Academic journal article ABA Banking Journal

Higher Margins Reflect Higher Productivity

Academic journal article ABA Banking Journal

Higher Margins Reflect Higher Productivity

Article excerpt

CORPORATE PROFIT MARGINS are at record highs by some measures. This suggests that profit growth may slow more than the economy if margins come down to "normalized" levels. While no one knows what those levels are, margins are likely to average higher than over the past 35 years. The experience of the 1950s and 1960s suggests pre-tax margins could easily rise another percentage point or two.

The chart shows the positive relationship between productivity growth and profit margins. The rising trend in productivity growth tends to lead profit margins by about two years. This suggests that there is still room for profit margins to rise over the next few years.

The recent productivity growth is a dividend of the Federal Reserve's long march toward price stability in the 1980s and 1990s. In a high-inflation environment, such as 1975 to 1995, relative price signals are harder to extract from the noise of inflation. Price stability makes it easier for businesses and consumers to discern real or relative price changes and adjust their behavior accordingly. This results in a more efficient allocation of resources--i.e, higher productivity.

Lower inflation also contributes to higher margins because it pushes interest rates lower. Net interest expense peaked at about 5% of nonfinancial corporate output 15 years ago. Since then, it has come back to 3%. While "leverage" pessimists have been worried about the dire consequences of over-indebtedness in the U. …

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