Thursday, August 28, 2008

U.S. GDP Allegedly Up - National Income Down

Predictably, markets cheered the seemingly strong GDP report.

Nominal GDP growth was upwardly revised from 3.0% to 4.6%. At the same time, as the domestic product deflator was upwardly revised from 1.1% to 1.3% and the domestic purchases deflator was upwardly revised from 4.3% to 4.4%, this means that unadjusted growth was upwardly revised from 1.9% to 3.3%, and adjusted growth from -1.3% to 0.2%.

Yet what seemed to be ignored was that the report also said that corporate profits fell again-and this despite the fact that the BEA definition of profits is unaffected by write-downs. Overall corporate profits fell in nominal terms by an annual rate of 9.2% compared to the previous quarter and by 7% compared to Q2 2007. If you adjust for inflation, then we're talking about double digit declines in corporate profits.

And moreover, this number would have been even more dismal if it hadn't been for the rising profits from the foreign subsidiaries of American companies compared to the profits of the subsidiaries of foreign companies in America. The profits of domestic non-financial companies fell in nominal terms as much as 21.8% at an annual rate compared to the previous quarter and by 17,4% compared to Q2 2007. Adjusted for inflation, these declines are even larger.

The point about that is first of all is that it will likely cause companies to reduce their investments in the future. And the second point about that is that if there really was such a strong boom as the headline GDP figure claims and if profits fell so dramatically, then who is reaping the benefits of this alleged boom? Workers? No. While they at least enjoyed rising nominal income (+3.1%), real compensation of workers fell by 1.2%. Government? No. The budget deficit soared during the second quarter and increased even excluding the effect of the so-called tax rebates.

So, if all sectors -corporations, workers, government- of the American economy suffers from falling real income, then how could real GDP boom by more than 3%? There's something seriously wrong with that picture.

However, this discrepancy is not a mystery. In my post on the previous GDP report, I explained this mystery. First, there is the terms of trade effect, which accounts for almost the entire alleged GDP growth. Secondly, there is the statistical discrepancy effect. National income rose only 2.1% in nominal terms, compared to 4.6% for nominal GDP, despite the fact that factor income from abroad fell this quarter compared to the previous one. This was the fifth quarter in a row that national income increased less (decreased more) than nominal GNP. With inflation during the quarter running at 4.3%, real national income fell by more than 2%.

Some would perhaps argue that I am biased by assuming that the national income measure is more reliable than GDP. After all, this discrepancy could reflect an underestimation of national income as well as an overestimation of GDP. This is true, but given the other indicators available, both in other government reports, in private sector reports and reports of increasing economic discontent, it seems clear that the national income number better reflect economic reality.


Blogger GS751 said...

I loved this post. You got a recognition in my blog.

6:53 PM  
Blogger LKQ said...

Have you factored in the fact that half of the sales were buy now and pay in five years? That is major to me.

8:14 PM  
Anonymous Anonymous said...

It seems to me that the changes in reporting to "mark-to-market" is having some impact on this, and makes comparing today's results to historical results difficult.
The significant write downs being done by financial institutions for housing debt, and CDA's, is having a major impact on "income growth" and "profitability". These write downs though are different, as they are non-cash losses, and not losses from lack of productivity. As this bottoms and starts to turn the other way, we can see write-ups, which will have the opposite effect. Income will grow at a much faster rate than GDP growth would indicate, but productivity would not be rising.

Your thoughts.

7:22 PM  
Blogger stefankarlsson said...

You need to read my post more carefully. As I wrote, write-downs are *not* included/considered in the BEA measure of corporate profits (and therefore also national income) so it is not a factor in the profit numbers I discussed, meaning that your speculation about future write-ups (which I don't think will happen BTW) is irrelevant in this context.

7:46 PM  
Anonymous Anonymous said...

I am wondering, don't you think that the export-driven growth will lead to higher profits going forward? As industries specialize and productivity grows, that is bound to lead to higher investment and profits in all exporting sectors. On the flip side, loss of jobs will likely occur with the increased productivity, but higher profits should eventually flow through to incomes.

Also, I read a post of your at the Mises blog, regarding the Gross Domestic Purchase index (; is that the CPI? Where do I see this data?

10:34 PM  
Blogger stefankarlsson said...

Rebecca, if exports continue to grow fast, then yes that will likely generate higher profits in at least some sectors. But it is far from certain that it really will continue given recent strengths.

As for the gross domestic purchases price index, it is not the same as the CPI. It is a different index that is published in the regular GDP reports

11:42 PM  

Post a Comment

<< Home