July 31, 2008 (GDP Byte)
By Dean Baker
"Revised data show the economy contracted in the 4th quarter of 2007."
Rising exports and plunging imports kept GDP growth in positive territory in the second quarter, as the collapse of the housing market continues to be a large drag on growth. Exports grew at a 9.2 percent annual rate. More importantly, imports fell at a 6.6 percent annual rate. Together, the change in net exports added 2.42 percentage points to GDP growth for the quarter, keeping the growth rate in positive territory.
The impact of the foreign sector on the economy in the last three quarters has been extraordinary. Gross domestic purchases, the sum of consumption, investment, and government expenditures, have actually been falling at a 0.5 percent annual rate since the third quarter of 2007. In other words, without the improvement in the trade balance, the economy clearly would be in a recession.
It is worth noting that the reduction in the trade deficit is only on the real side. The nominal trade deficit actually grew slightly in the second quarter to $737.3 billion (5.2 percent of GDP). The reason for the rise in the nominal deficit was an extraordinary 28.6 percent jump in import prices. While higher oil prices are the most important factor in this increase, prices of all imports are rising rapidly. The price of imported services rose at a 16.2 percent annual rate in the quarter. The dollar will have to fall much further to bring the trade deficit down to a sustainable level.
Housing fell at a 15.6 percent annual rate, its 10th consecutive quarter of decline. It subtracted 0.62 percentage points from growth in the quarter. The rate of decline in the housing sector is slowing. It is likely that it will bottom out in the fourth quarter or first quarter of 2009, and at least will no longer be a drag on growth.
Non-residential investment was a small net positive in the quarter, rising at a 2.3 percent annual rate. A 14.4 percent increase in structure investment was enough to offset a 3.4 percent decline in investment in equipment and software. This is the second consecutive decline for investment in equipment and software.
Consumption grew at a 1.5 percent annual rate adding 1.08 percentage points to growth. The biggest factor in this growth was consumption of non durable goods, which grew at a 4.0 percent annual rate. Purchases of shoes and clothes rose at a 10.4 percent annual rate. This is clear evidence of the tax rebates working.
The government sector grew at a 3.4 percent annual rate, adding 0.67 percentage points to growth. The biggest factor was a 7.3 percent jump in defense spending, as state and local spending grew at just a 1.6 percent annual rate. There is little reason to believe the timing of the defense boost is political, spending grew at a 8.5 percent rate in the second quarter of 2007 and a 10.2 percent rate in the third quarter. Defense spending is always erratic.
Inventory accumulation slowed sharply in the quarter, reversing a big buildup in the first quarter, subtracting 1.92 percentage points from growth. Inventory growth is likely to level off in future quarters.
The revisions knocked 0.1 percentage points off growth in the years from 2004-2007. This makes the productivity slowdown somewhat more striking, with growth averaging just 1.7 percent since the second quarter of 2004. Profits were revised higher for all three years. This has the effect of increasing the statistical discrepancy (the gap between output side GDP and income side GDP), with the -1.2 percent of GDP discrepancy shown for 2006 being one of the largest income side gaps on record.
While the stimulus package helped to sustain growth in the second quarter and will continue to provide a boost in the third quarter, the economy still faces serious problems ahead. It is unlikely that net exports will continue to provide as strong a boost to demand as they have over the last three quarters, even if the trade deficit continues to improve. The decline in housing will slow, but non-residential construction will soon fall also. Most importantly, the loss of housing wealth will start to slow consumption.
Dean Baker is the Co-director of the Center for Economic and Policy Research. CEPR’s GDP Byte is published quarterly upon release of the Bureau of Economic Analysis' report on the Gross Domestic Product.