There cannot be a closer connection in the capitalist system of production and exchange than that between profits and investment. In various previous posts, I have argued that the key to any economic recovery under capitalism will be a recovery in private sector investment, not consumption as the Keynesians claim. In an earlier post (see Greenspan gets it, 8 October 2010), I produced a graphic that showed how the rise and fall in profits and profitability drives the rise and fall in investment.
Here is that graphic again. The green line shows the year on year change in US corporate profits (or internally-generated revenues) against the year-on-year movement in private fixed investment (red line). Profits clearly lead investment in booms and slumps. And profits are recovering now, allowing investment to come back.
Let’s take this argument a little further by looking more closely at the current economic recovery, as usual by using US data that include Q3’10. The evidence on profits is clear. US corporate profits peaked in early 2006 – that’s the absolute amount, not the rate of profit, which I have shown elsewhere peaked earlier in 2005. From its peak in early 2006, the mass of profits fell until mid-2008, made a limited recovery in early 2009 and then fell to a new low in mid-2009. After that, the recovery in profits began and previous peak in dollars of early 2006 was surpassed in mid-2010.
What was the reaction of investment to this movement in US profits? When US corporate profit growth started to slow in mid-2005 and then fell in absolute terms in 2006, corporate investment went on growing for a while as companies used up reserves or increased borrowing in the hope that profits would be restored. But when that did not materialise, investment growth slowed during 2007 and then fell absolutely in 2008, at one point falling at a near 20% yoy rate. Profits started to recover at the end of 2009 and two quarters later, so did investment.
It’s what you would expect. It tells you that profits were falling well before the credit crunch began. So, as I have argued elsewhere, the crisis was not really financial in origin but did indeed follow a classic Marxist crisis of profitability even if the eventual trigger for the slump was in the financial sector. Second, the movement of profits leads the movement of investment, not vice versa (as many Keynesians would argue).
What is different about the recovery after the Great Recession is its weakness compared to previous recoveries after slumps in the US. Profits are recovering now, but at a much slower pace than in previous recoveries. It has taken eight quarters from the trough in 2008 to get back to the previous profits peak. In earlier recessions, the profits peak was restored within four quarters. The reason for that was explained in my previous post, The cycle of profitability and the next recession, 18 December 2010.
And the investment recovery this time still has some way to go. After the 1980s and 1990s recessions, it took eight quarters to restore investment to its previous nominal peak and only four quarters in 1974-5. But in the Great Recession, investment has only started to recovery 12 quarters after its peak in Q3’07 and is still 19% below that peak. This is a very weak recovery.