Recovery Continues, but Weaknesses Remain
SOURCE: AP/Mark Lennihan
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. A rise in GDP therefore shows that consumers, businesses, the government, and foreigners are buying more goods and services that were made here. More domestic sales mean more income for people, more gains for businesses, and more revenue for the government. A faster expansion is a good foundation for better 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. The most relevant economic policy intervention was last year’s stimulus, the American Recovery and Reinvestment Act of 2009. The recovery bill 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. Particularly important are private sector activities—consumption and investment—rather than short-term government spending activities. 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 first quarter of 2010 from the Department of Commerce’s Bureau of Economic Analysis show some good signs. The economy grew at an annual inflation-adjusted rate of 3.2 percent in the first quarter of 2010 after expanding at a very strong rate of 5.6 percent in the fourth quarter of 2009.* The first quarter GDP expansion was the third one in a row, suggesting that the economic recession is likely over, although the labor market is still struggling to come out of it. The economy in the first quarter of 2010, though, was still $136.5 billion (in 2005 dollars) smaller than at the start of the recession at the end of 2007, which indicates that we still have a long way to go before we catch up to where we were before the recession.
Private sector momentum carries growth
Today’s data show that private sector activities—business investment and consumption—are in fact gaining momentum and driving the economy forward. Business investment and consumption were strong enough to overcome losses to the economy from more imports—goods made in other countries that U.S. entities spent their money on—and from a contraction of government spending at the state and local level.
Anybody interested in understanding whether the recovery will last has to take a close look at business investment. 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.
Business investment grew at 4.1 percent in the first quarter of 2010, explaining 11.8 percent of the total growth in the U.S. economy. The business investment expansion resulted from an increase of 13.4 percent in equipment investment—such as computers, software, and cars—which was sufficient to compensate for the 14.0 percent drop in spending on structures—such as office buildings, factories, and mines. Spending on new manufacturing sites in particular dropped by $8.9 billion in inflation-adjusted terms in the first quarter of 2010. This drop explained 71.7 percent of the total decrease in commercial real estate. Put differently, business investment would have been stronger with a stronger manufacturing expansion, a weakness that is related to rising imports.
Businesses also spent more money on restocking their warehouses. An important part of the recovery is businesses’ resurgent confidence. This confidence is often apparent in businesses building up their inventories. Private businesses in the United States added $31.1 billion to their inventories in the first quarter. This addition contributed substantially to the economic expansion, explaining 49.1 percent of total growth in the first quarter of 2010.
Add to this increased consumer spending, and the private sector recovery looks pretty good. Consumers spent 3.6 percent more in the first quarter of 2010 than they did in the fourth quarter of 2009. This was the largest jump in consumer spending since the first quarter of 2007. Most of the increase in the first quarter came from more spending on durable goods, particularly recreational goods and vehicles such as boats, and furniture.
Yet the momentum in consumer spending will only last if there is a labor market recovery. The additional consumption in the first quarter of 2010 came in part at the cost of fewer savings. The personal saving rate dropped to 3.1 percent, down from 3.9 percent at the end of 2009. This is the lowest personal saving rate since the third quarter of 2008. Consumer spending needs to be carried by increases in incomes from more jobs to be strong and durable, rather than unsustainable cuts in already low levels of saving.
Imports and state and local government spending emerge as trouble spots
The economic expansion is not without its problems. Two trouble spots clearly emerge from the data. Imports are rising faster than exports, thus siphoning money from the United States to overseas, and state and local governments are struggling with massive fiscal problems.
U.S. imports increased faster than U.S. exports in the first quarter. Imports grew at a rate of 8.9 percent, compared to an export growth rate of 5.8 percent. 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 inputs. Imports of industrial supplies, for instance, increased by 23.1 percent in the first quarter, and the imports of capital goods such as aircrafts and computers rose by 11.8 percent. The lack of domestic manufacturing capacity to supply these goods thus lowers the momentum for economic growth.
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 3.5 percent of GDP, up from 3.1 percent at the end of 2009. 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.
The second trouble spot for the U.S. economy is the fiscal crisis in state and local governments. Spending by state and local governments decreased by 3.8 percent in the first quarter of 2010. This was the largest decline since the second quarter of 1981. The U.S. economy would have grown by 3.7 percent in the first quarter of 2010 without the drop in state and local government spending. The fiscal crisis in the states will, by all accounts, continue to linger for some years, dampening private sector momentum in the recovery.
Policy attention 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. 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.
*All figures are annual inflation-adjusted data. Dollar figures are expressed in 2005 dollars.
Christian E. Weller is a Senior Fellow at the Center for American Progress and an associate professor in the Department of Public Policy and Public Affairs at the University of Massachusetts Boston.
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