It's time for corporate profits to return to the '90s so companies can make up for decades of underpaying workers, Morgan Stanley says

• Workers' share of corporate revenues has fallen for two decades to the benefit of owners and investors.
• The labor shortage is closing that gap, and companies will have to shift cash from profits to pay, the bank said.

Morgan Stanley says it's time for corporations to roll back their profit margins to where they were about thirty years ago — all in the name of worker power.

The investment firm's research division released a report this week highlighting the gap between corporate profits and worker wages. The discrepancy has taken on new relevance in the pandemic-era economy amid the extraordinary labor shortage. Businesses have struggled to rehire, and workers continued to quit at record rates in September. The trends have fueled a new focus on decades of meager wage growth — and fresh scrutiny of companies' blockbuster profit gains.

To make up for underpaying workers, Morgan Stanley says corporations should dial back their own profits for the next five years to retroactively fill the gap. After all, the other option to make up for the higher wages being demanded by workers is to raise prices. Those profits, researchers write, should resemble their 1990s level.

"Real wages currently still have to grow by 7.3% in excess of productivity growth to make up the gap," the report reads. "If this catch-up takes place over the next 5 years, unit profits will fall 33% from current levels… This would move the corporate profit share back to its 1990s average on a pre-tax basis, and leave it just marginally above on a post-tax basis."

The team, led by chief US economist Ellen Zentner, argues that reducing the gap between profits and worker pay can serve as a "buffer" against higher wages driving prices higher. In turn, trading profits for higher wages would help minimize inflation while reaching the Federal Reserve's "maximum employment" goal, the team said.

The labor shortage is the US's new normal

The chasm between compensation and productivity is a relatively new one, Morgan Stanley added. There was a "tight" relationship between the two in nearly every industry from 1950 to 2000. As businesses' revenues rose, worker pay generally climbed in lockstep.

That link snapped in the 2000s, according to the bank. Workers' wages started to lag profit growth. Institutions that boosted worker power like unions and high minimum wages weakened. Corporations' owners and shareholders, meanwhile, benefitted from booming earnings and soaring stock values, Morgan Stanley said.

The gap between company profits and worker compensation in the past two decades is unprecedented and threatens the structure of the economy, the bank said.

"This divergence between real compensation and real productivity had never before been seen in the recorded data," they said, adding the drop in worker pay "marks a break in the fundamental structure of the economy."

Closing the gap wouldn't be a seamless transition, the bank added. Raising wages in today's tight labor market could put downward pressure on stocks in the near future. Still, strong corporate earnings and "ample liquidity" would cushion against a major selloff, the team said.

Reverting to the profit-wage structure of the 1990s is less radical than it may seem, the economists added. Wage growth rebounded during the pandemic as businesses scrambled to attract workers. The unusually tight labor market is already reversing the trend of the last two decades and policy is "[tipping] the scales in favor of labor," the team said.

It turns out, the labor shortage already kickstarted that economic time travel.