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TIMES BOARD OF ECONOMISTS

GNP Aside, Businesses Are Healthy

July 17, 1988|Irwin L. Kellner | IRWIN L. KELLNER is chief economist at Manufacturers Hanover in New York

You wouldn't know it from the data on the gross national product, but corporate profits are really in pretty good shape. This is important, for businessmen will need these bucks to help them weather any economic storm that may blow their way.

According to the government's calculations, both pretax and after-tax earnings declined in this year's first quarter, compared to fourth-quarter 1987, after adjusting for the usual seasonal fluctuations at this time of year. Pretax profits slid $4 billion, or 1.5%, to an annual rate of $281.5 billion. Net profits declined by $1.5 billion, or about 1%, over this same period.

Some of this was due to slowing sales. Domestic demand (GNP less trade flows) rose only 1.9%, after factoring out inflation, compared to a 4.3% jump in the fourth quarter.

However, another reason was an inability to pass along higher costs in the form of higher selling prices. The gross national product price deflator--which measures prices throughout the economy--rose at an annual rate of only 1.4% in the first quarter, after rising nearly twice as fast (2.7%) in the fourth quarter.

These trends notwithstanding, there are some positive developments that you should be aware of.

First of all, net cash flow, the actual dollars flowing into companies' coffers, rose $2.2 billion, or 0.6%, between the two quarters. Because of this, dividend payments rose by some $2 billion--marking the 10th consecutive quarterly increase.

Even more important, there was a jump in profitability. This is the ability of business to earn a buck on a given dollar of sales.

Firms More Efficient

The important manufacturing sector is a case in point. Factory profits in the first quarter rose to 6.3% of sales from 4.4% in last year's fourth quarter. At the same time, manufacturers' earnings jumped by a hefty 44%, while their return on equity, another measure of profits, rose to 15.8% in the first quarter from 11.5% in the fourth quarter of 1987, and 11.2% in last year's first quarter.

There's nothing very mysterious behind this trend. Business is becoming more efficient, thanks to cost-cutting programs, the shedding of low-profit operations--and a surge in capital spending.

After bouncing around during the first few years of this decade, business spending on new plants and equipment began shooting up at the beginning of 1983. Since then, these outlays have jumped by more than 40%, after correcting for higher prices.

What makes this even more significant is that virtually all of this increase traces to expenditures for equipment, which have shot up by about 70% over the past five years, while spending on physical plant has hardly budged.

With capacity utilization still below levels of early 1980--not to mention the peak rates of the 1970s and 1960s, it's not hard to see why business is reluctant to put up more structures. And if this doesn't convince you, recall the extremely low operation rates that were common in December, 1982--at the end of the last recession. It's very expensive to have all that capacity lying idle, running up fixed costs against fewer units of sales.

On the other hand, it's easy to see why businessmen are rushing to install the newest, most modern equipment they possibly can.

For one thing, it increases efficiency. This has already paid off in the form of increased profitability; it is also helping to offset rising labor costs.

During the second quarter, the unemployment rate hit its lowest point in 14 years, while employment reached an all-time high, both in actual numbers of people as well as when compared to the employable population.

Not surprisingly, labor flexed its muscles, sending hourly earnings up 3.5% over 1987. This compared to a 12-month rise of 2% only a year and a half earlier--and was the steepest such increase in four years.

But the bottom line for business when it comes to labor costs is costs per unit of output. Here, the trend is more favorable. Non-farm unit labor costs at the start of the second quarter were only about 1.5% higher than they were the year before. With the exception of the period just after the last recession, this is the smallest 12-month increase in more than 20 years.

Additionally, all this new equipment is helping businessmen to compete in another dimension--by improving product quality. And, in the final analysis, this will ensure continued strength in sales and earnings for years to come--fluctuations in the economy, interest rates and foreign exchange rates notwithstanding.

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