Monday, May 23, 2011

Do Companies Benefit From Recessions?

A somewhat odd theory has recently been posted on various left-wing blogs (for example this one) that goes something like this.

High unemployment weakens worker's bargaining powers, helping to reduce wage demands and therefore all else being equal boosts corporate profits.

Recessions and weak recoveries from recessions means unemployment.

Therefore, companies benefits from a weak economy, and the politicians they back will therefore deliberately try to weaken the economy

This might seem at first glance like a good syllogism, but it really isn't since the first premise is misleading. While it is true that weaker bargaining powers for workers will reduce labor income relative to corporate profits, that is not the main effect of recessions on corporate profits. Falling capacity utilization (which increases fixed costs relative to sale) and falling margins because of weak demand will seriously depress profits in a way that greatly overwhelms the positive effect for companies from stronger bargaining powers relative to workers.

The below chart used to prove their point does nothing of the kind, because by using 7-year averages they will at all points include both recessions and booms. This means that it will mainly describe structural rather than cyclical changes. If you look at specific years, you can see that profits as a share of national income tends to fall during recession, while share of national income that goes to workers rises.

Some concede that recessions might not be good for companies, but then argue that weak recoveries are better for companies than strong ones. But that's not true either. During the strong boom following the recession of 1982, corporate profits rose as a share of domestic income from 5.3% in 1982 to 7.2% in 1984, while during the initially weak recovery after the recession of 1991, corporate profits only rose from 6.4% of domestic income in 1991 to 7.1% in 1993.

While other factors that has weakened worker's bargaining power in the United States, both those that the left likes to talk about (like weaker labor unions) and those that leftists don't like to talk about (like immigration), have indeed increased corporate profits relative to labor income, a depressed economy will lower corporate profits even in relative terms (and by definition even more so in absolute terms).