Business Investment Carries Recovery Forward, but Trade Deficit Grows More Worrisome
Business Investment Carries Recovery Forward, but Trade Deficit Grows More Worrisome
Analysis of Second Quarter GDP Growth Estimates
Business investment and consumption are still driving economic recovery, writes Christian E. Weller, but the trade deficit is a source of tension.
An important measure of economic performance is economic growth, particularly the quarterly change in gross domestic product. GDP is the sum of all new products that were made and sold in the United States minus U.S. imports in a given quarter. It shows whether consumers, businesses, the government, and foreigners are buying more U.S. made goods and services. More domestic sales mean more income for people in the United States, more sales and profits for businesses, and more revenue for the government. A faster expansion is a good foundation for higher living standards. It is the rising tide that could lift all boats.
How fast and how long the tide is rising will depend to some degree on policy interventions and their effect, at least in the context of the most severe recession since the Great Depression. The most relevant economic policy intervention for economic growth was last year’s stimulus—the American Recovery and Reinvestment Act of 2009. The Recovery Act made it easier for consumers, businesses, and the government to spend money in the middle of a struggling economy. And this support, if it worked, should show up in an expanding economy, indicated by growing GDP.
Private sector activities—consumption and investment—are particularly important. Short-term government spending is necessary in a recession to fill the hole left by the lack of consumption and investment, but it is not a sustainable way to boost economic growth over the medium term. The private sector has to take on that role of generating sustainable momentum. That’s why it is critically important to see expansions in business investment and consumer spending at this point.
And GDP growth estimates for the second quarter of 2010 released today from the Department of Commerce’s Bureau of Economic Analysis show some very encouraging signs in this context. The economy grew at an annual, inflation-adjusted rate of 2.4 percent in the second quarter of 2010 after expanding at a strong rate of 3.7 percent in the first quarter of 2010.* The second quarter GDP expansion was the fourth in a row, suggesting that the economic recession has been over for a year. The economy in the second quarter of 2010, though, was still $147 billion (in 2005 dollars) smaller than at the start of the recession at the end of 2007.
Private-sector momentum carries growth
Today’s data show that private sector activities—business investment and consumption—are in fact the driving force behind the continued economic expansion and strong enough to overcome losses to the economy from more imports.
Anybody interested in understanding whether the recovery will continue and possibly gain strength needs to take a close look at what private businesses are doing. Businesses will only spend more money on new office buildings, factories, and supplies if they expect that the economy will continue to expand and there will be more customers for their products in the future. Many investments, after all, are rather long-term propositions.
Businesses have been very profitable since the end of 2008. Corporate profits for nonfinancial firms, for instance, reached $210.1 billion in the first quarter of 2010—the last quarter for which data are available. Businesses initially seemed reluctant to spend their money, as witnessed by declining or flat business investment through the second quarter of 2009. But business investment has steadily gained momentum since then.
Business investment has grown for four quarters in a row—from the second quarter of 2009 to the second quarter of 2010—beginning with increased spending on equipment, such as computers, software, and trucks. This type of business spending increased by 21.9 percent in the second quarter of 2010, the fastest growth rate since the first quarter of 1998. At the same time, businesses started to invest in stockpiles in their warehouses, presumably in anticipation of future growth in new customers. Change in inventories explained 43.8 percent of the growth rate in the second quarter of 2010. And finally, private businesses started to invest commercial construction such as factories, mines, and office buildings. Business spending on such structures expanded by 5.2 percent in the second quarter of this year, marking the first growth in this sector since the second quarter of 2008. Business spending on all investment items is expanding, and it is happening at an accelerated rate in the case of equipment and structures.
The Bureau of Economic Analysis data released today holds another small nugget about business investment. The BEA takes a closer look every July at its calculations for GDP growth for the past three years and compares those to potentially new data that may have come in over the past 12 months, revising its estimates, if necessary. That was the case with today’s data release.
The BEA revised its estimates for business investment on structures, equipment, and inventories upward for the second quarter of 2009, which means that the business contribution to the recovery was stronger, following ARRA, than initially thought. This is very critical since consumption, housing, and state and local governments were weaker than initially expected. The fact that business spending has been stronger than originally thought, and that its momentum has steadily increased for the past year, bodes well for a continuing recovery that is carried forward by private companies.
Consumer spending is the other, important piece of the puzzle for a strong, sustained recovery that will help bring back millions of jobs. The basic economic logic of recovery first looks to business investment as the driving motor. That should translate into more jobs and more earnings, which in turn raises consumption spending, begetting more investment. Jobs are indeed coming back. Data from the Bureau of Labor Statistics shows that the private sector has added close to 600,000 jobs in 2010, after consistently losing jobs in 2009. Consumer spending consequently grew again, albeit at a comparatively slow pace of 1.6 percent in the second quarter of 2010. Most of the increase in the first quarter came from more spending on durable goods, particularly cars and furniture.
Consumers also accelerated their spending on new homes. This type of consumer spending expanded at a rate of 27.9 percent in the second quarter of 2010, the largest such expansion since the third quarter of 1983.
Yet the momentum in consumer spending will only last if there is a labor market recovery and if consumers feel confident in spending their money again. The additional consumption in the second quarter of 2010 was lower than gains in after-tax income may have suggested. The personal saving rate grew to 6.2 percent, down from 5.5 percent in the first quarter of 2010. This is the highest personal saving rate since the second quarter of 2009. But strong and durable consumer spending will ultimately come from more jobs and higher incomes.
Government spending at all levels contributed to growth. Federal government spending increased by 9.2 percent, and spending by state and local governments rose by 1.3 percent in the second quarter of 2010. This was the first growth of state and local government spending in a year. Much of the increase was driven by more investments in structures such as schools, and equipment such as computers and car parks.
But the momentum in state and local government spending may not last. The fiscal crisis in the states will, by all accounts, continue to linger for some years, dampening momentum in the recovery.
Imports become a larger concern
The economic expansion is not without its problems. Imports are the main trouble spot that emerges from the data. Imports are rising much faster than exports, siphoning money from the United States to overseas.
U.S. imports increased faster than U.S. exports in the first quarter. Imports grew at an eye-popping rate of 28.8 percent, compared to an export growth rate of 10.3 percent. The surge in imports reduced economic growth by 4 percentage points, which means that economic growth in the second quarter would have amounted to 6.4 percent if imports had been flat. This is the single largest reduction of economic growth by imports since the BEA collected these quarterly data in 1947.
Export growth is still strong, but the surge in imports is clearly troublesome. Businesses and consumers in other countries are still increasing their demand for U.S. made products, but U.S. businesses and consumers are upping their purchases of foreign-made products at an even faster rate.
The story of U.S. imports is not all that complicated, and it is directly related to struggles in the manufacturing sector. U.S. businesses are now operating in an expanding economy where other businesses and consumers demand more of their products. Domestic businesses thus need to ramp up production to meet that demand. They need more inputs for this added production, and they often turn to overseas suppliers for these. Imports of industrial supplies, for instance, increased by 20.2 percent in the second quarter, and imports of capital goods such as aircrafts and computers rose by 51.7 percent. The lack of domestic manufacturing capacity to supply these goods thus lowers the momentum for economic growth.
The other part of the trade deficit story is the continued dependence on oil imports. Petroleum imports surged by 67 percent in the second quarter of 2010. Increased diversification into alternative fuels, preferably domestically produced ones, and more investment into energy efficiency will ultimately help to reduce the trade deficit.
This is not just a short-term problem. The fact that U.S. imports are rising faster than U.S. exports also means that the United States still struggles with a comparatively high and rising trade deficit of 3.6 percent of GDP, up from 3.3 percent in the first quarter of this year. Large and rising trade deficits pose a long-term problem for the United States since they basically mean that the country consumes more than it produces, and this added consumption needs to be paid for by borrowing money overseas. This growing international debt burden will over time put a damper on U.S. economic growth since the economy needs to generate more and more money to repay that debt to overseas lenders.
Policy attention is necessary for trouble spots
The U.S. economy is moving forward with respectable momentum. The question is whether it will last. Policy has shown that the federal government can play a vital role in jump starting private-sector activities. Private business investment is actually accelerating at this point, and the hope is that this acceleration will translate into more hiring, more wages, and ultimately more consumption. Continued public policy attention is necessary to protect this momentum and generate a strong and durable recovery. This requires attention to three primary areas: personal incomes from a strong labor market recovery and continued support for the unemployed; manufacturing, for example through the promotion of green technologies; and addressing the fiscal crisis in the states.
Christian E. Weller is a Senior Fellow at the Center for American Progress and an Associate Professor for Public Policy and Public Affairs at the University of Massachusetts, Boston.
*All figures are annual inflation-adjusted data. Dollar figures are expressed in 2005 dollars. The year to which the dollar figures are tied has no influence on the calculation of the growth rate.
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Christian E. Weller