On Friday, the Bureau of Economic Analysis reported a downward revision in the second quarter growth in the gross domestic product to 1.6 percent, from 2.4 percent. While the headline number was bad, the devil is in the details. The downward revision does not signal a new contraction or a double-dip recession. Instead, this revision demonstrates how one component of group that comprises a macro-statistic like the G.D.P. can skew the numbers.
First, let’s look at the G.D.P. equation:
1. Personal consumption expenditures, which account for 70.52 percent of G.D.P.
2. Gross domestic investment, which accounts for 12.61 percent of G.D.P.
3. Exports net of imports, which subtracts from G.D.P. because the United States imports more than it exports
4. Government spending, which accounts for 20.53 percent of total G.D.P.
Let’s start with personal consumption expenditures (P.C.E.s), the largest component of G.D.P. Starting with the third quarter of 2009, personal consumption expenditures have increased at a quarter-to-quarter rate of 2 percent, 0.9 percent, 1.9 percent and 2 percent. While this is not a barn-burning rate of growth, it does indicate that despite high unemployment, consumers are still spending money. Looking at the three subcategories of personal consumption expenditures, we see a decent picture of consumer spending. Most important, spending on durable goods (goods meant to last more than three years) increased 8.8 percent in the first quarter of 2010 and 6.9 percent in the second quarter.
Durable goods – while accounting for only about 10 percent of personal consumption expenditures – usually require some type of financing, which people don’t take on unless they have some confidence in the future. In addition to durable goods purchases, consumers increased their spending on services by 1.2 percent. This is the largest quarter-to-quarter increase in service expenditures (which account for 65 percent of P.C.E.s) since the first quarter of 2008. Spending on nondurable goods increased 2.1 percent. While this was the lowest rate of growth in the last three quarters, it is still a fair increase.
Let’s move on to the second largest component of G.D.P.: government spending. According to the Congressional Budget Office’s historical budget data, this component of G.D.P. has accounted for approximately 20 percent of G.D.P. since 1970. For the last four quarters, this part of G.D.P. has increased 1.6 percent, fell 1.4 percent, fell 1.6 percent and increased 4.3 percent on a quarter-to-quarter basis. The decreases in the fourth quarter of 2009 and the first quarter of 2010 were caused by declines in state spending of 2.3 percent and 3.8 percent, respectively, from the previous quarter. Government spending was responsible for about 54 percent of last quarter’s growth.
Accounting for about 13 percent of the United States’ G.D.P. is gross private domestic investment, which — since the third quarter of 2009 — has grown on a quarter-to-quarter basis of 11.8 percent, 26.7 percent, 29.1 percent and 25 percent. This part of G.D.P. is comprised of three subsets of data: nonresidential structures, nonresidential equipment and software investment, and residential investment. The primary area of growth has been equipment and software investment, which has increased on a quarter-to-quarter basis by 4.2 percent, 14.6 percent, 20.4 percent and 24.9 percent since the third quarter of 2009. Investment in nonresidential structures has decreased from the third quarter of 2009 to the first quarter of 2010, but increased slightly — 0.4 percent — last quarter. Residential investment is the last category of domestic investment, which increased 27.2 percent after contracting in the fourth quarter of 2009 and the first quarter of 2010 at a quarter-to-quarter rate of 0.8 percent and 12.3 percent.
All the above three categories of G.D.P. increased last quarter: P.C.E.s (which comprise 70 percent of G.D.P.) increased 2 percent; government spending (which comprises 20 percent of G.D.P.) increased 4.3 percent; and gross private domestic investment (which comprises 13 percent of G.D.P.) increased 25 percent.
The real story of the latest G.D.P. revision is imports. Because imports are paid for by a net outflow of money (we send money to another country and import the goods), they subtract from G.D.P. growth. Last quarter, imports increased 32.4 percent. Looking at the trade data from the Census Bureau’s most recent trade balance report, the increase was caused by a rise in imports of consumer goods, automotive vehicles and capital goods, and a slight increase in food imports. While exports also increased at a 9.1 percent quarter-to-quarter rate, this was not enough to overcome the negative impact of imports. While G.D.P. increased 1.6 percent, the net of exports and imports decreased G.D.P. 3.37 percent. In other words, the United States imported its way to lower growth.
There are several other points to note regarding the increase in imports. First, exports and imports are added together and their net total is either added to or subtracted from the G.D.P. If exports are larger than imports, the resulting number increases the G.D.P.; if imports are larger, the resulting number will lower G.D.P. Because imports were larger than exports last quarter — and because imports increased substantially more than exports on a quarter-to-quarter basis — the net of imports and exports was responsible for a decrease in G.D.P. of 3.37 percent. This is the largest decrease caused by the netting of exports and imports going back to the first quarter of 1980. In addition, a quarter-to-quarter increase in imports this large has not occurred since the first quarter of 1984, when imports increased 36.2 percent from the previous quarter. Obviously, this means it’s a fairly rare event. In short, the size of the increase in imports from the previous quarter and the increases’ overall effect on the G.D.P. calculation is extreme and shouldn’t be counted on to have the same effect in the third quarter calculation.
That is not to say the economy does not face headwinds. Manufacturing – which led the economy out of recession – is clearly slowing. The overall effect of the federal stimulus program is waning, and consumers – who are increasing their spending – are still under enormous pressure from high debt levels and a generational high in the unemployment rate. However, the decrease reported in the second quarter G.D.P. is not the result of a severe weakening of the underlying economic numbers, but instead a statistical rarity in the imports number, the magnitude of which has not occurred in over 25 years. As such, should third quarter G.D.P. weaken, it will probably be from other factors.