Arnold Kling  

Corporate Profits

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Great Out the Gate?... School Nurses and Econ 101...

In the comments on other posts, I have seen questions addressed to me about "excessive corporate profits." I am going to answer this question in very basic terms.

The way that national income accounting works, we have:

net private saving = government deficit + trade surplus

That is always true, just as 4 = 2 + 2 is always true. If you do not believe me, consult an economics textbook or look up "flow of funds identity." A Google search for that term yields this, which is a perfectly servicable explanation.

Let's ignore the trade surplus. If you want to bring it back into the story, feel free. But for now it adds complexity without illumination. So we have:

net private saving = government deficit

We can decompose net private saving as:

net private saving = household saving + corporate saving - investment

Some consequences:

1. When the government runs a large deficit, net private saving must be high.

2. When net private saving is high, either household saving is high, corporate saving (i.e. corporate profits) is high, or investment is low.

3. This is a consequence of the identity. It has nothing to do with crowding out or the multiplier. If you think that crowding out is high and the multiplier is low, then you expect the identity to resolve itself at a low level of investment. If you are more of a Keynesian, you expect the identity to resolve itself at a high level of investment.

4. The legitimate complaint is that investment is low. We all wish investment were higher.

5. If investment were higher, then the combination of personal saving and corporate profits would have to be higher.

6. Given the large government deficit, then if corporate profits were lower, we would necessarily have either higher household saving or lower investment. This is not a statement about economic behavior. It simply is a matter of accounting logic.

So, if you want to complain about "excessive" corporate profits, you are sort of backed into a corner. You have to be arguing that personal saving should be higher and corporate profits should be lower. But that is mostly a matter of how people hold their savings. If I hold my savings in the form of Treasuries, that is personal saving. If I own shares in corporations that own Treasuries, that shows up as corporate profits. Either way, it is net private saving, and ultimately people are doing the saving, either in personal accounts or through corporations that they own.

As an aside, I think that the mix of corporate saving is a problem. That is, I think that profits are too high at banks and too low at non-bank corporations. I think we would see more investment and employment growth if more of those profits were going to non-bank corporations.

Why are the banks doing well relative to non-banks? I cannot say for certain, but I suspect that the "success of TARP" has a lot to do with it. However, that strays into opinion, and I wanted to keep this post focused on plain logic.


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CATEGORIES: Macroeconomics



COMMENTS (12 to date)
effem writes:

My guess is that the vast majority of household saving via corporate ownership occurs in the top 10% of the population. I am not worried about them. I would like to see higher personal saving among the bottom 90% via deleveraging. Record corporate profits (as a % of GDP) just seems like yet another wealth/power concentration mechanism at this point in time.

Let's take the hypothetical example of an industry going from oligopolistic behavior to true competition and margins falling by half. Those who save via shares of those corporations will lose; those who purchase products of any of those corporations will win (it allows for more saving among those individuals). This seems like it would make a lot of sense as a redistribution mechanism - the costs would be incurred mostly by those who promoted anti-competitive behavior and the gains would be felt broadly.

And yes, I believe we have quite a few industries that practice anti-competitive behavior. Not illegal behavior, simply anti-competitive - e.g., regulatory capture, price signaling, obtuse contracts. I see many industries from the inside and they have become very, very good about making the system work for them (and avoiding taxation, but that's another issue).

As for the argument that healthy corporations invest more, I think that argument is less true than it used to be. A disproportionate amount of investment occurs ex-US and via CEO/Executive pay.

Given how narrow corporate ownership has become, it seems that reducing corporate profits would result in a public good.

Lord writes:

The other thing we can say is as government interest rates remain historically low, the government deficit is low relative to it.

Another problem with corporation savings is a sizable portion is owned internationally.

Cyberike writes:

Basic economics notwithstanding, I do not understand the relationship between the deficit and private savings.

The largest holders of treasury securities are (in order): the federal reserve, china, and japan.

Those 3 hold a LOT of treasury securities (4T?). How is this private savings?

Chris Koresko writes:

Another good concise econ lesson. Thank you!

effem: I believe we have quite a few industries that practice anti-competitive behavior. Not illegal behavior, simply anti-competitive - e.g., regulatory capture, price signaling, obtuse contracts.

I think a lot of people across the political spectrum agree with you on that point. The question is what to do about it. Most conservatives and libertarians would say the problem is that our oversized and overreaching government makes it inevitable: the highest returns come from investment in lobbyists at their ilk. I think most liberals would tend to call it an argument for tweaking the tax rules or adding another pile of regulation (Lord might want to disagree on that, though).

A disproportionate amount of investment occurs ex-US and via CEO/Executive pay.

I've read arguments that this is a result of the high tax that must be paid to bring corporate profits into the U.S... 35% if memory serves. Does this sound correct?

roystgnr writes:

The trouble with math is that it only works insofar as your definitions and your axioms correspond to reality.

The macroeconomic "net private savings" = "government deficit" equation is tautologically true, for a very weird definition of "net private savings". Under this definition, if I breed a goose that lays golden eggs, neither raising it for 20 years nor killing it for pâté tonight counts as "savings". Using macroeconomists' definitions leads to the conclusion that thrifty people should not prefer one decision over the other.

Comparison to a less misleading set of definitions leads to the conclusion that thrifty people should not prefer listening to macroeconomists.

effem writes:

Just by the lack of comments here it seems to me this is an issue that has not been well considered. Most just simply assume higher corporate profits = good news and vice versa.

Yet we are faced with a unique situation - record corporate profits co-existing with high unemployment and record deficits. My sense is we need to think a lot harder about the role of corporate profits. At the very least, before we go cutting poor/middle class benefits we should consider if there are other avenues to balancing the budget.

If we do the knee-jerk "cut benefits" approach I fear we will push our citizens into some sort of revolt. The lower/middle classes have been on the losing end of a lot of battles over the past few decadse. People in mid-America already seem quite agitated to me.

Simon K writes:

@effem - The vast majority of corporate ownership is via institutional investors, who hold the shares as parts of portfolios that support insurance policies, mutual funds, retirement accounts etc that are held by the general public. Its difficult to work out to what extent corporate profits benefit regular folk directly, but its also beside the point of this post, which is that if you're going to have high public deficits and low household saving, you must by definition have high corporate profits. Its just accounting.

@cyberike - The Fed is part of the government. The fact the government owes itself money is usually ignored. What are they going to do, sue the Treasury? The holdings of foreign central banks are (basically) part of the trade deficit, which Arnold explicitly said he was ignoring. The remaining debt - which is the vast majority of it, contrary to popular misconception - must as a matter of arithmetic be either corporate profits or household savings, since there's no other entity for the money to have come from.

Mark writes:

"3. This is a consequence of the identity.... If you are more of a Keynesian, you expect the identity to resolve itself at a high level of investment."

Could you clarify here? I don't understand this part. If investment is larger and savings is unchanged, then the definition doesn't hold, i.e. the left side decreases (saving minus investment) and the right side increases (larger budget deficit).

Did you mean that low crowding out and a large multiplier creates a small decrease in investment that is offset by an increase in household saving and corporate profits due to the large multiplier effect?

Thank you.

Cyberike writes:

@Simon:

You say that the vast majority of our debt is held in the form of corporate profits or household savings, but the data shows otherwise:

From July 2010: Deficit 12.8 T

Amount held by foreign governments: 3.9 T

Amount held by Banks and the public: 3.5 T

Amount held by the fed: 5.5 T

There is some rounding error, but the chart shows that less than a third of our debt is held by investors, as you define in your response to effem. The relationship between the government deficit and private savings would seem (to me) to be totally broken when government holds so much of its own debt.

For example, about 2.5 T is in the social security trust fund, which is an example of debt the government owes to itself. Yet you would count this as private savings.

Chart here: http://www.ritholtz.com/blog/2010/07/who-owns-us-treasury-debt/


Simon K writes:

@Cyberike - I wasn't counting the money the government owes itself at all, since it isn't relevant to corporate profits, which is what this post is about. Profits are a form of saving, and no-one has to save for one bit of the government to spend money that belongs to another bit of the government and give it a T-bill in exchange. Its purely internal accounting.

The numbers you posted are for the stock of debt. They're interesting, but what we're interested in here is the amount of new debt sold to the public, since that's what has to equal net private savings (minus foreign purchases).

Cyberike writes:

Mr. Kling quite clearly states that government deficit = net private savings, and that is the relationship I was questioning. It just doesn't seem right. There may be a relationship, but when the government is buying it's own debt it seems to me you could have a lower amount of private savings with a higher deficit.

Alistair Howard writes:

"Let's ignore the trade surplus"--the flaws with conventional economic reasoning in one simple statement.

"f you do not believe me, consult an economics textbook" --the flaws with conventional economic reasoning in a second simple statement.

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