Explaining the Rise in Corporate Profits

The Economist writes about the increasing share of national income that is being earned in the form of corporate profits:

Last year, America’s after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro area and Japan are also close to their highest for at least 25 years. UBS, a Swiss bank, estimates that in the G7 economies as a whole, the share of profits in national income has never been higher. The flip side is that labour’s share of the cake has never been lower.

The article posits a few possible explanations, but unfortunately it then only hints at the real answer.

Could the rise in profits be due to the very high productivity growth of the past few years? By itself that is not a sufficient explanation; as the article notes, “It is normal for the share of profits in national income to rise during the early stages of a technological revolution, but then those extra profits tend to be competed away. Higher profits tempt firms to cut prices to steal market share; they also increase the incentive for new firms to enter the market.”

What about globalization, and specifically the effective entry into the world market of millions of new low-cost workers in China and elsewhere? Again, the article notes that this by itself is not a sufficient explanation:

Outsourcing may not have destroyed many jobs in developed economies, but the threat that firms could produce offshore helps to keep a lid on wages. As a result, the share of profits in national income could stay relatively high for a period. Labour’s share would remain low, though workers may still be better off if the cake itself is growing faster. But this is not a reason to expect profits to continue to grow faster than GDP; indeed, in a competitive market profit margins will eventually narrow. Even if outsourcing reduces costs, competition will eventually force firms to reduce prices, distributing the benefits back to consumers and workers.

So if these two oft-cited causes of the rising share of income going to profits are not adequate explanations, what is? The answer is contained in the article, though never explicitly identified as such. The rise in profits as a share of income, if sustained, is only possible if competition is weaker than usual. Put simply, the lack of adequate competition is a necessary condition for the larger and larger share of income going to corporate profits. And I think it’s time for commentators and policy-makers to explicitly recognize this.