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There has been so much talk of “predatory inflation” in the United States that it is no longer controversial to discuss systemically important prices.
US corporate profitability remains fairly high today, and could rise further this year. Goldman Sachs economists expect non-financial corporate profit margins to rise slightly this year, overall, to 16.3 percent.
However, they don't think this will change inflation much. Not a word calls into question the “efficiency of capitalism,” even with margins well above those supposedly worrying levels since 2016.
First, some quick context on how gross profitability numbers compare to history, and how they are measured: GS compares the profits of non-financial companies to GDP production. By that measure, corporate profitability reached the highest level since the 1960s in 2022 — excluding coronavirus-related government transfers — and remains higher than the various peaks it has reached in the intervening decades.
But inflation should slow even as profit margins rise, JS says, because it will be offset by lower input costs (i.e. energy and materials) and lower labor costs.
This does not mean that Americans will immediately see input costs for businesses fall as prices fall:
Intermediate input costs have fallen by approximately 3% over the past year, and we expect lower costs to boost profit margins in the near term. Whereas we previously found that changes in input cost are mostly passed through to final prices in the long run, we find that firms experience input cost increases faster than input cost declines. Assuming intermediate inputs remain at current levels, we estimate that lower input costs would boost non-financial corporate profit margins by 0.2 percentage points in 2024.
This is not surprising, especially after the very clear demonstration of this dynamic that we have had with interest rates and banks. (When they go down, they go down for everyone. When they go up, bank customers don't see it for a while.)
They also say something about AI companies and margins. But as Alphaville readers know, the hype around AI seems to be mostly about labor costs. Also expected to decline this year:
Another way to measure the effect of wage growth on profit margins is to estimate the extent to which changes in wage growth are transmitted to prices or absorbed by profit margins. Using a set of industry- and country-level regression analyses, we estimate that a one-point increase in wage growth increases price inflation by about 0.3 percentage points (Figure 9). Because employee compensation represents about 60% of GDP, this implies that a 1-point reduction in wage growth leads to an increase in profit margins of about 0.3 basis points – net of a reduction in costs of about 0.6 percentage points and a decrease in prices of about 0.3 percentage points.
Finally – and perhaps most interestingly – economists look at how higher interest rates affect companies' income statements and profit margins.
. . . We estimate that companies pay approximately 30% of their higher interest expenses by cutting capital expenditures and labor costs, with the remainder absorbed by profit margins. This means higher interest payments will put a drag of about 0.1 percentage point on profit margins this year.
This seems like a fairly confident statement. How did economists arrive at these numbers? It's from a memo published in August of last year:
Using firm-level data on public firms since 1965, we estimate the effect of higher interest costs resulting from refinancing on capital spending and employment. We found that for every additional dollar of interest expense, companies reduce their capital expenditures by 10 cents and their labor costs by 20 cents, with about half coming from lower employment and half coming from lower wages.
Good. Thus, this data window opened in 1965, when approximately 31% of the private sector workforce was unionized. But today, it's about 7 percent — modern workers find themselves on the wrong side of that average calculation.
As for unprofitable companies, the calculation is somewhat different and bleaker. And there are a lot of them, according to this August 2023 memo:
In previous research, we found that unprofitable companies disproportionately reduce hiring and capital expenditures when facing margin pressure. The left panel of Figure 9 shows that nearly 50% of all listed companies were unprofitable in 2022. In contrast to typical recessions, the right panel of Figure 9 shows that the exit rate of unprofitable companies has declined since the beginning of the pandemic – on This is likely in part because generous financial support is no longer provided – a reflection of the decline in bankruptcies across the economy.
This opens up a different line of discussion again, which is whether concerns about zombie companies should focus less on returns and more on employment and investment.
Fortunately, companies' refinancing needs are not that urgent, because many of them issued debt when interest rates were low in 2020 and 2021.
GS found in a study last year of interest costs that if companies continued to refinance debt at prevailing rates — Treasury yields were very close to current levels at the time — the average corporate bond coupon in 2025 would be only half a percentage point higher. This is for investment grade and high yield bond markets.
In other words:
Together, our estimates suggest that economy-wide non-financial profit margins are likely to rise by about 0.1 percentage point this year to about 16.3%, above the pre-pandemic level and the peak of the last cycle. However, higher margins should be consistent with continued decline in inflation, as lower input and labor costs and diminishing scarcity effects are likely to continue to push inflation lower in 2024.
So, there's nothing to worry about here!? Clearly, newly unemployed Americans can enjoy gasoline prices of $3 a gallon while the corporate profit machine keeps grinding. ¯\_(ツ)_/¯
