“Profits Without Production”
For me, Profits Without Production equates to Profits sans Direct Labor Input. In most manufacture in the US today, Direct Labor Input is an extremely small ~10% of the Cost of Manufacturing which will vary up and down dependent upon the industry. (For the accountants and the purists, this does not include customary or legislative benefits which I categorize as Overhead. Drucker and many other consultants [including myself] have repeatedly pointed out that whacking labor to reduce the costs of manufacturing is akin to beating a dead horse and this cost has been dropping because of efficiencies since the sixties. It no longer represents the mountain of cost even though it has been fictionalized and demonized by Delphi’s Miller while Delphi was angling for bankruptcy in the last decade.) Maybe I have not searched in the right areas or blogs to read up on this topic; but, Paul Krugman in his latest article dicusses what I believe has become more wide spread in the US over the last decade, Profits Sans Labor or as he points to Production. Yet this is a growing trend and I have not seen much on the topic of Profits sans Labor or Production.
“You can argue that Apple earned its special position — although I’m not sure how many would make a similar claim for … the financial industry… But here’s the puzzle: Since profits are high while borrowing costs are low, why aren’t we seeing a boom in business investment? …
Well, there’s no puzzle here if rising profits reflect rents, not returns on investment. A monopolist can, after all, be highly profitable yet see no good reason to expand its productive capacity. . . .”
While it is possible to produce a part without direct labor input to it with automated machines, my point in particular is about the rise of profits in certain industries (if one could call them such) with no direct labor input or material product in the end. Paul points to the financial industry as having spectacular profits as a percentage of the whole and most recently at 30% of Corporate Profits in the US. Pre-2008 Wal Sreet/TBTF recession, the percentage of corporate profits coming from the financial industry was even higher at 40%. Given not much has changed in the financial industry with new regulations and transparency of transactions, I suspect the financial industry will recoup this high with the government’s backing after almost committing self destruction in 2008.
“From 1990 to 2006, the GDP share of the financial sector in the broad sense increased in the United States from 23% to 31%, or by 8 percentage points. The figures on profits are even more striking. For example, the financial services industry’s share of corporate profits in the United States was around 10% in the early 1980s but peaked at 40% last year.” How might the current financial crisis shape financial sector regulation and structure?
While I agree with Paul Krugman on the problem of growing monopoly rents or the profits without investment, I think he misses the larger picture. The growth of profit without production is coming at the expense of labor input and has been going on for a longer time than just recently. The financial industry has become gambling professionals with its CDS, naked CDS, etc. involving little or no investment in production or labor. That excessive profit-taking has expanded into nonfinancial industry such as Apple is no surprise. The tax rate supports such action by companies. Why should they invest?
Perhaps, I take it a bridge too far with Mr. Krugman’s comments; but until companies begin to expand utilizing Labor input, the problem with unemployment and a shrinking Particiaption Rate are not going to go away. In the end, we may yet reach the the Fed’s 7% unemployment goal as Participation Rate shrinks and U3 is determined from its smaller base.
Coberly:
I fixed it for you as I am definitely not Linda. I urge you to reread the post and Krugman’s message while you are at it. This has little to do wwith the substance of your reply to me and more to do with the unfolding business model comeing into existance today.
Clarify for me, please. The enormous portion of profits which are taken by the financial industry comes from all transactions? Including trading for their own accounts? Also, does the financial industry also include hedge funds which appear to perform no industrial production role?
Is there something inherently destructive to the economy as a whole in regards to the increasingly huge portion of capital that is confined to producing profits from short term trading? Are there any measures regarding the amount of capital assigned to trading activity vs investment activity?
Jack:
Tough but not-so tough questions. I am pointing to the derivatives market mostly when I am discussing profit taking by Wall Street and TBTF banks. Since the slow deterioration of Section 20 of Glass Stegall (Greenspan) and its eventual repeal, banks were heavy on to Wall Street investing whatever money that had. If you remember, Greenspan said he had no intention of increasing Fed rates to the world and their was plenty of currency holders looking for safe haven to stor their money even if the return was low. Consider also the amount of money turned loose on the market when Clinton signed a bill allowing homeowners to take equity out of their homes. All this currency and no place to invest it. Tranched MBS insured by CDS and counter insured with naked CDS AAA rated by S&P/Moody’s and suddenly banks could sell securities which would result in huge increases. My take on financial services as stated in the block quote looks at these very same instruments of destruction CDS, Naked CDS, etc.
– “Is there something inherently destructive to the economy as a whole in regards to the increasingly huge portion of capital that is confined to producing profits from short term trading?” Like LTCM, AIG, etc., it is a quick way to make money in a market which was acording to Greenspan supposed to be self-regulating. Pennies on the dollar were put in reserve in case everything collapsed.
– “Are there any measures regarding the amount of capital assigned to trading activity vs investment activity?” I have seem some charts and graphs around; but, I am damned if I cn find them right now. Safely stored away!
Run
thanks for fixing it. I am sure I agree with you in substance. I have never quite understood why you separate “direct labor costs” from “benefits.”
And just to be … to want to be… careful, i’d ask you to answer why “financial services” are any less “productive” than, say, “information processing services.” If it’s something people want to pay for, let em pay for it. I do agree that it’s a sick way to run an economy. But so is selling big cars.
Manufacturing has been getting more and more efficient and providing fewer and fewer jobs since the start of the 20th century. I was just reading an article about a worker at a Chevy plant in 1935. He worked as a paint sprayer. The new synthetic paints had wiped out the jobs of the sanders and buffers. His current fear was that the newer paints would only require one coat and eliminate another half the jobs. Of course, now his job is done by a robot.
If you compare manufacturing labor efficiency in the 1930s against the 1890s, you find factors of two or three orders of magnitude. In fact, back then they recognized technological redundancy as a major driver of the Great Depression. If you were 50 years old and lost your job, you’d never get one like it again. It all seemed strangely modern.
How did we get out of the Great Depression? Massive government spending helped. The New Deal kept things moving, and by 1939, the British government was pushing US manufacturing into overdrive. Then, the US entered the war. After the war there was massive redistribution with the GI Bill, the VHA, road building, and the general availability of war surplus property (I know several businesses that started with war surplus, including one winery.) It was enough to set up a generation. We should try it again, maybe without needing a world war as an excuse.
Kaleberg:
The name is familar and I had to look in order to remember you from Economists View and KOS. I would refereance this for my comments on peaking in and around 1960; 1840–1900: Robert E. Gallman and Thomas J. Weiss. “The Service Industries in the Nineteenth Century.” In Production and Productivity in the Service Industries and; 1900–1940: John W. Kendrick, “Productivity Trends in the United States”. Princeton: Princeton University Press (for NBER), 1961. The graph for this data ccan be found here: Distribution of the Labor Force by Sector 1840-2010 Dr. Elizabeth Warren had a marvelous focus on labor in her “The Coming Collapse of the Middle Class” which I will try to make as accurately as possible; The days of a high school education and a good work ethic being the ticket to the middle class gave way to a college education and the addition of a second income to insure that entry. The automotive industry was by far that ticket to the middle class and the growth of such areas as “Taylor” – tuckey Michigan as a place for people to settle into (I live in Michigan and have been active in automotive for 22 years and overall manufacturing for 40+ years).
This decrease in Labor hours which I speak of since the sixties in manufacturing can be attributed to the loss of the hourly labor intensive jobs overseas to the China, Phillipine, and Malaysia’s of the world. They were not throwing technology at it as much as labor at a lower cost and almost non-existant Overhead. In many cases, Labor is still a big factor overseas. The graph which I point to suggests such a peaking in the fifties and sixties and a downward trend since then. This is not to dispute your words as much as to explain mine. Technology has certainly played a role in decreasing labor content in that it decreasing the amount of time and people working on a component. It also decreases the amount of time between operations and the inventory on the floor both of which have impacts on the the two other components. I am one of those micro-people who does throughput analysis. A quick example of a recent project was reviewing the set-up on a Fanuc robotic(3) cell and looking for ways to improve setup. We took it from 65 minutes to < 10 minutes by making the tooling resident to the cell, reviwing positioning of the suction cups which moved the different hoods between the robots and finding a commonality of positioning on each hood, and by stacking of each component amd finished product nearby. We eliminated movement of tooling and the time to set up the robot suction cups. I agree a degree of fiscal input along the line of job creation would go a long way to get the economy going and also to improve tax revenues.
run, I thought Krugman’s article was one of the better he’s written in quite some time. But want to delve a little deeper into Financial Services as an industry.
As you well know, once a “sale” is made, i.e., revenue is generated, there are only limited places for the money to go – (1) salary and benefits to the employees (there’s a large majority among AB’s audience believing Fin Services employees are overpaid), (2) general corporate expense payments to suppliers and counterparties (i.e., “investment spending” in technology, facilities, consultants, external legal/consultants, rent), (3) financing/interest expense (again, reasonable to assume large majority among AB’s audience believe Fin Services to be carrying to much financial leverage), and (4) taxes (aside from ‘carried interest loophole’, and tax-loss carryforwards, rarely see commentary that banks, insurers, etc. as not paying fair share of corp taxes), and (5) shareholder profits. Considering (1), (3), and (5) are believed to be too high already, the only way to reduce them is to either lower revenues, i.e., charge less, or raise (2) or (4). Lowering revenues seems unlikely, considering there are low barriers to entry and lots of competition in the industry already. Raising (2) seems equally unlikely. Which leaves us with, what will no doubt be the most popular among this audience, increasing taxes. But again, aside from ‘carried interest loophole’, which affects neither banks nor insurers, and no one’s realistically talking about removing the pass-through tax status of REITs, the large majority of Financial Services pay statutory tax rates.
Jed:
I agree Paul’s article is good and it touches upon a topic which needs examination as it covers the majority of people today. Paul also follows up here: Rents and Returns: A Sketch of a Model
I do not have good answers for you as some of which seem unlikely (your comments) are most likely the ones which need to be implemented. I whine about labor because it is maligned in such a manner as to assume it is overpaid for what it does. It is not when one considers a lifetime of assembly line, machinest, construction, landscaping, etc. work is debilitating over time. Even so, an automotive worke’s starting salary is now $14.00/hour which for a family of 4 garners government subsidies the same as Wall-Marts workers obtain. This wage is down from $27/hour. Upper middle class levels appear to be jealous of the wage paid hourly workers. It was no mistake for Miller to go public with his $75/hour nonsense. It provoked a rapid and angry public response. Everyone missed Gettelfinger’s comment to Congress about the percentage of Labor in automobiles. No one wanted to hear it. In my opinion, there are bigger fish to fry.
My thoughts on whether today’s Financial Services contributes to the utilization of Labor is this; why would one invest in Labor intensive industry when profits can be gained through non-Labor intensive investments such as found in securization via trancheing, CDOs, and countering naked CDOs. The cumulative profit taking from this activity certainly well beyond anything witnessed before. It largely goes untouched by government regulations, transparency, subsequent taxes, and now is guaranteed with governemnt and Fed backing.
There is an article by Bruce Bartlett here: ‘Financialization’ as a Cause of Economic Malaise . Here is a comment or two from it which I believe makes sense.
Much of the latest investment strategy over in this century has been in areas which require little or no labor and in turn skews income to the 1% or less of the population. My thoughts.
Run
actually the comment that you did NOT delete was part of the comment to Linda.
Generally I am in agreement with you, barring a few language difficulties. I think there is some confusion in the word “production” and even in the word “labor.” It may not be a matter of “non productive” services… because even you are a “service provider” and not a “laborer” as most people seem to understand the words.
It is instead an issue of just what the services (and products) are. Generally society is not bettered if most of the “services” turn out to be facilitating gambling, and most of the products turn out to be essentially drugs.
I part company with many “liberals” because what they seem to want is to tax “the rich” (some of whom should better be in jail than taxed) in order that they will have more money for what i regard as essentially gambling and drugs. And of course they hated the idea that mere automobile factory workers should make almost as much as a college professor. There is no correlation that i can see between political persuasion and actual human decency. But some lies are more dangerous than others.
Jed
you might want to look at the Wiki article on Wells Fargo Bank. The first part of it makes Wells Fargo sound like a well managed and successful business. The last part raises questions about how much of that business is fraud. I think we have entered an era where cheating your customers is the standard business model. Unfortunately government has become just another business.
Anyone catch this more recent study as shown on Naked Capitalism? Colin Cooper; “Growing Apart A Political History of American Inequality” June 12, 2013 http://scalar.usc.edu/works/growing-apart-a-political-history-of-american-inequality/index
This adds credence to what I have been suggesting.