Macro Roundup

New McKinsey report breaks down large firms in OECD countries three large takeaways, first their impact on GDP, “…The business sector overall contributes 72 percent of GDP in the OECD, and corporations with more than $1 billion in revenue account for an increasingly large share of that.Measured in real GDP per capita, the contribution of the business sector— defined as for-profit companies of all types including corporations, partnerships, and sole proprietorships—has tripled since 1960 on average in major OECD economies, in proportion with those economies’ overall growth. Companies underpin 85 percent of technology investment and 85 percent of labor productivity growth since 1995, a larger proportion than their GDP contribution. The size of the business sector varies only modestly within each of the major economies, and its share has remained steady for the past 60 years. However, this steadiness masks significant underlying shifts, notably the growth of corporations with more than $1 billion in revenue, which increased their global value added by 60 percent relative to their home countries’ GDP since 1995….”
Their breakdown of how value flows from large firms to households largely via labor income and consumer surplus, “…Economic value flows from companies to households via eight pathways, ofwhich labor income and consumer surplus are the largest direct pathways. Our mapping work identifies eight pathways through which economic value from corporations flows to households and the economy. Five are directly measurable monetary flows: labor income, capital income, taxes, investment in capital assets, and payments to suppliers. The money flowing through the supplier and investment pathways passes through other companies to reach households and the economy. The sixth is consumer surplus (the difference between what consumers are prepared to pay and what they do pay), which we estimate. The final two pathways are negative and positive spillovers, which we do not assess comprehensively beyond the examples of environmental impact and contributions to total factor productivity growth (unaccounted for in additional labor or capital input). Based on our data set of about 5,000 corporations with more than $1 billion in revenue,we find that labor income is the largest direct measured pathway, with wages and benefits accounting for $0.25 flowing to households for each dollar of revenue. Just over half of every dollar, $0.58, goes to suppliers (themselves companies large and small), reflecting the role suppliers play in enabling corporations to create and deliver their products and services. The other significant pathway is consumer surplus, which we estimate to be about $0.40 per dollar of revenue….”
How the pathways have changed overtime, “…The size of the pathways has changed over the past 25 years, with capital income growing while labor income and supplier payments have declined. Between the periods 1994-96 and 2016-18, the biggest change has been a two-thirds increase in the capital income pathway, from $0.04 to $0.07 per revenue dollar. Applied to the $40 trillion in revenue represented by our large company data set, this $0.03 difference amounts to an increase in capital income of over $1 trillion. The labor income pathway shrank by $0.02, or 6 percent, as labor per dollar of revenue fell by 15 percent and wages grew only 11 percent. Productivity gains amounted to 25 percent in real terms, significantly more than wage growth, as gains from labor productivity went predominantly to capital income. Investment in intangible assets tripled as a proportion of revenue in this period, while investment in tangible assets dropped by half. Supplier payments fell by $0.02, or 4 percent. The decline was especially steep for suppliers that were small and midsize enterprises, which saw a 10 percent drop in share of payments to suppliers in the United States, with similar patterns in other countries. The share going to domestic suppliers in each country also fell; about half of the decrease in supplier payments moved to foreign OECD suppliers and the other half to non-OECD suppliers. The tax pathway held steady overall as decreases in corporate taxes, especially in the United Kingdom and the United States, were offset by slight increases in production taxes, especially in Japan, and in corporate income tax in France….Decline in the share of the labor income pathway. Labor income from the corporations with annual revenue above $1 billion grew from just under $4 trillion to almost $10 trillion over the past 25 years (in 2018 dollars). However, this represents a lower share of the value that these companies add to the economy, as the labor portion of household income attributable to these corporations declined from 67 percent to 59 percent of the total.That difference is the equivalent of $1.2 trillion. This represents a steeper overall decline than domestic economies in the OECD generally. Japan saw the biggest decrease at more than ten percentage points, followed by Germany (five), the United States (four), and France (three). The United Kingdom saw a rise of four percentage points. A declining labor share puts pressure on incomes of lower-income households, who rely predominantly on income from wages for their livelihoods…. 5. Two diverging trends in the consumer surplus. On one hand, consumers in all household income segments have benefited substantially from the consumer surplus generated by large corporations, especially that from Technologists and Makers. The gains to consumers in OECD countries from these two company archetypes in our data set over the past 25 years amount to about $8 trillion in consumer surplus, compared with a scenario under which their prices of products and services stayed constant. On the other hand, price increases by Experts and Discoverers in our data set, especially for health and education services, correspond to more than $2 trillion in lost consumer surplus. This puts some of these essential services out of the reach of low-income households, at a time when the need for them has risen…”

McKinsey’s description

Approach 2: (Require time series variation in prices)

1. Assume price decrease is pure gain for consumers + additional gains because of more sales e.g. price falls from 5 to 4; assume consumers capture that whole dollar of value plus assume expanded sales because the price is now lower.
2. Use “hedonic price deflators” to adjust products for quality changes (really feature changes).
3. Bottom line - Consumer Surplus = (-1) * change in price * total quantity at new prices * quality adjustment …”

Ben Comment on McKinsey’s consumer surplus calculation: “A little bit of a black box but we can make some headway: Approach 1:

1. Assume firms and consumers split value equally
2. Look at firm's/industry’s value added and assume that this is the firm’s/industry’s portion of value (so consumer gets the same amount)
3. Adjust value added (therefore consumer surplus) “based on evidence of markups above factor costs.” Factor costs are estimated as the WACC (within firms or across industries).
4. Bottom line - looks like Consumer Surplus = price - WACC

So FRED uses the Penn World Tables For theirLabor Share,in 2019 US was.597 (in GDP at Current National Prices), in 2007 it stood at.604, down from.64 in 2001. McKinsey’s labor share number mirror that (This is from a2019McKinsey Note), not that 57% is likely lower than the 60% in the current report as the later looks only at large firms that are presumably more efficient than the broader economy.

Nick Gillespie, "3 Myths About American Decline," Reason, May 27, 2021, https://reason.com/video/2021/05/27/3-myths-about-american-decline/

3 Myths About American Decline

The American Enterprise Institute sociologist Scott Winship says that Americans are prone to believing "declension narratives," or stories about how the Golden Age ended sometime in the past and we have the bad luck to live in a world that is uniquely awful, unfair, and corrupt. Three of today's most prominent and influential declension narratives hold that we're having fewer children because they cost too much money, the rich have captured all the economic gains of the past several decades as income inequality has increased, and that economic mobility has effectively ended.

Winship says such stories are incomplete at best and completely false at worst. He finds that millennial women are more likely to hit their fertility goals than boomer women, strongly suggesting that having fewer children is a cultural choice, not an economic hardship. The Gini coefficient, which measures inequality, has stayed relatively flat since 1989, especially when after-tax transfers are taken into account. Over the same time period, the inflation-adjusted median household income has increased by about $25,000 even as poverty has declined. Contrary to scare stories about younger Americans doing worse than their parents, Winship finds that about 70 percent of 30-year-olds are doing better than their parents at the same age.

We though the new Mian/Straub/Sufi paper in today’s briefing would likely be something you would want to take a look at in more detail (note theEconomistalso wrote it in this week’s issue, link is also in briefing)

New Mian/Straub/Sufi makes an effort to estimate the sustainability of debt level/fiscal deficits in advanced economies. They argues there is a "Goldilocks zone" in which a State can run permanent deficits, in the case of the US it's, "...the United States’ Goldilocks zone has a maximum government debt to GDP ratio of 220%, at which point R rises above G; and a maximum permanent primary deficit of 2% of GDP obtained at the threshold debt level of 110% of GDP..."

However permanent deficits that it can turn dangerous if those deficits are used to"...address longer-run structural problems such as rising inequality and an aging population...."

Natural experiment provided by the Georgia Senate runoff, “…Our assumption in the calculation below is that the win by the two Democrats in the Georgia Senate election of January 5, 2021 increased the expected government debt by $2 trillion, which at the time was about 7.4% of total debt outstanding. Figure 13 shows the effect on the 10 year nominal interest rate, the 10 year TIPS interest rate, and expected inflation. As it shows the victory by the Democrats in the Georgia Senate election led to a 15 basis point immediate reaction which then declined to an 8 basis point reaction after a week. Taken together, these numbers imply that a 3.7% rise in total government debt outstanding relative to prior expectations led to an 8 basis point decline in G − R, which gives an estimate of ∂(G−R) ∂ log b of -0.022. The data for these calculations come from Bloomberg….”

What the US looks like though this lens, “…The calibration suggests that the permanent primary deficit that the United States can run is z = 2.0% of GDP; it can run that at a debt level of b z = 109% of GDP; and the debt level at which R rises above G is b = 218% of GDP. These numbers are interesting against the backdrop that US government debt currently stands at around 126% as of the fourth quarter of 2020.15 According to this calibration, any increase in debt above 109% of GDP would have to be met by increases in taxes going forward (even if R remains below G).Moreover, note that even if debt remained stable at 109%, this would only allow the US government to run a 2% permanent deficit. As of March 2021, the average projected annual primary fiscal deficit to GDP ratio by the CBO for 2021 to 2030 is 3.3%. For 2021 to 2050, it is 3.9%. If the large projected deficit of 2021 is excluded, then the averages are 2.7% and 3.7%, respectively…”

The Goldilocks zone, ">... The steady states with debt levels between b ZLB and b in Figure 2 are situated such that the interest rate R lies above zero—and hence the economy is above the ZLB—but is not so large that the economy needs to run a primary surplus, i.e. R < G. We refer to this set of steady states as the Goldilocks zone. The Goldilocks zone represents a region of the state space in which the economy successfully avoids the ZLB on the one side and fiscally unsustainable deficits on the other. The latter presumes that the economy is able to sustain a steady state with R ≤ G, or in other words, is able to close any primary deficit. In that case, the Goldilocks zone corresponds to a “conservative” region of the state space that achieves fiscal sustainability. Alternatively, if a maximum amount of tax revenue τ is known, that could be used to derive an upper bound of the primary surplus x − τ. That upper bound could then be used to describe the upper limit of the Goldilocks zone, in lieu of b..."

What it implies for debt being a "free lunch", "...A stronger version of the “free lunch” idea is that permanent increases in deficits do not require tax increases going forward, even if they lead to permanently greater (non-explosive) debt levels....under the assumption of a constant interest rate R and a constant growth rate G > R. bt = − (G − R) bt + z describes a stable differential equation for debt b. This implies that temporary increases in deficits of arbitrary magnitude, leading to greater debt levels, can always be grown out of over time. Also, a permanent increase in deficits by some ∆z simply raises steady state debt levels by ∆z/(G − R), with no need for a reduction in deficits, i.e. an increase in taxes, at any point. Both versions of the free lunch property are satisfied with exogenous R and G in (17)…”

R and G aren’t independent“…In our model, R and G are endogenous to fiscal policy, and this has important implications for whether a free lunch policy is possible. Boosting deficits leads to high debt levels, which raise interest rates because the convenience premium on government debt declines when the market is saturated. In contrast, excessively conservative fiscal policy leads to weak aggregate demand and nominal interest rates being trapped at the zero lower bound, depressing both real output and nominal growth G. As a result, the condition R < G can be violated either because debt levels are high and convenience premia low, or because debt is low with R pinned at zero and G falling below zero due to deflation. The endogeneity of R and G to government debt levels implies that a simple examination of the difference between the two at any given point in time is insufficient to understand whether a free lunch policy is possible or not……We focus in particular on three factors that are relevant for the Goldilocks zone: aggregate demand (as captured by discount rates), trend growth rates, and inequality….”

Core point, "...we find that a government can sustain a large debt to GDP ratio in the Goldilocks zone, the maximum permanent deficit that can be sustained is in the range of 2%, which is lower than most projections of expected future deficits for the United States. Furthermore, the Goldilocks zone is fragile; a rise in aggregate demand, a decline in trend growth, or a decline in inequality can lead to a shrinkage, or even a vanishing, of the zone....”