October 31, 2007 (GDP Byte)
by Dean Baker
Goods exports grew at their fastest rate since 1989.
GDP rose at a 3.9 percent annual rate in the third quarter, driven by a 16.2 percent surge in exports growth and a 12.3 percent rise in investment in non-residential structures. A 9.7 percent jump in defense spending coupled with solid 3.0 percent growth in consumption were more than enough to offset a 20.1 percent decline in residential construction.
The increase in exports was the largest since a 20.8 percent increase in the fourth quarter of 2003. Interestingly, this rise was driven almost exclusively by goods exports, which rose at a 23.0 percent annual rate. Exports of services increased at just a 1.6 percent rate. The rise in goods exports was the fastest since a 24.7 percent jump in the second quarter of 1989, which was also driven by a falling dollar. Net exports contributed 0.93 percentage points to growth in the quarter. This is somewhat less than the 1.32 pp contribution in the second quarter, since imports rose this quarter after falling in the second quarter.
The rise in non-residential structures added 0.4 pp to GDP growth. Non-residential structure investment has soared since the fourth quarter of 2005, rising at a 13.3 percent annual rate. It currently accounts for 3.4 percent of GDP. Its share never exceeded 3.3 percent in the late 90s boom. This boom is explained by the fact that the housing boom pulled resources away from non-residential construction, creating a backlog of projects. This backlog is now being filled, causing growth to falloff in the quarters ahead.
Investment in equipment and software remains weak, rising at a 5.9 percent annual rate. Third quarter expenditures were just 1.4 percent above the year ago level, with all of the increase attributable to a rise in expenditures on software.
The growth in consumption was reasonably evenly divided among components and pretty much followed income growth, as the savings rate was virtually unchanged. At 0.8 percent, the savings rate is only slightly higher than the 0.4 percent rate for 2006, the lowest in the post-war era. This compares with an average savings rate of more than 8 percent through the 60s, 70s, and 80s. This indicates that the fall in housing prices has not yet impinged much on consumption.
This was the second consecutive quarter in which defense grew rapidly, in this case adding 0.45 pp to GDP growth. Federal non-defense spending grew at just a 0.9 percent annual rate for the second consecutive quarter and state and local spending grew at a 2.0 percent annual rate.
Inflation still seems well-contained in this report. The GDP deflator rose at just a 0.8 percent annual rate, held down by declining energy prices. The core personal consumption expenditures deflator grew at a 1.8 percent rate in the quarter and stands 1.9 percent above its year ago level. The recent inflation pattern appears to be flat or slightly downward.
On the whole this report indicates that the economy still looks relatively healthy, in spite of the weakness in the housing market. Consumption growth appears to have been largely unaffected by the fall in house prices. While equipment investment has been weak, non-residential construction, along with exports, have filled the gap in demand created by the falloff in housing construction. Even productivity growth appears to have turned up, with growth for the quarter likely to be close to 3.0 percent.
However, the clouds remain on the horizon. With real house prices now falling at close to a 7.0 percent annual rate, wealth in existing homes is falling by $1.4 trillion a year. It is difficult to believe that this rate of wealth destruction will not have an impact on consumption. In addition, the third quarter surge in exports is unlikely to be sustained, even with further declines in the dollar. With non-residential construction and defense spending leveling off, two important sources of growth for the economy will be lost. It is striking that the collapse of the housing market appears to have had a limited effect on overall growth thus far, but it is far too early to conclude that the economy will escape the collapse of the housing bubble unscathed.
Dean Baker is the Co-director of the Center for Economic and Policy Research.