The personal saving rate, as reported by the BEA, dropped almost steadily during the 1990s from a peak of 8.7% in 1992 to only 2.3% in 2001; in some quarters, it was hardly above zero. Many managers, when hearing this figure, assume that it does not include the amounts set aside by individuals and their employers toward retirement plans, but that is incorrect. These deductions and contributions are included in the BEA measure of personal saving. How, then, could the personal saving rate be so low?
In fact there are several reasons for this apparent anomaly, but most of them are related to the understatement of personal income. That could occur for several reasons. During the 1990s, the sharp rise in the stock market generated realized capital gains that were much larger than usual, and presumably some of that additional income was spent. That boosted consumption but not personal income. However, when the stock market crumbled in 2000–2002, the personal saving rate did not rise at all except for the impact of the tax cut, so that could not have been the only reason.
As long as interest rates are declining, many people refinance their homes. That reduces their mortgage payments, hence freeing up more money to be spent on goods and services. Also, to the extent that people withdraw money based on the increased equity in their homes, that really is dissaving, and to a certain extent offsets the increase in saving stemming from contributions to pension plans. Indeed, home equity loans rose an average of continued
MANAGER’S BRIEFCASE (continued )
24% in both 2000 and 2001 and then advanced at an astounding 44% annual rate during the first seven months of 2002.
A third distinct possibility is that income is understated because of the underground economy, which is extremely difficult to measure accurately. However, even if that impact were significant, it probably did not cause the major decline in the personal saving rate during the 1990s.
Because personal saving is a residual, it is subject to wider error – and larger percentage revisions – than most of the other numbers in the NIPA. Thus it must be interpreted with even more caution than the other data.
Nonetheless, to the extent that the personal saving rate declines, there is a shift in the economy toward more consumption and less investment, ceteris paribus. For a while, during the 1990s, the gap was filled by an increase in government saving and net foreign saving. However, when the Federal government moved back into deficit and net foreign saving declined along with the weaker dollar, the investment gap became more visible. Thus to that extent it is important to recognize that a very low reported personal saving rate, whatever its empirical flaws, means either (a) the investment gap must be offset by higher saving elsewhere in the economy, or (b) investment will decline as a proportion of GDP, which will generally reduce the average long-term growth rate.
2.6 Value added by stages of production: an example
One of the key concepts necessary to understand the NIPA bookkeeping system is the value added at each stage of production. The total value added at each stage of production must be equal to factor payments at that stage of production. This insures that total aggregate demand is equal to total aggregate income, validating the double-entry bookkeeping framework on which the NIPA figures are built.
A simplified example of value added is shown for the production of an automo-bile, starting from the initial stages of production of raw materials to the finished product. This case assumes the car is produced and sold domestically, although it would undoubtedly have some imported components. If that were the case, the total value added – the total contribution to GDP – would be reduced by the amount paid for those imported components.
The importance of the concept of value added can be summarized as follows. To measure the total amount produced and the total income earned in any economy, we only want to count everything once. Excluding intermediate goods removes double counting. Also, the double-entry system of bookkeeping should insure that total income and total production are the same. This identity can also be checked by calculating the value added at each stage of production. The methodology could break down only if some items (such as the use of new technological services) were not counted at all, in which case income would grow faster than product. Even in this case, though, the lack of balance between demand and production would indicate that something is amiss. Finally, we note that the double-entry method of bookkeeping works only for current dollar amounts – nominal values. When constant prices are used, additional complications can arise.
Table 2.6
Aggregate Demand Aggregate Income
Stage I. Production of Basic Materials
Iron and steel 500 Rent and royalties 300
Plastics and chemicals 1,000 Labor costs 700
Semiconductor chips 500 Interest and depreciation 600
Total value added 2,000 Profits 400
Stage II. Manufacturing Parts
Cost from previous stage 2,000 Labor costs 600
Tires, battery, etc. 500 Rent 200
Electronics 1,000 Interest 400
Margin at this stage 1,500 Depreciation 800
Total price of parts 5,000 Profits 1,000
Stage III. Assembling the Motor Vehicle
Cost of parts 5,000
Value added 10,000 Wages and salaries 2,000
Healthcare and other benefits 1,200
Rent 400
Interest 600
Depreciation 1,500
Marketing costs 2,000∗
Profits 2,300
Stage IV. Selling to Final Consumer
Manufacturer’s price 15,000
Value added 1,000 Transportation costs 400∗
Distribution costs 400∗
Profits 200
Wholesale price 16,000
Retail margin 2,000 Labor costs (commissions) 500
Rent 300
Advertising 1,000∗
Dealer profit margin 200
9% sales tax 1,620 Indirect business tax 1,620
Retail price 19,620 Total value added 19,620
∗These are then split further into wages and salaries, rent, interest, depreciation, and profits. All profits are before deduction of income tax
2.7 Inclusions and exclusions in the NIPA data
So far, the description of the components of GDP and NI has been fairly straightfor-ward, with the possible exception of corporate profits. However, in several cases, the treatment of components of purchases and income are unexpected. We now turn to several key examples where definitions are not as obvious.
Transfer of Assets
Transfers of assets are not included in either GDP or NI. Individuals often talk about ‘‘investing’’ in the stock market. In terms of the NIPA figures, no investment has taken place; the only entry in GDP is the brokerage commission, which is part of consumption. If someone buys 100 shares of Microsoft, no additional goods or services have been created when that transaction occurs. The stock certificate – or electronic computer record – is merely transferred from one person to another. Even buying a new stock in an initial public offering is not investment in the NIPA sense.
Except for the brokerage commission, GDP does not change until the company issuing the new stock spends the money on new equipment or construction, in which case it is counted as investment.
Similarly, if someone buys a house – even a new one – the transaction is merely a transfer of assets. Construction activity is included in the NIPA figures as the house is being built, not when it is sold. The only parts of this transaction included in NIPA at the time of purchase are the brokerage commission, the cost of title insurance, and any transfer taxes, since these represent taxes or income to various factors of production.
The same logic applies when buying any other existing asset, such as a painting, coins, or stamps. When someone buys a used car, only the dealer margin and any applicable sales taxes are part of GDP. Only when a newly created asset is sold – such as a ‘‘collectible’’ from the Franklin Mint or similar institution – is the entire transaction part of GDP.
Barter and Similar Items
Only items bought and sold in the marketplace are included, not implicit items such as mowing one’s own lawn. Payment to a baby-sitter outside the immediate family is theoretically part of GDP (although often it is not recorded); if older children sit for the younger ones, it isn’t. Payments to maids or cleaning services are part of GDP; work done by the spousal partner who stays home and cleans the house is not. Technically, the value of bartered goods and services should also be included in taxable income, although few if any taxpayers follow that procedure, so these items rarely if ever are recorded in GDP.