In theory, GDP should equal gross domestic income. In practice, it rarely does.
Every quarter, the Bureau of Economic Analysis publishes two estimates, arrived at differently, of how the economy performed in the previous three months. One of them gets next to no attention — a non-issue except at times like the present when the two are sending conflicting messages.
Gross domestic product measures the value of final goods and services produced in the US. It is calculated as the sum of expenditures. GDP equals consumption plus investment plus government spending plus exports minus imports. GDP garners all the headlines.
Gross domestic income is, as the name suggests, the sum of the income generated from the output of goods and services. It includes employee compensation, proprietors’ income, rental income, corporate profits and net interest. GDI doesn’t make the nightly news. It is of interest solely to economic professionals.
In theory, GDP should equal GDI. In practice, it rarely does.
The BEA reconciles the two measures in much the same way you and I reconcile checkbook with bank statement: Subtract one from the other, draw a line and label it “statistical discrepancy.” (OK, so we don’t give it a fancy name.)
In the last six quarters, the gap between the two has gone from negative $195 billion (GDI bigger than GDP) to positive $112 billion (GDP bigger than GDI). The swing of more than $300 billion is “breathtaking”, according to Bob Barbera, chief economist at ITG Inc, a New York brokerage. “We have no employment, no income and a jump in output. It’s like the virgin birth.”
Credibility gap
There are lots of reasons the two measures yield different results. For example, corporate profits are available from the Internal Revenue Service with a two-year lag. The BEA has other sources for estimating profits, including quarterly financial reports, but the real numbers aren’t available until two years after the fact.
Real GDP rose a revised 3.3 per cent in the second quarter, according to the BEA. That’s well above the 20-year average, not to mention the public’s perception of the state of the economy. Nine-in-10 consumers think the US is in recession, according to the Reuters/University of Michigan Survey of Consumers for August.
Employment, one key indicator of consumer well-being, has been falling for eight months (nine, if you exclude government jobs). The BEA revised down wage and salary growth for the first half of the year, implying bigger job losses when the Labor Department reconciles its estimates with comprehensive state unemployment insurance data, according to Doug Lee, president of Economics from Washington, an independent consulting firm in Potomac, Maryland.
Duck test
The unemployment rate shot up 0.4 percentage point to a five-year high of 6.1 per cent in August. House prices, stock prices and inflation-adjusted incomes are all falling. “The real GDP data don’t speak to that weakness,” Barbera says. “Another set of aggregate statistics do.”
That would be GDI. Real GDI rose 1.9 per cent last quarter following two quarterly declines. This income-based measure shows the economy growing 0.3 per cent in the past year.
If you gave consumers a multiple-choice quiz and asked them which measure reflected the true state of the economy, there’s no question they’d answer, GDI.
That’s true of many professionals, too.
“It’s not just that the two measures are telling a different story,” says Conrad DeQuadros, senior economist at RDQ Economics LLC, an independent research firm in New York. “The income-based measure squares much better with the employment data.”’
In a recent research note, DeQuadros and RDQ Economics’ chief economist John Ryding present their case for GDI.
Prosecution Exhibits
Prosecution Exhibit No. 1 is the rise in the unemployment rate to an average 5.9 per cent in the third quarter from 4.9 per cent in the first. Why is unemployment rising at such a rapid pace if the economy’s growing at 3-plus per cent? Has potential growth risen enough to produce that much slack? Doubtful.
Exhibit No. 2 is trade, which added 3.1 percentage points to second-quarter growth, the biggest contribution since 1980. Almost half the boost came from declining imports, hardly a sign of a robust US economy. Only once since 1970 has a large addition to growth from imports occurred outside recession, Ryding and DeQuadros say.
Exhibit No. 3 is the tiny increase in the second-quarter GDP deflator, or the inflation measure used to adjust nominal growth. The 1.3 per cent increase in the deflator was “held down by the surge in imported oil prices,” which are subtracted from GDP, the economists write. Most people would not read that as a “plausible” reflection of last quarter’s inflation rate.
GDI moment
BEA economist Bruce Grimm, who has studied the two measures, doesn’t assign an edge to either. He did find in a 2005 study that “real GDI generally, but not always, declines more than real GDP during recessions.”
That may be why “real time GDI has done a substantially better job recognising the start of the last several recessions than has real time GDP,” according to a paper by Federal Reserve Board economist Jeremy Nalewaik.
And it would certainly go a long way towards explaining 3.3 per cent real GDP growth in a period that walks and quacks like a recession.
