Gross domestic product (GDP) figures provide a convenient snapshot of a nation’s economic health. Unfortunately, we too often draw conclusions based upon GDP numbers alone, overlooking underlying factors.
Although a positive GDP report bolsters confidence about the country’s economy, it is important to look beneath the surface to assure that such optimism is supported by reality. The following is a recent example.
Quarterly GDP numbers are always revised three times. The original estimate for third-quarter growth in the U.S. marked the economy expanding at a 3.5 percent annual pace. A month ago, economists dropped the number to 2.8 percent. And most recently, the Commerce Department revised the third quarter GDP figure to 2.2 percent.
These GDP numbers mark the biggest positive growth in a quarter since 2007. On paper, the economy seems to have finally stabilized from the free-fall of the deep recession. Looking closer, however, I’m less optimistic of a fast recovery for a two big reasons.
Growth is Too Government-Driven
The first red flag is the fact that a big portion of the economic growth stems from government stimulus spending. If we were to subtract this government spending, the economy would not show a recovery.
The big sectors that contributed to GDP growth were automobiles (1.45 percent), residential investments (0.43 percent) and government spending (0.55 percent), for a total of 2.43 percent.
What’s wrong with this picture?
Automobile sales were largely boosted by the government’s cash-for-clunkers program, which provided a temporary backstop to Detroit’s woes, albeit inefficiently.
Cash-for-clunkers was a success in the short-term, as consumers rushed to purchase new cars in time for the rebate. However, it remains to be seen whether or not this program can help sustain automobile sales and stabilize the U.S. auto industry. At least for the few months following cash-for-clunkers, we can expect a natural decline in new-vehicle sales when compared to August levels.
Likewise, the first-time homebuyer tax credit temporarily boosted home sales throughout the country. But the stabilization of the housing market—a critical component to an economic rebound—is likely several months away from reaching sustained growth. Economists expect home sales to remain in a slump next year after the housing credit expires in April.
With the government planning additional stimulus plans such as a cash-for-appliances program followed by a cash-for-caulkers, will the benefits outweigh the costs to taxpayers in the long-term? We’ll have to wait and see.
Too Much Private Consumption
GDP is defined, using expenditures, as:
Private Consumption + Gross Investment + Government Spending + (Exports – Imports)
Another reason I am skeptical that positive GDP numbers do not indicate a quick rebound will occur is the high level of consumption in the U.S. that is included in those GDP figures. (Once again, the government stimulus programs contributed to high levels of private consumption).
The weight of each component contributing to GDP varies from nation to nation. A glaring example is the large role private consumption in the GDP of the United States compared to the GPD of other nations. For example, domestic consumption makes up just over a third of China’s economy compared to a whopping two-thirds in the U.S.
Consumption fuels America’s economic growth while other economies, including China’s, are expanding because of increasing exports—a much better foundation for long-term economic growth.
An increased effort to rebalance these figures has been the big theme in talks among the top twenty developed nations (G-20) in the world. In other words, U.S. consumers need to save more while Asian consumers should spend more.
Thus, even though China grew at an astonishing 9.6 percent in 2008 (recently revised from nine percent), China could expand even faster if its population consumed more.
The United States has been able to prop up a fraught economy with government investments and stimulus programs, but only time will tell if these actions will create a sustainable long-term recovery or are a window dressing that’s temporarily masking our ongoing economic weakness.
What do you think? Are you optimistic about the economy in 2010? Do you think the economy can sustain itself without aid from the government?
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I agree that just GDP growth by itself is a poor way to measure any sort of recovery. Two very glaring problems are the still-high rate of unemployment and that the GDP is not growing fast enough to recover our employment rate in anywhere near a short time frame.
I’m somewhat confused on your analysis of the private consumption of the US. It seems that you say it’s bad that private consumption is such a high portion of GDP but don’t necessarily specify why or what affect that percentage has on our recovery.
If you think that private consumption is a bad sign for recover, I have to disagree. Right now what our economy needs most in an increase in consumption, preferably private (although government seems to be the only real options) so business becomes more profitable and can begun running at full capacity again, thus rehiring more workers and fixing our unemployment woes.
Edwin,
Thanks for your comment. I’ll try to elaborate on what I meant.
I do agree with you that higher private consumption can help businesses become more profitable, driving the economy upward. However, in the US, throughout the long economic growth period of the 80′s, 90′s and 00′s, private consumption in the US has inched higher and higher, becoming a bigger piece of the GDP pie (a little over two-thirds now). One of the biggest problems with this trend is the growing trade deficit. Since the mid 1980s, the US has continued to accumulate deficit in tradeable goods, especially with Asian countries like China and Japan. These countries now hold large sums of US debt that has funded the consumption. Countries with a higher savings rate (Canada, Japan, China) tend to have trade surpluses. Many economists believe that GDP and employment can be dragged down by a large deficit in the long run.
Thus I’m advocating for a rebalancing of the GDP pie, where the majority of growth is not driven by private consumption, but by investments and exports.
A rebalancing away from consumption could help sustain a more long-term recovery.
Y.S., I think one unique aspect of the US economy that is affecting this offset ratio is the significance of financial institutions and financial services in our economy. We have so many different “investment” products which no longer really do the job that investments traditionally do for an economy (as was widely seen in this great recession).
I would be curious what our GDP would look like if we got this industry under control.