A Tepid Quarter for GDP

Thursday morning brought the first official look at GDP growth in the first quarter. Headline growth was a disappointing, if not surprising, 1.8%.

Here’s my usual graph of how various components of the economy contributed to overall growth:

Consumers continued to spend at a moderate pace; their spending grew at a 2.7% rate, thus adding 1.9 percentage points to overall growth. Equipment and software investment (up at a 12.6% rate), inventories, and exports also contributed to growth.

Residential investment fell back into negative territory, reflecting the latest down leg in the housing market. But the real negatives were structures (down at a 21.7% rate, thus cutting 0.6 percentage points from growth) and government (down at a 5.2% rate). Defense spending fell sharply (11.7% rate), and state and local continued its decline (down at a 3.3% rate).

Note: As usual, imports subtracted from growth as conventionally measured. As discussed in this post and this post, I’d like to see GDP contributions data that allocate imports across the other sectors. Such data would reveal, for example, how much consumer spending contributed to growth in the U.S. economy itself. Presumably it’s less than the 1.9 percentage points shown in the chart, which reflects consumer spending that was satisfied by both domestic and international production, but we don’t know by how much.

Another Tepid Quarter for GDP

BEA released its first estimates for third-quarter GDP yesterday. Headline growth was a disappointing, if not surprising, 2.0%.

Here’s my usual graph of how various components of the economy contributed to overall growth:

Housing fell back into the red, while non-residential structures eked out a small gain. Consumers continued to spend at a moderate pace (consumer spending grew at a 2.6% rate, thus adding 1.8 percentage points to growth). But the big stories were the continued boost from inventories, and the continued drag (in GDP-accounting terms) from imports.

The pessimistic take on inventories (see, for example, this tweet from Nouriel Roubini) is that the third quarter build up was unintentional, and thus is bearish for fourth quarter growth. The optimistic take, I suppose, is that maybe businesses see stronger demand ahead. But that feels rather, er, speculative.

For my usual set of caveats about the import figures (and, therefore, all of these figures), see my last post on the GDP numbers.

Further Signs of a Slowdown

As expected, BEA’s second stab at GDP growth for the second quarter was even less inspiring than the first. Headline growth was a tepid 1.6%, down from the 2.4% previously reported. Consumer spending and business spending on equipment and software were actually stronger than earlier estimates, but business structures, inventories, and exports all weakened, while imports (which deduct from GDP the way BEA calculates it) grew faster than previously expected.

Last month I pointed out one, small silver lining in the original GDP report: every major category of demand had increased. That is still true in the revised data, although structures just squeaked by with a miniscule 0.01 percentage point contribution to overall growth:

Investment showed particular strength. Business investment in equipment and software (E&S) grew at a 25% pace, thus adding about 1.5 percentage points to overall GDP growth. Boosted by the end (hopefully permanent) of the new homebuyer tax credit, housing investment grew at a bubble-like 27% pace (adding about 0.6 percentage points to GDP).

Despite solid growth in disposable incomes–up 4.4% adjusted for inflation–consumer spending grew at only a 2.0% pace.  As a result, the saving rate increased to 6.1%, compared with 5.5% in the first quarter.

And then there are imports. As I’ve discussed before, BEA calculates GDP by adding up all the components of demand for U.S. products–consumers, businesses, governments, and export markets–and then subtracting the portion of that demand that is supplied by imports. That means that any growth in imports appears as though it subtracts from overall economic growth.

That happened in a big way in the second quarter. Imports grew at a brisk 32% pace, thus subtracting (using BEA’s accounting approach) 4.5 percentage points from overall growth. Which is why all those blue bars in the graph net out to only 1.6% GDP growth.

I should also note that BEA’s calculation of contributions to GDP growth, which I graphed above, is subject to the same criticism that I’ve leveled at the claim that consumer spending is 70% of the economy. In a perfect world, an appropriate share of the imports (the red bar) would be netted against each of the components of demand (the blue bars). The result would be a graph of contributions that would truly illustrate how much each category of demand actually contributed to U.S. GDP growth. I hope to take a crack at that in the future (but I said that last month, too).

We’re Still #1 (Unfortunately)

The Bureau of Economic Analysis rewrote history on Friday. Along with GDP data for the second quarter, BEA also published revisions to its GDP estimates since the start of 2007.

Bottom line: The recession was worse than originally thought. The economy contracted by 4.1% from peak to trough (Q2 2008 to Q2 2009), up from the 3.9% previously estimated.

The Great Recession has thus solidified its position as the worst downturn since World War II:

As painful as it has been, the recession remains a far cry from the Great Depression, when economic activity plummeted almost 27%:

Which raises an important question: Just how close did the Great Recession get to being the Great Depression 2.0?

Mark Zandi and Alan Blinder took a crack at that question in a paper released last week.  Their answer: If it weren’t for aggressive monetary and fiscal policy responses, the U.S. economy would have contracted more than 12% during 2008, 2009, and 2010 — about half a Great Depression (and arithmetically, but not economically, comparable to the demobilization after WW II).

A Silver Lining in Second Quarter GDP?

Last Friday the Bureau of Economic Analysis released its first look at GDP growth in the second quarter. BEA estimates that the economy grew at a moderate 2.4% annual pace in the quarter, notably slower than the 3.7% pace in the first quarter and the 5.0% pace in the fourth quarter of 2009 (both those figures were revised in this release).

As usual, I think it’s helpful to break down economic growth into its key components. The following chart illustrates how much various types of economic activity contributed to (or subtracted from) second quarter growth:

The chart illustrates the silver lining in an otherwise tepid GDP report: every major category of domestic demand expanded in the second quarter. Consumers, businesses, export markets, and governments all increased their purchases. That’s a good sign. Indeed, you have to go back more than five years, to the first quarter of 2005, for the last time that happened.

Investment showed particular strength. Business investment in equipment and software (E&S) grew at a 22% pace, thus adding about 1.4 percentage points to overall GDP growth. Boosted by the end (hopefully permanent) of the new homebuyer tax credit, housing investment grew at a bubble-like 28% pace (adding about 0.6 percentage points to GDP). And business investment in new structures recorded its first gain in two years

Despite solid growth in disposable incomes–up 4.4% adjusted for inflation–consumer spending grew at only a 1.6% pace.  As a result, the saving rate increased to 6.2%, compared with 5.5% in the first quarter.

And then there are imports. As I’ve discussed before, BEA calculates GDP by adding up all the components of demand for U.S. products–consumers, businesses, governments, and export markets–and then subtracting the portion of that demand that is supplied by imports. That means that any growth in imports appears as though it subtracts from overall economic growth.

That’s what happened in the second quarter. Imports grew at a brisk 29% pace, thus subtracting (using BEA’s accounting approach) 4.0 percentage points from overall growth. Which is why all those blue bars in the graph net out to only 2.4% growth in GDP.

I should hasten to add that this does not actually mean that imports are bad for growth. The big red bar is an accounting convention, not a measure of economic impact. Indeed, many imports are essential to our economy, at least in the foreseeable future (think oil for transportation and coffee for Starbucks).

I should also note that BEA’s calculation of contributions to GDP growth, which I graphed above, is subject to the same criticism that I’ve leveled at the claim that consumer spending is 70% of the economy. In a perfect world, an appropriate share of the imports (the red bar) would be netted against each of the components of demand (the blue bars). The result would be a graph of contributions that would truly illustrate how much each category of demand actually contributed to U.S. GDP growth. I will take a crack at that in the future.

Consumer Spending is 60% of the Economy, not 70%

Early Friday, the Bureau of Economic Analysis released its third look at economic growth in the first quarter. The results were disappointing: BEA now estimates that Q1 growth was only 2.7%, down from the prior estimate of 3.0%. A key reason: consumer spending was weaker than previously thought.

As I noted in May, the monthly release of GDP data is inevitably followed by commentators claiming that “consumer spending makes up 70% of the U.S. economy” (see, for example, here). Unfortunately, that isn’t right. Consumer spending appears to be about 70% of the economy based on a seemingly obvious calculation (consumer spending divided by GDP), but that ignores the way that macroeconomic accounting handles imports. For reasons detailed in my earlier post, careful analysis suggests that the actual ratio is about 60%.

One reason the 70% error is so common is that doing the correct calculation requires a great deal of work; for example, you need to estimate the fraction of consumer purchases that come from imports. If we want commentators to start using the right figure, we need an easier way to get the idea across using the information reported in the headline GDP release.

Here’s one idea: Compare consumer spending to a measure of overall demand. To do so, we start with the usual macroeconomic identity:

GDP = C + I + G + X – M,

which says that GDP equals Consumer spending, Investment, Government spending, and eXports minus iMports (which are subtracted to avoid double-counting). Looking at this identity, you see that C, I, G, and X can be viewed as measures of demand from consumers, businesses, governments, and overseas markets, while M is a measure of supply from overseas producers.

To get a more reasonable measure of the importance of consumer spending, we can calculate what share of “overall demand” (C + I + G + X) comes from consumers. As shown in the chart, that measure (in red) has been roughly 60% for decades. The usual, misleading measure of consumer spending’s importance (in blue), however, has been up around 70% over the past decade, but used to be lower back when imports were smaller.

The C / (C + I + G + X) measure of consumer spending’s importance is hardly exact. For example, it doesn’t consider how much consumer spending actually comes from imports. However, it’s the simplest measure I could think of that comes close to the right answer. But maybe readers have an even better idea?

P.S. Thanks to Cornelia Strawser for helpful discussion of this measurement challenge.

Consumer Spending is Not 70% of the Economy

Journalists, commentators, and economists often say that consumer spending makes up 70% of the U.S. economy. Indeed, it’s easy to find several examples of that claim in today’s coverage of the latest GDP data (e.g., here). And, full confession, I’ve used that phrase a few times myself.

There’s just one problem with the 70% claim: it’s wrong. Consumer spending actually makes up only 60% of the economy.

This discrepancy exists because national income accounting doesn’t always mix well with simple arithmetic. If you look at data for 2009, you will find that consumer spending totaled $10.1 trillion, while GDP was $14.3 trillion, both measured in current dollars. Put those together, and it appears that consumer spending is about 71% of the economy (= 10.1 / 14.3). (You get almost the exact same percentage if you do the calculation with real values, but that introduces other complexities.)

That calculation is so simple, it’s easy to understand why it has a fan club. But there’s a hidden problem. To see it, it helps to do the same calculation for other parts of the economy. Again using current dollar figures for 2009, you will find the following:

     Consumer Spending            71%
     Investment                            12%
     Government                          21%
     Exports                                    11%

Notice anything strange? If you add these four sectors of the economy together, you discover that they account for 114% of GDP. In other words, consumer spending, investment, government spending, and exports, when combined, are one-seventh larger than the total economy.

This apparent paradox—the components of the economy are bigger than the economy itself—is resolved when you consider how the economic data handle imports. In order to determine gross domestic production, the statisticians add up domestic purchases and then subtract imports. So the full national income accounts for 2009 show the following shares of the economy:

     Consumer Spending           71%
     Investment                            12%
     Government                          21%
     Exports                                    11%
     Imports                                 -14%

These figures add to 100%, as they should. They also demonstrate why consumer spending was not really 71% of the U.S. economy in 2009. Total consumer spending was indeed 71% of the size of the economy, but part of that spending went to imported goods (clothes, coffee, cars, etc.). If you want to know how much consumers contributed to U.S. GDP, you need to take the 71% figure and then deduct the portion that was spent on imports.

I am not aware of a simple way to do this calculation using the data in the regular GDP reports. Over at Mandel on Innovation and Growth, however, Michael Mandel provides a useful discussion of a paper that does this calculation for several recent years, including 2008. (Michael deserves credit for taking a leading role in fighting back against the claim that consumers are 70% of the economy.)

The paper, “Induced Consumption: Its Impact on Gross Domestic Product (GDP) and Employment” by Carl Chentrens and Art Andreassen (you can find it in this conference proceeding) makes exactly the import adjustment I described above. For 2008, it concludes that the relative shares are as follows

                                        Unadjusted                   Adjusted

Consumer Spending           71%                           61%
Investment                            14%                           11%
Government                         20%                           17%
Exports                                   12%                            11%
Imports                                 -17%

The authors find similar results in previous years, including 1999, 2002, and 2006.

Bottom line: Consumer spending really makes up about 60% of the U.S. economy. But you’d be hard-pressed to know that from the usual GDP data.

Note: The authors make a second adjustment for “induced activity”, that Michael Mandel also picks up on. That makes the consumer share seem even smaller. I have serious reservations about that adjustment, however, particularly when trying to answer questions about (a) the overall size and composition of the economy and (b) its long-term growth. Thus, I favor the 60% figure.

Consumers Boosted GDP in Q1

The Bureau of Economic Analysis released its first look at Q1 GDP growth this morning. BEA estimates that GDP grew at a solid 3.2% annual pace in the first quarter. That’s slower than the 5.6% pace of the previous quarter, but is otherwise the strongest showing since the third quarter of 2007.

The following chart illustrates how much various types of economic activity added to (or subtracted from) first quarter growth:

The big story is the return of the American consumer. Their spending increased at a 3.6% pace during the first quarter, the fastest pace in three years. (Consumer spending added 2.6 percentage points to overall growth because it makes up about 70% of the economy).

Business investment in equipment and software (E&S) showed continued strength, rising at a 13.4% pace (and adding 0.8 percentage points to overall growth). That’s down from the blistering 19% recorded in the fourth quarter, but is still remarkably strong.

Inventories–the big story in Q4–continued to boost growth as well. Inventories actually increased in the first quarter, after seven quarters of declines.

On the downside, construction continued to suffer, with both housing and non-residential structures declining. Government spending fell as well, as reduced spending by state and local governments more than offset a moderate increase in purchases by the federal government.

Inventories Still the Growth Story in Q4

The Bureau of Economic Analysis has released its third look at the economy in the fourth quarter of 2009. The economy grew rapidly in the quarter, but slightly less than previously reported: the new estimate is a 5.6% pace of real GDP growth vs. 5.9% in the prior estimate.

As usual, I think the best way to understand this report is to see what sectors contributed the most or least to reported growth:

Almost two-thirds of the growth reflects businesses restocking their shelves and warehouses slowing the rate at which they were working down inventories; the change in inventory investment accounted for 3.8 percentage points of the overall 5.9% of growth. (Updated: 3/31/10)

Consumer spending grew at a modest 1.6% pace and thus added 1.2 percentage points to overall growth (consumer spending accounts for about 70% of the economy and 70% x 1.6% = 1.2%, allowing for some rounding). That’s down from the previous quarter, when cash-for-clunkers boosted car purchases. Housing investment also slowed, again in the wake of earlier efforts–the tax credit for new home buyers–that had boosted growth in the third quarter.

Business investment in equipment and software showed signs of life, growing at a healthy 19% pace. That added 1.1 percentage points to growth, more than half of which was offset by the ongoing decline in non-residential construction.

Government spending fell slightly during the quarter. Stimulus efforts boosted non-defense spending by the federal government, but that increase was more than offset by a decline in defense spending and in state and local spending.

The Legacy of the Economic Crisis

In its recent Going for Growth report, the OECD concludes that the economic and financial crisis will leave an unwelcome legacy: a permanent reduction in economic activity. This loss averages about 3% of potential GDP across the 20 member countries for which the OECD was able to make these estimates.

As the following chart shows, those losses differ greatly across countries:

Ireland and Spain are the clear losers, with the crisis cutting economic activity by more than 10%. Despite being a catalyst for much (but by no means all) of the crisis, the United States faces one of the smallest losses. The 2.4% reduction in potential U.S. GDP is a sobering hit, but is less than that faced by 16 of the other nations.

Why does the United States appear to be on track for comparatively moderate output losses? Continue reading “The Legacy of the Economic Crisis”