Corporate profits

Opinion: Inflation has been very good for corporate earnings

The highest inflation rates in four decades are squeezing people, but businesses are doing pretty well.

As wages and other forms of personal income continue to lag inflation, corporate profits have soared, the government’s Bureau of Economic Analysis reported Thursday.

Learn more about inflation: Inflation falls in July for the first time in 20 months, according to a key indicator, due to the fall in gasoline prices

After-tax corporate profits rose at an annual rate of 41% after inflation in the second quarter of the year and have risen at an annual rate of 17% since the end of the pandemic recession two years ago. Meanwhile, the inflation-adjusted purchasing power of personal after-tax income has declined for five consecutive quarters.

These facts dig a very important hole in the mainstream theory of inflation, which holds that prices are high because ordinary people have too much money to spend.

Simply put, workers’ share of the national pie is shrinking, while business owners are taking far more than before.

After-tax profit margins have reached record highs since the end of the pandemic recession.

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Profit margins are up

Government data allows us to look inside the non-financial business sector, which has a gross value added of over $13 trillion a year. Gross value added is the value that a company creates in the production process. It is the difference between a firm’s costs for the inputs it purchases and the sales revenue it receives.

For every dollar of gross value added, workers received 59 cents; taxes, depreciation and other fixed costs cost 28 cents; and the owners got the remaining 13 cents in after-tax profits.

Profit margins set a record 13.5% of gross value added in the second quarter of 2021 and have barely declined since that peak despite inflation raging to 40-year highs. The last time inflation was this high, profit margins were only half as high.

Learn more about profit margins: Corporate profit is at a much higher level than we’ve ever seen, and is expected to continue to grow

The long-term averages for these numbers are 63% for worker wages and benefits, 28% for taxes, depreciation and fixed costs, and 9% for owner profits.

Compared to historical averages, currently higher profit margins come at the expense of wages.

Before the pandemic, profit margins had never exceeded 13% and had exceeded 12% only twice: in 1949 and 1965. In the last eight quarters since the end of the pandemic recession, margins have exceeded 13% on three occasions and exceeded 12% in three other districts.

Workers’ wages and benefits have been a smaller share of gross value added since the end of the pandemic.

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Companies hoard all the money

These facts dig a very important hole in the mainstream theory of inflation, which holds that prices are high because ordinary people have too much money to spend. Higher wages are thought to force companies to raise their selling prices, which in turn induces workers to demand even higher wages, and so on.

This so-called theory of the inflationary spiral of wages and prices is the basis of the Federal Reserve’s policy of starving inflation by slowing the growth of personal income and thus preventing people from trying to buy more things than the economy can produce.

Some people – mostly Democrats – have offered an alternative theory of inflation that puts corporate earnings in the picture. Whether you call it rising prices, corporate greed, or just the status quo, this theory suggests the pandemic has shattered something in the economy that had previously brought inflation under control. For some reason, companies have regained the ability to set prices.

When companies can raise their prices without hurting their profit margins, they will. Data released by the government on Thursday is proof that charging higher prices has not hurt companies’ bottom lines at all. In fact, the higher prices have been a boon for businesses.

Learn more about corporate pricing power: Companies are using the pain of inflation as an opportunity to boost profits and line shareholders’ pockets, report says

And that: Will companies continue to raise prices to maintain their record profit margins?

And what about the workers? The data shows hourly compensation fell at an annual rate of 1.5% in the first half of the year after adjusting for higher prices and is now down 2.3% since the end of the pandemic recession.

That’s a lot of numbers to digest, I know. But here’s the bottom line: After adjusting for inflation, corporate profits are up and hourly compensation is down.

It doesn’t sound like a world in which workers have the upper hand when it comes to bargaining with their bosses. And it’s not like the textbooks blaming inflation on ordinary people who have too much money.

Rex Nutting is a columnist for MarketWatch and has covered the economy for over 25 years.

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