US economy - the combination of structural slowdown and cyclical recession

By John Ross

Summary

This article focuses on evidence confirming long-term slowdown, as well as cyclical recession, of the US economy as indicated in the latest release of the 2^nd quarter 2010 US GDP figures.

Introduction

As widely reported, the second estimate of 2^nd quarter 2010 US GDP revised annualised US growth down from 2.4% to 1.6% - i.e. US GDP grew by 0.4% during the 2^nd quarter. The main changes compared to the first GDP estimate, in constant and annualised 2005 price terms, were a downward revision of net exports by -$19bn, due primarily to an upward re-estimation of imports by $14bn, and a revision of inventories downwards by -$13bn. Fixed investment remained essentially unchanged compared to the earlier first GDP estimate, with a revision downwards of -$1bn, and personal consumption was recalculated as $8bn higher than in the first GDP estimate (Bureau of Economic Analysis, 2010b) (Bureau of Economic Analysis, 2010a). An earlier article made a detailed examination of 2^nd quarter US GDP data and therefore only the implications for long-term trends are dealt with here. (Ross, 2010)

Slow recovery

The downward revision of 2^nd quarter GDP naturally highlights how much slower present US recovery is than in previous post-World War II business cycles. Ten quarters into the downturn US GDP still remains 1.3% below its peak in the 4^th quarter of 2007 – see Figure 1. In the previous worst post-World War II business cycle, that following 1973, recovery to the previous peak level of GDP was complete after eight quarters. Unless there is a significant acceleration of growth, US GDP will not regain its peak level until 2011 – meaning at least three years of net zero percent growth.

Figure 1

This slow recovery is, however, in line with a gradual but clear deceleration of long-term growth in the US economy – see Figure 2. The moving 20 year average of US GDP growth has now fallen gradually to 2.5% - significantly below its 3.5% historical average. Reasons the US is unlikely to reverse this trend in the foreseeable future are analysed below.

Figure 2

Fixed Investment fall

The new GDP figures also cast clear light on the issues of whether the recession in the US is primarily created by trends in consumption or investment. A number of analyses suggested that the core of the US economic crisis would be deleveraging by US consumers– see for example (Roach, 2009). If so the decline in US GDP would be centred in US consumption. The present author has consistently argued that this analysis is in error and that the core of the recession in the US is the decline in fixed investment. (Ross, 2010a) This is again strongly confirmed by the new revision of US GDP data.

Due to the significant downward revision of the US GDP figures, and the small upward revision of the consumer expenditure figures, consumption as a percentage of US GDP clearly remains well above its pre-financial crisis level – see Figure 3. Between the peak of US GDP, in the 4^th quarter of 2007, and the 2^nd quarter of 2010, US personal consumption has risen from 69.9% of GDP to 70.5% and total US consumption has risen from 85.8% of GDP to 87.6%.

Figure 3

The 1.8% of GDP increase in consumption as a percentage of US GDP is accounted for by a 0.8% of GDP increase in the share of military expenditure, a 0.6% of GDP increase in the share of personal consumption, and a 0.4% of GDP increase in the share of Federal non-military consumption.

In contrast the share of fixed investment in US GDP has fallen sharply by 3.6% of GDP. The share of non-residential fixed investment has fallen by 2.1% of GDP and the share of residential fixed investment by 1.5% of GDP.

The changes in components of US GDP, in terms of fixed price annualised 2005 dollars, are shown in Figure 4. US GDP remains $172bn below its previous peak level. However net exports, inventories, and government consumption are already above their 4^th quarter 2007 level – by $116bn, $51bn and $112bn respectively. Personal consumption is below its 4^th quarter 2007 level but only by $72bn. The US recession is entirely dominated by the $410bn decline in fixed investment.

Figure 4

The US economy, therefore, has not responded to the financial crisis primarily by reducing consumption, through personal debt deleveraging or other means, but by sharply reducing fixed investment.

Implications for long term US growth rates

A severe decline in US fixed investment, however, does not have only short term effects. As confirmed in the latest data of Jorgenson and Vu, capital investment continues to account for more than fifty percent of US GDP growth – the percentage for the latest period they analyse, in 2004-2008, is 61%. (Jorgenson & Vu, 2010) Under such conditions a severe decline in US fixed investment, of the type seen during the current recession, in practice excludes a rapid resumption of US GDP growth.

The slowdown that has been witnessed in long term US economic growth is therefore likely to continue. The present recession confirms a pattern of not simply cyclical downturn but structural slowing.

In that context the marked acceleration of US GDP growth which took place in 1995-2000 would appear to be a temporary upward fluctuation, financed by large scale import of capital, within an overall context of a long term structural slowdown of the US economy. It would not appear to mark the beginning of a more rapid US growth period.

The above trends therefore indicate that not only short but medium and long term projections for US economic growth should be assumed to be lower than historical averages. The US economy has been gradually slowing in not only a cyclical but a structural fashion.

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This article originally appeared on the blog Key Trends in Globalisation.

Bibliography

Bureau of Economic Analysis. (2010b, August 27). National Income and Product Accounts Gross Domestic Product, 2nd quarter 2010 (second estimate). Retrieved August 27, 2010, from Bureau of Economic Analysis: http://www.bea.gov/newsreleases/national/gdp/2010/gdp2q10_2nd.htm

Bureau of Economic Analysis. (2010a, July 30). National Income and Product Accounts: Gross Domestic Product: Second Quarter 2010 (Advance Estimate). Retrieved July 30, 2010, from Bureau of Economic Analysis National Economic Accounts: http://www.bea.gov/newsreleases/national/gdp/2010/gdp2q10_adv.htm

Roach, S. (2009). The Next Asia. Hoboken, New Jersey: John Wiley and Sons.

Ross, J. (2010a, February 11). The myth of the decline of the US consumer. Retrieved August 28, 2010, from Key Trends in Globalisation: http://ablog.typepad.com/keytrendsinglobalisation/2010/02/the-myth-of-the-decline-of-the-us-consumer.html

Ross, J. (2010, July 31). US 2nd quarter GDP figures - investment remains the key issue for US recovery. Retrieved August 28, 2010, from Key Trends in Globalisation: http://ablog.typepad.com/keytrendsinglobalisation/2010/07/us-2nd-quarter-gdp.html