High Corporate Profits – Why?

The existence of high corporate profits during this terrible recession must prove that corporate America is hopelessly greedy and corrupt, right? With an unemployment rate at over 9% and profits soaring, the obvious answer, in the minds of the numb, is that we must do whatever is necessary to mandate hiring. “That’s why we call them employers!” is what they say. This past week, the mayor of Atlanta came out in that same spirit and encouraged business owners in the Atlanta area to “hire just one” new employee in the next year. Apparently, with the right level of political moral suasion, our local group of profiteering business owners will “do the right thing” and fix the economy by simply adding to their payrolls. And why should our corporations not do their fair share anyway? Don’t we all need to be doing our fair share?

The word profit has a whole raft of connotations, ranging from the essentially salutary to essence of pure evil. In the history of American capitalism, the amount of economic profit that has emerged from the conduct of our system has generally ranged from four to eight percent of GDP. These profits represent the underlying reason that our capitalist form of economy actually works. In the most simplistic of terms, business owners are effectively “assembling” one hundred units of inputs (costs, including the cost of government) and selling the outputs for about one-hundred and five units (revenues). The residual five units represent the value that is added in the process of the assemblage, and are the reason the capitalists go to all the work of creating something of value in the first place.

In our families, we don’t show profits on our financial statements. We just show revenues and expenses. Any residual “profit” that remains, just adds to our personal balance sheets. It ends up in a 401(k) plan or it shows up as a reduction in our outstanding mortgage balance.  Businesses are only different in the accounting for these economic activities and outcomes. The actual difference between revenues and expenses in the business world versus families is that in business the difference is “tagged and reported.” Profits are the ultimate demonstration that the business is being successful in adding productive value. It is this value that customers are both willing and eager to pay for and that create revenue.

Businesses, like families, have two types of expenses. The first type of expense, call them operating expenses, is that used to keep the business delivering on its current promises. These are the expenses that are incurred as a direct result of the existence of revenues. In order for any business to provide its product or service, a certain amount of expense must be incurred. In most businesses, these operating expenses consume a large percentage of both total expenses and total revenues.

The second type of expense, call them investments, are those that the business expends in an effort to improve their ability to drive revenues and profits in the future. All businesses recognize that without appropriate and well-directed investments in their futures, the competition will figure out how to provide better value, and their business’ revenues and profits will decline. All business leaders also know that without the right level and appropriate allocation of investments, their business may ultimately be forced to close.

 So, what does this have to do with the currently high corporate profits?

The answer becomes immediately apparent with a focus on the investments. During periods of political and economic uncertainty, businesses quit “spending” on their futures. They do this for the same reasons that cause families to “save” during periods of economic uncertainty. And they do it for the same reasons:  1) to create an economic cushion against a treacherous and unpredictable future, and 2) because they don’t know how and where to invest, given all the political and economic chaos. Businesses are now doing the very same thing that all the rest of us are doing. We are all justifiably saving for the very rainy day…that happens to be today.

Pursued to its obvious conclusion, if a business in a normal environment spends 90% of its total expenses on operating expenses and 10% of its total expenses on investments for the future (while making a five percent overall profit margin), what are they doing now? As their revenues are likely down, and their prospects for new revenues even more cloudy, they have cut their investment expenses by half or even more. So instead of making five percent margins and looking positively towards the future, they are making higher margins by “banking” their former investments. They are earning “new and improved” eight percent margins and are compromising their futures at the same time. And they know it. They wish they could put those investment dollars back in the budget, but the utterly naïve prompting of people like Mayor Reed falls on completely deaf ears. That is why two trillion dollars is now perched on the balance sheets of American businesses.

High current corporate profits are not what businesses want. At the least, they do not want them for the reasons that exist in the current environment. What they want are good current returns on their investments, and predictable and rising profits in the future. Businesses would love to go back to investing in the future. It is just very challenging to see what that future now holds. When a presidential administration holds in disdain that which is fundamental to the existence of the entire economic system, investment earnings, profits will go up in the short-term. Over time, they will however, ultimately disappear. And then we will live in a profitless and righteously equitable society.

Now I get it.

 

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