Profits are, of course, what capitalism is all about. The ultimate measure of success for any firm is the rate of profit – that is, its profits compared to the capital it invested to obtain them.
So the Financial Times had good news for British capitalism on Wednesday of last week. “Corporate profitability rose to its historically highest level at the end of last year as manufacturing and service sector companies benefited from strong sales growth combined with lower energy prices and subdued wage pressures,” it wrote.
In the fourth quarter of 2006, the net rate of return on capital in non-oil British companies rose to
14.7 percent. For the whole of 2006, and including oil companies as well, the net rate of return was 15.1 percent, the highest for more than 40 years.
The long economic downturn of the past generation began when the rate of profit fell sharply in the leading capitalist countries in the late 1960s and early 1970s.
This development seemed to confirm Karl Marx’s argument that underlying capitalism’s propensity to boom and slump was a long-term tendency for the rate of profit to fall. But has this now been reversed?
I doubt it. One of the main factors determining the rate of profit is what Marx called the rate of exploitation. This measures capitalists’ success in squeezing profits out of workers by making them work harder, directly or indirectly through lowering their wages and so on.
There is evidence that this has been a major factor in the surge in profitability. Last year, households’ disposable income grew more slowly than the economy, once inflation is taken into account.
In the last quarter of 2006, disposable income fell by 0.7 percent. This situation helps to explain the growing “feel bad” factor that will confront Gordon Brown when he takes over.
Karen Ward of HSBC bank told the Financial Times, “The profit share of GDP [gross domestic product] has risen, largely at the expense of households as the labour share has fallen.”
But there is a downside for capital in the profit surge. Workers who have seen their real income stagnate or fall are also consumers. If they spend less, then demand for goods and services will decline – and so will their profits.
To maintain their existing levels of spending households must save less and borrow more. But the resulting surge in debt makes the economy vulnerable to interest rate increases imposed by central banks worried about inflation.
We can see this pattern in a more advanced way in the US economy, of which the British is a kind of pale shadow. There the share of profits in national income rose from 7.0 to 12.4 percent between 2001 and 2006, thanks also to a squeeze on wages.
American consumers were able to keep the US and world economy afloat through building up higher and higher levels of debt, particularly by remortgaging their homes. Now, however, the housing market is plummeting, driving many poorer homeowners and dodgy mortgage companies into default.
Just before the good British profitability figures came out, it was announced that US profits fell in the last quarter of 2006. “Profits growth has turned decisively down and the end is not yet in sight,” wrote Gabriel Stein of Lombard Street Research.
“One of the key points about the US economy in recent years has been the spectacular rise in corporate profits, both in absolute terms and as a percentage of GDP. Now there are clear signs that this is changing.”
The conclusion that I draw from this is that bosses can drive the rate of profit to levels close to those that Western capitalism enjoyed during the great boom of the 1950s and 1960s. But, judging by the US case, they don’t seem to be able to sustain this higher profitability for long.
As long as this remains the case, global capitalism is likely to suffer the chronic instability it has experienced for the past few decades. This headline in last Saturday’s Financial Times comes as no surprise, then – “Fund Managers Get Set for a Downturn”.