The economy expanded at a remarkably strong rate of 3.4 percent in the second quarter of 2007, the largest since the first quarter of 2006, according to the advance estimate for the gross domestic product growth rate released by the Bureau of Economic Analysis today. This is a substantial improvement over the anemic growth rate of 0.6 percent in the first quarter. It’s also much needed good news since the BEA today revised its previous estimates of GDP growth for 2004, 2005, and 2006 downward. According to today’s figures, the economy grew on average 0.3 percentage points less each year during this three-year period than previously estimated.
The harbingers of today’s good news were a boost in trade fueled by rising exports and declining imports, and a continuously strong commercial construction sector that helped to offset the ongoing weakness in residential construction.
Yet not all was on the up and up in the second quarter. What has often been predicted now seems real: consumer spending is finally slowing down. Personal consumption grew at a rate of 1.3 percent in the second quarter of 2007, well below the rates of the previous few quarters and the smallest increase in consumption since the fourth quarter of 2005.
The weakness in consumer spending went hand in hand with further declines in residential real estate spending. Families spent 9.3 percent less on their own homes in the second quarter of 2007 than in the first quarter. While this is the sixth quarter of decline in residential real estate spending, it is also the smallest decline since the first quarter of 2006. All recent reports suggest that the housing weakness will continue for some time, but it may not continue the precipitous declines of the past few quarters if the trend reported today persists in the coming quarters.
A surprisingly strong showing in commercial construction also helped to offset the weakness in the residential real estate sector. Spending on commercial structures, such as manufacturing plants, office buildings, and hotels, increased by an annual rate of 22.1 percent in the second quarter, up from 6.4 percent in the first quarter. This is the fastest growth rate since the second quarter of 1994, 13 years ago. Commercial construction contributed 0.66 percentage points to the economic growth rate of the second quarter, whereas residential construction subtracted 0.49 percentage points. The very strong performance of commercial construction was thus sufficient to more than offset the drop in residential real estate.
Yet the strength of commercial construction seems to have come at the expense of falling prices. Prices for commercial structures were, on an annual basis, 0.6 percent lower in the second quarter than in the first quarter of this year—the first decline in prices in this sector since the second quarter of 2003. The obvious question here is if price declines are necessary to stimulate sales and if future growth in this sector depends on further price drops.
Business investment spending on equipment and software, however, expanded at a rate of 2.3 percent in the second quarter, up from 0.3 percent in the first quarter of this year.
Stronger business investment spending, especially on buildings, came along with a long awaited boost in international trade. The dollar has been declining against major currencies for several years, making U.S. exports more competitive in world markets, which also have been gaining strength, thus propelling exports forward. At the same time, imports have become more expensive in the wake of a falling dollar and thus less attractive for U.S. businesses and consumers.
Today’s economic growth figures reflect a substantial contribution from trade to economic growth. Exports grew at an annual rate of 6.4 percent, while imports fell by 2.6 percent. This is the first time in more than four years that imports dropped—the last time was the first quarter of 2003. The combination of rising exports and falling imports explains more than one-third of the economic growth rate in the second quarter of 2007. To be specific, 1.18 percentage points out of the total growth rate of 3.4 percent came from international trade; this was the largest absolute contribution to economic growth since the fourth quarter of 2006. Trade must therefore remain a strong contributor to economic growth in order for the economy to regain strength.
The danger is that higher oil imports in the wake of higher oil prices could dampen the positive impact of faster growth overseas and a weaker U.S. dollar in world markets. After all, in the second quarter of 2007, petroleum imports declined by a surprising 22.4 percent after increasing by 29.6 percent in the first quarter. With oil prices remaining high, petroleum imports could gain again and thus reduce the growth of international trade.
The economy was also helped by increased government spending, both at the federal and state and local levels. Federal spending increased by 6.7 percent in the second quarter after declining by 6.3 percent in the first quarter, mirroring a reversal in defense spending, which declined by 10.8 percent in the first quarter but grew by 9.5 percent in the second quarter. State and local government grew at a rate of 2.9 percent in the second quarter after expanding by 3.0 percent in the first quarter. Yet it is unclear if government spending will continue to be a strong contributor to economic growth in the coming quarters.
Right now the economy appears to be moving away from its old reliance on the American consumers and toward a more investment and export driven model. It is clearly too early to pop the champagne bottles since higher oil prices and lower commercial construction prices could dampen the positive momentum that emerged in the second quarter of 2007. But if business investment and international trade remain strong, the U.S. economy may be able to avoid the grim, predicted outcomes in the wake of the current housing crisis.