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Home Publications Blogs Beat the Press What's Holding the Economy Back: Revised Version

What's Holding the Economy Back: Revised Version

Monday, 04 August 2014 20:26

In the NYT Upshot section Neil Irwin had an interesting piece assessing which sectors are most responsible for the weakness of the economy. His culprits (in order) were residential invesment (housing), state and local government, durable goods consumption, business equipment investment, and federal spending. Irwin's methodology was to take the Congressional Budget Office's estimate of potential GDP (roughly 5 percent higher than the current level) and then assume that each component has the same share of this potential as its average of GDP over the two decades from 1993 to 2013. The difference between this hypothetical level of demand from a component and the actual level of demand from that component in the second quarter of 2014 is the basis for determining the shortfall.

I decided to do a similar exercise with a couple of minor differences. The table below shows the difference between each component's average share of GDP in the period from 1990-2013 (this was an accident -- misread Irwin's start point) and the average for the first two quarters of 2014. The two quarters are taken together because for many components a strong second quarter offset a weak first quarter. I have also lumped components together (e.g. the categories of consumption are all together). The categories in bold are the major components that together add to GDP.

  Percentage Point Change
  Average 1990-2013
  Minus 2014
Consumption expenditures -2.3
Durable goods 0.7
Nondurable goods -0.1
Services -2.9
Nonresidential investment 0.0
Structures 0.0
Equipment 0.4
Intellectual property products -0.4
Residential 1.1
Change in inventories -0.1
Net exports 0.3
Exports -2.7
Imports -3.0
Government 1.1
Federal 0.5
State and local 0.5

 Source: Bureau of Economic Analysis, National Income and Product Accounts, Table 1.1.5.


There are a few points that can be made from this table. First, the items that have fallen substantially as a share of GDP are government spending, which had roughly equal dropoffs at the federal and state and local levels, and residential construction. Net exports are also down as the import share had grown more than the export share. Non-residential investment is at its average level for the 1990-2013 period. The big gainer in shares is consumption, which had a 2.3 percentage points larger share of GDP in 2014 than its average in the prior period.

The second point is that it is worth keeping the categories together because components can be substitutes. To be specific, the large growth in consumption of services noted by Irwin more than offset the drop in durable goods consumption that he notes. The story here is that if households are going to spend more on services, primarily health care, then they will have less money to spend on other consumption goods. Taken together we can see that the consumption share of GDP is higher in 2014 than it was on average in the earlier period.

We see the same story with equipment investment investment. While Irwin lists this component as one of the culprits, the drop in equipment investment was fully offset by a rise in investment in intellectual property products. Taken together, non-residential investment is just keeping even with its average over the prior twenty three years.

This brings up the third point. We can think of some components as being largely a function of GDP, whereas others are to a substantial extent independent of short-term changes in GDP. Consumption falls into the former category. If GDP were to increase by $100 billion, it is a safe bet that consumption would increase by around $70 billion. Imports also largely follow GDP. On the other hand, investment to some extent follows GDP, but also a fair degree of independent determinants. This is also true for housing, and even more so for exports and federal spending.

This is important, because we envision getting back to potential GDP it will depend on increases in one or more of the components that are not primarily determined by GDP. Our candidate list is then non-residential investment, housing, exports, and federal government spending.

Taking these in turn, it would be great to increase non-residential investment, but we don't have any great tricks to accomplish the task. Lower interest rates from the Fed can help, but the impact is limited and it is not easy to make interest rates go lower than they have been.

We can and will see some upturn in residential construction, especially as the vacancy rate falls back closer to normal levels. However it may not rise back to its two decade average. The fact that households are spending so much more on health care now than they did over the longer period means that they will have less money to spend on housing. As a result, we may never see residential construction rise to the same share of GDP as its average in the period from 1990-2013.

Skipping to government, we can see more spending, but that will mean larger budget deficits. That's fine by me, but doesn't sit well with the people calling the shots in Washington. (We could raise taxes, but that is hardly an easy political sell and it would also reduce consumption.)

This leaves net exports, my pet peeve. We can boost exports by lowering the value of the dollar against other currencies. A lower valued dollar will also lead people to substitute consumption of domestically produced goods for imports. That could do the trick for getting us back to full employment, but we would first need to get a lower valued dollar on the nation's political agenda. Don't hold your breath.





Comments (7)Add Comment
Fatally Flawed Model
written by Robert Salzberg, August 04, 2014 10:22
Irwin's analysis assumes that the average GDP of the years 1993-2013 is our new normal. The years 1993-2013 should be seen as the destruction of the American Economy because of the cumulative dominance of Reaganomics which gave us deregulation, trickle down theory, and starve the beast (except military spending).

Starve the beast has lead to the U.S. underfunding our infrastructure by around 1% of GDP a year with similar cuts to education. Deregulation has allowed the financial sector to siphon off around 4% more of GDP despite computerization which should have reduced its share of GDP. (Plus the S&L crisis, systemic lending fraud, and the Great Recession.)

But the real damage is the growth of corporate power which allows corporations to avoid their fair share of taxation, not pay for the external costs of the pollution they create, and their relentless attacks on workers that has contributed to stagnating wages including a below poverty level minimum wage.

Between 1993 and 2013, Americans saved roughly half of what they had been saving the previous 3 decades. Has any one coined the phrase stickiness of lifestyle? Till debt/bankruptcy do they part.

If 1993-2013 is our new normal, the U.S. is doomed.
written by urban legend, August 05, 2014 12:49
"Starve the beast has lead to the U.S. underfunding our infrastructure by around 1% of GDP a year with similar cuts to education."

So with a combined 2%, that's somewhere in the neighborhood of 2.5 - 3 million jobs per year, and that's not counting the effect of their spending in creating other jobs. And to some extent that shortfall is cumulative, such that, today it will take a lot more infrastructure jobs not only to fill the gap that shouldn't have been there, but to catch up to where we should have been in fixing and modernizing our infrastructure.

This (Robert's) looks like a better set of explanations for what has happened over the past generation than anything else I've seen. Consider especially the "jobless recovery" of the Bush II years, when we needed a real estate bubble just to put up halfway decent (but still woefully deficient) employment rate numbers. Too often I've seen economists act as if we should consider the pre-Great Recession as some kind of benchmark. The last year that actually looked good was 2000, but even then, since it was fueled by the dot-com bubble and capital gains windfalls, it was no better than a good start.
Are Economic Models Destroying Civil Society and the Earth?
written by Robert Salzberg, August 05, 2014 5:13
Economists do love their models. But unlike physics, economic models are ubiquitously built on flawed assumptions like rational consumers. While economists try to compensate for their flawed assumptions, you can't build a stable house on an unstable foundation.

Irwin's flawed assumption is that he blurs/confuses cause and effect. Looking at relative sector growth in a 20 year period mostly gives you information about relative sector growth in a 20 year period. Irwin's leap to conclude relatively low or declining sector growth is causing a drag on our economy confuses macro effect with macro cause.

The root causes of our anemic growth are painfully obvious. We have stagnant wages, declining population growth, declining relative productivity growth, declining government investment, and a market system that is rigged towards a large upward distribution of income.

The likely biggest threat to our future growth is catastrophic climate change. Industry in general and the fossil fuel industry in particular haven't paid for the externalities of their pollution. The chaos in the Middle East, increased terrorism, food shortages, water shortages, unstable governments, and increasing tensions between countries over limited resources are additional externalities caused in no small part by the fossil fuel industry, our lack of a carbon tax, and strong military support of regimes that keep the oil flowing.
written by skeptonomist, August 05, 2014 8:39
Total government expenditures


seems to tell a simple story - if there ever is a simple story. Basically all government - federal and state and local - quit expanding. It's hard to see how there could be a strong recovery under these conditions. It's asking the private sector to do it all in a way that it never did before in recessions. Actually private jobs did recover pretty well, but government jobs, mostly state and local, kept shrinking.
written by Dave, August 06, 2014 8:07
I find it interesting that government spending has decreased yet private investment has not filled in the gap. The foundation of our current conservative movement is that if you get rid of government, private industry will fill in and even grow beyond what government was spending.

I suspect it just isn't so. Many of the services that government offers are not things that private industry is interested in pursuing. When government stops spending, the services just disappear for good never to be seen again.

Of course, the people behind this idea didn't really want a reduction in government spending, they wanted to move that spending to private industry through privatization. Another word for privatization could be crony capitalism -- that is, guaranteed revenues from taxes to flow into private industry.

It isn't surprising that the politicians can't make sense of this. They're dealing with funders that are fundamentally deceptive, and even when they use common sense and believe the funders are honest, they end up being wrong. They try to explain this to their base, and the base seems fooled by twisted logic and absolute nonsense. So they get away with it all anyway.

written by ezra abrams, August 06, 2014 8:38
Dear Dr Baker:
what would you say to a student who presented such a table, without indicating the absolute magnitude of the diff components ?
surely IP is insignifcant next to residential construction ?
Nothing Personal Dean
written by Incubus, succubus, gog and agog, August 06, 2014 8:32
What can our country do to lower the value of USD? It has to be something rival political economies can't emulate and send right back at us. It has to be sticky. It does no good to lower it when in a matter of days if not hours our rivals' counter measures have put the bottom rail back on top.

I don't like your ideas on government spending. Government spending is like Reaganomics, where you give money to the government workers and their contractors and the money is supposed to trickle down to the rest of us, or in the case of Reaganomics, you give the money, in the form of tax relief to Reagan's beloved country club elite and it some how, magically rains down upon us like a golden shower.

I know you're smart Mr. Baker but beware. People of average intelligence are actually quite smart themselves.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.