Saturday, March 30, 2024

Wages, Profit, and the Cost of Interest

The first graph below compares employee compensation paid by corporate business to the interest cost paid by corporate business. Employee compensation was more than 25 times as much as interest cost in the late 1940s. 

There was little business debt back then, and interest rates were low. But corporate business debt was growing, and interest rates were rising, so interest cost grew faster than labor cost. Much faster. Relative to the cost of interest, the cost of labor fell markedly. That's what the graph shows in the early post-WWII decades.

Graph #1: Employee Compensation versus the Cost of Interest for Corporate Business

The growing cost of interest drained revenue from corporate coffers. Business found wage increases less and less affordable. That's the economics of those early decades.

By 1981 when interest rates stopped rising, employee compensation was only 2.4 times the cost of interest. Rates started coming down, then, but corporate business debt was still growing. The growth of business interest cost slowed to about the same rate as the growth of employee compensation, so on the graph the ratio remained low and fairly stable through the 1980s and '90s and up to the 2008 financial crisis. 

Since the financial crisis, employee compensation has been gaining on interest cost, but not because our paychecks have been swelling. It's because interest rates went low.

Here's a similar graph showing a similar pattern. This time the graph compares corporate business profit to the interest cost paid by corporate business:

Graph #2: Profit versus the Cost of Interest

The patterns are similar mostly because the growth of interest cost is the same on both graphs. Not so much because profits are similar to wages. As you can see, the second graph starts in the 1940s at about $10, profit about ten times the size of interest cost in the late 1940s. For the first graph it was over $25, employee cost more than 25 times the size of interest cost. So employee cost must have been about 2½ times the size of corporate business profit in those early years.

But if you really want to compare employee cost and corporate profit, we need one more graph. I put the compensation-to-interest-cost line and the profit-to-interest-cost line together on this new graph, and indexed them so they both start at the same level in 1947:

Graph #3: A Comparison of Corporate Business Costs
Employee Compensation relative to Interest Cost (blue)
and Business Profit relative to Interest Cost (red)

The indexing gives both lines the same value in 1947, so we can see how they differ in later years. They run close together, start to finish, because the patterns are similar. Because of the indexing, we don't see the one being 2½ times the other. But we can verify the pattern similarity. And we can see that profit runs lower than compensation for almost all the years, even though they start at the same level on this graph.

It also appears that profit has been rising faster than compensation since around the time of the post-covid inflation. 

Profit is what remains after the costs called "deductions" are subtracted from business receipts. If interest cost is reduced by a dollar, other things equal, profit increases by a dollar. 

Of course, if the cost of interest falls by a dollar and corporate spending on employee compensation increases by a dollar, corporate costs are unchanged. But that would violate our "other things equal" assumption. 

My point of course is that if the interest cost business pays is substantially reduced, a substantial amount of revenue will be freed up for other uses like better pay and better profit. Reducing interest cost is a simple matter of policy. Existing policy is built upon excessive reliance on credit and the wrong-headed notion that excessive debt is never a problem (unless it is government debt). Unfortunately, wrong-headed notions cannot fix our economic problems.

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