Something has fundamentally changed in the U.S. economy over the last decade. In the past, the well-being of corporations was generally tied to the well being of their workers. Gains from improvements in productivity were shared between higher returns to labor through higher wages, and higher returns to capital in the form of higher profits.
If a firm went from making 100 widgets a day to making 110 a day and used the same 10 workers to do so, over time, both sides would tend to see their income rise by about 10%. It was not always in lockstep and profits were a bit more volatile than wages, but within a year or two things would even out.
That stopped starting about a decade ago. Now all the return is going to capital. Wages, particularly if you exclude the wages at the very top of the spectrum, have been stagnant at best. When adjusted for inflation, the median income has been shrinking.
In the U.S. we have a very exaggerated view of what the middle class is. People who earn $250,000 a year tend to think of themselves as middle class, or perhaps upper middle class. In fact, they are near the top of the income scale: in 2010, that was over five times what the median household earned.
The median, where half earn more and half earn less, is the true middle: $49,445. That was down 2.3% from 2009, and off 6.4% from 2007, before the start of the Great Recession. The peak was way back in 1999, and we are down 7.1% from there. Profits have done significantly better. In fact, they have set a new high, more than fully recovering from the Great Recession.
The graph below uses a somewhat different measure: total wages and salaries. The median income includes income from all sources — wages, interest, dividends, capital gains, etc. However, for the real middle class, it is wages that matter to their income.
Things like dividends and capital gains are highly skewed towards the very upper incomes. The graph looks at the Corporate Profits measure used by the government in computing the GDP statistics, and includes the profits of privately-held firms, not just the S&P 500. Both the wage numbers and the profits numbers are nominal, not adjusted for inflation.
The wage and salary numbers and profits are indexed to put them on the same scale (1981 =100). I also included the S&P 500 index (right scale) as it is normally quoted.
What’s Changed?
One thing that jumps off the chart is the “irrational exuberance” of the late 1990’s when stock prices soared, even though actual corporate profits were stagnating. Now we have a huge gap going the other way. That gap suggests to me that stocks are cheap now. It is earnings that power the stock market, and earnings are doing just fine.
As an investor, I have to love the rapid rebound in corporate profits. As a citizen, the fact that it seems to be coming at the expense of wage and salary growth it makes me deeply uneasy. It also raises substantial questions of how long it can be sustained. Ultimately a company depends on having customers, and workers are also consumers.
If the consumers don’t have any money, they are not going to be very good customers. Of course if a big share of your business is overseas, it might not matter that the middle class here in the U.S. is broke. However, as a citizen I think it matters a great deal.
From 1957 (actually earlier, but that is where the graph starts) through about 2002 corporate profits and wages tracked each other pretty well. The stock market managed to do OK with that.
I think that this graph goes a long way towards explaining what the Occupy Wall Street protesters are on about. To the extent that income has grown in this country, it has come from sources like higher dividends and capital gains, not from higher salaries. In fact, over the last decade, 80% of all income gains accrued to the top 1%. Yes, part of that is higher salaries of CEOs, but much more of it has come from higher returns on capital.
As unequal as the distribution of income is in this country, the distribution of wealth is far more concentrated. As capital produces more income, it flows to the owners of it — the wealthy. A strong stock market tends to produce lots of capital gains income as well.
The Gini Index
Based on income, the U.S. has by far the most unequal distribution of any advanced economy. The best single measure of income inequality is called the Gini Index. Based on it (and the figures are calculated by the CIA, not exactly a liberal organization), the distribution of income in the U.S. more closely resembles that of Jamaica, Cameroon or Uganda than it does Japan, Canada or the United Kingdom.
From an investment point of view, the lesson seems to be: if you can’t beat ’em, join ’em. Ownership of corporations is, quite frankly, the reason that the rich are rich. The increasing profitability of corporations is the key reason why the incomes at the top of the scale have been soaring while for everyone else they have been stagnant. You can “join the club” simply by buying some stock.
I’m not saying that buying 100 shares of Microsoft (MSFT) will make you as rich as Bill Gates, or holding 100 shares of Berkshire Hathaway Class B (BRK.B) will make you another Warren Buffett (well, 100 shares of Class A would be a good start). However, your income from dividends if you buy the sorts of stocks that Buffett buys for Berkshire is likely to rise more quickly than the income you get from your job.
Berkshire itself does not pay a dividend, but it holds large amounts of stock in firms like Procter & Gamble (PG) and Coca Cola (KO) that have healthy dividends and a long history of raising them each year. Not only that, but dividend and capital gains income is currently taxed at only 15%, regardless of your tax bracket from other income. That is the reason why Buffett (and the 400 highest-income Americans as a group on average) pay a higher percentage of their income than does Mr. Buffett’s secretary.
So it turns out that the Occupy Wall Street protesters are not just a bunch of crazy hippie anarchists, no matter what the hosts on CNBC think. Take another look at the graph above if you still question this.
BERKSHIRE HTH-B (BRK.B): Free Stock Analysis Report
COCA COLA CO (KO): Free Stock Analysis Report
MICROSOFT CORP (MSFT): Free Stock Analysis Report
PROCTER & GAMBL (PG): Free Stock Analysis Report
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