Who will get the spoils of an improving economy: Shareholders or workers?

April 9, 2013

There are two big forces at work that will together determine the future of the stock market, corporate profits and workers’ pay. And as Corporate America starts to report how it did at the start of 2013 (aluminum giant Alcoa was the first major company to put out its first quarter results this week, but more on that later), we will learn a whole lot more about which of those forces is winning — with implications for us all.

It’s almost a cliche at this point to observe that while the stock market has returned to its pre-crisis highs, the recovery on Wall Street barely touched Main Street. There’s real data to back it up. The stock market has jumped sharply over the last four years in no small part due to a rebound in corporate profits, which have been rising as a share of the economy -- to more than 11 percent of GDP, the highest on record (data go back to 1947) and up from an average of 6 percent since 1980. Here is a chart of after-tax corporate profits as a percentage of GDP:


The chart shows corporate profits after taxes as a proportion of gross domestic product. Source: BEA via FRED.

If you want to know where that extra profit is coming from, one major answer is simple: Companies are spending less on paying their workers. With unemployment high, workers haven’t been able to demand big pay increases, and many companies seem to have become more efficient in the recession and its aftermath, being able to produce more with fewer workers. This chart shows compensation of employees as a percentage of GDP. It is basically the inverse of the profits graph, and has fallen as decisively as profits have risen, to 54.6 percent at the end of 2012 compared to an average of 57 percent since 1980.


This chart shows compensation of employees as a percentage of gross domestic product (BEA via FRED)

So, to know how America’s companies are going to do in 2013, how the stock market will perform and whether working Americans will start getting their share of the economic recovery that has thus far gone to shareholders, the question is which of two forces will be more powerful.

First there’s economic growth. Before we can debate whether a rising tide will lift all boats, we have to know whether the tide is rising at all. First quarter economic growth looks to have been pretty solid, with forecasters expecting something in the 3 percent range. But the latest signals have been more mixed, including that crummy jobs report Friday.

Then there’s the question of how the gains from economic growth get divided. If CEOs and stock investors get their way, historically high profit margins and the high proportions of corporate income going into shareholders’ pockets would remain in place, or rise further. If workers get their way, the tightening in the labor market over the last year (the unemployment rate was 7.6 percent in March, down from 8.2 percent a year earlier) will mean workers have more clout to demand pay increases, and margins will start to return to more like their normal levels.

All of which brings us to Alcoa, the major maker of aluminum. Analysts use the company as a bellwether to predict how the rest of earnings season will go; we can similarly use it as a bellwether as to what will happen to economic growth and profit margins, the two forces shaping the outlook for stocks.

While Alcoa’s revenue and earnings were a smidgen below what analysts had expected their first quarter results to show, the good news is that they affirmed their predictions for 2013, suggesting they expect economic growth to be steady: Overall, the firm expects global aluminum demand to grow 7 percent this year, which would be consistent with a steadily recovering global economy.

Then there’s the question of margins. And here, Alcoa’s numbers seem to offer better news for shareholders than they do for workers. Operating margins at the company were 5.6 percent in the first quarter, the highest since the third quarter of 2011. Those numbers are volatile, and are affected by far more than labor costs (for an aluminum maker, commodity prices are a huge portion of costs), but at a first glance they don't offer much reason to think that workers are starting to claim a larger part of the corporate revenue pie.

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Brad Plumer | April 9, 2013