In a Tight Labor Market, the Profit Share of Income is Falling

Photograph by Nathaniel St. Clair

Last month’s GDP report also included revisions to previously reported profit data for the last three years. The earlier reports showed a slight increase in the profit share in 2018; the revised data showed that the profit share of corporate income had fallen by 0.4 percentage points from the prior year. This is important both because it means that workers are now clearly getting their share of the gains from growth and also because of what it tells us about the structure of the economy.

On the first point, we have seen four decades during which the wages of the typical worker have not kept pace with productivity growth.[1] While productivity growth has not been great over much of this period, it was slow from 1979 to 1995 and again in the years since 2005, the median wage has generally lagged annual productivity growth over most of this period.[2]

The one exception was the years of low unemployment from 1996 to 2001, when the wages of the typical worker rose in line with productivity growth. With unemployment again falling to relatively low levels in the last four years, many of us expected that wages would again be keeping pace with productivity growth.

The earlier data on profits suggested that this might not be the case. It showed a small increase in the profit share of corporate income, suggesting that corporations were able to increase their share of income at the expense of labor, even with an unemployment rate below 4.0 percent.

The revised data indicate this is not the case. The low unemployment rate is creating an environment in which workers have enough bargaining power to get their share of productivity growth and even gain back some of the income share lost in the Great Recession. In the last few years, wage growth has exceeded the rate of inflation by roughly one percentage point annually. This is not spectacular wage growth, but it is in line with, if not slightly above the rate of productivity growth.[3]

It’s also worth pointing out that we are not going to reverse four decades of rising inequality with four years of decent wage growth. (And things were not so great in 1979 either.) So the fact that many people are still facing hard times is neither surprising nor a contradiction of the fact that most workers are seeing rising real wages.

The other reason this story of falling profit share is important is that it suggests that the high unemployment of the Great Recession was the major factor in the rising profit share of recent years. Most of the upward redistribution of the last four decades was not from ordinary workers to profits, but rather to high end workers. The big winners have been CEOs, hedge fund and private equity partners, and at a somewhat lower level, highly paid professionals like doctors and dentists.

The shift to profits takes place only in this century, after most of the upward redistribution had already occurred. An obvious explanation was the weak labor market following the Great Recession. With unemployment remaining stubbornly high, wages were not keeping pace with productivity growth or even inflation. An alternative explanation was that growing monopolization of major sectors (think of Google, Facebook, and Apple) was allowing capital to gain at the expense of labor.

The revised profit data support the first story. In the last four years the profit share has fallen by 3.2 percentage points. (It had dropped another percentage point in the first quarter of 2019, although the quarterly data are highly erratic.) At this rate, in four more years the run up in profit shares in this century will be completely reversed.

If the weak labor market following the Great Recession is the story of the rise in profit shares, there is still the problem of the run-up in share in 2003-2007, the years preceding the Great Recession. One explanation is that the profits recorded in these years were inflated by phony profits booked by the financial sector.

Banks like Citigroup and Bank of America were recording large profits in these years on loans that subsequently went bad. This would be equivalent to a business booking large profits on sales to customers that did not exist. Their books would show large profits when the sales were recorded, but then they would show large losses when the business had to acknowledge that the customer didn’t exist and therefore write off a previously booked sale.

Profits that are based on sales to non-existent customers don’t come at the expense of workers, nor do profits that are booked on loans that go bad. (The subsequent recession was of course very much at the expense of workers.) For this reason, we should be somewhat skeptical of the shift from wages to profits in the years of the housing bubble.

Total financial industry losses in 2008-2010 were certainly large enough (running into the high hundreds of billions) to offset the excess profit shares in the years 2003-2007. The losses were almost certainly in excess of 10 percent of total corporate profits in the bubble years.

Furthermore, industry losses would have been considerably larger in 2008-2010 if the Treasury and the Fed had not pursued an aggressive bailout policy that allowed the industry to borrow trillions of dollars at below market interest rates. By borrowing at below market rates from the government and lending at market rates, banks and other financial institutions were given an assured profit stream.

Also, the explicit too big to fail guarantee given by the Treasury, described as a “no more Lehmans” policy by Timothy Geithner in his autobiography, allowed the large banks to borrow from the private sector at a lower interest rate. Together, these policies prevented hundreds of billions of further losses in the financial industry.

For these reasons, it is plausible to view much of the profits booked in the financial industry in the years from 2003 to 2007 as fake profits as described earlier. They were closer to a story of mass counterfeiting than a story of a shift from wages to profits.

Anyhow, this explanation is of course speculative. But if the economy continues to move forward without a recession, then we will be able to further test the extent to which the shift in profit shares can be attributed to a weak labor market as opposed to increasing monopolization. If we continue to see a shift to labor and we get closer to the 1980-2000 average profit share, then it would rule out the monopolization explanation.

Of course this doesn’t mean that we should not be worried about excessive industry concentration. It is certainly plausible that concentration explains part of the weakness of investment in the last decade. (It is weak, but not really much below long-term averages as a share of GDP.) Also, excessive concentration can make life difficult for innovative start-ups, which can be a factor in slow productivity growth. And, there is the issue that large companies, like Facebook and Google, can gain extraordinary political power, giving them an extraordinary voice in determining public policy in important areas like control of the Internet.

These are all reasons that we should be concerned about monopoly power. But if we have the same profit share of income given the current market structure, as we did twenty or thirty years ago, then we can’t blame monopolization for a rising profit share.


[1] While the period of wage stagnation for the median worker begins in 1973, the years from 1973 to 1979 were not years of upward redistribution. This was a period of very weak productivity growth, likely in large part due to the twin oil shocks, as well as a sharp deterioration in the terms of trade for the United States. The weak productivity growth of these years, coupled with the worsening terms of trade, fully explain the weak growth in labor compensation during this period. Upward redistribution began in the 1980s.

[2] The weak productivity growth of the years since 2005 is noteworthy, since we have so many people running around claiming that robots are taking all the jobs, leading to mass displacement of workers. Productivity growth is the measure of the rate at which robots are taking jobs. In the years since 2005, economy-wide productivity growth has averaged just 1.0 percent annually, lower than for any other period in the post-World War II era. This means the data show the precise opposite of the robots taking all the jobs story. We are seeing a very slow rate of workers being displaced by technology.

This essay first appeared on Dean Baker’s Beat the Press blog.

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC.