Fortune reported Sunday that Fortune 500 companies "generated unprecedented earnings" in 2006, collectively earning of $785 billion in profits, almost 30% more than in 2005. -- "American companies are enjoying the most sumptuously profitable period in the 500's 53-year history," Shawn Tully wrote. -- "These happy numbers are largely due to a sort of harmonious convergence, a perfect economic calm." -- Tully observed that "Virtually every conceivable force, from mild labor costs to a falling dollar to soaring productivity, has favored big companies," but forgot to mention one of the most important "forces" — the decline in corporate taxes. -- A few years ago, David R. Francis noted that "Federal revenue from corporate taxes has fallen from 6.4 percent of gross domestic product, the nation's output of goods and services, in 1951 to a mere 1.5 percent to 2 percent of GDP in the last few years" ("As Corporate Taxes Shrink, Who Pays?" Christian Science Monitor, March 14, 2005). -- Since in 2005 the U.S. GDP was $12.49 trillion, the decline in corporate taxes Francis noted amounts to about $562 billion, or about 72% of the total in 2006. -- Increasingly, the U.S. is a corporatocracy. -- The word, allegedly coined by John Perkins in his Confessions of an Economic Hit Man (2004), has not yet entered the Oxford English Dictionary, but it has a substantial Wikipedia entry. -- The cost of being elected to Congress may perhaps be taken as a rough index of corporatocracy in the U.S., and this cost is rising sharply. -- "[T]he cost of waging a competitive campaign against an incumbent has increased dramatically in the past decade," Alan I. Abramowitz, Brad Alexander, and Matthew Gunning of Emory University wrote in a 2005 essay entitled "Incumbency, Redistricting, and the Decline of Competition in U.S. House Elections." -- "Between the 1994-1996 election cycle and the 2000-2002 election cycle, the average amount spent by challengers in moderately competitive races rose from $246,000 to $699,000; during this same period, the average amount spent by challengers in highly competitive races rose from $454,000 to $1,289,000. -- As the cost of waging a competitive campaign has soared, the proportion of challengers capable of raising this kind of money has fallen. . . . [T]he rising cost of congressional campaigns is becoming a larger and larger obstacle to competition in House elections." -- The failure of U.S. public opinion to translate into action from its leaders on issues like ending the Iraq war (which is a source of considerable profit to U.S. corporations) is one of many practical consequences of corporatocracy....
A PROFIT GUSHER OF EPIC PROPORTIONS
By Shawn Tully
** America's largest corporations generated record earnings in 2006, thanks to a happy confluence of circumstances. How much longer can the outpouring last? **
April 30, 2007 (posted Apr. 15)
The notion of the little guy striking it rich -- finding gold at Sutter's Mill, discovering oil at Spindletop, or cashing in on a dot-com IPO in Silicon Valley -- runs deep in American lore. But something even more historic transpired in 2006: A massive swath of the established economy -- also known as the Fortune 500 -- collectively generated unprecedented earnings.
The grand total: $785 billion, a 29% increase over 2005. Those returns obliterated the previous cyclical peak, $444 billion, achieved in 2000 at the height of the tech explosion. Put simply, American companies are enjoying the most sumptuously profitable period in the 500's 53-year history. Last year post-tax profit margins hit 7.9%. That's 27% higher than the 6.2% posted in 2000, then lauded as exceptional.
These happy numbers are largely due to a sort of harmonious convergence, a perfect economic calm. Virtually every conceivable force, from mild labor costs to a falling dollar to soaring productivity, has favored big companies. "For the past few years business couldn't have asked for a better environment for profits," says Mark Zandi of Moody's Economy.com. But companies also deserve credit for their restraint. Instead of squandering their good fortune on poor acquisitions and other bad investments, they used a huge chunk of those booming profits to reduce debt, a practice that slashed interest payments and drove earnings still higher. Instead of hiring recklessly, they found ways to produce with a trim workforce.
To explain this golden age, let's start with the definition of profits: revenues minus expenses, a list that includes the cost of components, interest, depreciation of capital equipment, taxes, and, most of all, labor. This boom is so exceptional because from 2000 to 2006, while FORTUNE 500 revenues trotted forward at a stately 38%, earnings galloped ahead at more than twice that rate. The reason: Sales accelerated far faster than expenses, accounting for the glorious expansion in margins. Hence, the profit story is mainly a tribute to an exceptionally favorable period for costs.
LOVE'S LABOR LOST
The big gorilla -- labor -- has stayed remarkably tame in the new century. As measured by the Department of Commerce, the total bill for labor has inched up 4.3% a year. It's reasonable to assume that the 500 experienced a similar increase, since its companies provide a large portion of total U.S. output. Typically labor accounts for around two-thirds of corporate spending. So the FORTUNE 500 was able to raise revenues more than one percentage point faster (5.5% vs. 4.3%), year after year, than its biggest charge, wages.
That's highly unusual in the heart of an economic expansion, when companies usually hire battalions of employees. But companies, burned by the tech meltdown and 2001 recession, have kept payrolls amazingly lean this time. Of course, it was easier to do so with large pools of skilled workers available and union power at a nadir. By 2006 companies were barely paying any more for a unit of production than they did in 2000.
Companies were aided by a surge in productivity, defined as the hours needed to turn out a car, TV, or any other product or service. "Very little of the productivity increases went to labor," says Ken Goldstein, an economist with the Conference Board, an association of top executives. "So most of those cost savings fell straight to the bottom line." The effect of soaring productivity was dramatic: It took a mere 3.6% increase in the Fortune 500 workforce from 2000 to 2006 to generate a profit increase of almost 80%.
The productivity improvement was partially due to the capital-expenditure boom of the '90s. During that period companies gorged on everything from PCs to routers to fiber-optic cables. Flush with airline ticket machines and computerized mortgage applications, companies generated productivity growth that almost matched the modest increase in labor costs.
Because they stocked up then, companies haven't had to invest heavily of late. That means depreciation expenses declined sharply, and companies used the cash to chop down their debt. What they didn't retire they often refinanced when rates dropped in 2001, cutting interest expenses still further. From 2001 to 2006 the portion of cash flow going to pay interest dropped from 24% to 13% for U.S. corporations, says Economy.com. The 500 mirrored that trend, with Boeing a typical example: Its interest debt dropped from $358 million in 2003 to $240 million last year.
For all the benefit from reduced costs, the revenue side has played a role too. Sales for the 500 got a strong boost from the return of pricing power. Since 2003 a weak dollar has forced importers to boost prices, thereby protecting the flanks of U.S. companies and allowing them to lift prices a healthy 3% a year. Stronger prices, backed by solid growth both here and abroad, raised Fortune 500 revenues 5.5% a year since 2000. The dollar's 15% slide vs. a worldwide basket of currencies brought a second bonus: Foreign sales translated into far more dollars.
That said, the prosperity has been anything but uniform. Just three sectors, accounting for 40% of Fortune 500 sales -- energy, financial services, and consumer staples -- gobbled up almost 80% of the increase in profits since 2000. The doubling of oil prices from $35 a barrel in 2004 to more than $70 in mid-2006 made Exxon Mobil the biggest moneymaker in Fortune 500 history, with $39.5 billion in earnings. But overall the energy windfall was a wash: The gaudy oil profits were extracted from the bottom lines of automakers, airlines, homebuilders, and plastics manufacturers.
In consumer staples the gains after 2000 stem from strong productivity growth and a consumer spending spree that persists to this day. Coca-Cola and Pepsi's earnings rocketed upward by 134% and 156%, respectively, while P&G's leaped 149%.
But the biggest jump -- $131 billion -- came in financial services. Five securities firms, Merrill Lynch, Morgan Stanley, Goldman Sachs, Lehman Bros., and Bear Stearns, more than doubled earnings to $31 billion, minting cash from proprietary trading, where they make huge bets on stock and bond prices with their own capital.
Even more astonishing were the insurers. Property and casualty companies, a group that includes State Farm, Chubb, and Travelers, tripled their profits to $65 billion in the past six years. The comeback started after 2001, when claims for asbestos and medical malpractice rocked the big players, and 9/11 raised fears of more terrorist attacks. The insurers responded by raising their rates even as claims began to drop, thanks to tort reform in a number of states. So the insurers prospered despite the damage wrought by Katrina and other hurricanes in 2005.
In 2006 the skies turned clear: The insurers boosted their rates as much as 100% for catastrophe insurance on the coasts yet experienced few damaging storms. As a result their returns soared. (For all the unlikely winners, there was one big loser: tech. The champion of the last boom endured an earnings decline of 14% since 2000. See tech stocks. )
Sad to say, the historic rise won't continue. In fact, we're at a turning point. Wages are now increasing faster than revenues, and productivity growth is whisker-thin. Profit margins are beginning to shrink, and companies will probably ramp up their dormant capital spending. They need an infusion of plants and equipment for two reasons. First, only by adding to their depleted stock of tech equipment can they raise productivity and keep margins healthy. Second, they need to invest in new plants -- something they've been neglecting -- to drive growth. As their cash hoards decline, they'll need to borrow heavily again. Indeed, corporate borrowing and bond issuance are already rising steeply.
The extra borrowing will raise interest costs, and the heavy capital investment will boost depreciation expenses. With unemployment at just 4.4%, labor will take a far bigger share of productivity increases as companies vie for skilled workers. A surge in capital investment will help tech, while problems in the housing market will depress earnings growth for lenders.
The best guess is that profits will grow slightly less fast than GDP for the next several years, or in the mid-single digits. That's not bad considering the lofty peak we're starting from. And it will keep margins well above average for years to come. The gusher may recede a bit, but the well is far from dry.