Martin Wolf has recently reminded us the role that corporate surpluses played during the ‘Great Moderation’. He reports the well-known fact that while corporations saw how their gross savings (i.e. current revenues minus current expenses, capital expenses excluded) rose during this period, the level of corporate investment remained stagnant. This means, as a matter of logical necessity, that corporations were accumulating net assets over the entire period. Wolf concludes that ‘it has to be accepted that, so long as the corporate sector runs a structural financial surplus, macroeconomic balance is likely to require fiscal deficits’, something which I can hardly disagree with.
At the same time, the Spanish press (here, in Spanish) reports that non-financial corporations have seen a growth in profits, during the first three quarters of 2015, of 28.6% (in comparison to the first three quarters of 2014), due mainly to ‘an improvement of the economic activity’ and the impact of some one-off (non-recurrent) revenues. Both articles have nudged me enough to provide an update of the Spanish macroeconomic profit series and to explain their implications for the Spanish macroeconomic performance.
Regular readers of this blog will know that I usually study the profitability of the corporate sector as a whole using the Levy-Kalecki profit equation (see here for a thorough explanation), which is a handy tool to break down macroeconomic profits according to their sources – as we will see in a while. The Levy-Kalecki profit equation has another advantage, an obvious one, but often overlooked by economists: it provides the only measure for the absolute amount of profits using national accounts data. In the US, the lucky land for profit-watchers, the Bureau of Economic Analysis already provides series for corporate profits (NIPA profits, as they are usually known), but that’s an exception, because the rest of countries (that follow the recommendations of the SNA) do not publish this figure, but something that is very close (gross savings), but not the same – true, many statistical agencies report micro-databases at the firm level, as the Bank of Spain does with the Balance Sheet Data Office, but they are outside from the scope of the National Accounts. Therefore, the Levy-Kalecki exercise (i.e. to retrieve profit series) is not only valuable because it provides a macroeconomic breakdown for corporate profits, but also because it can shed some light for these countries that are not in the same favourable situation as the US is.
Levy-Kalecki profits in Spain, 1999-2014
Besides, the Spanish case is an especially instructive case of the usefulness of the Levy-Kalecki profit equation. Actually, I can hardly think of a better application of this tool than the recent economic history of Spain. In a paper that I wrote with two other economists some years ago, we already noted the counterintuitive evolution of LK profits in Spain since 2000. You may be thinking that, roughly speaking, there was an upward trend in the profits series up to 2007, then a decline from 2007 to 2013, and since then more or less they have remained flat. Well, in that case, you would have got right only the last part of the sentence. The following figure shows the evolution of LK profits (non-financial plus financial corporations) since 1999:
Some background is needed. The LK series come from National Accounts, so they do not include unrealised capital gains. The purpose of the National Accounts is, by definition, to measure changes in real production, not in prices, and that’s why unrealised (and most of the realised) capital gains cannot be found in the income and product accounts – they can be found in the revaluation accounts, but that’s another story. In a nutshell, capital gains are not income.
In Spain, during the ‘roaring’ 2000s a huge chunk of profits booked by corporations (especially real estate and financial ones) were of this nature. However, when one looks at the ‘operating’ component of firms’ profits through the LK profit equation, things were a bit different. Profits declined from around 6.7% of GDP in 1999 to 3.3% in 2005 – if you think this evolution is some kind of joke, try to plot the evolution of gross savings of non-financial plus financial corporations as a % of GDP, the closest figure we have in the National Accounts to the profits I am reporting here. For newcomers, this range of numbers (3.3% – 6.7%) is quite low in comparison to other economies. For instance, the US historical average has been around 7.5% and in the UK a bit less. This low number should have warned us about the real profitability of Spanish firms. Since then, profit margins have been climbing up to the current 8%, and they have been quite stable for a few years. This period has coincided with massive write-offs by Spanish financial firms, which have produced exactly the opposite effect that they produced before the crisis. I think that the reason why the LK series seems now to be more reasonable (or at least closer to what one would expect) is that the Spanish pre-crisis business model (over reliance in real estate) has gone, and now that non-income generating activities are coming back to normal levels in the profit and loss statement of Spanish firms, then the importance of income generating activities should be clearly reflected. Summing up, the Spanish case shows that over long periods of time the LK profit series can be more informative on the real health of the corporate sector than measures reported directly by firms.
The ‘sources’ of profits can give us some additional insights. Up to the crisis LK profits were driven by investment, notably investment by the household sector (the investment split is not displayed in the graph) and households that were reducing their savings. Government was roughly neutral with some surplus in the years just before the crisis (which indicates, by the way, that the Spanish crisis did not have anything to do with fiscal irresponsibility, as many media outlets want us to believe) and the external sector was a big drag on corporate profitability. One of the main features of the Spanish series is the low contribution of dividends, for in many other countries they fluctuate between 3% and 4.5% of GDP (e.g. US and UK), whereas in Spain they barely reach 2.5%. On the other hand, the post-crisis period has been led by a large government intervention and by the improvement in the current account, which is now a (small) positive contribution to the Spanish profits: these two forces have balanced a sluggish investment and a household sector that has come back to higher levels of savings. Overall, in my opinion, except for the low levels of investment, the post-crisis profit composition of the Spanish economy is a much better one than the one displayed in the pre-crisis period: the post-crisis profit composition can last longer without creating huge (internal and external) imbalances in the Spanish economy.
And the one-million-dollar question is: what about the future? This is a difficult question (you know, economists are good at predicting the past, not the future), but there are two things that something can be said about them. First, the current low levels (from a historical perspective) of investment provide room for further increases in profit margins; an improvement in investment will certainly happen in 2016 given further improvements in national economic activity – our most likely scenario for Spain in 2016 if no big international shock occurs, notably China. And second, the Spanish government is known to be committed to further reductions in the deficit number until (at least) 2018 – although it will depend, of course, on the composition of the new government that will be elected in December. However, it will be crucial as well to follow the current account, given that its evolution can make all the difference and can hinder on the sustainability of Spanish profits. Although the Spanish export performance has been impressive in the last two decades (and there is no reason to believe it will come to an end soon) and the weak euro and oil prices we have seen in 2015 have helped a bit lately, the low growth of Spain’s main trading partners (euro countries) and the halt in world trade are major challenges that Spanish firms are bound to face.