One of the most fundamental identities in macro economics is that income = spending. Since this is a macro-level national income accounting identity, that means two things: First, it must be true after-the-fact as an accounting factoid. In other words, when the BEA adds up the numbers each quarter, the money spent in the economy had to be equal to the income (really sources of funds). Another way of stating this is that we say the size of the economy is the market value of everything we produced for final use. There’s two ways we could count this. We could count how much was spent to buy all of the goods/services we produced – that’s called GDP, gross domestic product. We count GDP by counting what was spent by whom, consumers (C), businesses for investment (I), government (G), and rest-of-world (eXports – iMports). Hence the equation GDP = C + I + G + (X – M) which I’m forever repeating in class.
But there’s a second way to count how much we produced and that’s to count the money flow through the Resources or Factor markets. We call this the GDI, or Gross Domestic Income. It’s what we got paid to produce the GDP. We break-up GDI according to the type of income being paid and to whom. Roughly it’s wages, profits, interest, and taxes.
Like I said, income = spending. So, GDI = GDP. It’s an after-the-fact necessity of the accounting framework by definition. But it’s also a useful concept for analysis of disequilibrium and dynamics. After all, think of what happens in the following scenario. Suppose every month we spend $1000 and we get paid $1000. Income = spending. But suppose some month, income declines unexpectedly to $900. In the month the income declines, we either cut our spending short to adjust to the new lower income, or we borrow (or spend from accumulated financial assets) to make up for the shortfall and adjust our spending the following month. In this scenario, we can identify that when income from productive sources = spending we have an equilibrium in the economy and no changes are expected. But if income is less, then we are at a disequilibrium and can expect changes. For the economy as whole then, we have:
C + I + G + X – M = GDP = GDI = Wages + Profits + Interest + Taxes.
So with that in mind, let’s look at what’s been happening. I turn to Rebecca Wilder at Angry Bear:
There are two measures of income: the spending side (Gross Domestic Product, or GDP) and the income side (Gross Domestic Income, GDI). I’d like to see what GDI is telling us about the Y/Y recovery, since it’s a better predictor of turning points, according to FRB economist Jeremy J. Nalewaik.
The chart illustrates the contribution to Y/Y GDI growth coming from each of the main income components. (Click to enlarge.)The series is deflated using the GDP deflator, since the BEA only releases the nominal numbers. All references to GDP and GDI below refer to the real series.
What conclusions can we draw? Well it’s largely a confirmation of conclusions about GDP – the “recovery” is unbalanced. It isn’t being shared with 80-90% of the population that works for a living. Wages are not growing, but corporate profits have recovered in record time near record levels. Productivity has improved but the benefit goes to capital owners, not labor. A very interesting comment was provided by Mark Sadowski:
We only have five quarters of data for the current recovery. However, how does it compare so far? So far 76.7% of the growth in RGDI has gone to corporate profits. Needless to say this recovery is setting a totally new precedent.
What can we conclude? This seems to be an increasing pattern with recent recoveries. I speculate that much of it has to do with the combination of sticky wages, an increasing degree of labor flexibility and a trend towards lower inflation rates. Such a combination means adverse shocks to AD result in larger increases in unemployment. Recoveries in a low inflation environment are notably slower due to the limitations of conventional monetary stimulus against the zero lower bound. Thus the labor surpluses are increasingly persistent and compensation growth becomes slower and slower in each subsequent recovery.
Is this bad? Only if you work for a living.