Thursday, September 2, 2010

Why are both unemployment and corporate profits high?

Marginal Revolution, among others, have wondered why corporate profits are so high and corporations have so much cash, while employment has foundered.

I have two possible theories that I haven't heard mentioned anywhere else.

1) One answer may lie in projected growth rates.

Imagine a model in which labor is hired in anticipation of projected growth. Employees take a while to train, so you have to "skate to where the puck is going".

If corporations hire for projected output a few years forward, then corporations, in general, will hire more people when growth is expected to be robust. These people will be a negative drain for a year or two, but they'll become productive as they learn and the company grows into a position for them to be productive.

Imagine an exogenous shock reduces expected growth rates - whether the product of policy, the pop of an unpredicted housing bubble, or whatever - these new employees don't need to be there anymore. That structurally means that there will be fewer employees employed, but significantly, you're likely getting rid of the less trained employees - the ones who don't already add value - because they're likely to never have an opportunity to add value.

The result is that currently-unproductive employees get fired and margins go up. Additionally, the people who have been laid off are less experienced or less skilled (or less talented), so their time on unemployment is going to be much higher than a typical situation, where people are laid off but long term growth rates are unchanged.

This implies a significant structural overcapacity. Costs can be cut all over the place, leading to increased profits with lower employment and more long-term unemployment. This may get competed away but it takes time to feel comfortable enough that the status quo will continue that you'll tend towards equilibrium.


2) Falling costs also factor into this, as the fact that raw and intermediate materials have fallen in cost falls on raw and intermediate materials producers, many of whom are foreign. Thus, while our trade deficit kills us on manufacturing jobs, it helps us on (some, short-term oriented) corporate profits because our corporate profits line includes the cost savings of the raw-and intermediate-material consumers but not the revenue loss of the producers. Net corporate balance sheets look wonderful and profits go up, at least until either raw and intermediate prices go back up, or people become convinced enough that raw/intermediate prices will stay low that they enter and add competition.

If people think raw and intermediate prices will go back up, then investing for expanding future production makes no sense, you see no competition entering the market, and employment stays crappy even though corporate profits skyrocket.

(Note that this is perfectly compatible with the view - that I also hold - that the trade deficit is killing jobs in this country.)



It's also worth noting that manufacturing has been recovering wonderfully, thanks to the inventory boost. Hard to know if that will continue. Housing is still brutal (which is ahistorical given the level of housing underinvestment over the last 3 years, even counting the prior overinvestment), but manufacturing seems fine, thus far. Businesses are spending on equipment and software - more so than in most recoveries - so cash hoarding isn't the easiest answer. Perhaps companies don't want to deal with banks so they don't return cash to shareholders (though I hope they do so before the dividend and capital gains tax increases next year). Something, somewhere, is gumming up a normal housing recovery - whether it's banks, or policy.


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