls “learning to get by without as much work” is what we generally call productivity growth and expect it to lead to an increase in the real demand for labour.

Indeed, we find that the ratio of unit labor costs to consumer prices fell particularly rapidly during the last recession.

Consumer prices have been rising steadily faster than labor costs since the mid-1970s, but the recent rise has been more pronounced. Thus, the labor share fell more rapidly during this recession.

These two statistics have different profiles in part because the United States is not a closed economy. If our exports are sold to businesses but what we import is sold to consumers, the deterioration in the terms of trade will cause consumer prices to rise faster than labor costs.

But that’s not all, because work takes away a much smaller fraction of total income.

So why aren’t increases in productivity translating into increases in labor demand and therefore employment and wages. A simple explanation is that nominal incomes are not growing as fast as real output.

You can try to increase total sales by lowering prices, but if you face a downward sloping demand curve, maximum profits will always occur at a level of production below maximum revenue.

The natural process towards equilibrium would cause everyone to lower prices a little, which would lead to an increase in real income and an increase in everyone’s nominal demand.

More clearly. Technology is improving. Each company can produce more with the same old workers. Every company lowers its prices a little. Now workers can buy the same things as before with less money. They use the money they have left to buy more. Every business now sees stronger nominal demand and wants to hire more workers.

But suppose you stifle nominal demand by taking money out of the economy. Then the loop does not close. More production, but no more labor demand.

If we cross our numbers and hope that what is true in a stationary economy is also true in an expanding economy, then maintaining the level of nominal demand growth will maintain the level of growth in labor demand.

There should still be growth in labor demand, but just not as much as you would have thought in the absence of a decline in the trajectory of nominal demand.