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Here’s to hoping: wage, salary, and income gains

There are reasons to expect the second half of the year to be be stronger than the first. Here are two: (1) the rebound in industrial activity following supply chain disruptions, and (2) possible impetus to investment spending coming from the depreciation allowance that expires this year. These factors, though, are just dressing up what may be weak underlying demand. Why? Because without significant jobs growth, it’s unclear that we’ll see the wage, salary, and income generation needed for a healthy continuation of the deleveraging cycle.

On the bright side, the Q1 2011 Gross Domestic Income, GDI, report does show a smart rebound in wage and salary accruals. The problem is, that corporate profit growth, which generally leads wage and salary accruals growth, is slowing. (GDI is the income side of the BEA’s GDP release and you can download the data here.)


READ MORE AFTER THE JUMP!
The chart illustrates annual domestic profit and wage/salary growth spanning 1981 Q1 to 2011 Q1. The series are deflated by the GDP price index. Real domestic profit growth has been robust, peaking at 65% Yr/Yr in Q4 2009 and decelerating to 7% in Q1 2011. The surge in corporate profits brought real wage and salary accruals growth to a 2.1% annual pace in Q1 2011.

With higher input costs and slowing productivity gains, domestic profit margins are likely to be squeezed unless demand re-emerges smartly. The implication is that real wage and salary accruals growth may be nearing ‘as good as it gets’ territory during the aftermath of a balance sheet recession.

And labor’s losing it’s share of the pie. The chart below illustrates the various component contributions to annual gross domestic income growth. (the best that I could do on size vs. clarity – click to enlarge)

The data are quarterly data spanning 1981 Q1 to 2011 Q1 and deflated by the GDP price index. Wage and salary accruals have become a smaller part of income growth in the last decade. Spanning 1981-2000, the average contribution to income growth from wage and salary accruals was 1.5% (simple average), where that spanning the years 2001-current was just 0.3%. The average corporate profit contribution held firm over the same two periods, roughly 0.3%.

Growth momentum has slowed over the period, however, the deceleration in wage and salary contribution is quite striking. I can’t explain it even with the ‘demographic shift’; but this trend is likewise reflected in the employment to population ratio.

Wages, income, spending power, consumption, saving – they’re all different ways to say the same thing: earned income can be spent in one of three ways, on taxes, consumption, or saving. And in this recovery, saving via income gains is important as households further deleverage. We can’t afford compensationless expansion.

The key to growth in 2011 and 2012 is wages, salaries, and income – here’s to hoping.

Rebecca Wilder

Update: Spencer has a foreboding point in comments from my earlier post on GDP. He notes that inflation measured by the GDP deflator probably understates the impetus to domestic prices – domestic purchases is more appropriate at a 3.8% annual rate. The implication, according to Spencer via Email is, “If the inflation rate is really 3.8%, not 1.9 %, it strongly implies that the dominant cause of the economic weakness is higher inflation, not supply chain disruptions.”

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The other measure of income, GDI, shows faster growth and an oversized profit contribution

There are two measures of income: the spending side (Gross Domestic Product, or GDP) and the income side (Gross Domestic Income, GDI). I’d like to see what GDI is telling us about the Y/Y recovery, since it’s a better predictor of turning points, according to FRB economist Jeremy J. Nalewaik.

The chart illustrates the contribution to Y/Y GDI growth coming from each of the main income components. (Click to enlarge.)The series is deflated using the GDP deflator, since the BEA only releases the nominal numbers. All references to GDP and GDI below refer to the real series.

Observations I note:

1. The Y/Y growth rate of GDI surpassed that of GDP in Q2 2010, continuing into Q3 2010. In Q3 2010, GDI grew at a 3.6% annual clip, while GDP marked a lesser 3.2% rate. Don’t know what this means, exactly; but it could imply that the economy is expanding more rapidly than the GDP measure would suggest.

(more after the jump)

2. The Q3 2010 corporate profit contribution to annual income growth, 2.2%, is overwhelming that from wages and salary accruals (labor income), 0.73%. This oversized contribution is rather remarkable, given that domestic corporate profits are just 8% of GDI, while that of wages and salaries is 55%. This will probably even out, though, as history shows a more balanced contribution between profits and wages.

3. The chart illustrates the ‘stickiness’ of labor income. The corporate profit contribution turned negative in Q4 2006, while that of wages and accruals turned negative in Q3 2008. That’s a near 2-yr lag from profits to wages. Wages are recovering now; but there will be further quarters of weak wage growth relative to profits, as claims remain elevated above the 350k mark.

4. The contribution to GDI growth from net interest payments is in negative territory. Low rates are dragging this component.

5. Supplements to wages and salaries – government transfer payments like unemployment insurance, for example – contributed 0.3% to annual GDI growth in Q3 2010. Interesting thing about this, is that the average contribution spanning the 2000-2004 period, 0.5%, outweighs that during the 2005-2010 period, 0.14%. I say interesting because the labor decline was far deeper in this cycle compared to the previous cycle. (See Calculated Risk chart from 12.3.2010)

Overall, the GDI report implies that the economy may be improving more quickly than the GDP report suggests. There’s plenty of room for improvement in this picture, however, as the labor wages remain stuck in the mud with corporate profits strong.

Tomorrow we’ll see the Q4 2010 GDP report – consensus forecast is for 3.5% Q/Q SAAR.

Rebecca Wilder

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