Feb 23rd 2006
"NOTHING contributes so much to the prosperity and happiness of a country as
high profits," said David Ricardo, a British economist, in the early 19th
century. Today, however, corporate profits are booming in economies, such as
Germany's, which have been stagnating. And virtually everywhere, even as
profits surge, workers' real incomes have been flat or even falling. In
other words, the old relationship between corporate and national prosperity
has broken down.
This observation has two sides to it. First, as Stephen King and Janet
Henry, of the HSBC bank, point out, companies are no longer tied to the
economic conditions and policies of the countries in which they are listed.
Firms in Europe are delivering handsome profits that are more in line with
the performance of the robust global economy than with that of their
sclerotic homelands. In the past two years, the earnings per share of big
listed companies have climbed by over 100% in Germany, 50% in France, 70% in
Japan and 35% in America. No wonder Europe's and Japan's stockmarkets have
outpaced those in America, despite the latter's faster GDP growth.
Second and more worrying, the success of companies no longer guarantees the
prosperity of domestic economies or, more particularly, of domestic workers.
Fatter profits are supposed to encourage firms to invest more, to offer
higher wages and to hire more workers. Yet even though profits' share of
national income in the G7 economies is close to an all-time high, corporate
investment has been unusually weak in recent years. Companies have been
reluctant to increase hiring or wages by as much as in previous recoveries.
In America, a bigger slice of the increase in national income has gone to
profits than in any recovery since 1945.
The main reason why the health of companies and economies have become
detached is that big firms have become more international. The world's 40
biggest multinationals now employ, on average, 55% of their workforces in
foreign countries and earn 59% of their revenues abroad. According to an
analysis by Patrick Artus, chief economist of IXIS, a French investment
bank, only 53% of the staff of companies in the DAX 30 stockmarket index are
based in Germany; and only one-third of those firms' total turnover comes
from there. Only 43% of all the jobs at companies in France's CAC 40 are in
France. With the profits of these firms so dependent on their global
operations, it is not surprising that corporate prosperity has failed to
spur "home" economies.
American and Japanese companies remain more closely tied to their domestic
markets. Just one-fifth of the turnover of firms in Japan's Nikkei index
comes from overseas. Foreign sales of America's S&P 500 companies amount to
a modest 25% of the total. Even so, at the 50 biggest firms the figure is
higher, at around 40%. The old saying, "What's good for General Motors is
good for America", no longer rings true: over one-third of GM's employees
work outside the group's home country.
If a large part of the spurt in profits comes from foreign operations, it is
less likely to be used to finance investment or extra job creation at home.
If they reason that the recent past is a fair guide to the immediate future,
companies are likely to plough their extra profit into further investment
abroad. Alternatively, they may buy back shares or repay debt.
Globalisation has also shifted the balance of power in the labour market in
favour of companies. It gives firms access to cheap labour abroad; and the
threat that they will shift more production offshore also helps to keep a
lid on wages at home. This is one reason why, despite record profits, real
wages in Germany have fallen over the past two years. That in turn has
depressed domestic spending and hence GDP growth.
Workers can still gain from rising profits if they own shares, either
directly or through pension funds. There is reason to think that the share
prices of large listed companies will fare better than their home economies.
Economic theory and historical experience argue that, in the long run,
profits grow at the same pace as GDP. However, if the profits of big
companies are increasingly linked to global production, then the profits of
listed companies in developed economies could rise faster than domestic GDP
for many years.
In America, capital gains on shares have played a big role in supporting
household spending over the past decade. But Mr Artus worries that workers
in continental Europe are losing out, because a surprisingly high proportion
of shares are held by foreigners: as much as 35% in France and 16% in
Germany. This is partly because of the smaller role played by institutional
investors, such as pension funds, in Europe compared with, say, America.
If profits (and hence executive pay) continue on their merry way, while
ordinary employees' real wages stand still and their health benefits and
pensions are eroded, workers might well expect their governments to do
something to close the gap. It's not hard to think of ideas that would be
popular-higher taxes on profits, restrictions on overseas investment, import
barriers, or making it harder to lay off workers. The trouble is, in a
globalised economy such measures would also be suicidal. Firms would simply
move operations' head offices to friendlier countries.