Tuesday, May 24, 2011

Slow Recoveries

Stefan Karlsson disagrees with my argument that the current very slow recovery in the US is quite satisfactory for the owners of corporations. His criticism centers on the fact that recessions are bad for companies because they result in underutilized capacity and thus depress margins. And I agree. It's quite true that companies don't like recessions (which is exactly what I wrote in my previous post on this subject). However, my point was that the owners of corporations do benefit from slow, relatively jobless recoveries, such as we saw after the recessions of 1991 and 2001, and what we're now seeing after the Great Recession of 2008-09.

Think of it this way. There are two countervailing effects at work during the business cycle: the size of the pie is changing, and the way that pie is divided between workers and firms is changing. A recession makes the pie smaller, but a high unemployment rate means that firms get to keep a larger share of that smaller pie. My argument is that there may be times when an increase in the size of the slice going to firms more than makes up for the fact that the pie isn't growing very fast.

Since these two forces work in opposite directions, this is ultimately an empirical question. So let's look at the data. The chart below shows nonfinancial corporate profits in the US as a percent of GDP and in real (inflation-adjusted) dollar terms since 1980. It seems clear that companies did better during the weak recoveries of 1992-96 and 2002-06 than they did during the strong recovery of 1982-4.

There's nothing particularly surprising or profound about the idea that corporate profits do best in the first part of a recovery; that is well understood. But the dramatic increases in profitability during the recoveries from the 1991 and 2001 recessions suggest that something was different about them.

I would argue that the difference is that those recoveries were very slow in the US. If we pair the notion that corporate profits do best in the initial stages of a recovery together with the table at right, then I think we get a good explanation for what we have observed, which is stagnant worker compensation and strong corporate profits. Recoveries from the past 3 recessions in the US have happened relatively slowly compared to typical recoveries in the 1950s through 1980s, and with only very gradual improvements in the labor market. And this has helped corporations keep the majority of the productivity gains of their workers for themselves.

In other words, the "good times" for corporations have tended to last much, much longer during recent recoveries than they did prior to 1990. And when combined with the fact that the relative bargaining power of workers is weak during this particular phase of the business cycle, this has had the effect of substantially changing the share of worker productivity that has been returned to workers in the form of higher compensation in the US.

This has two significant implications. First, it's certainly not a stretch to say that the owners of US firms are probably quite content with the slow pace of the current recovery. Second, this reasoning suggests that gaining a better understanding of why recoveries in the job market are so much slower now than they were prior to 1990 may be an important step toward understanding the relatively poor growth of average worker compensation in the US over the past 20 years. Could the stagnation in median household income in the US be in part the result of these very slow recoveries? It's an intriguing line of thought to pursue...


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