Today’s release of the latest economic growth figures show that our economy is demonstrably on the mend, but the strength of the recovery remains to be seen. Gross domestic product grew at an annual rate of 2 percent between July and September this year, powered by business investment and consumption, the largest driving force behind continued economic expansion and strong enough to overcome less spending on real estate by households. Third quarter GDP growth accelerated slightly from the 1.7 percent increase in the second quarter of 2010
The quarterly change in GDP, the sum of all new products that were produced in the United States minus U.S. imports in a given quarter, is a crucial indicator of the economy’s strength. It shows whether consumers, businesses, the government, and foreigners are buying more U.S.-made goods and services. More domestic production can ultimately 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.
Economic policy will play some role in determining the strength of economic growth, especially in the current situation, where the economy and the labor market are trying to recover from the worst recession since the Great Depression. The most relevant economic policy intervention to shake the grip of Great Recession was the American Recovery and Reinvestment Act of 2009. The Recovery Act made it easier for consumers, businesses, and the government to spend money by cutting taxes, raising unemployment and Social Security benefits, and helping struggling states and localities cope with shortfalls in their budgets due to falling tax revenue. In addition, stimulus spending focused on infrastructure projects, investments in green technologies, and new transportation efforts ensured there would be sustained economic growth over the course of 2009 and 2010.
And that’s what happened. The private sector turned around in the summer of 2009—18 months after the recession started—and the recession officially ended. (The official business cycle dates are chosen by the business cycle dating committee of the National Bureau of Economic Research, a private economic research group in Cambridge, Massachusetts.)
The overwhelming majority of the stimulus spending was intended to go to the private sector—households and businesses—because that’s where the greatest weaknesses of the economy were during the recession. There could be no strong, sustained recovery without a turnaround in the private sector. 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 sustained and hopefully strengthened expansions in business investment and consumer spending at this point.
The most recent GDP growth figures the Department of Commerce’s Bureau of Economic Analysis underscore that this is now happening across large parts of our economy. The third quarter GDP expansion was the fifth in a row, coinciding with the official recovery. The economy in the third quarter of 2010, though, was still $103 billion (calculated in 2005 dollars) smaller than at the start of the recession at the end of 2007.
This is just one indicator that we have a ways to go for a full recovery and that the economy consequently may need continued policy efforts targeted at building up the private sector. Still, the foundations are there for a strong, sustained recovery, as I’ll detail in the analysis that follows.
Private-sector momentum carries growth
Today’s data confirms that private sector activities—business investment and consumption—are the largest driving force behind continued economic expansion. These trends are strong enough to overcome rising import growth and less spending on real estate by households.
Business investment spending is a bellwether for the strength of the recovery right now and for the future. Business spending impacts economic growth right now since more U.S. products are sold. Increased investment spending should also lead to more private-sector hiring since businesses will need people to use all of the new equipment and fill all of the new factories, office buildings, and mines. Finally, business spending is an indicator for business expectations for the economy’s future. Businesses will only tie up a lot of their money in new projects if they expect that the economy will continue to expand, and that there will be more customers for their products in the future. After all, investing money in new projects in the United States means that the money cannot be used to speculate in the stock market or to purchase companies overseas.
Business investment has steadily gained momentum since the middle for 2009. It has now grown for five quarters in a row—from the second quarter of 2009 to the third quarter of 2010—beginning with increased spending on equipment such as computers, software, and trucks. This type of business spending increased by 12.0 percent in the third quarter of 2010, substantially slower, though, than the 24.8 percent increase in the second quarter of 2010.
Private businesses also continued to invest in stockpiles in their warehouses, presumably in anticipation of future growth in new customers. Businesses added $47 billion worth of goods to their inventories in the third quarter of 2010, continuing to rebuild their inventories after a prolonged recession. The change of inventories explained 72.0 percent of the growth rate in the third quarter of 2010. And finally, private businesses increased their investments in commercial construction such as factories, mines, and office buildings in the third quarter of 2010. Commercial construction spending grew by 3.9 percent, the first increase in this area since the second quarter of 2008.
Business spending on all investment items is expanding, although spending on new equipment is not rising as fast as it has in the past. The slowdown in business-equipment spending is to be expected since it occurred from rather high levels; equipment investment increased by more than 20 percent in the first half of 2010.
Overall, then, the 12.0 percent increase of business investment spending on equipment is still relatively strong. There were only five quarters (out of 27) during the last business cycle, which lasted from March 2001 to December 2007, when there were larger increases in business investment spending on equipment.
The continued strength in equipment spending by businesses coupled with new growth in commercial construction bodes well for a continuing recovery that is carried forward by private companies. This is a good foundation on which to build more growth through well-crafted economic policies. The goal at this point is to bend the growth curve upward, to accelerate private sector activity, rather than to prevent another recession or even depression, as was the valid fear in early 2009.
The economy will not see the desperately needed millions of jobs return in short order unless consumer spending increases, too. More spending by businesses, however, should lead to more hiring and then to more consumer spending, which in turn could result in more business investment. And there are good signs on this front, too, as jobs are indeed coming back. Data from the Bureau of Labor Statistics shows that the private sector has added 863,000 jobs in 2010, after consistently losing jobs in 2009. Consumer spending consequently grew again at a rate of 2.6 percent in the third quarter of 2010, accelerating over the 2.2 percent increase in the second quarter of 2010.
Consumer spending on durable goods, particularly furniture and recreational goods and vehicles, were the fastest growing part of consumer spending. Durable goods consumption increased by 6.1 percent in the third quarter. This indicates a certain amount of confidence among consumers in the economy. People wouldn’t spend more money on furniture, sports equipment, and boats, if they thought that the economy was heading for another recession.
What then to make of the decline in housing spending? Spending on real estate by private households dropped by 29.1 percent in the third quarter of this year, after growing by 25.7 percent in the second quarter. The acceleration in the housing sector in the second quarter was largely the result of the final quarter of the new homebuyer’s tax credit. Home buyer’s rushed to buy a home before the credit expired in April 2010 (sales could be closed and recorded later than that). The decline in housing spending in the third quarter then seems to be a correction of this one-time bump from the expiring tax credit.
The conclusion from these figures, then, is that the housing market has essentially been flat on average for the second and third quarter of 2010. This is a big improvement from the years of double-digit declines, but it also means that housing spending is not contributing to economic growth, as it usually does—and usually does so very strongly—in a recovery.
Alas, we will likely not see a recovery in housing spending until policymakers get a handle on the foreclosure mess and until homeowners can dig out from the mountain of debt that is still there. According to Federal Reserve data, household debt stood at 118 percent of after-tax income in the second quarter of 2010, down from 130 percent in September 2007, but still higher than at any point before 2005.
A recovery in housing spending and continued momentum of consumer spending will crucially depend on a labor market recovery. Part of the increase in consumption in the third quarter came from a decline in the personal saving rate. The personal saving rate fell to 5.5 percent of after-tax income in the third quarter of this year, down from 5.9 percent in the second quarter 2010. Strong and durable consumer spending will ultimately have to come from more jobs and higher incomes.
Federal government spending also contributed to growth. Federal government spending increased by 8.8 percent, while spending by state and local governments declined slightly by 0.2 percent in the third quarter of 2010. Cutbacks in state and local government spending thus continue to be a drag on economic growth. The fiscal crisis in the states will, by all accounts, continue linger for some years, dampening momentum in the recovery. State- and local-government spending is thus one area, where the federal government could quickly intervene to strengthen economic growth and build a sustained recovery.
Import growth remain worrisome
Imports are rising much faster than exports, siphoning money from the United States to overseas. This poses a serious drag to domestic economic expansion. U.S. exports increased faster than U.S. imports in the first quarter of this year, but grew at slower rate in the third quarter than in the second quarter—17.4 percent compared to a whopping 33.5 percent. Yet U.S. export growth also slowed to 5.0 percent in the third quarter from 9.1 percent in the previous three months.
What explains these trends? Much of the surge in imports is driven by petroleum imports, which expanded by 41.9 percent in the third quarter, down from a growth rate of 78.6 percent in the second quarter. Petroleum imports remained the fastest growing import category, despite this slowdown. Congress should start to tackle comprehensive energy legislation, in part to reduce the adverse economic effects on the country’s growth from strong petroleum import surges. Increased diversification into alternative fuels, preferably domestically produced ones, and more investment into energy efficiency will ultimately help to reduce the negative effects of petroleum import jumps on 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 3.8 percent of GDP, up from 3.6 percent in the second 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. 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 solid private-sector momentum, but the question is whether there is a chance that growth will accelerate to create the millions of jobs necessary to reduce the unemployment rate in the near future. The experience of the past few years shows that federal policy can play a vital role in stabilizing and jump starting private-sector activities. Continued public policy attention is necessary to protect this momentum and accelerate private sector activities. This requires attention to three primary areas:
- Personal incomes from a strong labor market recovery and continued support for the unemployed
- Addressing the fiscal crisis in the states
- Efforts to reduce the country’s dependence on oil imports.
Well-crafted policies in each of these areas are well within the reach of Congress and the Obama administration this year and next. That’s the good news. Whether congressional leaders and the administration can come to terms after the partisan gridlock of the past two years remains in doubt, however, which means bad news for the economy if policymakers fall short.
Christian E. Weller is a Senior Fellow at the Center for American Progress and Associate Professor for Public Policy and Public Affairs, University of Massachusetts Boston.