Economic pundits are bemoaning the fact that first quarter GDP numbers released last Friday were weaker than expected – growth was 2.5% rather than the 3% that everyone had been expecting.
I actually took it as positive news. For starters, was it really possible that we’d suddenly gone back to our normal, historic 3% trend growth? The optimism in the economic forecasts always seemed to have more to do with the fact that we didn’t fall completely off the fiscal cliff a few months back.
In fact, the economists and investors letting out a collective exhale a few months back made us forget about the coming effects of the sequester. But there was no denying them in the first quarter numbers – the slower than expected growth was all about the public sector slamming on the brakes. “The decline in government expenditure over the past two quarters is the biggest six month contraction since the Korean War ended,” notes Capital Economics’ chief US economist Paul Ashworth.
The lack of government spending is the reason for the 2% economy – since mid 2009, GDP growth has averaged 2.1% in the U.S., but if you strip out the public sector, that average jumps up to 3.1%. In the first quarter, for example, consumer spending was the major source of growth — consumption accelerated to 3.2%, up from 1.8% at the end of the previous year. That was due in large part to the fact that American consumers have done the hard work of repairing their personal balance sheets, and are finally in the black. They can afford to dip into savings to spend a bit more, and they did – the savings rate in the first quarter was down to 2.6% from 4.7% before.
But that’s unlikely to continue. There’s no sign of the unemployment rate ticking down anytime soon, and what downward movement we have seen recently is likely because the labor force participation rate in this country is at its lowest since the early 1980s, before women fully entered the workforce. People are frustrated about not finding jobs, and they are settling for less — or leaving the market altogether. That means wages can’t rise, and you simply can’t have a robust recovery in an economy like ours, which is 70% consumer spending, if consumers don’t have more money to spend.
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In fact, the second quarter numbers this year are likely to make the first quarter seem a gift. University of Michigan consumer confidence numbers are now at their lowest level since the fiscal cliff crisis. Retail sales in April look weak. And housing, while in recovery, isn’t yet booming in a way that would make people feel a lot wealthier. My sense is that we’ll see a slow and steady recovery for another couple of years, if we’re lucky. Meanwhile, the sequester ensures that we’ll have yet another big contraction in government spending over the next few months. The result? Likely a continuation of the 2% economy.
It’s amazingly bad policy, particularly considering all the news over the last couple of weeks about the flaws in the argument made by economists Ken Rogoff and Carmen Reinhart that high government debt levels undermine growth. It turns out there isn’t necessarily a magic debt number after which growth falls off the cliff; it’s more about what sort of debt you have, and whether government spending is actually helping spur growth. Sure, we need to rein in longer term entitlement spending, but as Ashworth notes, much of that debt comes due decades in the future and is calculated based on interest rates and mathematical formulas that will almost surely be revised downward in time. Meanwhile, we’re in the process of cutting all sorts of useful government spending for things like education and government funded R & D at a time when the private sector still can’t (or won’t?) pick up the slack, and consumers have little wiggle room.
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On a more positive note, however, I do think that the second half of the year is going to be better than the first. It’s even possible that we could see growth creep back up closer to 3% if housing does well, and companies flush with cash start to spend a bit more on workers. But the growth will continue to be dampened by government – which makes you wonder what sort of GDP figures we might have if Washington actually worked.
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