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Last week the Commerce Department announced that the U.S. economy grew by 0.5% in the first quarter of 2015. This was below the number that economists had projected and it was below the 1.4% growth rate that the economy registered during the fourth quarter of 2014. The numbers were quickly seized on by critics of the Obama administration, who argued that they proved that the President has failed to generate significant economic momentum under his watch. Defenders of the administration argue that first quarter numbers can typically be stubborn as weather factors can inhibit economic growth in some seasonal industries such as construction or agriculture. Either way, the numbers are likely to temper the attitude of some members of the Federal Reserve Board for another interest rate hike and they could change the dynamic of the presidential race as a weak economy would favor Republicans in the fall.
This topic brief will provide some important vocabulary that extempers should know when discussing first quarter economic numbers, analyze arguments for why the GDP numbers are concerning, and then provide reasons why becoming panicked over these first quarter numbers is unnecessary.
Readers are also encouraged to use the links below and in the related R&D to bolster their files about this topic.
Vocabulary
Durable Goods: Refers to consumer products that consumers do not frequently need, but typically buy every three or so years. This applies to automobiles, appliances such as refrigerators or washing machines, and televisions. Economists use purchases of durable goods to assess the confidence that consumers have in an economy because these products tend to be more expensive and show signs of long-term investment.
Gross Domestic Product (GDP): An economic figure that represents the value of all of the finished goods and services that a country produces within its borders. Economist traditionally calculate GDP on a quarterly basis, meaning that they measure economic numbers in three month cycles. The number can also be used on a yearly basis to compare economic activity. GDP calculations can provide information about the overall value of a given economy, while also giving a measurement for whether a nation’s economic growth is sustainable and is of significant benefit to its people. For example, developing economies typically need to grow at 3% or higher in order to continue a healthy trajectory. More developed economies should grow at 2% or higher to continue providing sufficient job opportunities for their populations.
Residential Investment: According to the U.S. Bureau of Economic Analysis (BEA), residential investment can be defined as “investment in residential structures consisting of new construction of permanent-site single-family and multi-family units, improvements to housing units, buying manufactured homes, brokers’ commissions on the sale of residential property, and net purchases of used structures from government agencies.” The figure is often used to measure the strength (or lack thereof) of the U.S. housing market.
Trade Deficit: The term used to denote a situation where a nation imports more goods from elsewhere in the world than it exports. The U.S. has run a trade deficit for decades, partly due to increased demand for cheap goods from major exporters such as China, as well as declining manufacturing strength in the U.S.
Reasons to be Alarmed Over the GDP Figure
Business Investment in the Economy is Low: Economists warned at the beginning of 2016 that the economy would not see significant growth by the private sector. This is due to businesses “waiting out” the result of the presidential election before investing in long-term projects (businesses would probably welcome a Donald Trump presidency more than they would a Hillary Clinton presidency), as well as a weakening global economy. Questions remain about the health of some Latin American economies such as Brazil and Argentina, and the ongoing bust in commodities markets has dampened the wealth of other economies such as South Africa. China’s massive economy is also experiencing a slowdown, which has already had a negative impact on companies such as Apple. Furthermore, the U.S. economy is being weighed down by problems in the oil and gas sector, which is suffering from Saudi Arabia’s decision to keep global oil prices fairly low. Also, investment in mining is plummeting drastically, with an 86% decline reported in the first quarterly, the biggest decline the nation has seen since 1958.
Lending Standards Are Tightening: When seeking to explain why some business investment is lagging in the economy, some point to how lending standards by banks for commercial and industrial businesses are tightening. A survey from the Federal Reserve found that 11.6% of respondents think that lending standards are getting tighter, a swing of 16.9% since the second quarter of 2015, when respondents said that there was an easing of standards by a 5.3% margin. The tightening of credit standards hurt the economy in 2008 and the same situation could derail future economic growth if the pattern continues.
Problems Elsewhere in the Economy Are Depressing Growth: Economists that remain pessimistic about American economic prospects note that the problem in the first quarter is that gains being made in employment and wages are going to non-productive areas of the economy. For example, they highlight how there was increased spending in the first quarter by consumers but 41% of this ended up channeled into rent and health. For the economy to get better consumers need to spend money on goods, but all of this increased by a mere 0.1%.
Productivity Growth Remains Stubborn: One of the concerns of some economists about the first quarter GDP figures is that productivity growth remains flat. During the Internet boom of the 1990s, productivity moved along at a pace of 2.5%. During the last few decades productivity gains averaged 1.5%, but productivity over the last five years has increased a mere 0.5%. This is a worrying sign that businesses are not investing in the technologies necessary to raise production. As a result, the standard of living for workers may not significantly rise like previous eras.
The Evidence Suggests that Consumers Are Still Hesitant to Spend: Extempers should always remember that consumer spending is a major component of the U.S. economy. Since the U.S. is now more of a service economy than a manufacturing economy, it is very important that consumers continue to put money into the economy. Economists have estimated that consumer spending drives more than two-thirds of the U.S. economy, so the GDP figure’s recent data on consumer spending is somewhat alarming. Although gas prices are low, it appears that consumers are not putting those savings into increased spending elsewhere. In fact, household spending only grew at a 1.9% pace versus 2.4% in the fourth quarter. Consumer spending also rose at a 0.1% pace, leading to fears that consumers are not confident about the state of the economy and/or are using funds to pay down debts. Spending on popular expensive items such as new cars, televisions, and appliances fell by 2.6%, while consumer savings grew by5.2%. If Americans choose to save more than spend it could eventually produce deflationary fears and the Federal Reserve may be tempted in the long-term to experiment with negative interest rates, which Europe is already experimenting with. And prospects for the economy may not improve as Gallup has found that Americans have the lowest confidence in the economy since August.
The Trade Deficit is Still a Problem: One of the few things that Donald Trump and Bernie Sanders agree upon on the campaign trail is that the United States is not benefitting from free trade agreement. These accords, which include the North American Free Trade Agreement (NAFTA), have been a contributing factor to decades of American trade deficits, thereby depressing overall economic growth (a trade deficit can be a negative versus other parts of GDP that are typically positive such as consumer spending, business investment, and government investment). The recent GDP figures show that exports declined by 2.6% in the first quarter, which is partly a result of a strong U.S. dollar (making U.S. products more expensive in other countries) and weakening global economic growth.
Reasons to Not be Alarmed Over the GDP Figure
First Quarter Numbers Have Been Weak Since the Great Recession: Economists that are not worried about the recent GDP figure note that since the Great Recession of 2008-2009, first quarter growth has typically been anemic. For example, in 2010 first quarter GDP registered at 0.8%, but the second quarter saw growth roaring back at 3.1%. Last year, GDP growth clocked in at 0.2% and across all years since 2010, GDP growth has averaged a paltry 0.6%. The Commerce Department told reporters last year that it was going to adjust its GDP calculations to account for seasonal factors such as weather, production schedules, and hiring changes, but it does not appear that these adjustments have produced a higher GDP growth figure. Still, the U.S. economy has a pattern of registering higher growth rates in the second through fourth quarters, so first quarter GDP may not be something extempers (or investors) should worry about.
Structural Worries About the Economy Are Being Alleviated: Optimists not that the terrible oil market was probably responsible for the contraction in mining investment and that a drop of 83% is not going to happen in the second quarter. Also, the U.S. government is doing better reducing the deficit, which has fallen to 2.4% of GDP and overall debt, although high at 74% of GDP, seems to have stabilized. Furthermore, banks might tighten some of their lending in the short-term, but government statistics actually show that lending has increased by 8% and this is borne out in how the U.S. housing market is improving (see below). Additionally, inflation appears to be under control so this will temper the Federal Reserve raising interest rates by a significant amount and denting U.S. economic growth. And they conclude by noting that 2% economic growth may not be amazing, but it is better than the alternative.
The Housing Market is Showing Signs of Life: The implosion of the U.S. housing market was one of the primary contributors to the Great Recession. A healthy housing market can affect other parts of the economy, notably construction, and it can also raise the long-term wealth of Americans that use a home as one of their primary retirement vehicles. The recent GDP figures showed that fixed residential investment grew by 14.8% in the first quarter and this is the strongest number acquired since the fourth quarter of 2012. If the housing market continues to grow this could eventually raise the entire economy, by providing job opportunities, increasing spending patterns, and raising the asset wealth of various Americans. Mortgage rates remain low as well, so there is a greater incentive for Americans to buy a home than in the past.
The Labor Market is a Better Indicator of Where the Economy is Going: Economists argue that being alarmed at first quarter GDP is silly because employment shows how healthy an economy is. They note that the U.S. economy continues to add jobs and may add up to 200,000 new jobs for April (the new employment report will be issued by the Bureau of Labor Statistics on Friday) and employers have added nearly 1.5 million jobs over the last six months. This job growth could provide more consumer spending (wages are estimated to have risen by 2.3% over the last year), and is also a signal that businesses are becoming more confident about the long-term health of the economy to the degree that they will employ more workers (in times of bad economic health businesses will tend to place a greater workload on existing employees rather than take the risk of expanding their employee pool). Still, there are some dangers here as factories cut 50,000 jobs in February and March, six million workers are desiring full-time work but trapped in part-time jobs, and the active labor force is lower than it has been in more than sixty years.
Sources
“America’s Economy Will Rebound From this False Dusk” (UK Telegraph, May 1, 2016)
“Americans’ Confidence in Economy at 2016 Low” (CNN, April 28, 2016)
“At a Glance: First-Quarter U.S. GDP” (The Wall Street Journal, April 28, 2016)
“Cash is Still King in U.S. Economy, but Spending’s a Drag” (The New York Daily News, May 2, 2016)
“Economist React to First-Quarter GDP: ‘Pretty Lackluster’ (The Wall Street Journal, April 28, 2016)
“Figuring the True Cost of a ‘Sluggish U.S. Economy’ (The Dallas Morning News, April 29, 2016)
“First-Quarter GDP Shows Economy Grew at Slowest Pace in Two Years” (MarketWatch, April 28, 2016)
“The Economy is Great; the Economy is Terrible” (The Atlantic, May 3, 2016)
“The Recovery’s Two Sides: Weak Growth Even as Hiring Surges” (The New York Times, April 28, 2016)
“U.S. Economic Confidence Index Hits Lowest Point in 2016” (Gallup, April 26, 2016)
“U.S. Economy Still Seen Growth 1.8 Percent in Second Quarter: Atlanta Fed” (Reuters, May 2, 2016)
“Warren Buffett: U.S. GDP Figures Are Inherently Suspect” (CNBC, May 2, 2016)