Goodbye, good times?

Jan 21st 2005
From The Economist Global Agenda

Most American companies have enjoyed several years of bumper profits. But, as the results season gets under way, some big firms are reporting that times are getting tougher. Are many more set to follow?

BY MOST measures American companies should have it easy. The country’s economy is growing at a healthy pace—around 4% a year—and consumer spending is holding up. Although the Federal Reserve has pushed up interest rates and is set to increase them further, borrowing is still cheap. And a weak dollar makes America’s exports all the more alluring to buyers abroad, who currently account for almost a quarter of American firms’ profits. No wonder, then, that American companies' profits as a share of GDP are close to an all-time record, or that the Dow Jones Industrial Average hovers around 10,500, over 40% higher than where it stood in late 2002.

As the reporting season gets under way, the news from many American companies is rosy. Bigger profits here, analysts’ expectations exceeded there. But for some firms business is less bright. These include eBay, which saw profits rise by 44% in the latest quarter compared with a year ago while failing to live up to expectations. Its shares plunged by 18%. Qualcomm, a mobile-phone technology firm, said that it would miss Wall Street’s forecasts, and Motorola’s shares fell by 7% after the mobile-phone manufacturer also admitted to performing less well than expected. Continental and Delta, two airlines, reported big losses in the fourth quarter. And General Motors said that profits in the same quarter had fallen by 37% compared with a year ago.

These results perhaps point to a wider truth: the days of vast and ever-growing profits may be coming to an end for the time being. In fact, according to figures from the Bureau of Economic Analysis, overall profits for all businesses decreased by $55.9 billion in the third quarter, a 4.8% drop compared with the previous quarter. For non-financial firms things look better: profits have soared since 2001 and are still growing. But that growth began to slow in the second half of last year.

The specific travails of individual companies offer only a partial explanation for the slew of disappointing earnings news in recent days. More generally, the high oil price has hit profits and may also contribute to slowing economic growth and hence further depress earnings. Other corporate costs have also escalated. For example, America’s car companies have had to endure big rises in steel prices.

However, another factor lies behind the slowing growth of profits: productivity growth. Between 1995 and 2000 output per man hour grew by around 2.5% a year; between 2001 and 2003 it jumped to 4.2%. The cause of this sudden burst lies in the reaction of firms in the aftermath of the bursting of the technology bubble and subsequent recession. As the recession hit, firms shed labour. As the economy recovered, slimmed-down companies squeezed more out of workers who responded favourably while labour markets remained slack, boosting productivity. As a result, hiring stagnated, unit labour costs fell and profits rose, resulting in America’s much-discussed “jobless recovery”.

The bumper growth in productivity was fuelled by another, related factor. As Alan Greenspan, the Fed chairman, remarked last year, the boom in technology spending during the bubble created a “backlog of unexploited capabilities”. It is generally accepted that a period of reorganisation is required to exploit fully the benefits of new technology. The round of corporate cutbacks in the recession afforded just such an opportunity for workers to make the most of new technology.

The problem that faces America’s companies is that productivity growth of 4% is unsustainable. The measure slumped to 1.8% at an annualised rate in the third quarter of 2004 and could continue in the doldrums for a time to come. Optimistic estimates suggest that productivity growth could bounce back at the end of 2005, but only to the trend level of around 2.5% that America saw in the years preceding the recession rather than the rampant rate of growth underlying the profits bonanza since 2001.

Though companies and their shareholders may find little cause for celebration, the immediate prospects for America’s workers are a little brighter. Some argue that America’s corporations have accrued more than their fair share of the fruits of a growing economy, by extracting extra productivity from their employees over the past three years, and that a period of rebalance between profits and wages (and jobs) is due. There is some evidence that this is happening. Hiring is a little better: 157,000 non-farm employees were added to payrolls in December. And in some cases non-wage compensation, such as health-care benefits, is rising. A dark cloud may be forming over America’s corporations, but it has a silver lining.

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