Shifting sources and uses of profits: sustaining US financialization with global value chains

Abstract

This paper links the financialization of non-financial corporations to the extensive development of global value chains by these corporations. The main focus is the US and its offshoring in China. Financialization has encouraged a restructuring of production, with firms narrowing their scope to core competence. And the rising ability of firms to disintegrate production vertically and internationally has allowed them to maintain cost mark-ups – and thus profits and shareholder value – even in a context of slower economic growth. The resulting rise in the profit share has not supported dynamic gains from offshoring as often predicted, since financialization pressures have reduced fixed investment to allow for higher dividend payments, share buybacks, M&A activity and other financial asset purchases. The paper explores the sustainability of the global value chain–financialization link and its operation in other industrialized countries. The conclusion briefly considers the role of the non-financial corporate sector in the face of the current financial sector decline.

Keywords:

• profit share
• financialization
• global value chains

Acknowledgements

I am grateful to Dean Baker, Robert Blecker, Peter Gibbon, Dominique Levy and two anonymous referees for comments on a previous draft, and to participants in the workshop on ‘Governing Production, Trade and Consumption: Power and Agency in Global Value Chains and Networks’, Danish Institute for International Studies, Copenhagen, 19–20 June 2007. Thanks to Bobo Diallo, Andrew McCarthy and Daniel Samaan for excellent research assistance.

Notes

1. For early discussion of shareholder value, see Rappaport (1986) and on core competence, see Prahalad and Hamel (1990).

2. In some cases – for example, the recent case of Mattel Inc. and its sale of unsafe toys in the US – the identity of supplier firms is not known even to the buyer. Mattel relies on Chinese vendors who outsource to companies whose identity is not necessarily known to Mattel.

3. Epstein and Jayadev (2005, p. 50), for example, define financialization as a rise in the rentier share of national income, where rentier share is the profits of financial firms plus interest income earned in the rest of the economy.

4. See, for example, Eatwell and Taylor (2002).

5. See, for example, Stockhammer (2004) and Crotty (2005).

6. Offshoring data can be found in Milberg and Scholler (2008, Table 7).

7. Other measures of the US profit share show a smaller increase. See Figure 2 below. For an international comparison of labour shares (the inverse of the profit share) in some OECD countries, see Figure 5 below.

8. The more demanding consumer has been noted in the popular press but received little attention in scholarly research. See, for example, Cassidy (2005).

9. On US wage stagnation, see Temin and Levy (2006). On the issue of the distribution of productivity gains, see Dew-Becker and Gordon (2005).

10. See, for example, Arndt and Kierzkowski (2001) or Bhagwati et al. (2004).

11. For a review of this vast and growing literature, see Milberg and Scholler (2008).

12. See, for example, Mann (2006, 2007). For a longer discussion of the various effects of offshoring (although in the context of the issue of labour demand), see Milberg and Scholler (2008). Curiously, the dynamic model is more in the spirit of the classical trade theory of Ricardo, Mill and Marx than the neoclassical theory of Heckscher-Ohlin. See Milberg et al. (2007).

13. See Burke and Epstein (2001) on the impact of threat effects on US wage bargain outcomes.

14. The evidence is not unambiguous. Gorg and Hanley (2004), using a sample of twelve Irish electronics manufacturers, find that firm-level profits are directly related to outsourcing for large firms (in employment terms) and not significantly related for the small firms in the sample. In a study of small- and medium-size Japanese firms, Kimura (2002) found no relation between subcontracting and profitability. In a study of German manufacturing firms, Gorzig and Stephan (2002) found outsourcing of materials to be associated with higher profits but outsourcing of services to be associated with lower profits.

15. A study by Ellis and Smith (2007) finds no connection between openness and the profit share, but links the rising profit share to increased ‘churning’ in the labour market. While the authors attribute this to technological change, it seems likely that it also results from some of the indirect effects of globalization, such as the threat effect mentioned above.

16. According to Houseman, another implication of this misattribution is an overstatement of US GDP, since productivity gains figure in domestic, not foreign output.

17. Outward foreign direct investment would be an offsetting factor.

18. Bates, Kahle and Stulz (2006) report a 129 per cent increase in the cash ratio of US industry over the period 1980–2004.

19. See, for example, Marris (1964).

20. The corporate profit share is the one shown in Figure 1.

21. One possible explanation for the decline in the investment rate out of profits is that companies were investing abroad instead of in the domestic economy. The official statistics on US outward foreign direct investment indicate that this does not account for much of the use of profits.

22. Note that this case provides another good example of divestment of manufacturing by a US firm in order to focus on ‘core competence’, in this case business consulting services. According to Mark Loughridge, chief financial officer at IBM, the deal ‘helps IBM focus on enterprise and SMB [small and medium-size business] segments where we can best leverage our value-add’ (cited in PC World magazine, 2005).

23. See, for example, Arestis, Luintel and Luintel (2005).

24. Watson comments that shareholder value strategies are likely to become a ‘site of political struggle’ (2007, p. 17) for similar reasons, that is, heightened income and wealth inequality. Another issue in the sustainability debate is whether yuan revaluation (vis-à-vis the dollar) would necessarily bring US trade balance improvement of the magnitude normally predicted. Even ignoring short-run J-curve effects, the revaluation might simply trigger a shift in sourcing from China to other locations, perhaps raising costs to US firms and thus the value of US imports, lowering Chinese exports and raising exports by other countries (e.g. Vietnam). In effect this would be a transfer of rents from US company stockholders to producers in the other countries who capture the export markets.

25. Note also that there is an older literature on the relation between financial institutions and production relations based on Gershenkron's (1962, pp. 38–50) study of the institutional foundations of economic development, according to which financial institutions are the result of the specific production system. Zysman (1983) filled out this picture and identified different sets of financial institutions as enabling of three distinct systems of industrial relations, the Anglo-Saxon, the Japanese and the French. Palpacuer, Gibbon and Thomsen (2005) provide a rare recent sectoral analysis along these lines.

26. Montgomerie (2007) also questions the idea of a single direction of causation, arguing that financialization is ‘an entry point into an analysis of a dynamic system of social interaction, rather than a static description of unitary will and collective logic’ (2007, p. 6). On the long-run shifts in the profit share, see Wolff (2003) and Glyn (2006), who link it specifically to financialization and globalization.

27. The analysis also has implications for the relation between international trade and economic growth which merit further research. Our analysis of the contemporary US situation – whereby a growing trade deficit is integral to retaining profits, mark-ups and domestic market share – contrasts starkly with some classic heterodox writings on open economy macroeconomics, such as Kalecki or Hobson.