Sliding Incomes Threaten Consumer Spending

Employee compensation last quarter accounted for its smallest share of the gross domestic product since 1955 as growth in incomes slowed, raising the risk that consumer spending will slacken in the new year.

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Gross domestic income — the money earned by the people, businesses, and government agencies whose purchases go into calculating growth — rose at an annual rate of 2.8% in the April-September period after climbing 4.3% in the previous six months, according to the U.S. Department of Commerce.

In contrast, the portion of GDP accruing to corporate profits was its biggest since 1950 as companies hoard cash on concerns related to the European sovereign debt crisis and the deficit-reduction deadlock in Washington.

“Businesses are very cautious so they’re not hiring and they’re not distributing their profits to consumers as they had in past expansions,” said Michelle Meyer, a senior U.S. economist at Bank of America (NYSE:BAC) in New York. “With slow wage and salary growth, consumer spending will be on a sluggish trajectory.”

Consumer spending, which accounts for roughly 70% of the U.S. economy, rose just 0.1% in October following a 0.7% increase in the previous month, according to a Commerce Department report on Wednesday.

According to Tom Porcelli, chief U.S. economist at RBC Capital Markets Corp. in New York, a pickup in spending in the third quarter was the “worst possible outcome” since it was “entirely because of a draw down in savings.” In the July-September period, spending climbed 2.3% after a 0.7% increase in the previous three months.

The savings rate dropped to 3.8% in the third quarter, its lowest level since the fourth quarter of 2007, which marked the end of the last economic expansion. And that plunge in savings came after consumers experienced two consecutive quarterly declines in after-tax income, adjusted for inflation. Consumers are likely to work on rebuilding their nest eggs before the economy witnesses that kind of spending again.

Companies’ earnings climbed 2.1% last quarter to $1.98 trillion at an annual rate, making up 13% of the $15.1 trillion in gross domestic income — the most since 1950. At $8.25 trillion, employee compensation accounted for a 56-year low of 55%.

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While surges in earnings usually lead to more hiring and rising incomes, such has not been the case since the recession. Ken Mayland, president of ClearView Economics LLC, attributes the lack of job creation to companies’ discovery that they can “squeeze” productivity from the existing workforce and “a tremendous amount…of uncertainty coming from fear of higher costs, the regulatory and tax environment,” and the looming threat of Europe.