Thursday, October 11

GDI and jobs: are we up for a 7% contraction in the economy

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.


  1. Not being trained in economics concepts, I'm confused as to why GDI and GDP are not the same. In fact this says that they should be:

    Is the difference just not the statistical difference between the two samples. Or is the equality somehow only true for a closed economy?

    (I guess I'm asking for a link/reference).

  2. Austin, an authoritative reference is the National Accounts Concepts and Methods document available from the ABS website. However, that is over 500 pages long!

    The story that is driving the difference shown here between real GDP and real GDI is not the GDP vs GDI difference, but rather the way in which they are both converted to constant dollars (the 'real' part). Real GDP is a measure of how much 'stuff' is produced by the economy. Real GDI is a measure of how much stuff can be purchased with the income arising from that production. The difference arises because much of this is purchased from other countries. So the difference is mainly about the falling price of imports relative to exports.

  3. Austin - this technical point is not my area of expertise, but I think there is a language issue here.

    What Wiki calls GDI, I would call GDP(I) (it is the income measure for GDP - one of the three identities that are used to measure GDP - the production measure, the income measure and the expenditure measure). In that sense, Wiki is right, GDP(I) it should be much the same as GDP [which in the initial Australian releases is an average of GDP(I), GDP(P) and GDP(E). In subsequent revisions the three Australian measures are standardised to one account and become equal]. While GDP(I) is real, it is not adjusted for terms of trade movements.

    What the ABS calls real gross domestic income, I think US Americans call: GDP (constant LCU), where LCU stands for local currency unit. Calculating GDP in constant LCU takes account of the terms of trade effects.

  4. GDP(E)and GDP(I) are not so much identities but methods. (E) uses expenditures, consumption, investment, government and net exports (exports minus imports). (I) measures wages, profits, taxes, and net foreign income. Theoretically they should come out at the same value but they don't. Real GDP, whether (I) or (E), should be about measuring volumes, not prices. That's why a deflator is always used when calculating Real GDP. The difference often lies in the standard price measure used, the terms of trade for instance. It may be that the ToT does not properly account for the compositional shift in relative prices for example.