By Robert J. Samuelson
Monday, July 26, 2010; A13
Judging from corporate profits, we should be enjoying a powerful economic recovery. The drop in profits in the recession was about a third, the worst since World War II. But every day brings reports of gains. In the second quarter, IBM's earnings rose 9.1 percent from a year earlier. Government statistics through the first quarter (the latest available) show that profits have recovered 87 percent of what they lost in the recession. When second-quarter results are tabulated, profits may exceed their previous peak.
The rebound in profits ought to be a good omen. It frees companies to be more aggressive. They're sitting on huge cash reserves: a record of $838 billion for industrial companies in the Standard & Poor's 500 index (companies such as Apple, Boeing and Caterpillar) at the end of March, up 26 percent from a year earlier. "They have the wherewithal to do whatever they want -- hire; make new investments; raise dividends; do mergers and acquisitions," says S&P's Howard Silverblatt. Historically, higher profits lead to higher employment, says Mark Zandi of Moody's Economy.com. Except for start-ups, loss-making companies don't generate many new jobs.
So far, history be damned. The contrast between revived profits and stunted job growth is stunning. From late 2007 to late 2009, payroll employment dropped nearly 8.4 million. Since then, the economy has recovered a scant 11 percent of those lost jobs. Companies are doing much better than workers; that defines today's economy.
The most obvious explanation is that the relationship between labor and capital (to borrow Marxist vocabulary) has changed. Capital has gotten stronger; labor has weakened. Economist Robert J. Gordon of Northwestern University argues that the "shift of executive compensation towards much greater use of stock options" has made corporate managers more zealous cost-cutters in recessions and more reluctant hirers early in recoveries. Lowering the head count is the quickest way to restore profits and, from there, a company's stock price.
In a new study, Gordon dates the economy's changed behavior to the 1980s. Until then, companies tended to protect career workers, and unemployment followed a path predicted by economist Arthur Okun in a famous 1962 paper. But now, unemployment exceeds Okun's formula, and "jobless recoveries" have become standard. After the 1990-91 recession, consistent employment growth did not resume for about a year; the lag was nearly two years after the 2001 recession. (The National Bureau of Economic Research, an economists group, determines the end of recessions, usually when economic output begins expanding. Job growth does not automatically coincide with output expansion. The difference is accounted for by productivity gains -- greater efficiency, or more output per worker. The bureau has not yet declared an end to the last recession, though the economy began expanding in the summer of 2009.)
Aside from executives' stock options, Gordon cites weaker unions and more competition from both imports and immigrants as subverting workers' bargaining power. History also mattered. The harsh 1981-82 recession threatened the survival of many firms. The near-death experience made managers more open to bigger layoffs. What started as last resorts slowly became routine. There was a generational change, too. Depression-era CEOs, highly sensitive to job insecurity, retired. Younger executives worried more about competitive challenges and corporate takeovers.
In hindsight, the massive job cuts of 2008 and 2009 should not have been surprising. "With the collapse of the financial system," says economist Lynn Reaser of Point Loma Nazarene University in San Diego, "companies had to conserve cash desperately, [because] they couldn't rely on outside financing." So they savagely axed jobs, inventories and new investment projects (computers, machinery, factories). In the fourth quarter of 2008 and the first and second quarters of 2009, business investment dropped at annual rates of 24 percent, 50 percent and 24 percent. Nothing like this had occurred since at least the 1940s, Gordon notes.
"Businesses can't cost-cut their way to consistent profit growth," argues Zandi. "Eventually, they need to generate revenue growth that requires investment and hiring." There are some favorable signs. Companies seem to have stepped up replacement of aging computers; this could create jobs. General Electric says its 2009 research and development budget of $3.3 billion was up 18 percent since 2006, and it is supporting new products, from batteries to solar films.
But it's unclear whether corporate elites were so traumatized by the crisis that they've adopted a bunker mentality. That, as much as uncertainty over Obama administration policies, could be fearsome. What might appeal to individual firms -- paring expenses to maximize profits, hoarding cash to protect against a future financial crisis, waiting to hire until sales improve -- could, if adopted by most companies, sabotage a stronger recovery. If labor is cowed and capital is overcautious, the economy must suffer.