The UK’s weak recovery and profitability

The right-wing free market rag, City AM, hit on an important aspect of the UK economy in an editorial this week (http://www.cityam.com/latest-news/allister-heath/secret-collapse-corporate-profits-hurting-uk-s-recovery). Its editor, Allistair Heath, announced that there was a “secret collapse in corporate profits” that ” is hurting the UK’s recovery“.   Heath pointed out that “the supposedly well-established fact that profits are booming despite the recession” is not correct for the UK economy.  It may be “the story in America and in emerging markets … but the general picture for profits generated in the UK is actually pretty gloomy.”   Indeed, “the bounce-back in UK profits in 2009-10 has already been dramatically reversed, with the share of profits by private companies (excluding oil and financial firms) down from 18.2 per cent of GDP in the second quarter of 2007 (prior to the popping of the bubble and subsequent recession) to 14.6 per cent of GDP in the fourth quarter of 2011.”  Heath then quotes Michael Saunders of Citicorp that  “profits account for their lowest share of GDP since 1984.”

But Heath’s revelation should not be new to readers of my blog.  I raised just this point way back in January (see The UK rate of profit and others, 4 January 2012).  This is what I said then: “The UK authorities publish their own measure of the rate of profit in UK non-financial companies also using the net operating surplus divided by net fixed assets (but measured at replacement costs).  They have just released the latest quarterly figures, for Q3 2011…..They confirm my own finding that the UK non-financial corporate rate of profit peaked at the end of 2007, then slumped 30%  to Q3’2009.  Since then there has been a 21% recovery in the rate of profit, although it is still not back to the peak of end-2007.  Interestingly, the UK authorities report that the rate of profit in the manufacturing sector has continued to fall and is now at its lowest level since records were kept in 1997.  It’s the services sector that has driven the rise in the rate of profit.  And I added that “the recovery in the mass of profits has been less than in the US.  At the end of 2010, the mass of profits in the UK was still some 6% below the peak of 2007, although up from the trough of 2009.  In 2011, there has been no real further recovery.”

It’s the figures for the last quarter of 2011 that Heath has latched onto, using the analysis of Citicorp.  In the graphic below, I reproduce figures for up to Q4 2011, but using the net profit rate for all UK corporations and for the manufacturing sector.  The graphic shows that UK profitability is still some 27% below its peak in Q4’2007 for all corporations, and has hardly recovered since the trough of Q3’2009.  It’s even worse in the manufacturing sector.  Profitability there is 58% down from its peak in early 2008 and is now at a low since records began.

Even the mass of profits for UK companies has not returned to the peak before the crisis.  Total profits are still 9% below the level reached in early 2008.

Now Heath concludes that this poor profitability is due to British workers gaining a larger share of new value and thus squeezing profits.  He argues: “labour’s share of UK GDP has risen from 60.1 per cent at the start of 2008 to 62.9 per cent at the end of last year, well above the 1985-2010 average of 61.7 per cent, according to Citigroup.  Workers are being priced out of work. … This cannot last: unless growth recovers very quickly, real wages are going to have to fall.”  So it’s the fault of the workers not capitalist production and the answer is a cut in wages.  For Heath there is no way round this as “collapsing profits are the key reason why firms are not investing more. If they have spare capital, they are better off pulling it out of the UK and investing in an emerging nation. Companies invest and hire for one reason only: to make money. …Unless the UK becomes a more profitable place for firms to conduct business, we will be condemned to years of falling real wages, scandalously high unemployment and economic stagnation.”

Heath is right that, under capitalism, unless profitability rises, production and employment will stagnate or fall.  From a capitalist point of view, wage cuts will help.  The decline in UK profitability began in 1997  as the graph above shows.  This coincided with a rise in labour’ s share, which suggests that profitability has fallen because wages have held up.

But that’s too simple.  Employee compensation as a share of GDP usually rises in capitalist slumps because profits and investment collapse first before employment and worker’s incomes, but then it falls back as profits recover.  Employee compensation as a share of UK GDP was 54.6% in Q4’2011, according to the official figures (not Citicorp’s).  That’s only slightly above the average for the period from 1985 of 54.1%, that Citicorp refers to.  And it’s well below the average since 1955 of 56.7%.  More important, it’s actually down from a peak at the middle of 2009 of 56.3%, even if it is up from the beginning of 2008.  In statistics, you can choose your date and get what you want.  It’s called cherry-picking.

On official figures, labour’s share of UK GDP has been falling since 2009 and yet UK corporate profitability is still weakening.  So it cannot be labour’s fault.  Indeed, household real disposable income per capita has been falling for seven consecutive quarters.

What is the reason for falling profitability if it is not a rise in labour’s share of GDP?  The problem is ‘dead capital’, or excess capacity in the UK capitalist sector.  This must be cleared before profitability will rise sufficiently for investment to resume.  Since 1997, when the overall rate of profit peaked in the UK (see graphic above), the mass of profits has risen 38%, but capital stock has jumped 65%.  So it’s the falling productivity of capital that is the problem, not a rising share of new value going to labour.   And until profitability rises, as Heath says, UK capitalists are on an investment strike.  UK businesses are still investing 15% less than they did before the crisis at end 2007.

Heath says the other reason the UK economy is not recovering is that banks cannot lend to businesses because they are hamstrung by too much regulation.  Bank lending to businesses is down 3% over the latest 12 months, continuing a fall that began in the early part of 2009.  Lending to small businesses is down roughly 10%.   As Heath says: “It is not unusual for lending to firms to be weak in the aftermath of a recession. Banks become risk-averse. After the recession of the early 1990s, when they suffered large losses on their small firm loan books, business lending was also negative.  We have, however, now gone beyond the point at which business lending should be turning positive. In the 1990s it was two and a half years into the recovery. This recovery is now near its third anniversary and business lending continues to fall inexorably.”

The answer for Heath is to end the ‘over-regulation’ of the banks: “Unless somebody in authority gets to grips with the conflicts between regulation and growth and realises a credit-starved economy will always struggle, we can only expect more disappointing GDP figures.”  But this is codswallop.  The fall in lending is not because of too much regulation.  It is demand-driven. The evidence is clear from the Bank of England’s’ own survey.  Nobody wants to borrow money.

Demand for loans by small businesses collapsed back in mid 2010.   They had too much debt and did not want to borrow more when revenues plummeted.  Large companies don’t want to borrow either and need to less because they have built up stockpiles of cash (see my post, Why is the US recovery so weak? – look at profitability, 3 April 2012).  Why borrow more when profits are down and prospects are poor?

5 Responses to “The UK’s weak recovery and profitability”

  1. Guy Says:

    Interesting stuff. Do you know of possible explanations for loan demand Q2 2011?

  2. paulc Says:

    “Indeed, real disposable income has been falling for eight consecutive quarters.”

    This is probably just me being thick but after you write the above you display the ‘real disposable income’ chart and it appears that real income rose during 2011 from the low point of the first quarter. Can’t see 8 consecutive quarters of falling real income’ in any case unless you are referring to the fall from 2nd Q 2009 through to the first Q of 2011 which would be 7 quarters? Not being pedantic.

    • michael roberts Says:

      Paul

      You are not being pedantic. You have to get things right and the graph shows I have wrongly characterised the change in disposable income. I haven’t got the data in front of me at the moment but as soon as I do, I’ll double check it. Anyway, it’s clear that real incomes have fallen in the same period that profits were. Also, employee compensation to GDP graph shows, so profits have benefited from a squeeze on wages over the last decade or so, not the other way round.

    • michael roberts Says:

      Paul
      I’ve checked my data and revised that graphic to show that annualised real household income per capita has been falling for seven consecutive quarters. I have also revised slightly my comments on employee compensation. Thanks for that spot.

  3. Jim Devine Says:

    Michael,
    you have to figure out some way to separate the trend from the cycle. Even though a lot of the fall of the rate of profit is due to the trend, some of it is due to low aggregate demand and realization problems, which hurt the profit rate and the profit share.

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