GDP: When Is Growth Not A Recovery?

Today’s revised GDP numbers for the Third Quarter are disappointing. You may recall that the original estimate last month was that we saw the economy grow about 3.5% in those three months. As better data has been accumulated, that growth is now estimated to have been smaller, at 2.8%.

While any growth is good, especially after the crisis of the past year or so, this level of activity is scarcely sufficient o keep us treading water on the one big issue we have to fix: jobs.

First let me show you the numbers:

• Personal Consumption added 2.07% to GDP in the third quarter, compared to a negative 0.62% the prior quarter
• Private Non-Residential investment reduced GDP by 0.4%; which was better then the second quarter’s -1.01%
• Residential Investment bounced back a bit, adding 0.45%; it had been-0.67% in the second quarter
• Inventories showed a big swing, adding 0.87% in the third after having reduced the second quarter by -1.42%
• Trade was a problem: exports added 1.71% to GDP in the third quarter after being a -0.45% drag in the second; but imports grew rapidly as well to offset that export improvement, imports reduced GDP 2.53% in the third after having added 2.09% in the second quarter
• Government Spending was positive both quarters: Federal expenditures added 0.65% in the third quarter slightly down from the 0.85% contribution of the second; State spending fell rapidly and has become a drag on growth, it reduced GDP by -0.02% in the third quarter after having added 0.48% in the second.

If you add all these figures together you arrive at the -0.74 reported for the second quarter and the 2.79% announced this morning.

So here’s the problem:

This is just not strong enough to make a goodly dent in our enormous overhang of spare capacity. I was very disappointed to see that both personal consumption and private non-residential investment were both adjusted down from the initial announcement. Even a cursory review of the results makes it obvious that all our talk about an inventory and stimulus led recovery was spot on. The basic economy is still quite weak and shows no real sign of gathering much momentum. The pick up in exports was easily offset by the acceleration in imports as the economy began to suck in more oil and manufactured goods. Plus there seems to be a problem developing in the level of state expenditure: as states struggle to balance their books they will reduce spending which will act a significant drag on the economy. Already the Federal level spending burst is beginning to dissipate, so when we add in the movement in trade and in state spending activity, the burden for the next few quarters shifts decisively to the private sector, which while not dormant is not exactly humming along either.

The big problem is that capacity gap. This is the difference between what GDP would be if we were utilizing all our resources, and its level given the percentage of our resources we are actually using. Currently this gap is huge. We have the capacity to be generating a GDP several points higher than that we are actually producing. Such is the collapse in private sector activity that this gap will take years to close if we meander about at the pace of growth we achieved in the third quarter.

It is this enormous overhang of spare capacity – most of it in the form of unemployment – that makes the economy feel as if it were still in recession, even though the data says it is growing again.

We are simply mired in fear. Consumers are afraid to spend as they struggle with debt loads that now seem out of whack with income and wealth prospects, and business keeps moderating its expectations for the future and refuses to ramp up employment. This is beggar thy neighbor writ very large. Until the fear subsides we will wallow about in mediocrity.

Oddly the one hope we had is the government and that now seems to be getting ready to step aside. All the talk in Washington and in the financial media is now fear driven too. Fear of the Chinese bailing out on our debt; fear of the bond market; fear of the dollar sliding some more; fear of a burst of inflation resulting from the money supply binge needed to prop up the banks; and fear of just about anything else you can imagine that could cost money. Except defense of course. Always except defense. These fears are all unfounded, but are easy to exploit politically in the absence of strong leadership.

Compound this fear by adding in a political system that has become totally unresponsive and easily ground to a halt, and we look set of a long period of frustrating and sub-optimal economic behavior.

No one wants to fix the problem.

I think this gridlock is a natural outcome of the crisis in economic thinking itself – where the free market ideology is being uprooted at long last – and in politics where the basic tenets of right wing economic policy beliefs have been overcome by reality.

So we are undergoing a sea change. A shift in worldview away from the Reaganite free market, free wheeling, laissez-faire system towards something that has yet to emerge. The rearguard from the free market crowd is fierce at all levels – in Washington as well as in academia – and it is this rearguard action that is stalling our progress: as an example, it prevents us from moving quickly to implement jobs programs because the free market folks object to more government spending.

Couple this with the health care reform ‘debate’ which has surfaced deep ideological divisions even in the Democratic Party and nothing much gets done. What legislation is passed comes at an increasing cost in terms of time and pent up emnity.

Our political system is teetering on the brink of failure. In particular the gentlemanly rules of engagement in the Senate are breaking under the strain of an increasingly entrenched ideological separation between the parties. The GOP has moved sharply rightward over the last few years and actively uses arcane rules to reduce the Senate to a standstill. The threat of filibuster essentially ends any chance of major legislation by either party. Unless the rules are changed neither will get a coherent program through and the Senate will deteriorate into a farcical debating chamber incapable of addressing big issues. Perhaps this is what the GOP wants. It certainly acts to their advantage currently. But in politics what goes around …. at some point the Republicans will suffer the same. Much of this will go away with time as the old time methods of reaching across party lines evaporate and legislation becomes more party line oriented. For this to happen we need to rid ourselves of the centrists who like to wheel and deal: they trade their votes for bundles of pork barrel spending in their home states. They also like the attention and power they get from being able to hold up action.

This clubbiness is a major deficiency of the American system as long as the nation is deeply divided along cultural or ideological lines. Those divisions are now so deep that reaching across party lines to form consensus on anything significant is just not possible. This slide towards dysfunction has been going on for a while. The American system was never designed to handle or reflect ideological divisions as deep as we now have. It was designed to operate best on a middle ground where there was general agreement on national goals and characteristics. Yes of course horse trading took place, but once that was done most major votes were very lopsided. Now the very notion of horse trading is limited to those few centrists. The Republican central committee has even banned cooperation, saying that it will not support candidates who reach out across the ideological divide.

I don’t know if this is good or bad. I come from a very confrontational style of politics with deeply rooted ideologies, so I am empathic with anything that simplifies party lines. At the same time the American system, which is unique and very parochial in its mechanics, has served well. It is only in the light of the culture wars and social changes of the past thirty years that it has been under strain.

What I do know is that unless the political fog clears and allows us to eliminate anyone’s ability to exploit fear, we are more likely than not to stay mired in the mess we just created for ourselves.

That could result in a ‘lost decade’. Which would be tragic.