For those of you at the last session upstairs, I was a little shocked with the talk by someone from the Swiss Central Bank and he, the standard disclaimer, which is sort of routine if you've ever heard a talk by a Fed economist, they always start out and say, well, these are not my views of the Federal Bank or the organization I'm from, these are just my own views. I need to take that disclaimer one step further. I retired from the Kansas City Fed over a decade ago. If they thought I was trying to represent the Department
So let me start out by trying to motivate my talk a little bit, and I'll just give you a few economic statistics here that I think will stand out and provide some motivation.
This first one I'm sure won't surprise you too much, and that is at the end of the fiscal year 2011,
In 2011, the federal debt was at almost $15 trillion, which is the highest since 1948.
This is maybe not quite so widely known, which is that corporate profits is a share of national
income or almost 15% of national income, and that's the highest since the Department of
Commerce started collecting quarterly data way back in 1947.
At the same time, these researchers here have pointed out that the labor share of national
income is at a record low.
So the question I'm addressing in this paper, is this all a coincidence?
That the federal debt and corporate profits as a share of income are so high at the same
time labor share is so low?
And as you might expect, given that this is the way I introduced the talk, I'm going to
claim it's not a coincidence.
Let me apologize a little bit.
So I've got overheads here so I see there's a little bit of glare here but I don't think
there's anything I can do about it. So I'll just have to read over the parts where the
glare is. So to put my talk in a broad perspective, there are two broad areas of research that
I'm sort of bridging. One of them is people have looked at the effect of debt and deficits
on the economy. And there's another branch of research that looked at how national income
gets divided up between capital and labor. And to my knowledge there's no one that really
is bridged these together, so that's kind of where my talk fits in and this paper fits
in in this area of research.
So to quickly summarize these two different areas to put my paper in context, I'll start
out by just talking about what some people have talked about or found out when they've
looked at the effect of debt and deficits.
If any of you have worked in this area, let me apologize.
I've taken thousands of pages of research and put them in nine bullet points so that
Something that does get lost in the condensed version here, but if you're interested in learning more about this, the first two papers I've mentioned from Gail and Orsay Engen and Hubbard have excellent summaries of what's been going on, and of course part of the debate is how important are debt and deficits, and some people say well it's not really that big a deal, I'm sure there's going to be a lot of skeptics of that view here, but they've looked primarily at interest rate effects, and early research really did not find much of an effect of interest rates
from Federal Debt and Deficits. That has changed with more recent research. There is now a consensus that raising the Federal debt or raising deficits do have an effect on Federal or the interest rate on Treasury securities.
Of course, that's not the whole story. In addition to the effect on interest rates, of course, it's going to reduce national wealth. People do not boost their savings to compensate for large Federal deficits.
There's not enough money coming in from abroad to compensate for federal deficits, so ultimately deficits will reduce national wealth.
So that's a synopsis of that area of research. Let me do a quick synopsis of what people have decided when they've looked at the labor and capital share of income.
And there's three different explanations as to why the profit share is so high and the labor share is so low.
And the first one I've listed up there is the decline of unionization.
But as we look at the private sector at least, there are many fewer people unionized today
than there were 20, 30, 40 years ago.
Another explanation that's given is globalization, and that is, with the opening up of Eastern
Europe, the Chinese labor force, there's now a huge supply of low-skill labor.
Unions can't compete without low-skill labor, or it's reduced their bargaining power, and
therefore, labor share has declined.
And finally, there's a technological explanation, which is that because technology is changing
so fast, not just unionized workers, workers in general are finding their skills evaporating
because of the technological change, because their skills are evaporating so fast, they're
losing their bargaining power, and that's another reason labor share is declining.
So if I've got to give you a consensus here, there is no consensus explanation, so that's
That's where my paper is coming up with another alternative as to why, potentially, capital
and labor shares are shifting.
So to briefly describe the economics, and I apologize for some of the neoclassical terminology
here, I heard the talk yesterday, Nikolai was sort of criticizing neoclassical terminology,
but then he regressed later on and started using it, so I don't feel quite so defensive
about using it.
What happens when the government runs huge deficits is that it tracks from national savings.
There's not enough resources for investment. So what happens is business investment goes
down. You do not have as large a capital stock. With the lower capital stock, workers are
less productive. The marginal product of labor goes down and wages go down. At the same time,
with the lower capital stock, the value of that capital has gone up. That is, the marginal
and the product of capital increases, and therefore businesses are earning higher profits.
So again, as a final point to make here, and I'll come back to this maybe a little bit
at the end, you know, one of the hot issues today in the public sphere is income inequality.
The curiosity is this trend is going to actually make income inequality worse, the current
increase in the federal debt.
Okay, let's start looking at a little bit of the data here, and I won't go into this
in too much detail.
I'll show you one time chart here to get an idea of what the empirical foundation of this
paper is.
I'm looking at data from 1947 roughly to the current period.
I actually end up dividing it up into business cycles.
If you look at the trends I'm showing here, I'm showing profits first of all as a proportion
of national income, and I'm showing business investment as a fraction of GDP.
Unfortunately, these are about on the same scale, so I can plot them simultaneously looking
at the left-hand side here.
You can see these things go up and down over time, and there are business cycle effects,
like right here in the early 90s, both of these moved together, they moved together
here in the late 70s, early 80s, and so on, so you can see co-movement above business
cycles.
However, here in the late 70s when business investment was very high, the profits were
are relatively low.
So I want to separate the business cycle effects from kind of the longer term trends.
So my preferred way of looking at this data is as follows, here again the same data, its
profits as a share of income, its investment as a share of GDP, and I've divided it up
into 10 business cycles, there are 10 full business cycles since 1947, and I've plotted
them on this scatter chart, where I've got profits as a share of income here, business
This investment is the share of GDP here, and you can see when investment is very high here, the profits are low and vice versa. There's an inverse relationship there. The trend line is negatively sloped.
So for those of you involved in corporate finance, this may be a little bit surprising because businesses tend to take a lot of their funding from finance, from internal finance, from retained earnings.
So that would suggest that when profits are high, you'd have a lot of retained earnings
and a high investment, and that's certainly true through the business cycle, but this
chart suggests that that is not true over the longer term, that what really dominates
is when you have too much investment, profits actually go down.
So that chart links profits and investment.
Of course, ultimately I want to talk about the debt, so let me see how debt behaves here.
So this shows how debt varies, or how investment varies with debt.
So again, here on the horizontal axis, I've got debt as a fraction of GDP. On the vertical
axis, I have business investment as a GDP. And again, if you believe in crowding out,
and this is really a crowding out story, federal debt, crowd out business investment. When
the debt ratio is high, investment is low and vice versa.
Okay, so now I've linked profits and investment. I've linked investment and debt. So let's
Let's just sort of look right across the chasm here and look, so what's the relationship
between profits and debt? And of course, from those other two, this is exactly what you'd
expect when debt gets high and crowds things out, profits go up, so we've got a positive
relationship between debt and profits. Again, looking at business cycle averages, each one
of these data points is an average of the ten post-war business cycles. And the other
I saw that, of course, if profits are going up when it goes up, then employee compensation
or the labor share of income should go down, and again, that shows up in that chart.
So to me, I thought that'd be sort of the most interesting part of the empirical results
of my paper, but I had a special request over lunch that someone insisted on seeing regressions
from the Fed economists, so I've got some regressions of the same information.
So my dependent variables here, again, I'm mostly concerned about with the profit share
and the labor share of income. So those are over here. Here I've got some independent
variables. I don't have time to sort of talk about how I chose these. For those of you
who are econometricians, it's largely ad hoc, even though I'm copying what other people
did that was ad hoc. So I would claim this is less ad hoc than what they did. But the
main point is, again, the debt to GDP ratio is significant in these regressions. Negative
Positive in the case of compensation, positive in the case of profits.
So that's pretty much the story.
Where do I go from here?
Potentially looking at international data might be interesting.
It turns out the same things have been observed internationally, at least in other industrialized
economies.
Profit shares have gone up, labor shares have gone down, and of course debt has also gone
up.
Curiously, if you look at developing countries, they tend to also have lower labor shares
and Profit Shares, so to the extent that if we spend all our national wealth through the
budget deficit, we're going to start looking more like developing countries, so this is
consistent with the hypothesis in my paper.
So to finally wrap this up, let me just say that I think this is a good example of the
law of unintended consequences, and that is people sometimes justify spending a lot of
of Federal Money because we need to combat this evil thing of income inequality and the
unintended consequences, high debt is driving up the profit share, driving down the labor
share and having exactly the opposite consequence than was intended. Thank you.