This Economy May Not Be What We Think It Is
There are two ways that Economists measure the Economy. The first you are likely familiar with is the Gross Domestic PRODUCT (GDP), how many “goods and services” we produce.
The second measurement, less known, is the Gross Domestic INCOME (GDI), how much we income “make” from those goods and services.
These two measurements should always be equal. Like the cash register at a local store, the cash in the drawer should always be the same as the cash register has rung in.
That’s not the case today. In the latest report, there is a $345 billion difference between the two. The most significant differential, I recall. This differential has become so large that it’s gotten the attention of the Federal Reserve. In an article entitled: “Is The Economy Growing? It Depends On How You Measure It.” The Fed tells us they’re still determining what is causing this difference.
Now, I certainly do not have access to any unique data, and I certainly need the available resources of the Fed. But I do like to read murder mysteries. So, let’s go at this mystery like Agatha Christie would.
THE SCENE OF THE CRIME
Like almost everything about our current Economy, this began with the COVID-19 pandemic and the steps to “lockdown” commercial activity. American politicians, from the President down to the local councilman, put in special rules to quarantine people everywhere. Their objective was to halt the spread of the Covid-19 disease, but their result was to grind the Economy to a halt. In the Second Quarter of 2020, the Economy fell further and faster than at any time in our country’s history. It was a more significant fall than the Great Depression of the 1930s. The result was absolute chaos.
Many businesses were deemed to be “non-essential” and forced to close. (This is our first clue). These were predominantly small, privately owned shops and stores often seen downtown or in shopping malls. The local “mom and pop” shop that people frequent on their way to work or shopping. What’s unique about these establishments is that they do not keep public records. These shops usually operate under the Sub Chapter S of the IRS Code. Their Income is reported on their personal income tax return (Clue #2). In short, these small businesses are as far away from an Apple Computer or an Amazon as possible.
THE SUSPECTS
There are two “suspects” in this case: INCOME (GDI) and PRODUCT (GDP). While both suspects may be mistaken in their results, that’s highly unlikely. It is more probable that one reports accurate results (not guilty) while one is inaccurate (guilty!).
First, we’ll look at INCOME (GDI). Income has an auditor, the Internal Revenue Service (IRS). While the IRS could be better, it does an excellent job of catching errors in income statements. (Even in recent reports of the IRS missing some tax cheats, the error rate is at least 80% less than the differential we’re discussing between GDP and GDI).
Additionally, we noted that even the tiniest boutique shop reports INCOME, likely as personal Income, via Sub Chapter “S.”
So, overall, the “data flow” for INCOME is relatively complete; after all, tax revenue is a principal source of Income for the Federal, State, and Local Governments. And besides, we have the IRS performing an “audit” function on those taxes.
The other “suspect” is PRODUCT (GDP).
The Bureau Of Economic Analysis is the Government Agency that assembles and reports on GDP and GDI. They produce the Preliminary GDP Report less than a month after the last calendar quarter, while GDI reports later.
It is a remarkable effort to publish PRODUCT (GDP) shortly after the end of the quarter. From personal experience, it is reporting results that quickly is a challenging task.
In their “Primer On The National INCOME And PRODUCT Accounts,” the BEA makes a similar point:
“A variety of data sources are used to estimate the NIPA measures. These data sources differ in availability, quality, coverage, and underlying definitions. Consequently, the timing of the release of estimates and subsequent revisions is based on the availability of these source data.”
BEA “NIPA Primer,” p.14.
Of course, data is often unavailable or, if available, is preliminary and will need to be revised later. And, as we’ve noted, this is more often the case with goods and services than with Income.
From a strictly operational perspective, it is only possible to account for some products and services produced. In its place, the BEA has sophisticated computer models, with reams of historical data, combined with current updates to help them make the most accurate estimate of GDP. But to meet the pressing need to publish results on time requires some estimation.
We come back to the COVID-19 pandemic. I’m speculating, but the models went off track during the lockdown. When the BEA projects the number of small businesses operating in the country, they must be more accurate. When these tiny shops were required to close, it was a permanent condition. They never re-opened.
That would explain why PRODUCT (GDP) is currently $345 Billion greater than INCOME (GDI).
Unfortunately, there is a bureaucratic bungle regarding the INCOME (GDI) Report. The BEA publishes PRODUCT (GDP) first, within a month of the quarter’s end. However, INCOME (GDI) will not be reported for several weeks, making it woefully outdated (the current release date still needs to be added to the BEA calendar). So it is very likely that the PRODUCT (GDP) Report of last week, which showed economic growth of 4.9%, is likely higher than what INCOME will reveal. INCOME (GDI) is currently running about one-third lower than PRODUCT (GDP).
So that economic “growth” that Wall Street is celebrating, and upon which the Federal Reserve may use to tighten monetary conditions, may, in INCOME terms, be dramatically overstated. Unfortunately, we won’t know for several weeks. We’ll have to wait until the BEA releases the INCOME (GDI)data sometime from now.
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