By Michael Burke
A previous SEB article examined the profit rate in the Irish economy which is rising even though the economy continues to contract. Yet at the same time Ireland’s level of investment is falling. Corporate incomes – profits - are rising even though total economic activity is falling. Arithmetically, this can only occur by reducing the income of labour - wages are falling both in absolute terms and as a proportion of total economic activity. It happens that the Irish Department of Finance set this out with some clarity. This is indeed is the thrust of the entire ‘austerity’ policy – a transfer of incomes from labour to capital across the industrialised economies of Europe, as well as in the US and Japan.
Who Is Paying for the Crisis?
The table below shows the Gross Value Added (GVA) of selected economies, and how this is divided between the compensation of employees and the gross operating surplus of the corporate sector. GVA is a measure of all the value created in an economy. It is the same as GDP except that it excludes the impact of taxes and subsidies. With some important qualifications the Compensation of Employees (CoE) is akin to labour’s share of that value added, while the Gross Operating Surplus (GOS) is akin to the level of profits in each economy. This provides an approximate measure of economic activity and its distribution as income: Value-Wages-Profits. In the table blow the profit rate is calculated as the share of GOS in Gross Value Added.
Table 1. GVA, Compensation of Employees, Gross Operating Surplus and the Profit Rate, €bn in 2010 (unless otherwise stated)
The general tendency has been that the crisis-hit countries have the highest profit rates. This was an important factor in the build-up to the crisis. In nearly all countries the crisis was characterised by reduced investment by the corporate sector, which remains the driving force behind the economic crisis. In these higher profit countries the fall in investment had a greater impact on aggregate demand as the corporate sector takes a bigger share of GVA. In turn, the fall in investment had a bigger negative impact on household incomes, especially through rising unemployment.
Profits and deficits
The profit rates should also be seen in relation to the public sector deficits that have caused so much turmoil. In all cases the public sector deficits are a fraction of the level of profits. In Greece the 2010 deficit was €25bn, in Italy it was €70bn, in Ireland it was €19bn (excluding an extraordinary bank bailout), and so on. The deficits could easily be covered in their entirety simply by extracting a fraction of the profit level from the corporate sector in each country. The same is true of Britain, where the profit level in 2010 was £475bn compared to a deficit of £137bn. (The British profit level is depressed and consequently the profit rate is lower because of the slump in the financial sector – a factor which also applies to a lesser degree in the US and even to France).
Who can pay for the crisis?
There are effectively three destinations for profits. These are investment, which raises future prosperity, or dividends for shareholders which are not invested or huge executive compensation and bonuses, both of which do not. The table below shows the level of profits, the level of public sector borrowing and the level of gross fixed capital formation (investment). In the last column the difference is shown between the level of profits and the level of public borrowing and investment combined.
Table 2. Gross Operating Surplus, Public Sector Borrowing and Investment, €bn in 2010 (unless otherwise stated)
Table 2 shows that in all cases the current level of both the public sector borrowing and the current level of investment can be funded by the level of profits in each country and in the Euro Area. In most cases there is scope to fund both the deficit and significantly increase the level of investment. But the opposite has been happening.
The struggle over distribution of national income
In most recessions capital’s share of income falls. This is not because wages rise, but because profits fall at a faster rate than the fall in output. What then usually occurs is a struggle by capital to regain its lost share of income. It does this by cutting wages and benefits, by increasing unemployment and by reducing its tax burden - financed by reducing social welfare benefits. This is the content of ‘austerity’ measures.
Figure 1 below shows how this has operated in the Euro Area as a whole. Between 2008 and 2009 GVA in the Euro Area fell by €254. Confirming the idea that profits fall at a faster rate than output, Euro Area profits (GOS) fell by €227bn. Profits fell by over 6%, twice as fast as the fall in output. Wages (CoE) fell by €17bn.
However, this natural tendency for profits to fall at a greater pace than the fall in output is interrupted and diverted by a series of interventions, including rising unemployment, wages and benefit cuts as itemised above. In the period 2009 to 2010 Euro Area GVA rose by €188bn. Of this increase in output €139bn went to profits and just €53bn accrued to wages.
Because of inflation the real level of both wages and profits has fallen sharply – all these data are in nominal terms and do not take account of inflation. The ‘austerity’ offensive to increase the profit share has partly been successful, but the wage share of national income has not undergone any strategic reversal.
This is contrasted with Greece. Greek nominal GVA did not fall in 2009 at all as the Greek recession was shallower than most. GVA fell in 2010 by €6bn. This is shown in chart 2. The massive offensive against Greek workers and the poor means that the natural tendency for profits to fall faster than output has not operated. The level of wages fell by €4.4bn and profits fell by just €1.8bn. The wage share of national income has suffered a reversal.
Readers will be interested to know where Britain stands in relation to these examples, one of them the extreme case of Greece (and previously, Ireland). In 2009 British GVA fell by £38bn, shown in Chart 3 below. This was exceeded by the fall in profits, down £43bn and wages rose by £5bn. The entirety of policy since has been to reverse those trends. GVA rose in 2010 by €40bn. (It should again be stressed that these are nominal data, in real terms output is still over 4% below its peak and real wages have fallen).
As a result of initial ‘austerity’ measures, £18bn of the increase in output has been claimed for profits. But it is widely understood that the real offensive in Britain only began in the new Financial Year, which began in April this year. What is being attempted is a decisive reversal of the wages’ share of national income.
Countries like Greece are experiencing a qualitatively sharper crisis than the European average. There is a high correlation between the likelihood of economies falling into this type of extreme crisis and their exceptionally high level of pre-crisis profits. Because the income of the corporate sector is a much greater factor in the economy, their investment strike hass a proportionately greater impact on total output and/or government finances.
Profits remain exceptionally high, so much so that they could finance the deficit while simultaneously increasing the level of investment.
Under normal working of a market economy the tendency is for profits to fall faster than output. The entire ‘austerity’ policy is to prevent this tendency from operating, and to reverse it by reducing wages even faster than the decline in output. In the Euro Area, to date this has only been achieved in Ireland and Greece.
In Britain, it’s too early to say whether a similar ‘austerity’ drive will achieve the same disastrous results. But it is clearly the aim of government policy to drive up profits even while the economy is stagnating. This can only be achieved by driving down wages.