The EconomistJuly 20th 2019 Leaders 1112 firms rose from 5.9% of gdpin 1994 to close to 10% now (the dip
in the 2008-09 recession was short-lived). The trend echoes the
prediction of Thomas Piketty, an economist, who argues that the
rate of return on capital exceeds the rate of economic growth.
This implies that company owners win an inexorably rising
share of output as the rest of society is squeezed.
Yet peer closer and the reality is murkier. Domestic profits,
and the worldwide profits of American firms, peaked relative to
gdpin 2012, and have plateaued since then. President Donald
Trump’s tax cuts boosted earnings in 2018. But the underlying
trend is one of stagnation. The members of the s&p500 index of
big companies are forecast to say that second-quarter earnings-
per-share dropped by 3% compared with the pri-
or year, the second consecutive quarter of mild
decline. Individual firms’ fortunes wax and
wane—General Electric’s second-quarter profits
are expected to drop by 91% from their peak in
2015; Microsoft should book its highest absolute
quarterly profits since it was founded in 1975.
But there are also deeper forces that are muting
the earnings boom.
Globalisation helped make firms more efficient but now pulls
down profits. The share of pre-tax earnings made abroad has
slipped from 35% a decade ago to 25%. Company conference calls
with investors now feature discussions about trade wars. At
home the jobs market is tightening, putting more pressure on
wage bills, which rose by about 5% last year.
The earnings boom of the past two decades has also been fu-
elled by the rise of a few exceptionally profitable tech firms, such
as Alphabet and Facebook. But their growth rates are slowing and
the next generation of tech stars, such as Uber and Netflix, burn
up cash rather than print it. On July 17th Netflix’s shares tumbled
after it announced weak subscriber figures. Lastly, there is some
sign that competition is biting at last in cosy industries, such as
telecoms, media and branded foods. After years of waving
through mergers, antitrust regulators are taking a tougher line
on deals.
During recessions corporate earnings typically fall by a sixth
or more. But even if the economy keeps on growing—at 121
months old the expansion is now the longest on record—down-
ward pressure on profit margins is on the cards. That would al-
low consumers and workers to get a better deal from big busi-
ness, but presents two risks for investors and executives.
First, equity-fund managers and Wall Street analysts, accus-
tomed to years of high growth, expect a rebound in profits later
in the year. They may be disappointed. Second, many firms have
geared up their balance-sheets in the belief that
the good times will roll on for ever. Corporate
borrowing in America has risen to 74% of gdp,
above the peak in 2008; 40% of the stock of debt
is owed by highly leveraged firms with debts of
over four times their gross operating profits.
Although most managers accept that a mix-
ture of flat profits and high debts is toxic, they
never think it will undo them. But already sever-
al giants that were considered reliable profit-machines are
struggling. at&tneeds to pay down a colossal pile of $169bn of
net debt even as its profits come under pressure from tvcustom-
ers jumping ship. Kraft Heinz has to service $30bn of net debts
even as a new generation of consumers abandon Mac & Cheese
for healthier products.
In the past, profits have been considered a fickle friend by
business people. But after a long boom, rising earnings have be-
come baked into American corporate life. Most investors and
creditors assume that profits will go on growing. Almost every
company presentation assumes that rising margins are the natu-
ral state of affairs. This groupthink is complacent—and possibly
dangerous. That’s the bottom line. 7US corporate profits
Post-tax, as % of GDP0369121987 2000 10 18T
ake justabout any trade fight today, and President Donald
Trump’s America is at the centre of it: with Europe over cars
and aeroplanes; with foreign producers of steel; with China over,
well, everything. But a brawl now under way in Asia, between Ja-
pan and South Korea, has the potential to be as damaging as
much of what Mr Trump has stirred up. It is also a sign that his
model of abusing economic partners is spreading.
Tensions between Japan and South Korea go back centuries.
Japan’s colonisation of Korea between 1910 and 1945 is still re-
sented. Japan believes a 1965 agreement resolved claims by South
Korea over forced labour. It is incensed that South Korea’s su-
preme court last year ordered Japanese firms to compensate vic-
tims (see Banyan). Amid a widening rift, Japan took its most seri-
ous action on July 4th when it began restricting exports to South
Korea of three specialised chemicals used to make semiconduc-
tors and smartphones.
The stakes are high. Japan accounts for as much as 90% of glo-
bal production of these chemicals. It exported nearly $400m-
worth of them to South Korea last year. That may not sound likemuch, but their importance is outsized. They are needed to make
memory chips, which are essential to all sorts of electronic de-
vices. And South Korean firms are the world’s dominant manu-
facturers of memory chips. If Japan were to choke off exports, the
pain would ripple through global tech supply chains.
Japan has also hinted that it might start requiring case-by-
case licences for the sale to South Korea of some 850 products
with military uses. South Korean firms have called for boycotts
of Japanese goods. The two countries, whose trade relationship,
worth over $80bn a year, is larger than that between France and
Britain, need to step back from the brink.
Japan’s decision to limit exports is economically short-
sighted, as it should know since it has itself been on the other
side of such controls. When China restricted exports of rare-
earth minerals in 2011, Japan responded by investing in its own
mines. China’s market share dropped. Already, the South Korean
government is discussing plans to foster the domestic chemicals
production. Japan insists that South Korean companies will,
once approved, still be able to buy its chemicals, but the threat ofHistory wars
A trade dispute between Japan and South Korea has echoes of Donald Trump’s tacticsExport controls in Asia