U.S. Department of the Treasury

By: Assistant Secretary for Economic Policy Ben Harris and Deputy Assistant Secretary for Macroeconomics Neil Mehrotra

One of the most important macroeconomic issues surrounds the current state of U.S. growth. Concerns about recession risks largely arise from the 1.6 percent decline in U.S. gross domestic product (GDP) last quarter, largely due to unique and technical factors, and the observation that tracking estimates suggest that GDP may have contracted in the second quarter. However, considerable evidence suggests that the economy is not currently in a recession, including persistent strength in the labor market, expanding industrial production, and alternative estimates of economic growth that suggest rapid expansion.

In this blog, we revisit one important piece of evidence that shows stronger growth for the U.S. economy – the continued divergence between gross domestic product and gross domestic income (GDI). As we detailed in our previous blog, gross domestic income shows a faster recovery in U.S. output over the pandemic, resulting in a historically large discrepancy between the two series. This divergence further widened in the first quarter of 2022, when real GDI increased while real GDP contracted. Available data for the second quarter suggests that this pattern may continue. The advance estimate for 2022Q2 GDP will be released later this week, on Thursday, July 28th, and will provide additional insight on the current state of the economy.

Understanding Last Quarter’s Divergence Between GDI and GDP

Last quarter’s divergence between GDP and GDI raises several important questions about underlying trends in the economy. Here, we discuss three: whether the data suggest productivity is rising or falling; whether falling GDP may be due to the nature of goods and services produced; and what alternative measures of output can tell us about growth.

An important implication of the macroeconomic growth data concerns trends in productivity. If American workers and businesses had become less productive, that should show up as lower income through some combination of lower wages or lower profits. As of the most recent revision, U.S. real GDP fell 1.6 percent (annualized rate) in the first quarter of 2021 despite adding 1.7 million jobs. Taken at face value, this suggests a sharp decline in labor productivity – where U.S. corporations and firms produced less goods and services despite having more Americans working.

However, the data on gross domestic income does not bear that out for the first quarter. While corporate profits fell in the first quarter, this decrease was virtually entirely due to a decline in profits from financial firms, as non-financial corporate profits remained flat. At the same time, other business income grew modestly, and labor income surged over 11 percent (annualized rate).^[1] Gains in labor income were more modest once adjusted for inflation, but remained positive, accounting for the strong 1.8 percent growth in real GDI. The combination of rising wages, rising industrial production, and high non-financial corporate profits are not suggestive of a sharp decline in productivity.

We now turn to the question of whether falling GDP may be due to the type of goods and services produced. An important observation here is that, in addition to rising GDI, the first quarter saw an increase in real gross output of 2.0 percent (annualized rate). Relative to GDP, gross output is a broader measure of economic activity in that it not only includes “final” goods and services produced, but “intermediate” goods and services as well. An example of intermediate goods would be the parts produced by an auto manufacturer that would ultimately go into a new car. To avoid double counting the creation of value, GDP counts only the value of the car itself and not the parts used to construct it.

The fact that real gross output grew in the first quarter helps reconcile the observed gain in employment; more workers did indeed produce more “stuff.” Rather, the Bureau of Economic Analysis (BEA) finds that more of gross output went to intermediate goods rather than final goods. Put another way, the U.S. economy produced fewer final goods but more intermediate goods, which should eventually beget more future final goods.

It is possible that the gross output data points to a decline in productivity as more intermediate goods were required to produce less final output. However, timing issues may be leading to discrepancies between gross output, GDP, and GDI. The surge in intermediate goods in the gross output data along with a sharp rise in imports in the month of March may reflect difficulties in tracking goods due to a strained supply chain. For example, if an imported consumer good is finally brought ashore and counted by customs but has not yet reached a wholesaler or retailer, the negative contribution to GDP will be recorded but the offsetting positive contribution to inventories is not.

Lastly in this section, we turn to the question of alternative measures of output. As noted in our previous blog, the simple average of GDP and GDI provides a rule of thumb to infer the true rate of economic growth. This gross domestic output (GDO) – the average of GDI and GDP – grew at just 0.1 percent in the first quarter. However, there may be a better way to extract underlying output growth from noisy indicators like GDP and GDI.

A sophisticated measure of growth, termed GDPplus, suggests even stronger growth in the first quarter of 2022. GDPplus was created by economists at the Federal Reserve Bank of Philadelphia to tease out measurement errors by attempting to extract the true underlying level of growth using both GDP and GDI as imperfect measures of growth and how measurement errors in each of these series are typically revised over time.^[2] GDPplus grew at 2.7 percent in the first quarter – faster than GDP, GDI, and gross output.

Income Growth in the Second Quarter

The divergence between GDI and GDP in the first quarter may continue into the second quarter as the expansion in GDI is expected to continue. While the first estimate for GDP for 2022Q2 will be released later this week, the first estimate for GDI for the quarter is only available in at the end of August. However, some of the series that go into GDI are already available or will be released along with the advance estimate for GDP. As the table below shows, estimates suggest continued positive growth for those categories of income.