Depreciation and the Profit Margin Puzzle

Dean Baker provides (a small) part of the answer to my “profit margin puzzle” (although he doesn’t frame it in those terms). Gross profit margins (represented by the divergence between the GDP deflator and unit labor cost) partly had to rise to compensate for increased depreciation, to keep net profit margins from falling. In other words, if you know your capital will have to be replaced more often, you have to charge more for your products in order to make provision for that replacement. However, for the period I looked at (starting in 1991) depreciation as a fraction of GDP rose only from 12.1% to 12.9%. Since the GDP deflator diverges from unit labor cost by an average of more than 0.5% per year over 15 years, this roughly 0.8 percentage point difference just chips away at the puzzle (less than 2 years worth out of 15).