So Far … So Good
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Dr. Martin Regalia
Senior Vice President and Chief Economist,
U.S. Chamber of Commerce
This month, I thought that I would start with a bit of good news. According to the most recent data, real GDP increased at a 3.0% annual rate in the first quarter of 2010, following a 5.6% increase in the previous quarter and a 2.2% bump in Q3 2009—that’s about a 3.5% annual growth rate since the middle of last year. Furthermore, the labor market is finally adding jobs, businesses are increasing investment levels, and the consumer is spending again, albeit at a somewhat subdued pace. The incoming data generally point toward a continuation of this growth over the remainder of this year and into 2011.
So if I were forced to summarize the economy at this point, I would have to say, so far … so good. But because I am a long-standing practitioner of the “dismal science,” I must also add a few caveats and concerns.
Consumption Not Growing Fast Enough
Let’s take a closer look at some of the major components of this growth. Consumption makes up about two-thirds of the economy. Real personal consumption expenditures accelerated to a 3.5% annual rate of growth in the first quarter of 2010, up from 1.6% during the last quarter of last year. While the improvement is welcomed, current consumption is considerably weaker than what we saw coming out of the recessions in the mid-1970s and early ’80s, when consumption growth was almost 6.5%, and well short of what we need to really get this economy moving.
Ultimately, consumption is driven by increases in income and wealth. Real disposable income per capita began to grow in the second half of 2009 and has continued to improve over the first half of this year, growing at an annual rate of 4.4% in April, the latest data available. However, much of the improvement has come from stronger wage growth, and significantly stronger job growth will be necessary to see improvement from this point.
Household wealth has improved markedly, since bottoming out in early 2009. Over the past year, improvements in the stock market have driven household wealth up by about $4 trillion. Despite these gains, household wealth remains down about $10 trillion from its prerecession peak, and the recent weakness in the equity markets is likely to delay any additional improvement.
In addition to the stock market, the other main contributor to household wealth is housing. The housing market has stabilized, but so far we’ve seen little outright improvement. In April, housing starts showed a solid gain of 5.8% after increasing 5.0% in March. Existing home sales increased 7.6% in April after increasing 7.0% in March, and new home sales have followed a similar trend. Much of this recent strength is likely due to the first-time homebuyer tax credit, but with the expiration of the homebuyer tax credit in April, we expect less improvement in coming months.
From the household wealth point of view, the price of existing homes is the key indicator, and here the data are mixed. Median prices of existing homes rose 2.1% in April, offsetting earlier weakness, but they are yet to demonstrate consistent improvement. While we are working through existing inventories, the rate of foreclosures is still high, bringing new supply on the market and delaying fundamental improvement. We probably won’t see consistent gains in housing prices until early next year at the earliest.
After consumption, investment is the next largest contributor to GDP. Following years of weak growth and outright declines during the recession, investment in equipment and software has picked up noticeably in the past few quarters. This component increased at an annual rate of 12.7% in the first quarter of this year after growing 19% in the previous quarter. Moreover, strong improvement in durable goods orders for April indicates continued strength in this component during the second quarter of this year. With overall demand tepid, however, it is unclear whether investment in equipment will maintain its recent strength.
Investment in structures has been a different story, with double-digit declines occurring throughout the recession and continuing, although at a slightly reduced pace, through the most recent time period. With a capacity utilization rate in the low 70% range indicating significant excess capacity, prospects for resurgence in capacity building do not look good.
Finally, inventory investment provided a significant boost to GDP growth in both the fourth quarter of last year and in this year’s first quarter, but with an inventory-to-sales ratio still above its prerecession level, the inventory surge is unlikely to continue.
Trade Sector Slips
Improvement in the trade sector, which was a real bright spot in the economy over the last few years, has recently slipped from the positive category into more of a neutral stance with a stronger dollar and more uncertain growth abroad. Problems in Greece, Spain, Portugal, and Italy threaten the viability of the EU and raise the specter of a double-dip recession in Europe. Such weakness in one of our major trading partners, coupled with renewed appreciation in the dollar, questions our ability to expand exports.
The latest GDP report included the first estimate of first quarter corporate profits, which were up for the fifth straight quarter. Corporate profits have gradually improved since their recent low in the first quarter of 2009, but they remain below prerecession peaks. These gains reflect a modest increase in sales but are primarily driven by productivity increases. While productivity growth is a major contributor to long-run increases in our standard of living, in the short run, it means that firms can make do with a smaller labor force. Thus, the growth we have seen of late has produced only a small improvement in the labor markets.
Nearly 1 Million Net New Jobs
The economy lost almost 8.5 million jobs during the recession and is still down about 7.5 million jobs from its prerecession peak. The good news is that over the last five months, the economy has once again begun to add jobs—creating 982,000 net new jobs. Granted, half of these jobs were government jobs, many of them temporary Census jobs. But such hiring will nonetheless help underpin demand and spur additional spending. Unfortunately, even this pace of job creation will be insufficient to drive the unemployment rate down to acceptable levels anytime soon.
The unemployment rate in May dropped 0.2 percentage points to 9.7%, but this drop was as much due to a decline in labor force participation rates as to any real job creation. Moreover, as the temporary surge in Census workers unwinds and more unemployed workers start to look for work and thus rejoin the measured labor force, the economy will be hard pressed to maintain any improvement in the unemployment rate.
With regard to this latter point, in addition to the measured unemployed, there are also about 1 million unemployed who are too discouraged to look for work, and about 9 million people are working part time as a result of the current economy even though they would prefer to work full time. As if the number of people unemployed were not bad enough, the duration of unemployment is well above what we saw during the previous recession. In other words, the job losses appear to be more permanent.
If there is a bright spot anywhere in the economy, it would have to be the inflation front. Inflation is currently at rock-bottom levels and shows no indication of rising any-time soon. This has allowed the Fed to remain very aggressive in its monetary policy and keep short-term interest rates close to zero. I believe that it will continue this policy into 2011.