Same Here

Tyler Cowen writes:

If aggregate demand is so low, why are profits so high?

TJIC responds

SmartFlix  [TJIC's company] has show paper losses every year it's been in existence "¦ but I expect that this year it will show it's first ever paper profit.

"¦which is not a sign of macroeconomic health, but is, in fact, a sign of my very poor expectations for the economy.

Ditto here. We will probably show our largest paper profit this year, but it is mainly because we have cut way back on investment in new projects.  And this has nothing to do with demand - we are experiencing a boom, as the recession pushes Americans towards lower cost recreation of the type we operate, at the same time it cuts state budgets and makes them more amenable to our business model of private operation of public parks.

So why are we cutting back investment?  I run a very low margin service business. Here is a simplified calculation: We make, say, 8% of revenues before taxes and accelerated depreciation. 50% of our costs are labor, and the new health care law may raise our labor costs by 8% or even more.  A four percentage point cut in margins is not a big deal to Microsoft, but it is to us.  Until we figure out how this all will play out, we are still investing but only in above-average opportunities.

When we invest in a new project, it hits that year's income in two ways.  First, we have accelerated depreciation on the new capital equipment.  And second, we typically have a startup loss in the first year.  In the last few years of rapid growth, we have had close to zero paper earnings because of these growth effects.  Once we take our foot off the pedal this year, though, we will show a large positive income.  For us, reduced growth and investment = higher short term reported profits.

  • Mark

    Were corporate tax cuts part of the Bush Tax cuts which expire next year? I am not sure, but if they were I can see a lot of forwarding of income to avoid the bigger tax hit next year.

  • caseyboy

    One would have to manage a business to understand concepts like margin, investment, cost of capital, ROI and the impact of tax policy on these components of business enterprise. Alas we don't have elected officials with the necessary business experience and worse far too many have socialist leanings.

  • Craig

    The president's spokesmartass, Gibbs, mentioned today that since corporate profits are so high, obviously, all the hand-wringing over Obama's supposed hatred of business is false. But corporate profits are high because, as with your company, capital investment is nil, travel expenses have been eliminated except for the CEO, there's no paper for the printers and 10% of the labor force has been laid off.

    I suspect that the administration's ignorance of business leads them to believe that good profits really do mean that all is well.

  • joshv

    I think one of the darkest secrets of the American economy is that many of the people it employs are not needed to keep up production levels. I've seen the waste and fat in a modern corporation up close, and it's significant - but the barriers to wholesale cutting are high in times of plenty. In lean times we find out just how productive we can be with all this modern technology.

  • anon

    Trust me, 4% would hit Microsoft rather hard. They live by small margins as well.

  • GregS

    It's a common practice at companies that are looking for a buyer to slash or eliminate spending on R&D, new product development, and other long-range investments. This cuts expenses in the short term and makes the company look more profitable. But clearly it's not a strategy that can succeed long-term. It's a bad sign that the current administration in Washington is encouraging this type of short-term behavior across the entire economy, and an even worse sign that they seem to be so clueless that they don't understand that the higher profits they're seeing are a bad sign, a symptom of reduced investment in the future, not a result of improving business conditions in the present.

    Also, as Mark commented above, a lot of companies are probably moving what revenue they can forward to 2010 to reduce the impact of the expiration of the Bush tax cuts in 2011. This makes 2010 look like a good year, but means 2011 won't be.

  • http://evilredscandi.blogspot.com Evil Red Scandi

    It's gotten to the point where I can't imagine taking an economist seriously unless they have some experience in business. Macroeconomics generates a lot of fascinating data, but it's then used to make observations and pronouncements that are bizarre to anyone with any actual perspective.

    Another cause of economic activity spikes that I've seen in my business is companies catching up on deferred capital maintenance - this often gets cut in the first year or two or a recession, and then becomes "emergency spending" as things start to fall apart "unexpectedly" later (folks on the ground expect it; upper management is usually caught flat-footed).

  • Bob Smith

    "Were corporate tax cuts part of the Bush Tax cuts which expire next year? I am not sure, but if they were I can see a lot of forwarding of income to avoid the bigger tax hit next year."

    No, corporate taxes didn't change. That's too bad, because corporate tax brackets aren't inflation-indexed and haven't changed since ~1975. Given inflation over that time they should really be about 4x larger than their current values.