Why the GDP Drop is No Big Deal
Is the U.S. economy really slipping back in recession? The Commerce Department reported Wednesday morning that the economy shrank at a .1 percent annual rate in the fourth quarter. If the figure stands up to further revisions, coming in the next two months, it would mark the first quarterly decline since the middle of 2009 and the end of this deeply unsatisfying expansion.
But that’s not what’s happening. ““This report is nowhere near as bad as it looks on the surface,” said Nigel Gault, chief U.S. economist at HIS Global Insight. “It would be a mistake to view this drop in GDP – driven by temporary corrections in defense spending and inventories – as a possible harbinger of recession.
Quarterly GDP numbers are famously spiky and volatile. The economy can seem to be expanding at a really rapid rate in one quarter – 3.1 percent in the third of 2012 – and then fall into negative territory in the next quarter, only to rebound again. Macroeconomic Advisers, among the most sober and data-driven forecasters out there, pegs the current quarter growth rate at 2.4 percent.
Also, and I hate to use the phrase, but the fundamentals of the private-sector economy are relatively strong. ADP reported Wednesday that the private sector created an estimated 192,000 jobs in January 2012 – up from the revised figure of 185,000 in December. The virtuous cycle of more jobs leading to more spending and better housing activity, which in turns leads to more jobs and more spending and more housing activity, is very much in intact. Housing sales and prices continue to rise on a year-over-year basis. And while consumers remain fearful and are likely bummed at the impact of higher payroll taxes, they’re in relatively good shape.
In its report, the Commerce Department breaks down sectors by their contribution to—and subtraction from—the GDP figure. In the fourth quarter, personal consumption, which accounts for 70 percent of economic activity, rose at a 2.2 percent annual rate. Residential fixed investment (that is to say, housing), rose at a 15.3 percent annual rate.
It turns out that the decline was caused by two factors that Americans love to hate, and that they can’t control: the weather, and the government.
The volume of trade uncharacteristically fell in the fourth quarter – with both exports and imports down. That cut 25 basis points off the growth rate in the quarter. The vicious storm that shut down a large section of the east coast may be partially to blame. In a statement, Alan Krueger, chairman of the White House Council of Economic Advisers, said that “both international trade flows and inventory accumulation could have been affected by disruptions caused by Hurricane Sandy, although a precise estimate of the effect of the hurricane on GDP is not available,” Krueger said.
But the real culprit this time was the federal government. We’ve noted this time and again, but it bears repeating. We are having a conservative recovery. Federal government spending may be up, on health care, entitlements, and benefits. But pretty much everywhere else in the vast government sector, spending is down – especially on employment. Since May 2010, some 1.072 million public-sector jobs have been cut.
Austerity, it turns out, detracts from growth. In the fourth quarter, declining state and local government spending reduced GDP by 8 basis points. But the real drag on growth in the fourth quarter was the federal government, and especially the Pentagon. Defense spending plunged 22.2 percent, subtracting 1.28 percentage points from the growth rate. The decline is partly due to the continuing drawdowns from Iraq and Afghanistan, and partly due to seasonal spending factors (defense spending in the third quarter actually rose sharply.) But there’s a third factor at work: “A likely explanation for the sharp decline in Federal defense spending is uncertainty concerning the automatic spending cuts that were scheduled to take effect in January, and are currently scheduled to take effect on March 1st,” Alan Krueger noted.
Before our eyes, the economy is continuing to change its shape – it is one increasingly dominated by the private sector and consumers, by private spending and investment, and less dependent on public sector and government spending, especially on things like weapons and wars. That’s a good thing.
The issue, however, is the speed and timing of this shift. We may have negotiated the fiscal cliff and a debt ceiling debacle. But we shouldn’t delude ourselves into thinking that Washington is no longer a threat to the recovery. To a degree, austerity at the federal level is just beginning. The payroll tax and other higher taxes are likely to take a bite out of consumption this year, and in coming years. Defense spending is likely to tick down. Bipartisan pressure for a deficit deal remains high. And the sequestration – a set of indiscriminate, across-the-board cuts – is supposed to go into effect in a matter of weeks.