FIP-to-NIP ratio ~ Real Interest Rate

Half as a joke, I started writing something that turned into the idea I call "industrial productivity":

To figure the labor productivity for our economy, we divide GDP by a cost factor, the hours of labor required to produce GDP. We want to do something similar when we ask how productive finance is.

But when we ask "How productive is finance?" we do not mean to ask how much the employees produce. We mean to ask how much the industry produces. The appropriate unit of cost is not the wage, but the profit. The appropriate ratio is not output-per-hour, but output-per-dollar-of-profit.

My natural inclination is to look at profit-relative-to-other-things, not other-things-relative-to-profit. But if the profit-per-dollar-of-output ratio is twice as high for financial corporate business as for nonfinancial, then output-per-dollar-of-profit must be half as high for finance. And if the productivity of finance is extraordinarily low, well, then the growth of finance is a big problem. And that is no joke.

 

I bring this up because I have one more graph to show. 

In Graph #1 here we compared profit per dollar of output for financial (FCB) and nonfinancial (NCB) corporate business. In Graph #2 we compared output per dollar of profit for financial and nonfinancial corporate business. And in Graph #3 we looked at the ratio for financial relative to nonfinancial, of the output per dollar of profit values. 

Table 1

The third graph shows that finance, on average, creates less than 40% percent as much output as nonfinancial corporate business, per dollar of profit. For example, if NCB produced $10 of output for every dollar of profit earned, FCB created less than $4 of output for every dollar it earned. Table 1 shows five dates when the NCB output-to-profit ratio was close to $10, and the FCB ratio for the same date. At the bottom it shows the five-value averages.

Reduced proportionally, as $10.18 falls to $10 even, $4.04 falls to $3.97. It's just dumb luck, really, that the FCB number comes out less than $4 for five sample values. For the whole dataset, however, it is not dumb luck at all. It is evidence. Per dollar of profit, the nonfinancial sector is far more productive than the financial sector. More yet, when you remove the "recasting" that exaggerates financial output.

 

But I have one more graph to show. We start with the third graph, the ratio of financial relative to nonfinancial industrial productivity. Then we add a second line, to show the real rate of interest.

Stephen Williamson shows "a crude measure of the real interest rate." I looked up his graph at FRED. He takes TB3MS, the 3-Month Treasury Bill Secondary Market Rate, and subtracts the percent-change-from-year-ago of PCEPI, the PCE price index. I used the same datasets and the same calculation for the second line on my graph.

PCEPI begins in 1959, so we miss some years at the start. And I end my graph early to eliminate the superhigh and superlow spikes of 2008, because they make everything else too small to see. But we still get to compare my ratio to the real interest rate for almost 50 years. 

To my eye, the comparison shows a lot of similarity:

Graph #4: Comparison of the FIP-to-NIP Ratio and the Real Interest Rate

The blue line is the ratio of industrial productivities, financial as a percent of nonfinancial, using the left scale.

The dark red line is Williamson's real interest rate, using the right scale.

The light red line that runs flat, just below the 40% level, left scale, shows the 37.9% average of all the blue values (Q4 1951 to Q3 2021).

The blue and dark red lines, to my eye, show similar trend paths, rising and falling together. It does look like blue leads and red lags behind; I'm looking at the blue lows of 1970, 1986, 1991, and 2001. And the high between 1986 and 1991, for example.

But red and blue show similarity all through the 1960s and into the 1970s. They separate sharply after September 1973, probably because of the oil embargo in October of that year. They are back on track, rising together, after 1977.

The only other separation that I see, comparable to the 1973 separation, occurs just at the end of the graph, after July 2007.

Abbreviations:

FCB = Financial Corporate Business
NCB = Nonfinancial Corporate Business
GVA = Gross Value Added
Industrial Productivity = GVA per dollar of Profit
FIP = Industrial Productivity of FCB
NIP = Industrial Productivity of NCB

The behavior of the FCB-to-NCB ratio is described as follows, other things equal:

Change in Financial Data:

Increasing GVA increases FIP as a percent of NIP
Increasing Profit reduces FIP as a percent of NIP
Increase in Industrial Productivity increases FIP as a percent of NIP

Change in Nonfinancial Data:

Increase in GVA reduces FIP as a percent of NIP
Increase in Profit increases FIP as a percent of NIP
Increase in Industrial Productivity reduces FIP as a percent of NIP

These changes appear to be related to changes in the real rate of interest.