April 27, 2007 (GDP Byte)
By Dean Baker
Productivity Growth has averaged just 1.6 percent since 2004.
Continuing declines in the housing sector, coupled with a fall in net exports, held GDP growth in the first quarter to 1.3 percent. This is the slowest growth rate since the first quarter of 2003, when the economy grew at a 1.2 percent annual rate.
Consumption remains the main prop to the economy, growing at a 3.8 percent rate and adding 2.66 percentage points to growth for the quarter. An 11.4 percent increase in the rate of car sales added 0.56 percentage points to growth. Medical care was also a big factor, adding 0.55 percentage points and accounting for more than 40 percent of the growth in the quarter. The savings rate was -1.0 percent, up slightly from the -1.2 percent rate of the fourth quarter. This was the eighth consecutive quarter of negative savings.
Housing investment declined at a 17.0 percent annual rate, the sixth consecutive quarter of decline. Housing investment is now 17 percent below its 2005 peak. The last time there was such a sustained falloff in the housing sector was in the 1981-82 recession. With inventories of new and existing homes both at near record levels, this decline is likely to continue.
Non-residential investment grew at a very modest 2.0 percent rate after falling at a 3.1 percent rate in the fourth quarter. It is unusual to see this sort of weakness in investment outside of a recession. Structure investment increased at a 2.2 percent rate, while equipment and software investment grew at a 1.9 percent rate, not quite reversing a 4.8 percent decline in the fourth quarter.
The export situation is also discouraging. After contributing 1.6 percentage points to growth in the fourth quarter, net exports were again a drag on growth, knocking 0.52 percentage points off the first quarter growth rate. While imports grew at a modest 2.3 percent annual rate, after falling at a 2.6 percent rate in the fourth quarter, exports actually fell at a 0.8 percent rate. This is the first drop in exports since the second quarter of 2003.
Perhaps the most noteworthy aspect of this report is the further evidence it provides of weakening productivity growth. The reported growth in hours implies that productivity grew at close to a 0.5 percent rate. Since the second quarter of 2004, productivity growth has averaged just 1.6 percent. This is only slightly above the 1.5 percent rate during the 1973-95 slowdown. It is likely that measurement issues have depressed this figure somewhat (layoffs of undocumented workers in construction have likely not been picked up in the data), but 11 quarters of markedly slower productivity growth cannot be ignored.
The prospect of slower productivity growth will raise concerns about inflation. Driven by higher food and energy prices, the price deflator grew at a 4.0 percent annual rate in the quarter, the sharpest increase since a 4.4 percent rise in the first quarter of 1991. Even excluding food and energy, the GDP deflator rose 3.0 percent in the quarter. If the rise in food prices proves permanent, driven by the increased use of corn for ethanol, then non-core price increases are likely to eventually show up in higher core inflation.
The weakness of overall growth in the first quarter, and specifically the weakness in investment and exports, should raise concerns about the future direction of the recovery. If growth is going to be sustained though a period of weakness in the housing market and presumably some dampening of consumption growth, as the savings rate begins to rise back to more normal levels, these two sectors will have to provide most of the stimulus. This report provides little evidence that they will be able to fill this role.
At the moment, consumption growth is continuing at a healthy pace, but as homeowners increasingly lose the ability to take out equity from their homes, it is unlikely that this rate of consumption growth will be sustained much longer. If energy and food prices continue on their recent upward path, then it is very likely that the economy will be facing a recession before the end of the year.