One of the key features of the US economic recovery from the financial crisis has been the divergent performances of the business sector and labour market.
Although the unemployment rate of 6.3 per cent is well below its peak, the US economy is still a long way off full employment. Long-term unemployment – those out of work for more than 12 months – remains stubbornly high while the slow recovery in the participation rate points to still far too many discouraged workers.
Janet Yellen, the Federal Reserve chairwoman, recently reiterated that monetary policy will remain accommodative for as long as it takes to restore full employment to the US economy.
A flipside of considerable slack in the labour market has been a rapid recovery in the corporate sector. Profit margins and the profit share of GDP have continued to increase to reach record highs as has the S&P500, which is 20 per cent above its pre-GFC peak. The boom in profitability stems largely from near-zero interest rates and corporate America’s aggressive approach to trimming costs in the face of a weak domestic economy and anaemic revenue growth.
More recently, the penny has dropped for Australian firms that low nominal GDP growth and an anaemic revenue environment is the new normal. The economy has been stuck in a nominal recession for two years now, with nominal GDP growing by less than 4 per cent per annum in 2012 and 2013, the weakest consecutive years since the recession of the early 1990s.
Faced with the headwind of weak top-line growth, companies have sought to boost profitability by deferring capex, shedding non-core businesses, trimming costs and lifting efficiency. BHP and Rio Tinto have divested underperforming assets; Telstra, ANZ and QBE are just some companies that continue to offshore IT and other back-office operations, while the big banks have cut back on staff in areas burdened by excess capacity, notably business lending.
The relentless focus on cost control is now being reflected in generational change among senior management and boards. CEOs and chairmen who have a demonstrated track record of delivering strong acquisition-led growth during the boom years no longer command a premium in the managerial market, and are being replaced by more cost-conscious CEOs.
The new cost discipline is a welcome development following decades where CEOs focused on growing revenues and empire building, at the expense of profitability and shareholder value. The more ruthless approach is starting to pay dividends; gross operating surplus – the key economy-wide measure of profits – grew by almost 10 per cent in 2013.
From its quarterly statement of monetary policy released last week, it is clear the RBA expects nominal GDP growth to remain weak, due to further falls in the terms of trade and the view that the economy still has a fair degree of spare capacity.
The prospect that revenue conditions will remain soft for a while will therefore continue to focus the minds of CEOs on what they can control rather than chasing the pipedream of double-digit revenue growth and market share gains that destroy shareholder wealth.
Any risk that corporate Australia’s focus on cost control could lead to a shortfall in aggregate demand should give the RBA plenty of scope to keep interest rates lower for longer than many expect. Ultimately, the new cost discipline promises to be good news for investors, less so for workers and job-seekers.
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