The link between real GDP growth and personal income distribution

Quantitatively, real economic growth has been studied since Kuznets’ works on accounting of national income and aggregate factor inputs. Hodrick and Prescott (1980) introduced a concept of two-component economic growth – an economic trend and a deviation or business cycle component. The trend component is responsible for the long-term growth and defines economic efficiency. In the long run, the fluctuating component of economic growth has to have (by definition) a zero mean value. In 2004, Prescott and Kydland received a Nobel Prize for the study of "the driving forces behind business cycle" (Bank of Sweden, 2004), what demonstrates the importance of the best understanding of the processes of real growth and the explanation of the two-component behavior.
Prescott and Kydland, together with many other researchers, have proposed and studied exogenous shocks as the force driving fluctuations of the growth rate of real GDP. During the last 25 years, their research has revealed numerous features (potential links) of principal variables involved in the description of the economic growth. There are many problems left in the theory of real economic growth. We propose a model with real GDP growth dependent only on the change in a specific age cohort and the attained level of real GDP per capita. According to our model, real GDP per capita has a trend defined by a constant growth increment (not constant rate) and observed fluctuations can be explained by the change in some population component. In developed countries, real GDP per capita has to grow along a straight line, (i.e. with a constant annual increment) if no large change in corresponding specific age population is observed. The growth rate of real GDP per capita has to be an inverse function of the attained level of real GDP per capita with a potentially constant numerator for developed economies.
Chapter 2 is devoted to the validation of this model using GDP per capita and population data for some selected developed countries. Our principal purpose is to demonstrate the possibility to decompose GDP per capita growth into the two components. A comprehensive study of the US personal income distribution and detailed modeling of some important characteristics of the distribution is carried out in Chapter 1. The principal finding is that people, as economic agents producing (equivalent - earning) money, are distributed according to a fixed and hierarchical structure resulting in a very rigid response of the PID to any external disturbances including inflation and real economic growth. There is a predefined distribution of relative income, i.e. the portion of total population obtaining a given portion of total (real or nominal) income. In addition, every available position in the distribution is occupied by individual agents. A person occupying a given place may propagate to a position with a different income, but the vacant place must be filled by somebody. For example, in might be occupied by the person who was shifted from his old position. Only such an exchange of income positions in the PID, or more complicated change of positions with circular substitutes, is possible. This mechanism provides a dynamic equilibrium and the observed stable personal income distribution. As shown in §1.7, the measured PIDs in the USA corrected for the observed nominal Gross Personal Income growth rate has been showing a very stable shape since 1947 – the start year of corresponding measurements. This stability is interpreted as the existence of an almost stable relative income distribution hierarchy in American society, which might be evolving very slowly over time according to the long-term changes in age structure. This income (or economic) structure also predefines the evolution of real economy. Only specific characteristics of the population age distribution in the US are important for the growth rate of real GDP beyond the economic trend, as defined by the attained level of real GDP per capita. Here I would like to stress that inflation has no impact on real economic growth since no component of the model depends on it. In Chapter 1, the growth rate of per capita real GDP in the USA was used as an external parameter in prediction of the observed evolution of the PID, its components and derivatives. The PID has been expressed as a simple and predetermined function of GDP per capita and the age structure of the working age population in the USA. Now we are trying to interpret this relationship in the reverse direction. The observed PID is considered as a result of each and every individual effort to earn money (equivalent - to produce goods and services) in the economically structured society as exists in the USA. Thus, these individual money productions (earnings) aggregated over the US working age population are the inherent driving force of the observed economic development. As before, the working age means the age eligible to receive income, i.e. 15 years of age and above. In addition, this population effectively includes all retired people. The principal assumption made in Chapter 1 and retained in the current study is that GDP denominated in money is the sum of all personal incomes of all people. This approach not only formulates the income side of GDP definition but extends the Walrasian equilibrium to all people above 14 years of age, with income (with predefined distribution) being the only measure of the produced goods and services whatever they are. This statement unambiguously defines the upper limit to the total real income (Gross Domestic Income) or real GDP which can be produced by a population with a given age structure and characterized by some attained level of real GDP per capita. As the age structure is estimated by the US Census Bureau or enumerated in decennial censuses and individual incomes in the society are predefined by a strict relationship between age and per capita GDP, the total potential income growth (and accordingly the growth of real GDP) has to be also predefined. By definition, a person produces exactly the same amount of money (in form of goods and services) as s/he receives as income. This provides a global balance of income (earnings) and production, but also a more strict and important local balance. Economic structure of a developed economic society confines its possible evolution as everybody has an income place (position in corresponding PID) and produces according to this place.This approach also implies that there is no economic means to disturb the economic structure of such a society. For example, it is impossible to reduce poverty or to limit individual incomes of rich people compared to the level predefined by corresponding economic (income) structure itself. According to the PID observations in the USA, all positions of poor and rich people in the structure are always occupied. This might be not the case in other developed or developing countries. The extent to which the positions are occupied can be potentially linked to the degree of economic performance. Performance in a somewhat disturbed income structure would be likely reduced compared to its potential level only defined by per capita GDP and age structure. Thus, only some non-economic means is available to reduce poverty. A society can provide higher living standards, as associated with better quality of goods and services, but not higher incomes if it does not want to lose economic competitiveness. When applied, any economic means (income redistribution in favor of poorer people) has to result in economic underperformance. Another possibility is that some mechanisms out of control of economic and political authorities will return the PID to its original shape with the same number of poor people. Therefore, people with low incomes should be ultimately interested in those social and political developments which are associated with accelerating improvements in living standards. Paragraph 2.2 and 2.3 presents the model for real economic development. The fluctuating component is analyzed using data on real economic growth and population in the USA, Japan, France, and the UK. The trend component is studied using an extended set of developed countries since the fluctuations are practically canceled out in most of the countries during the period of the last 50 years. In fact, it is shown that these fluctuations are normally distributed, i.e. are likely the manifestation of a large number of stochastic processes. I am not going to present here conventional theories of economic growth. Interested readers can easily find appropriate sources of information. Personally, I do not find them quantitatively convincing and reliable. The RBC model, for example, separates the growth into two parts. One part is inherently theoretical and links numerous measurable and immeasurable variables by a finite number of calibrated equations. Among these variables is the growth rate of real GDP. The unexplained difference between actually observed growth and that predicted by the theoretical part is announced as induced by stochastic exogenous shock. In other words, the unexplained difference is attributed to the effects beyond control (stochastic) and understanding (related to some unknown forces). It does not look like a fruitful direction for any quantitative modeling. In spite we also separate real economic growth into two components, the growth is completely defined. Therefore our model can be verified by statistical and econometrical tools and is open for validation using additional data sets.