Has long-run profitability risen in the 1990s

Abstract

This article analyzes the underlying sources of the recent rebound in corporate profits. Contrary to popular perception, virtually all of the resurgence in corporate profitability during the 1990s reflects a cyclical increase in profits and a decline in net interest expense associated with deleveraging After fluctuating in a high range during the 1960s and 1970s, the profit share (the ratio of after-tax profits to output) of nonfinancial corporations moved within a lower range through the early 1990s. In recent years, this measure of profitability has rebounded somewhat (Figure 1), largely owing to strong growth in corporate profits, which has both buoyed optimism about the long-run prospects for American companies—partly reflected by rising stock prices—and spurred criticism that companies have profited at the expense of workers (Bernstein 1995). Whether the recent improvement is permanent or transitory is important for several reasons. First, profitability affects the financial strength of firms and has implications for their ability to weather downturns. Second, because retained earnings bolster investment, the permanence or impermanence of the recent improvement will have implications for investment and thus the long-run growth of the U.S. economy. 1 Finally, profitability is a key determinant of stock prices, which are important not only because they are indicators of future economic growth but also because they affect wealth and, thereby, consumption and investment. 2 This article analyzes the underlying sources of the recent rebound in corporate profits. Contrary to popular perception, virtually all of the resurgence in corporate profitability during the 1990s reflects a cyclical increase in profits and a decline in net interest expense associated with deleveraging and lower interest rates. In other and lower interest rates.

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