Journalists love numbers and every end of tax season they have a field day reporting a whole lot of data that in our minds should be the same thing, but aren’t. Why is income not equal to GDP per capita (per capita = per person)? What is the difference between income and wealth?
GDP represents everything that happens on an economic level in your country. It is the value of all products and services. Income, sadly, is the money workers earn. The gap between the two could be due to several things: businesses may not have paid the money out in income to their workers, but rather saved it or re-invested it, some money in your country is being sent abroad, etc.
The second reason is the measurement – refer back to the post about averages. GDP is an average (mean), whilst income is a median (the middle in a set of numbers – i.e. 50 % earned more and 50 % earned less). The reason why we don’t use the average (mean) on income, is because depending on where you live, Bezos, Arnault, Ambani and Jack Ma could make you look very rich when the reality is looking vastly different.
GDP is used in an economic sense and it is meant to give you a measure of productivity/value created. The math would look like this: GDP = private consumption +gross private investment + government investment + government spending + (exports-imports). This all sounds so confusing, so let’s look at the elements:
- Private consumption is simply all the money spent by consumers in the country to buy goods and services. (Sometimes economists refer to this as consumer expenditure.). Think of this of all the money the people spent – so everything from your rent to your groceries. (We see non-profit organizations as people, not companies, in this equation.)
- Gross private investment measures the amount of money that domestic businesses invest in their own country. These investments could be very different, company to company. It could include machinery, computers, perhaps a new factory, etc. If you are a landlord and you purchase a new property that you are planning to rent out, this will also be counted as gross private investment. It also includes companies replacing inventory. I think you are getting the idea here.
- Government spending and investment: Governments spend lots of money – they have to do something with all the tax they earned on all the stuff we bought! – and hopefully, if you have a good government, the money would spend on things that will make your country a better place for the people that live in it and would help economic growth. Government investment would include the money they spend on hospitals and schools, but also roads, railways and communication networks and infrastructure. So which is which? If the government spends the money on buying things that we are going to use today or to answer a specific need, it is consider spending. If the government does the same but for future use, it is considered an investment.
Think of all this as a food chain: You and I buy things and companies make more money and (hopefully) more profit. Part of their profits goes to government taxes and another part will be used to pay workers. When you earn more money, you buy more things – and so the circle continues.
So all the above sounds good – the more we buy, the higher salaries we will earn and the more we will be able to buy tomorrow. What a wonderful world. Not quite, because we have this funny thing called inflation. When inflation is high, people buy fewer things, companies make less profit, workers get retrenched or don’t get salary increases (but the prices of goods keep going up, so even if they are spending the same amount of money next year, they are buying fewer goods) and the circle goes in the other way.
Wealth considers the things you already have, as well as the obligations: Wealth = Everything I have (cash, savings, real estate, etc.) – debt. Effectively that means you could be wealthy but have no income. How often have you read about rich people worth billions that don’t pay taxes – and then the comparison about how much the normal man or woman in the street pay. Remember that they are not comparing apples with apples. When they refer to the rich person worth billions, they are referring to wealth, not income. However, when they do the comparison, they are pitting their wealth against your income – not the same thing.
Inequality is probably the biggest challenge we face across the globe. It is important to understand how things are put together. We cannot solve the problems of inequality if we don’t understand the workings and what would influence what. As long as the media, politicians and big business can confuse us, they can mislead us. When there is a mystery, there is margin – so we aim to have less mystery and less margin where appropriate.
There are no dumb questions when it comes to your money – or how your money (even in the form of taxes) are being spent.
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