How wages to labourers compare with profits to entrepreneurs

How do wages to labour compare with profits to entrepreneurs? This question has been of interest to economists and policy makers and industry associations and trade unions alike since Adam Smith and Karl Marx.

Wages and profits are the two major sources of national income, the other two being interest paid to capital and rent paid to land. In India, the official statistical machinery does not produce the complete break-up of the national income by these factors of production. The reason for this is that a large part of the Indian economy is in the unorganised sector where it is difficult to allocate the creation of national income to any of these unambiguously.

Your friendly tea-stall at the end of the street is operated using the labour of the owner on land that is not accounted for. The owner understands that the profits are his but he finds it unnecessary to recognise the distinction between wages he needs to pay himself and the profits that may be left after that. If he re-invests a part of the profits into his business he will find it equally unnecessary to account for the interest on the capital thus employed before counting his profits. Most enterprises in India are self-owned, self-operated and self-funded that defy the theoretical constructs of national accounts that are based on double-entry accounts. Tea-stall owners like farmers, small traders, small consultants and small businesses in general do not maintain accounts.

But, larger business units do maintain accounts and even get them audited by independent professional accountants. While an individual account can be suspect of manipulation, collectively, they tell a pretty compelling story and sometimes a startling one. The relative shares of wages and profits as seen in the accounts of listed companies are worth a look for the story it tells us.

We observe the aggregate wage bill and aggregate profit before tax of all listed companies that have been providing their quarterly financial statements. Both, wages and profits are before taxes paid by their respective claimants. This is a time-series of 20 years with 80 quarterly observations.

The first observation from this time-series is that wages tend to rise steadily over time. The year-to-year variations are small and the rise seems to be independent of any major business cycle variations. If there have been business cycles since the end of the last millennium then at least the series of aggregate wages do not seem to reflect it.

Profits, on the other hand, are a lot more volatile. Year-on-year variations are larger, particularly in recent years. More importantly, unlike wages, its trend is not secularly rising in time. Further, the relative shares of wages and profits have been changing over time. And finally, the recent change in relative shares are a significant break from the past.

Through much of the two decades since the turn of the millennium, profits have been growing at a much faster and volatile rate than wages. Quarter-on-quarter wage growth rates averaged at less than 4 per cent while profits grew at 6.5 per cent. The standard deviation of wage increases was 6.3 per cent while that of profits was 32.6 per cent. The coefficient of variation of profits at 5 was more than thrice that of wages, which was 1.6. 

Evidently, entrepreneurs have been getting higher though riskier returns compared to labour that is benefitting from slower but steadier growth in wages.

Save for a few initial years, profits were systematically and significantly higher than wages in corporate India. At its peak in the quarter ended September 2007, profits were 2.2 times wages. This is odd for a labour-surplus country like India.

In the European Union, wages were 50 per cent higher than profits and in the US they were twice as high as profits. In contrast, in India, wages were mostly significantly lower than profits.

Between 2002 and 2014, on an average wages were only 63 per cent of profits.

Since 2016, profits of listed companies have stopped growing. But wages, have continued to grow. Profits started losing steam in 2015 and by 2017, they fell below wages. Given the very high volatility in profits in recent years, a trailing four-quarter average is more revealing than the quarterly data. This average shows a clear drop in profits below wages for the first time in nearly two decades.

But, this is not good for labour. The lower share of wages is a structural phenomenon, possibly peculiar to India. The fall in profits growth could have adverse implications on employment and wage growth. It requires enterprise to grow employment and wages through greater investments. With falling profits, it will not have sufficient incentive to invest, to the detriment of labour.