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5:36 pm By Arnold Kling Corporate Profits: New Economy or Same-old Same-old?If we can assume that nominal GDP will grow at about 6 percent per year on average for the next several years, then corporate profits probably will grow at the same rate. There is no basis to expect a "new economy" effect. Does the "new economy" mean that corporate profits are doomed? John Robb, a weblog-based pundit, thinks so.
I am going to argue against this thesis. So let me point out that I am not picking on John Robb. As he points out, Business Week took a similar position. Several years ago, Edward Yardeni made the argument that the Internet economy would be highly competitive, which would restrain profits. (Prudential Securities hired Yardeni earlier this year, and they silenced him. That is, they shut down his web site, which had been one of the deepest, most educational destinations for economics on the Internet. Boo, Pru!) I am going to make the same argument that I made in 1997 and 1998. Back then, profits were growing at rates that I thought were unsustainably high. The "new economy" thesis then was that corporate managers had found a magic bullet, enabling them to raise productivity and profits, seemingly without bound. My argument goes like this:
In 1998, when many people were thinking that profits could continue to grow indefinitely at 15 percent per year, I was arguing for 6 percent. Now, when some people think that profits are never going to increase again, I am arguing for 6 percent. I think that most of the short-term fluctuation in the profit share reflects the slow reaction of wages and prices to productivity surprises. Hence, when productivity is surprisingly high, as at the peak of a boom, the profit share rises. When productivity is suprisingly low, as it was in the 1970's, the profit share falls. The important point is that profits are not something that corporations steal from consumers/workers by subterfuge. If that were the model, then perhaps greater transparency on the Internet would cut into profits. Instead, profits are a return to capital. If capital investment--plant and equipment, computers, medical technology, etc.--is productive, it will earn a return. No matter how transparent or competitive the economy becomes, capital investment will earn a return. Companies make mistakes (the telecom bubble comes to mind), and they earn poor returns when that happens. Other companies make sound decisions, and they earn high returns. To argue that the Internet makes profit growth passe, you have to make a case either that there will be no growth in capital or that capital will earn a low return, or both. However, the profit pessimists are not saying that we are going to stop investing in capital goods. And that does not seem like a credible scenario. The return on capital has a self-equilibrating nature. If the returns are high, firms will invest more, which will bring in more capital and drive down the return. If the returns are low, firms will cut back investment, which will reduce the supply of capital and drive up the return. The Internet does not change the way that the return on capital is determined. Therefore, the argument that companies will be unable to earn profits because of greater transparency or more vigorous competition does not hold up. The argument that the Internet will depress profits sounds appealing now, because people like to tell these sorts of stories, and because recently the profit share has been declining. However, it is a false argument. At some point in this decade, we will have above-normal profit growth again, and then we will have new stories that imply that such a phenomenon is permanent. And once again, I will have to explain why we can expect over long periods for profits to grow at the same rate as nominal GDP, or about 6 percent. Copyright 2002 Corante. All rights reserved. Terms of use |
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