The Case for Profits

Arnold Kling argues that what really need right now is profits:

A stimulus will work if and when it serves to increase profits, because profits are at the core of a free market system. The economy will recover if and when profits recover.
Wages and salaries rose by 3%, while corporate profits fell by 9%, from the third quarter of 2007 through the third quarter of 2008, according to Commerce Department data. Fourth-quarter figures, which will be available in late February, are expected to show weakening in both types of income, with wages and salaries showing almost no increase, and profits falling by more than 15% relative to last year’s fourth quarter.
The economy is in trouble today because of, pardon the pun, false profits. The financial sector reported as much as 40% of all profits in recent years. However, the reported profits on instruments such as mortgage-backed securities and the sale of credit default swaps did not reflect the long-term risks of those instruments. That is, the return on capital in the financial sector was artificially high because the amount of capital used to protect against risk was artificially low. Losses at many financial firms are inevitable. It is the market’s way of telling the bloated industry to contract, releasing capital and talent for use elsewhere in the economy.

Posted by on January 29th, 2009 at 3:23 pm

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