Companies' and countries' prosperity
Decoupled Feb 25th 2006 >From The Economist print edition p 75-6 http://economist.com/PrinterFriendly.cfm?story_id=5556642 The health of companies and the wealth of economies no longer go together "NOTHING contributes so much to the prosperity and happiness of a country as high profits," said David Ricardo, a British economist, in the early 19th century. Today, however, corporate profits are booming in economies, such as Germany's, which have been stagnating. And virtually everywhere, even as profits surge, workers' real incomes have been flat or even falling. In other words, the old relationship between corporate and national prosperity has broken down. This observation has two sides to it. First, as Stephen King and Janet Henry, of the HSBC bank, point out, companies are no longer tied to the economic conditions and policies of the countries in which they are listed. Firms in Europe are delivering handsome profits that are more in line with the performance of the robust global economy than with that of their sclerotic homelands. In the past two years, the earnings per share of big listed companies have climbed by over 100% in Germany, 50% in France, 70% in Japan and 35% in America. No wonder Europe's and Japan's stockmarkets have outpaced those in America, despite the latter's faster GDP growth. Second and more worrying, the success of companies no longer guarantees the prosperity of domestic economies or, more particularly, of domestic workers. Fatter profits are supposed to encourage firms to invest more, to offer higher wages and to hire more workers. Yet even though profits' share of national income in the G7 economies is close to an all-time high, corporate investment has been unusually weak in recent years. Companies have been reluctant to increase hiring or wages by as much as in previous recoveries. In America, a bigger slice of the increase in national income has gone to profits than in any recovery since 1945. Home truths The main reason why the health of companies and economies have become detached is that big firms have become more international. The world's 40 biggest multinationals now employ, on average, 55% of their workforces in foreign countries and earn 59% of their revenues abroad. According to an analysis by Patrick Artus, chief economist of IXIS, a French investment bank, only 53% of the staff of companies in the DAX 30 stockmarket index are based in Germany; and only one-third of those firms' total turnover comes from there. Only 43% of all the jobs at companies in France's CAC 40 are in France. With the profits of these firms so dependent on their global operations, it is not surprising that corporate prosperity has failed to spur "home" economies. American and Japanese companies remain more closely tied to their domestic markets. Just one-fifth of the turnover of firms in Japan's Nikkei index comes from overseas. Foreign sales of America's S&P 500 companies amount to a modest 25% of the total. Even so, at the 50 biggest firms the figure is higher, at around 40%. The old saying, "What's good for General Motors is good for America", no longer rings true: over one-third of GM's employees work outside the group's home country. If a large part of the spurt in profits comes from foreign operations, it is less likely to be used to finance investment or extra job creation at home. If they reason that the recent past is a fair guide to the immediate future, companies are likely to plough their extra profit into further investment abroad. Alternatively, they may buy back shares or repay debt. Globalisation has also shifted the balance of power in the labour market in favour of companies. It gives firms access to cheap labour abroad; and the threat that they will shift more production offshore also helps to keep a lid on wages at home. This is one reason why, despite record profits, real wages in Germany have fallen over the past two years. That in turn has depressed domestic spending and hence GDP growth. Workers can still gain from rising profits if they own shares, either directly or through pension funds. There is reason to think that the share prices of large listed companies will fare better than their home economies. Economic theory and historical experience argue that, in the long run, profits grow at the same pace as GDP. However, if the profits of big companies are increasingly linked to global production, then the profits of listed companies in developed economies could rise faster than domestic GDP for many years. In America, capital gains on shares have played a big role in supporting household spending over the past decade. But Mr Artus worries that workers in continental Europe are losing out, because a surprisingly high proportion of shares are held by foreigners: as much as 35% in France and 16% in Germany. This is partly because of the smaller role played by institutional investors, such as pension funds, in Europe compared with, say, America. If profits (and hence executive pay) continue on their merry way, while ordinary employees' real wages stand still and their health benefits and pensions are eroded, workers might well expect their governments to do something to close the gap. It's not hard to think of ideas that would be popular-higher taxes on profits, restrictions on overseas investment, import barriers, or making it harder to lay off workers. The trouble is, in a globalised economy such measures would also be suicidal. Firms would simply move operations' head offices to friendlier countries. A more promising way of allowing workers to share in companies' prosperity is to encourage firms to introduce profit-sharing schemes for employees. But perhaps the most useful thing that governments can do is to ensure that consumers (ie, workers) benefit from lower prices as a result of the shifting of production to low-cost countries. The prices of consumer goods have fallen by much more in America in recent years than in the euro area, where retailers are shielded from competition and have not passed on cost reductions. Greater competition in Europe would allow workers to share in the gains of globalisation through lower prices. The clear lesson is that policies aimed at penalising companies will fail to spread the rewards of corporate success to the wider economy. The only sure way to boost national economic prosperity is to make labour and product markets work more efficiently and to improve education, to make the home country a more attractive production base. The growing internationalisation of companies also makes a nonsense of the paranoia, in both America and Europe, about foreigners buying "our" companies. It has always been foolish for governments to block foreign takeovers which make good economic sense. It is even more so today. When over half of the workforce of many big companies is based abroad, the distinction between foreign and domestic firms has become increasingly blurred. There was patriotic outrage in France at the hostile bid for Arcelor by Mittal, a global steel giant. Yet although Arcelor is a member of the CAC 40 and viewed in France as a national corporate jewel, it is actually the product of a three-way European merger. It is incorporated in Luxembourg and only one-third of its employees are in France. In future the notion of "our" companies will become even more elusive. 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