Category Archives: Econ Data

Why Have Productivity and Profits Gone Up During Obama’s Term?

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In the post immediately preceding this one (see directly below, or here), I noted that a glance at the economic data makes clear that productivity and profitability have both increased under Obama.  Hence, the argument made by Mitt Romney and the other Republican candidates that onerous regulations imposed by Obama are the cause of disappointing job and output growth, is simply not correct.  If new regulations were such a problem, one would have expected productivity and especially profitability to have suffered, and yet both have improved.  Indeed, profitability has sky-rocketed.

For convenience, here is the basic graph again:

But this naturally then also raises the question of why productivity and especially profitability have gone up by so much under Obama.  Indeed, some might wonder whether Obama’s administration has deliberately favored profits at the expense of wages.

While a full analysis cannot be done here, I find no reason to jump to such a conclusion.  The path of profits is what one would expect over the last few years, with the sharp collapse in output at the end of the Bush Administration and then only a slow recovery with unemployment staying high.  There is the separate issue of the longer term trends, where profits have been growing as a share of National Income since about 1980 (for the last decade, see here, and for the underlying data and the longer term see the BEA data at here).  But the fluctuations over the last few years can be well understood in terms of the short term dynamics of the economic collapse and subsequent slow recovery.

Specifically, profits fell sharply in the economic downturn at the end of the Bush Administration, and started to to fall (per unit of production) as far back as 2006.  It is worth noting that housing prices peaked in the first half of 2006, and the economy began to slow after that.  A collapse in profits when the economy collapsed is as one would expect.

In response to the economic downturn, the Federal Reserve Board cut interest rates, ultimately to historically low levels of essentially zero for rates on risk-free assets.  Coupled with other aggressive Fed measures, as well as the TARP program to stabilize the banks (launched by Bush) and then the Obama stimulus program, the collapse was halted and the economy then started to grow in the middle of 2009.  Profitability then recovered.

The business response to the downturn was to lay off workers, as they always do in a downturn, and then later they invested in new machinery and equipment.  The investment was spurred in part by the low interest rates following from the Fed policies, and indeed the recovery in non-residential private fixed investment was surprisingly strong (see here).  Both these actions increased labor productivity, as shown in the diagram above.

But aggregate demand growth remained sluggish, despite the growth in private investment.   The downturn was due primarily to the bursting of the housing price bubble that the Bush Administration regulators had allowed to build up (or at least made no attempt to limit).  As housing prices collapsed, home owners became poorer and many ended up with mortgages that were larger than the now lower values of their homes.  Stock prices also fell, hurting retirement and savings accounts.  Coupled also with worries generated by high unemployment, households hunkered down to consume less and try to save more.  Private consumption stagnated.  And after the Obama stimulus plan was passed (helping to stop the free-fall in output and to turn around the economy), political pressures from the Republican Party and especially the Tea Party wing made it impossible for government to maintain a high enough demand to fill in the still large gap in aggregate national demand.

As a consequence, the recovery in growth was limited and unemployment has stayed high.    This has kept wages largely flat.  But labor productivity rose due to the large early lay-offs and later the growth in business investment.  With wages flat but labor productivity higher, unit labor costs fell.

In addition, there are non-labor costs (not shown in the diagram) which also fell.  The main component of such costs that fell was interest payments, which the Fed reduced to the maximum extent it could to try to spur the economy.

With both unit labor costs and non-labor costs down, profits rose and rose sharply.

Regulations Under Obama Cannot Be Blamed: Productivity and Profits Have Gone Up

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The Republican Presidential candidates, and especially Mitt Romney, have repeatedly asserted that burdensome regulations imposed by the Obama Administration are to blame for the disappointing performance of the economy during the recovery, and especially the disappointing job performance.  The evidence points to the opposite:  productivity has in fact performed quite well and profitability has sky-rocketed.  If regulations were a problem, one would have expected productivity to have declined and profitability to have suffered, and they haven’t.

The disappointing performance of the economy in recent years can rather be attributed to slow growth in aggregate demand.  Households have had to scale back consumption after the housing bubble burst, while conservative fiscal policies forced by a Republican Congress have not allowed government expenditures to fill in the resulting gap.

The chart above shows how labor productivity, unit labor costs, and unit profits have performed in recent years (for non-financial corporations), each indexed so that the 2005 average equals 100.  Labor productivity (in green in the chart) is the amount of output produced per unit of labor.  It was basically flat prior to Obama taking office, rising by just 2.2% total in those four years, but then jumped by 8.6% total in the subsequent 2 1/2 years.  If regulations imposed by Obama were a major hindrance, productivity would not have gone up like this.

But while labor productivity improved, labor compensation (not shown in the chart to reduce clutter) was basically flat.  Indeed, hourly wages in real terms have declined slightly since Obama took office (by 0.8% total).  This is consistent with a slack labor market, with high unemployment depressing wages.  With higher productivity and wages not increasing, the result was falling unit labor costs (labor costs per unit of output), as shown in blue in the chart.

What did shoot up after Obama took office was unit profits (profits per unit of output, in red in the chart).  This is much more volatile, but it is interesting to note that it peaked in the third quarter of 2006 and then fell sharply well before Obama took office.  If someone is to be “blamed” for this, it would have to be Bush.  Unit profits then reached its low point in the second quarter of 2009, as the recession came to an end, and then skyrocketed by over 75% up to the third quarter of 2011 (the most recent data available).  This is of course all consistent with what has been observed at the level of the aggregate National Income accounts, which was reviewed in an earlier post (see here) on this blog.

Mitt Romney and the other Republican candidates assert that burdensome regulations under Obama have stifled the ability of business to make a profit, and with that, businesses have been unwilling to employ more workers.  But productivity has improved and profitability has soared.  The evidence simply does not support their assertions.

Home Prices Stagnate, at Levels Similar to Those of 2003

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US home prices, Case-Shiller 10-City index, 1987 to 2011

US home prices continue to stagnate, at levels well below the peak reached in 2006 during the housing bubble. They fell sharply in 2007 and 2008 during the last two years of the Bush Administration and then stabilized under Obama, first rising a bit and then falling back a bit, but with no overall trend so far.  Based on the 10-city composite home price index of S&P / Case-Shiller, the prices of single-family homes in September 2011 were 33% below the peak reached in April 2006.

It is useful to view this in the longer term context, as presented in the graph above.  While home prices are fully a third off their peak, they are still higher than they ever were prior to 2003.  The sharp fall in prices is a reflection of the sharp rise in the middle of the decade, as a bubble built up and policy makers decided not to try to do anything to moderate it.  Indeed, many politicians, as well as many existing homeowners, felt quite good about the rapidly rising prices.

Then the bubble burst, and the consequences for the economy have been clear, as the economy collapsed in the sharpest downturn since the Great Depression.  This was then followed by an anemic recovery, with still high unemployment.  Recovery from such “balance sheet recessions” are normally slow, as the entities with the over-extended balance sheets (mortgage holders in the US; the corporate sector in Japan in the 1990s) seek to hunker down and save their way out of their predicament.  Asset prices recover only slowly at best.

If nothing is done, US home prices are likely to continue to stagnate, and may well fall further.  As indicated above, while prices after the bubble burst fell by a third, they are still only at the level seen in 2003.  Yet between 1997 and 2003 they had already doubled.  That home prices have not now fallen further than simply to 2003 levels is therefore even a bit of a surprise.  They could fall more.  And as seen prior to 1997, there can be long periods when prices are basically just flat.

Those households with negative equity in their homes (commonly referred to as “underwater”) face major difficulties, even if they can afford to make continued payments on their homes.  They cannot refinance at the current low rates for mortgages, unless they can come up with extra cash to bring the mortgage down to 80% (generally) of their current lower home value.  And they cannot sell their house to someone else, perhaps to move elsewhere for a new job, without bringing extra cash to the closing to pay off the remaining mortgage balance.  The housing market remains frozen, and with that, the economy remains in the doldrums.

Unless something major is done, this weak housing market will likely keep the economy in the doldrums.  And there is no reason to believe that there will be a jump in housing prices to levels similar to those at the peak of the bubble, with this then curing the problem of the underwater mortgages.   Rather, a comprehensive program, led by government, will be necessary to restructure these mortgages, to unfreeze this market and allow the economy to recover.