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October 30, 2003

GDP Up, Employment Down, Confusion Reigns Supreme

By Jim Dallas

DailyKOS is on this one, but I think misses part of the story.

WASHINGTON (Reuters) - The U.S. economy rocketed ahead at its fastest pace in more than 19 years in the third quarter of 2003 as consumers, their wallets fattened by tax cuts, went on a buying spree, an unexpectedly strong government report showed on Thursday.

U.S. gross domestic product surged at a 7.2 percent annual rate in the July-September period, the Commerce Department (news - web sites) said. It was the steepest climb since the first quarter of 1984 and more than double the second quarter's 3.3 percent rate.

That's all fine and good, but is it sustainable? Looking at the details, one needn't be an economist (and I am not) to worry.

First, consumption of durable goods has been high for the last two quarters, and it stands to reason that this is in large part a function of tax-cutting (purchases of durable goods also bounced up in Q4 of 2001 and Q3 of last year). Obviously, people don't go out and buy durable goods (cars, refrigerators, TV sets) just everyday. And personally I'd suspect that consumers may be blowing their wad all at one time, making future growth in this area unlikely.

Similarly, residential investment went up 20 percent last quarter. That's pretty aberrant. People and businesses don't go out and fix their homes/offices/etc. up everyday, either.

And it's clear where the money for all these improvements is coming from; scroll down to "disposable income." Real disposable income was also up 7.2% last quarter. However, the decrease in tax collections (largely from advance payments on child tax credits - another one hit wonder) outpaced increases in income. In short, the federal budget deficit has been this quarter's sugar-daddy (and we know how that's going to end up).

On the other hand, Brad DeLong, who is an economist, sees a silver lining: a big boost in equipment investment.

That coupled with some signs (noted in Reuters) that the labor market is starting to turn around suggest that we've finally hit rock-bottom in the quest to clear out inventories, and that demand is (finally) catching up with supply. Of course, as KOS and Brad DeLong both note, unemployment isn't going anywhere fast. Which is a crying shame, because it clearly indicates a gap between potential growth and actual growth.

If I had to make a completely amateur guess as to what is going on, it is this -- that low interest rates and tax cuts are fueling a short-term boost in consumption of goods that people wouldn't otherwise buy. This is not bad, but it probably isn't the foundation for job growth and economic expansion that the country really needs right now.

UPDATE: Paul Krugman's NYT column this morning mostly agrees with my hypothesis, arguing that:

First, while there was a significant pickup in business investment, the bulk of last quarter's growth came from a huge surge in consumer spending, with a further boost from housing. These components of spending stayed strong even when the economy was weak, so there shouldn't have been any pent-up demand. Yet housing grew at a 20 percent rate, while spending on consumer durables (that's stuff like cars and TV sets) — which last year grew three times as fast as the economy — rose at an incredible 27 percent rate last quarter.

This can't go on — in the long run, consumer spending can't outpace the growth in consumer income. Stephen Roach of Morgan Stanley has suggested, plausibly, that much of last quarter's consumer splurge was "borrowed" from the future: consumers took advantage of low-interest financing, cash from home refinancing and tax rebate checks to accelerate purchases they would otherwise have made later. If he's right, we'll see below-normal purchases and slower growth in the months ahead.

Speaking of all-things Krugman, we should find out in the next 72 hours whether Krugman stalker (and we mean that in the opinionated, figurative sense) Donald Luskin will follow through with his threat to subpoena blogspot in order to obtain Atrios's secret superhero identity.

Posted by Jim Dallas at October 30, 2003 12:16 PM | TrackBack


Just a few quick points:

The way GDP is calculated, consumer spending virtually has to amount for any reported growth. Business investment in "intermediate goods" doesn't count towards GDP, only the final sale of the product to the consumer, although business investment in capital goods does. I.e. If I am a firm, and I am spending money producing leather, that money doesn't show up in the GDP. What shows up is the purchase of the completed jacket, belt, shoes, whatever. If I buy a new tanning machine, or factory, or whatever, then that would count as "capital investment," which the new numbers show is way up too.

By definition, consumption drives GDP, since that's what they count. I would argue it is a flawed system, since investment in producing goods that aren't ready for consumption accounts for a large and significant part of the economy, but that's not the way they run the numbers. In the end you get "consumer spending" accounting for about 2/3 of the economy. Thus, arguing that the growth was fueled by consumer spending is true, but not very relevant. The way GDP is calculated, most growth in the economy will be accounted for at the point of final sale, as consumer spending.

Second, I am glad to see that those of you on the left have finally accepted that pure spending is not the driving engine of economic growth. This was (well, in a dramatic simplification) the central tenet of Keynesian economics, that spending, no matter what it is on, is what is needed to "prime" the economy, with the help of the fictitious "multiplier effect." How do you boost spending? Preferable through government public works projects. Keynes once remarked that it didn't matter what the money was spent on, pyramids, digging holes in the earth and filling them in, whatever, just so long as the money was spent, the economy would do well. It has been pretty thoroughly refuted in the academic world since the 70's, and in the real world in general. You only need to look at Japan or the EU's efforts to stimulated their economy out of their recessions to see how wrong Keynesian remedies fail in practice.

Finally, that "residential investment went up 20 percent last quarter" is people refinancing their homes at low interest rates. Those savings tend to last. If your mortgage bill has dropped by $250 a month, that's $250 more a month you can spend or invest for several years into the future. That's not a "one time" gain, that will continue for quite a while into the future.



Posted by: Sherk at October 31, 2003 03:54 PM

An update here, according to the Boston Globe:

"Overall consumer spending grew by 6.6 percent and accounted for two-thirds of economic growth."
You can read the whole article here:http://www.boston.com/news/nation/articles/2003/10/31/economy_puts_on_a_surge/

2/3 is exactly the proportion of the overall economy that the GDP counts as consumer spending. This basically means consumer spending isn't an unusually large portion of the growth in GDP, in fact,it is exactly what you would expect.


Posted by: Sherk at October 31, 2003 05:10 PM
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