Why corporate profits are at an all time high

(Synopsis and commentary on an Economist article (Buttonwood), July 21, 2012, p.62)
Corporate profits are at unheard of levels.  In the United States Corporate profits amount to 15% of Gross Domestic Product.  The article cites three possible reasons:
The first is a claim often made by business people, that corporate executives are worried about excessive regulation, so are unwilling to make capital investments.  I am not aware of any evidence offered that overall regulatory burdens are any heavier than they were 10 years ago, or 30 years ago.  This argument smacks of setting up a straw man to deflect blame - it is an easy thing to claim and resonates with everyone who ever struggled with a bureaucracy.  
The second is that firms are reluctant to invest because of weak domestic demand, and the euro crisis and slowing growth in the rest of the world is making exporting products less attractive.  (I find this is a plausible explanation for some reluctance to invest).
The third, and, to quote Buttonwood, "the most intriguing", is that pay incentives for Corporate executives are to blame.  As bonuses managers get share options, and the value of the option is usually linked to corporate profits.  Long term investments undermine short term profits, so executives are disinclined toward long term investments as they may undermine their bonus.  In addition professional fund managers may prefer companies who hoard profits as that keeps the companies share prices up, and makes the fund manager's short term performance figures healthier.  So the Fund managers prefer the money go to share buy-bacsk that boost the value of the remaining shares.
Buttonwood finishes by noting "Business-people are among the most vocal in their calls for government deficits to be cut, but if firms spent more, and hired new workers, deficits would fall of their own accord."

On Capitalism and Socialism

One of the curious characteristics about debates about Capitalism and Socialism is the tendency for those on both sides of the debate to assume a system can't have elements of both.  The Capitalists argue ferociously that a little bit of socialism will undermine Capitalism, the economy (and freedom).  On the other hand those of a Socialist bent are equally vociferous in arguing Capitalism has no redeeming quality's.


In my experience either/or choices are seldom imposed by reality, they are imposed by our own desire for simple answers.


What sparked  a recurrence of this thought in my mind was reading a book review (Economist, July 14, 2012, p.74).  The book is "Why Capitalism" by Alan Metzger.  As the Economist characterizes Mr. Metzger's argument, he believes Capitalism is the only system that leads to freedom and economic growth.  I assume Mr. Metzger isn't arguing there has been no society in history that wasn't free that experience economic growth, so I guess he is somehow arguing you can't have freedom without (pure?) capitalism.  


I wonder what the people of Sweden, or the other very successful and happy denizens of  Northern Europe that have created pretty successful amalgams of free enterprise and socialism would say to him?


As summarized by the Economist Mr. Metzger evidently argues the problems in Capitalism aren't from the theory, the problems are a result of the "elements of state control" and that get grafted onto the capitalist systems that always lead to corruption, waste and excessive regulation.  I wonder if he was paying attention in the last decade to things like Enron, Lehman Brothers, or if he has any friends or relatives who got sucked up by sharp real estate people selling nonsense loans to buy overpriced houses.


What strikes me as most startling is his assumption freedom and capitalism go hand in hand - that you can't have a free society that isn't capitalist.  Modern free societies are scarcely 2 centuries old, a fraction of the history of humanity, and up until the last 50 years you could count the "free" countries on one hand.   In my estimation a truly free society does not yet exist.  Even in the US if someone wants to make stupid personal decisions that affect no one else, government often steps in.  In the scope of human history the democratic free society is a pup just beginning to develop.  Mr. Metzer seems to be stuck in a mindset sort of like the ancients convincing themselves the earth is flat because they wanted to be an expert and did not have the powers of observation and imagination to conceive of any other explanation.  


Another book reviewed at the same time (same cite) - "A Capitalism for the People: Recapturing the Lost Genius of American Prosperity" by Luigi Zingales - is focused more narrowly on what the problem is in the US (and most other countries).  Government focuses on being pro-business instead of pro-markets.  US Law is riddled with complex subsidies that favor certain businesses to the detriment of the market - and the detriment of taxpayers.  


Overall these reviews seem reflective of a tendency in public dialogue to assume we have to be either capitalist or socialist, we can't choose different systems for different parts of society.  I do not believe it is impossible to develop a system that combines the best attributes of Capitalism and Socialism in a successful free society.  I do believe it won't be easy, but few things worth having are easy.  

Economists need to step outside themselves

Economist Paul Krugman's recently released book "Stop this Depression Now" reminded me of one of the basic truisms I have harbored about economics - the subject is so complex that although any economist who wants to build a career has to develop and publish hugely complex mathematical formulations and theoretical constructs, since there is no consensus on much of anything, in the end many famous economists are pretty clueless about what makes an economy work.


At the moment we are enduring the spectacle of Republican leaning Noble Prize winning economist's who shower data on folks to support their believe that Government taxes and spending are the problem with the economy, while Democrats have their Noble Prize winning economists who have volumes of data to support their view that Government spending is the cure for our economy.


If you took a group of average folks and asked them how to fix the economy, you would get a wide variety of responses, generally reflecting the emotional worldview each person is comfortable in rather than any real hard data.  We all adopt views in life so we have some default position from which to make decisions.  That adoption usually has more to do with our personality as it interacts with our life situation than it does with dispassionate careful study of all the diversity in human behavior.  We have to many decisions in life to spend time studying everything, and most of the time macroeconomics is pretty far removed from the things that touch our lives on a daily basis.


I don't think some economists are any different.  Early in life they found a viewpoint they felt comfortable with and they built their career's on developing data and theories to support their viewpoint.


Krugman's book cited a bunch of economists who agreed with his view Government spending is the way out of our current economic morass, and a bunch who believed  the private sector and the free market are the pathway to jump start our economy.  On the assumption the side of the political fence any particular economist falls on might be a function of his personality and background I randomly picked 10 names out of Krugman's book (including Krugman) and did a little spread sheet  with some basic data about each. 


Two of the 10 were born long ago.  Englishman John Maynard Keynes - the patriarch of the Government spending view, - who was born in 1883, and Milton Friedman - the patriarch of the supply side theories that were the intellectual justification for the Reagan and Bush tax cuts  - was born in 1912.


Of the other 8 the 4 cited as being the spokesperson for the tax cuts and deficit reduction wing of economics, were all born between 1925 and 1939.  The 4 (including Krugman) who are supporters of the idea Government spending is the cure for this economic doldrums were all born between 1939 and 1953.


Nothing scientific about this little survey, but it does suggest the possibility a more careful review may provide some support for the view that an economist's basic predilections may often have more to do with when they are born than with a hard headed view of all the available data.

Economic Illusions

When I was young I recall sometimes hiking with friends or siblings up a wild creek that was near where we lived.  From time to time we would find a stick and use a pocket knife to create a sharp point and then try to spear the fish in the cool, shaded waters of the pools in the creek.   It was extraordinarily difficult because the way the light refracted off the water the fish were never where they appear to be.


Republicans economic ideas sometimes remind of of that experience.  It seems like somehow the Republican view of the world is refracted so what they see isn't reality.


Republicans believe government is what stands between us and peace and prosperity.  In fact good Government is what allows society to be peaceful, productive and compassionate.  The cultural evolution of our species for the last several thousand years consists of an achingly slow evolution away from government that consisted of greedy and selfish people using others for their own benefit towards government that exists to serve all people.


Government is absolutely necessary.  But we are still a long way from Government that exists to serve all the people.  The use of government to line the pockets of a few is still a big problem.  Here in California the Prison Guards union typify the modern iteration of greedy government.  As of a year or so ago somewhere around 50 of the California State Department of Corrections employee's took home over 1/2 million dollars in salary a year.  The lowliest prison guard makes well over $100,000 a year, and the retirement programs are exceedingly generous.  How did the Prison Guards union get their members these extraordinary benefits?  They teamed up with law and order Republicans 30 years ago, who rewarded them with big budgets for their electoral support.


Contrast that with 30 years of Republican attacks on teachers and teachers unions (because they support Democrats).  The average prison guard probably makes twice the salary of the average teacher, and no person in public K-12 education is making anything like half a million dollars in salary.  Yet to this day Republicans all over the country are going after teachers and school budgets, and saying nothing about law enforcement budgets.


It is not that Democrats aren't overly accommodating with public employee unions sometimes, but they are up front about it.  Republican's rail against the unions on one hand, then quietly hand huge paydays at taxpayer expense to those who support them.


For the last decade California has stood common sense on its head, spending far more on prisons than universities, and paying corrections officers 2 or 3 times as much as even the most well payed teacher receives.  Even as the third world races to lift the poorest members of society up to become healthy, educated and productive citizens that can contribute to making their country a better place for everyone we in California seem to be moving the other direction.

The Romney economic plan

I have seen a couple of articles recently where supporters of Mitt Romney's economic plan have argued that the Romney plan follows President Reagan's plan for dealing with the recession in 1981-82, and that that is a good thing. (See side comment in footnote)


The articles generally compare that 1981-82 recession with the current recession, throw in some similar arguments how the Bush tax cuts last decade were great for the economy and conclude the Romney plan is the cure for our economic woes.  


To me these comparisons are either woefully ignorant or a cynical effort to sell the Romney plan to get their guy elected regardless of the consequences.


1.  They seem to be either unaware, or unwilling to face the fact the two recessions were caused by completely different events.  The 1981-82 recession, which was pretty mild, followed a decade long period of high inflation as the Government tried to inflate away the deficit from the Viet-Nam war rather than imposing taxes to pay the cost of the war.  The current recession was caused by a private sector meltdown and the continuing malaise in the economy is rooted in deep seated problems in the private sector.


2.  The article assumes if you put more money in the pocket of rich folks, they will create jobs.  It ignores the fact big corporations have been making record profits, and stockpiling money for years.  There is no shortage of investment capital, the shortage is on the demand side of the equation - there are few opportunities for investment because ordinary folks don't have much money to spend.

3.   As a country we are in a completely different place than in 1981.  The Baby boomer generation was then just beginning to flood the labor market with energetic young workers.  Now they (we) are just beginning to leave the job market in droves to retirement and the percentage of the population in their prime working years is much smaller in comparison.


4.  Their arguments ignore the deficit.  They tout the Reagan and Bush tax cuts as curing the recession, but ignore the fact both the Reagan and Bush tax cuts caused a huge spike in our National Debt.  In effect the Reagan and Bush plans were sort of like if you or I stopped  paying our bills.  Heck yes, we would have more money to spend - for awhile.

5.  Perhaps most damning is the fact they ignore empirical economic studies that have looked at what happens when a country cuts government spending and found that, in a low interest rate environment, there is virtually a 100% correlation between cutting government spending and a rise in unemployment and a drop in GDP. 


Basically, if the Romney plan is implemented we face one of two options.  If we chop government spending dramatically, we will sink into another recession or perhaps a depression. If we cut taxes without cutting government spending we put the deficit back onto its skyward trajectory, and since our problem isn't a lack of investment capital, we will see very little economic improvement in return.


We can't get out of our current economic problems by handing out more candy to rich folks, which is what the Romney plan is all about.


Footnote - Romney's plan has much in common with the Herbert Hoover plans in 1930-32 that turned a stock market crash into the great depression.  Ironically, the most recent article I read pushing the Romney plan was by a Hoover Institute Fellow in the San Francisco Chronicle Insight Section for July 15, 2012 - evidently the Hoover Institute is still unwilling to accept that the depth of the Great Depression might be related to Hoover's private sector based attempts to reinvigorate the economy.

Fair taxes - How taxes on Capital should be structured

If one assumes that all income should be taxed equally so people share the burden of expense of government equally here is how taxes on Capital should be structured:


Dividends should be treated as ordinary income (as they used to be before the Bush tax cuts).  They are distributed profits from a business and there is no reason to give them favorable tax treatment.


Capital Gain should also be treated as ordinary income.  But there should be two special provisions, one for fairness purposes and one to encourage investment.


For fairness gain should be reduced by how long you held the asset to account for inflation.


To encourage investment you should be allowed to sell an asset and immediately roll the proceeds over into a new asset.  All the rollover proceeds would not be taxed, and you would carry the same basis into the new asset (basis is how much of your own money you originally put in).  This would need rules to ensure it is not abused, particularly when you are using borrowed money to buy an asset.

Income inequality

Heard an interview of author Edward Conard, a Bain Capital guy, who has written a book called "Why Everything you Have Been Told About the Economy is Wrong".   The interview focused on what is apparently his main thesis, that income inequality is a good thing.  In the interview it seemed the crux of his argument was that we are richer than Germany or Japan, and we have greater income inequality, therefore the reason we are richer is because the investor class in Germany and Japan are more highly taxed.


His argument in the interview did not address some pretty basic facts, so it makes me wonder if he addresses issues like:


1.  He seemed to be focused on the period since WW II, does he address that time in our history that is most like our current situation, the roaring twenties and the Great Depression?  Where we had rising income inequality and then an housing and finance based collapse that led to years of economic weakness.


2.  In citing Germany and Japan does he address the fact we started from different places?  At the end of WW II our country, our infrastructure and manufacturing capability were untouched, and in fact had been pumped up on steroids by the war.  In Germany and Japan, on the other hand, the major cities were piles of rubble, big chunks of their infrastructure were destroyed and their manufacturing base was in tatters.  We had a huge economic head start and the fact we are still are richer says nothing about our economy beyond the fact we have avoided catastrophe and kept moving forward.


2.  Does he address population distribution?  Because of our success in WW II we had a ton of kids between 1947 and 1957, the so called baby boomers.  No such event occurred in Germany or Japan (or the rest of the world as far as I know).  A result of that explosion in the number of children meant that in the period from the late 1970's through the early 2000's we had an extraordinarily high percentage of our population in what economists consider the prime productive years - the time of our life we we create a lot of wealth and build our financial life.  The simple fact is if 5 out of every 10 people are in that time of life in country #1, that country is going to be richer than country 2 where only 4 out of 10 are in that period of life.


Perhaps he deals with these issues in his book.  I'm sure the Economist will review it soon, unless that review suggests he deals with issues like these I will see no reason to read the book.