What is the propensity to consume by capital income? Well, for every dollar of capital income, roughly 18% is being spent on consumption. (15% effective tax rate, 67% savings rate)
What is the propensity to consume of labor income? Well, for every dollar of labor income, roughly 85% is being spent on consumption. (10% effective tax rate, 5% savings rate)
So, what does it mean in an economy with a real GDP around $16 trillion that labor share of income has fallen by 6.8% since 2007? Well, 6.8% of %16 trillion is $1.088 trillion. If that money was in the hands of labor income, $925 billion of it would be spent on consumption. However, that money is in the hands of capital income, so only $196 billion of it is spent on consumption.
The difference is $729 billion less being spent on consumption.
Brendan Greeley and Matthew Phillips at Bloomberg Businessweek tell us what the current shortfall in potential GDP is according to the 2007 CBO projections …
“The CBO’s own data show this as a current output gap of $754 billion.”
The fall in labor share looks to have accounted for almost all of the fall in potential output.
Update note: Real GDP is made up of consumption, net government spending, investment and net exports. Yet, total real GDP is split into labor share and capital share. Thus consumption, net government spending, investment and net exports are all contained within the split between labor and capital shares. An increase in capital share lowers consumption and is hopefully made up for in increased investment. Investment was $2.639 trillion in 1st quarter 2007 (real 2009 dollars). It was $2.656 trillion in 4th quarter 2013. An increase of $17 billion in real terms. So increased capital share did not lead to a significant increase in investment. The rich are richer, but real GDP has fallen.