Capital gains - American profits have been high but the trend may not last

NEVER mind the divide between Main Street and Wall Street. The big gap at the moment is between workers and corporations. Although unemployment remains stubbornly high and wage rises are hard to come by, corporate profits are taking a larger share of American GDP than before the financial crisis (see chart).

America stands out from the pack, one reason why its stockmarket has been outperforming the rest of the developed world. In both continental Europe and Japan, earnings per share are well below their November 2007 levels.

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Why have profits been so high, despite the fragility of the economy? American firms were very quick to sack workers after the crisis started. But there is also a longer-term explanation, based on the weakened power of labour after the entry of countries like China into the global employment market. Companies have been able to move production offshore and to resist demands for wage increases from workers in their domestic market.

But even if capital is lording it over labour, a second mechanism ought to bring corporate profits down. A high return on capital should encourage a wave of investment. The resulting expansion in capacity should increase competition and reduce returns. But that has yet to happen: companies are still hoarding cash.

There are three potential explanations for this cash mountain. The first is that executives are worried about excessive regulation. American bosses in particular may be waiting for a possible change of administration after the presidential election in November.

The second is that firms are reluctant to invest in the face of weak demand. Domestic consumers have been under pressure from austerity and higher commodity prices; the euro-zone crisis and a slowdown in developing economies is weighing on export prospects. Companies may have milked all they can from productivity improvements. The irony here is that a high share of GDP for profits automatically results in a low share for wages and thus may eventually be self-limiting—a positively Marxist outcome.

The third explanation for cash hoarding is the most intriguing. Andrew Smithers of Smithers & Co, a consultancy, suggests incentives may be to blame. Managers are motivated by share options and share prices are driven by changes in earnings per share. Spending cash on share buy-backs boosts earnings per share immediately, whereas a capital-investment programme may actually reduce earnings in the short term.