Is the Current Recovery a Pinata with No Candy Inside?

Many commentators would have us believe that the economy hit bottom in the second quarter of 2009, and afterward commenced a recovery, albeit a “jobless” one, as employment continued to decline. The main reason for believing in this recovery seems to be that real gross domestic product (GDP) reached a trough in the second quarter of 2009 and increased somewhat in the following two quarters.

Although macroeconomists, especially in theoretical work, tend to equate the economy’s aggregate output and its aggregate income, this equation does not hold when output is measured by GDP. To arrive at the concept known as national income (or net national product at factor cost), one must deduct several items, the most important of which is the capital consumption (or depreciation) allowance on the fixed capital stock. In 2008, for example, GDP was $14,441 billion, and national income was $12,635 billion. Even then, one has not arrived at personal income, and getting there requires several additional deductions. In 2008, personal income was estimated to be $12,239 billion.

Personal income includes the various “factor returns”―wages, salaries, rents, interest, dividends, and proprietors’ income―plus transfer payments that individuals receive from the government. All of these items together constitute the income available to individuals for use in purchasing consumption goods, paying taxes, and saving. Personal income is much superior to GDP as a measure whose variations tell us something about changes in people’s economic well-being as the economy ebbs and flows.

In the fourth quarter of 2007, which the National Bureau of Economic Research has identified as the peak of the previous business expansion, personal income was running at an annual rate of $12,100 billion, but it did not reach its own peak until the second quarter of 2008, when it was $12,293 billion. After three quarters of decline, it reached a trough in the first quarter of 2009 at $11,953, having fallen by 2.8 percent. Its rise during the final three quarters of last year brought it back to 99.3 percent of its previous quarterly peak and placed it within hailing distance of what on its face might appear to be a complete recovery.

Examining how the components of personal income have changed, however, we see that the recovery so far has been somewhat ambiguous, even apart from its “joblessness.” For example, private wages and salaries, which peaked in the third quarter of 2008 at $5,419 billion and then fell during the next three quarters to $5,129 billion, or by 5.4 percent, regained only a small fraction of their loss and ended the year at an annual rate of $5,179 billion, still 4.4 percent below their previous quarterly peak. It seems unlikely that the current shortfall will be eliminated within the next two years, even if the economy continues to recover steadily. Absent a turnaround in private employment, the prospects for a return to the previous high rate of wage and salary payments seem even less encouraging.

While private wage and salary income was falling, the disbursement of government wages and salaries was ascending. Between the fourth quarter of 2007 and the fourth quarter of 2009, such government payments (at an annual rate) increased from $1,106 billion to $1,189 billion, or by 7.5 percent in just two years. This increase is a development that most private workers can only lament, considering that their taxes (present and future) must fund such enriched largess for government hirelings to enjoy at a time when private labor earnings have fallen substantially.

Several smaller components of personal income also remain well below their levels in the fourth quarter of 2007. In the fourth quarter of 2009, proprietors’ income was still down by 3.3 percent, and interest-and-dividend income was down by almost 14 percent.

An exception to these patterns, however, pertains to personal rental income, which rose steadily after the first quarter of 2007 and ended up a whopping 137 percent higher in the fourth quarter of 2009. Most likely this oddity reflects many people’s shift from owner-occupied housing to rental housing as the ongoing real-estate bust caused them to lose the titles to their homes and, in most cases, required them to resort to rental housing―sometimes to rental of the same house they formerly owned. Although this incongruous occurrence may be good news for landlords, it cannot be taken as a good sign of recovery for the overall economy. On the contrary, it merely manifests a continuing adjustment to mistakes and foolish bets made during the housing boom, a process that still seems far from complete.

Another such troubling sign has to do with the flow of government transfer payments to individuals, which have increased greatly since the recession’s onset. In the fourth quarter of 2007, they were running at an annual rate of $1,721 billion; by the fourth quarter of 2009, they had reached $2,130, having risen by an astounding 24 percent in just two years. Of course, unemployment insurance payments (a subset of all government transfer payments to individuals) ballooned even faster, increasing from an annual rate of $34 billion in the fourth quarter of 2007 to $127 billion in the fourth quarter of 2009, or by 274 percent. In 2007 as a whole, total government transfers to individuals amounted to 14.2 percent of personal income; late in 2009, they constituted 17.5 percent. This rapidly growing dependence on the dole does not portend a healthy recovery. Indeed, it heralds the exacerbation of what was already a serious problem for the U.S. political economy.

In sum, when we disaggregate the recent increase in personal income, we find signs that the recovery has been weaker and less sustainable than many observers have taken it to be. Not all sources of personal income are created equal, and in the present circumstances, not even the rise in personal rental income counts as grounds for optimism. Because the recovery, such as it is, has begun only recently, it may acquire a healthier tone as it proceeds, if indeed it does. For the moment, however, we must recognize that recent changes give little warrant to the expectation of a full, sustainable recovery in the near term.

(Data discussed in this article come for the most part from Table B-29 of the statistical appendix to the 2010 Report of the President’s Council of Economic Advisers, pp. 365-366. A few items have been taken from other tables in this report. All dollar figures are given in nominal dollars. Between January 2008 and December 2009, the consumer price index increased by 2.3 percent, and between June and December 2009 it remained virtually unchanged, so correction for price inflation would have only a slight effect on the nominal dollar data for the period since the recession began.)