Compound loss upon compound loss

You've heard of compound interest: You get interest on your money, plus you get interest on the interest. Gosh! Debtors are remarkably generous to creditors. What a lovely world this must be.

My topic here is compound loss: It works like compound interest, but in the other direction: Less instead of more, and less on top of less. It isn't about the money we get. It's about the money we don't get.

You've heard of "Potential GDP". Brookings defines it as

an estimate of the value of the output that the economy would have produced if labor and capital had been employed at their maximum sustainable rates—that is, rates that are consistent with steady growth and stable inflation.

Note, however, that "maximum sustainable" employment does not mean we all have to work 80 hours a week. I have seen people say "economic equilibrium" occurs when no one wants to change the existing conditions. No one wants more profit, for example, and no one wants to work less hours. That concept probably applies to Potential GDP.

Whatever. I just call it "best-case GDP". Here is the graph:

Graph #1: Potential GDP

It goes up. The graph shows a pretty smooth upward curve, except it goes up faster than usual in the latter 1990s.

Here's the same data, shown as "Percent Change from Year Ago" values:

Graph #2: High on the Left, Low on the Right: Potential GDP Growth is Slowing!

To my eye, two things stand out on this graph. One is that conehead-looking high spot in the latter 1990s. That's how the good years of the latter 1990s look, when you look at Potential GDP growth.

The other thing that stands out on this graph is the strong downhill trend. Except during the latter 1990s, it is all downhill from start to finish: From above 5 percent annual growth in the early 1950s, to above 4 percent in the 1960s, to 2 percent or less in recent (and future) years. Best-case GDP is not as good as it was 50, 60, 70 years ago.

You might think economists would spend their lives studying the latter 1990s to learn everything they could learn about those years, so as to duplicate that high-performance era and, well, avoid that wide gray recession bar and the lower-than-usual low that came a decade after the conehead high. That's pretty much what I do. Study the economy. Not economics, but the economy. This, my hobby. This, my life.

 

Here is a graph of Real GDP as a percent of Potential GDP:

Graph #3: It goes up and down, but the overall trend is down.
In other words, GDP is growing even more slowly than Potential GDP.

Real GDP is sometimes higher, sometimes lower than Potential. But the overall trend is down: As time goes by, Real GDP comes out to be less and less of Potential GDP. The growth of Potential, today, is half what it was in the 1960s, and Real GDP cannot even keep up with that. This is compound loss.

A linear trend line on this data in Excel shows Real GDP growth close to 1 percent faster than Potential GDP growth in the early years. In recent years, Real GDP growth is almost 2 percent slower than Potential. This relatively small loss means Real GDP growth has slowed 2.58 percent more than Potential GDP growth, which has fallen by 50 percent since the 1960s.

GDP is a measure of income. The slowing growth of Potential GDP is the slowing growth of best-case income. Best-case income growth today is half what it was in the 1960s. Real GDP growth cannot even keep up with that. And Real GDP growth is Real Income growth. 

As time goes by, we get less and less of the income we would have in a "best-case" world. The income growth in our less-than-perfect world decreases even faster than the income growth of our best-case world. This is compound loss.

And speaking of income, the next graph shows Compensation of Employees as a percent of GDP. Remember, Potential GDP growth is slowing, and GDP growth is slowing even faster. But on this graph, employee compensation has fallen rapidly as a share of GDP, for more than half a century:

Graph #4: Employee Compensation: Wages, Salaries, and Benefits as a Percent of GDP

From a high of 58 percent of GDP in 1970, it is all downhill to less than 52 percent today. Well there is the one big increase there, in the latter 1990s. But it did come back down right quick. 

We're getting paid 6 percent less of GDP now than we got in 1970. And GDP doesn't keep up with Potential GDP. And Potential GDP is growing at half the rate it was growing in the 1960s. We are dealing here with compound loss upon compound loss.