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PhiNotPi's avatar

Do excessive corporate profits hurt the economy?

Asked by PhiNotPi (11637 points ) February 16th, 2013

A lot of times, an increase in profits is seen as a sign of an improving economy. When a company makes net profit (revenue minus expenditures and wages), the company can now use the money to expand.

If a company makes excessive profits and saves the money instead of using it, then could this actually hurt the economy?

Take a look at this diagram.

When consumers save money, they reduce consumption and thus the revenues of businesses. These businesses must then cut back, reducing the wages/number of employees. This means that individuals have less income to spend with.

On the flip side, if multi-billion-dollar corporations decide to sit on their profits and not use the money, wouldn’t this take money out of circulation and reduce the flow of goods?

My whole idea behind this is that the circular flow diagram is pretty much symmetric. “Saving” is when people take in more income than they spend, while “net profit” is when businesses take in more revenue than they spend.

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12 Answers

DrBill's avatar

Making a profit is good
Making excessive profit is not .

CWOTUS's avatar

No company “saves” money in a vault like the old-fashioned idea of a miser in a counting house or Scrooge McDuck. The money is put to use in one way or another. If their profits are so extreme because their products are in such demand that they command a high premium relative to other products (or they have a monopoly position based on exclusive patent protection or licensing agreements), then they will very likely expand their production facilities.

Not using the money puts the company at risk of being bought out in a hostile takeover by raiders who leverage their investment with the company’s own retained earnings and cash. Recall the “greenmail” takeovers of the 1980s, which is what that was all about.

There is no such thing as “excessive profit”. It’s an absurd idea.

jerv's avatar

It really depends on what they do with the money.

Holding on to it is dangerous for reasons @CWOTUS points out.
Investing in the company by expansion may work well, or it may cause you to set yourself up for a big fall when the demand for your goods/services goes down. It is possible to get too big, so sometimes expansion is a bad idea.
Improving compensation for current workers is a Socialist idea that leads to increased overhead and thus reduced shareholder value; lose-lose.

But the most important thing is that the very foundation of a healthy economy is the flow of money; no flow = no health. Any business that is at risk of even being accused of “excess profits” knows enough to avoid cutting their own throats by tanking the economy. At worst, they will place their “excess” money into some form of investment, earn a little interest on money they weren’t using, and somebody else will spend it, thus keep the cash flowing.

gorillapaws's avatar

When I hear the term “excessive profit” I tend to interpret that as companies making large short-term profits at the expense of much larger profits over the long term. This is bad, and I think the trend of rapidly churning investments is playing a major role in incentivizing short term gains at the expense of long-term health/growth/investment. Generally speaking, people aren’t investing in companies with a 10+ year timeframe in mind, more like a 10+ week timeframe, if not much shorter.

wundayatta's avatar

There is always a dynamic balance between savings, spending, and productivity. When confidence is high, people spend more and companies make more and they become more profitable (if run well) as a result. They then hire more people or find other ways to improve productivity so they can meet the demands of the market and make a much profit as possible.

When a broad spectrum of companies are doing well, then most people will also be doing well. Labor will be in demand. Wages will be higher. People will have more money in their pockets and will be able to spend more and save more.

Savings is important because that provides capital which allows people to use that capital to form new business or expand existing ones.

What keeps capital flowing is confidence in the economy. Government must regulate the economy in order to maintain confidence. We must be sure that no one is lying, and saying there is a million dollars where there is really only half a million or worse, nothing. There must be enough reserves to cover the unexpected problems.

If there isn’t enough regulation, business starts lying and cheating, and eventually they are discovered, and confidence tanks, and the economy dies. If there aren’t enough reserves, when things go wrong, too many businesses fail, and confidence tanks and the economy dies.

It’s all a delicate balance. The pressures are dynamic and sometimes the system gets out of balance and the economy dies, as it did over the last five years or so. Then everyone points fingers at everyone else, about what went wrong. If we point the fingers and the wrong people get blamed, the solution is wrong, and the economy stays rotten. Fortunately, the fingers are pointing at the right targets, and the right government is in place, and the economy is improving, albeit slowly. We might improve more quickly if the Republicans had less power. Or it might be worse. All we know is that what we are doing now is moving us in the right direction.

ETpro's avatar

It depends on what corporations do with the profits. Companies can and do sit on cash at times. During the height of the Great Recession US firms were sitting on $2 trillion in cash. If all that’s invested in offshore tax sheltered accounts and not in investment vehicles here where the cash gets loaned back out to people who will put it to work, then darned shooting that’s bad for the economy.

When the economy is good, sitting on too much cash makes a company a target for a hostile takeover by robbers vulture capitalists. Willie Sutton was asked, “Why do you rob banks, Willie?”

His answer was simple and honest, “Because that’s where the money is.”

But in poor economic times, vulture capitalists don’t want to risk aquisistions, even when there is a good deal of cash in savings and pension funds they can loot. There’s too much chance of being stuck with the asset till the shit they pumped in in place of the corporation’s assets hits the fan, and they end up on the hook for the debt they acquired in the takeover instead of accomplishing a pump and dump. So in bad economic times, holding cash is safe, and even wise.

Despite all the con men lies about all jobs being through the divine benevolence of The Creators, wealthy investors do not create jobs when the productivity from those jobs is not in demand. A healthy middle class flush with cash creates demand. When you have that, corporations can and will borrow to get the cash to expand production, creating even more jobs and even more demand.

Because

DaphneT's avatar

Excessive corporate profits do hurt the economy because that money slides into the hands of people who don’t spend it or spend it on luxury goods and services, neither of which spread it around enough to benefit the economy of the masses.

Diagrams are tricky. Your diagram appears symmetrical at first glance, at the second I started asking if the flow lines are weighted, meaning are they the same size, should they be, etc.

Gabby101's avatar

Most companies can’t make “excessive” profits for long because those profits will attract more and more competitors, many of whom will compete with slightly lower prices until the excessive profits are no more – this is why Wall Street has lost some of its love for Apple. Of course, there are limitations – companies with high start up costs or that sell something of limited supply (in the long-run), like oil companies, don’t fit this model, which is why we are basically screwed when it comes to fuel prices, unless we think of some new solutions.

Gabby101's avatar

@ETpro – $$ in the hands of small businesses creates demand as well. We may not hire many people, but we spend money on supplies, equipment and services at a proportion to our income that is much higher than a larger business.

jerv's avatar

@Gabby101 I think it safe to say that small businesses, the type that create most of the jobs, are rarely at risk of “excess profits”; those that are generally use that money to grow, at which point it’s not exactly profit, but merely capital.

ETpro's avatar

@Gabby101 Being a small business owner, how well I know. Dollars in the hands of any who will spend those dollars in short order creates demand. Even dollars in the hands of local, state and federal government, as they spend what they take in.

mattbrowne's avatar

Yes, because it’s the middle class that creates jobs by spending money. Excessive profits serve a small percentage of people who already have enough of everyday’s goods. These rich folks might create a few jobs for people building yachts, but very often their money sits in bank accounts in tax havens. And banks need debtors willing to borrow that money, which becomes more and more difficult. It was one of the reasons for the real estate bubble hustling people to buy homes they couldn’t afford.

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