Are Profits Too High?

Wall Street’s unlikely worry.

For the past four years, American companies have demonstrated great skill in keeping more pennies of every dollar for themselves and doling out fewer to workers. As Isaac Shapiro and David Kamin of the Center for Budget and Policy Priorities have noted, between the first quarter of 2001 and the third quarter of 2004, the portion of GDP funneled into wages and salaries dropped from 49.5 percent to 45.4 percent. Meanwhile, between the first quarter of 2001 and the second quarter of 2004, corporate profits as a percentage of GDP rose sharply from 7.8 percent to 10.1 percent.

Greater corporate profit margins are generally good news for stocks. But in recent weeks, several shrewd observers have suggested that the rising profits are unsustainable if they’re at the expense of wages. Justin Lahart, the daily columnist at the Wall Street Journal wondered yesterday how much longer companies could avoid hiring and boosting wages while continuing to increase sales and profits. “Wringing water out of a stone would be an easier feat.” Noting the same data, David Merkel on suggested “the only way to do better is for profits to become an even greater portion of GDP (labor unrest anyone?), or for interest rates to fall without harming profits.”

But anyone who thinks American corporations are going to start shoving raises on employees is dreaming. The notion that there will be some backlash—cultural, social, or political—against high-profit companies seeking even greater profits is either a misplaced fear or a misplaced hope, depending on where you sit.

In the last several years, labor—organized and unorganized—has been getting kicked in the teeth. As corporate profits grew 40 percent in real terms between the first quarter of 2001 and the second quarter of 2004, wages and salaries grew by only about 0.3 percent in real terms, according to the CBPP.

In many sectors, labor is under a great deal of stress—if not outright assault—as a result of several macrotrends: failing industrial companies with unsustainable business models, outsourcing, the threat of outsourcing, free trade, excess capacity, and a labor market that remains unaccountably slack three years after the recession ended. Only 13 percent of the nation’s workers are represented by unions, and employees have fewer advocates in Republican-dominated Washington than ever before. Benefits like health care and guaranteed pensions are increasingly decoupled from jobs. Just yesterday, Delta Airlines’ unionized pilots voted to reduce their own salaries by almost one-third. And yet there has been virtually no labor unrest, no pressure on corporations to stop worrying so darned much about profits.

The sluggish growth in wage and salary compensation could be partially explained by the fact that some workers—and unions in particular—accept slower wage growth in exchange for more compensation in health and retirement benefits. And indeed, companies have found that while their wage bills have been relatively stagnant, their bills have been rising for health insurance (because medical costs have been soaring) and for pension benefits (because the slow stock market has forced companies to increase their contributions to plans).

Investors shouldn’t worry too much about these rising costs, though. For American corporations are increasingly viewing health insurance and pensions as cost items to be cut rather than as contractual obligations to be met. And they’re cutting these profit-hampering costs with abandon. In a front-page article in yesterday’s Wall Street Journal, Ellen Schultz documented the appalling trend of companies suing union retirees to slash benefits promised to them for life. (One of the legal tactics is to “argue that contract references to ‘lifetime’ coverage don’t mean the lifetime of the retirees, but the life of the labor contract.”) Failing companies terminate health-care plans and dump retirement plans onto the federally sponsored Pension Benefit Guaranty Corp., instantly increasing their profit potential. The passage of the Medicare prescription drug benefit has given firms an excuse to slash drug coverage. Some large industrial firms want taxpayers to relieve them of the burden of living up to their health insurance commitments. Or they shift costs onto employees—by increasing co-pays and offering bare-bones, high-deductible policies. This long goodbye of welfare capitalism is far from over.

For much of the 20th century—first in the Progressive Era and then in the New Deal and its lengthy, prosperous aftermath—government acted as a countervailing force against the corporation’s search for profits by imposing or raising taxes, assisting labor, or increasing regulations. No longer.

The consulting firm Global Insight frets that in 2005, corporate tax breaks worth more than $300 billion, “representing well over one-third of the total value of all U.S. profits,” are set to expire. Relax. In October, Congress passed a new round of corporate tax breaks. With K Street-funded Republican majorities and a president who left his veto pen in Crawford, there’s more where that came from. And as part of the ownership society, we’re likely to get legislation that will make it easier for companies to push the costs of benefits onto employees’ balance sheet and off of theirs (see health savings accounts, for example).

The corporation may not be the pathological beast the eponymous documentary would have us believe it is. But it is both ingenious and highly aggressive. And with a permissive political environment and the persistence of long-term trends weighing in their favor, it may be too soon to call a peak in the power of American corporations to retain profits. They could just be getting started.