What happens when national income falls?

Cross-posted from Mark the Graph.

The main statistic we use to measure the size of the economy is Gross Domestic Product. The ABS defines GDP as:

The total market value of goods and services produced in Australia after deducting the cost of goods and services used up (intermediate consumption) in the process of production, but before deducting allowances for the consumption of fixed capital (depreciation). It is equivalent to gross national expenditure plus exports of goods and services less imports of goods and services.

But GDP is not the only indicator of the size of the national economy. Real Gross Domestic Income (GDI) is another. According to the ABS, the real purchasing power of income generated by domestic production is affected by changes in import and export prices. Real gross domestic income adjusts the chain volume measure of GDP for the terms of trade effect. Some argue that GDI is a more accurate measure of the size of our economy than GDP.

Let’s look at some charts.

What to make of all this?

I am going to theorise that there is a long-run equilibrium relationship between GDP and GDI. Statisticians have a lovely technical term for this kind of relationship: cointegration.  In the long-run real GDP lies some $15 to $20 billion above GDI. Up until the early noughties, both series grew at a similar pace. Since mid 2002, the start of the terms of trade boom, this relationship has broken down. Another chart.

If I am right, and these series are cointegrated in the long-run, then over time as the ToT boom unwinds we can expect the GDP-GDI relationship to return to its equilibrium difference relationship (that existed prior to mid-2002). This will mean that something like $100 billion to $120 billion would be removed from our annual $1.4 trillion national income (around 7%).

That has got to hurt. I suspect it is already hitting employment. Since  2011 the GDI growth rate has declined significantly and the number of jobs in the economy has stagnated (not withstanding a GDP growth bounce at the same time). From Okun, a GDP bounce would normally be correlated with an unemployment fall.

If real GDI starts to actually decline, I suspect we will see the number of people in jobs decline. We will see government revenues decline (or at least slow in growth). Ultimately it may even challenge wage growth that exceeds inflation.

It is not going to be pretty as we learn to live on a reduced nation income.

Houses and Holes

Comments

  1. “That has got to hurt. I suspect it is already hitting employment”

    It is. In the engine room of new job generation (WA), the power plant has been at idle since the early Sept ructions.

    Probably to hit the UE stats but all the miners shed masses of contractor labour and new hiring has been put on hold to a large extent. That on top of the project unwinding that has been going on since July August – lots of project related work there shelved and wound down. I suspect the full extent would not be seen until Dec figures become available.

  2. Jumping jack flash

    This is an excellent post, thank you.

    “This will mean that something like $100 billion to $120 billion would be removed from our annual $1.4 trillion national income (around 7%).”

    My guess is that incomes are going to shrink. The problem of course is that incomes will not shrink, but rather jobs will be lost while incomes continue to grow.

    Here at the factory, we are forging out a new enterprise agreement. Everyone is waiting with baited breath to see how much extra we get… it will be around 5% over a couple of years, so they reckon.

    If anyone asks me, I say I would gladly take a 10% pay cut, at least, because that is closer to my globally adjusted productive output. They look at me rather strangely.

    • If anyone asks me, I say I would gladly take a 10% pay cut, at least, because that is closer to my globally adjusted productive output. They look at me rather strangely.

      As a matter of interest, how are you working this out ?

    • I understand that in the US a similar trend has emerged as the growth in jobs has been in lower paid jobs so that while employment might not be falling income is.

      In Australia I suspect falling unionisation rates and outsourcing could be expected to have the same impact on incomes if not on the unemployment rate.

      No one outsources to a higher cost producer!

  3. When national income falls it could reduce the ability of the top 10% to aggregate more of the existing assets or it could mean starving children, it depends on whose income is reduced and by how much.

    Capital formation could be increased in spite of a fall in GDI if suitable policies were used such as increased super contributions, higher tax free threshold and higher marginal rates at the top 10% of incomes and an infrastructure replacement and addition program.

    It’s as much a fight between sectors to avoid negative/gain positive adjustment as it is to increase national income.

    • “…… if suitable policies ….”

      Why are people so blind to that great wealth confiscator : Govt?

      How about Gov’t shrinking, creating the possibility for more after tax incomes for all. WHY is it that MORE taxes are always the small minded myopic response from those wanting more for essentially doing nothing extra?