GDP Picture: July 29, 2005

July 29, 2005

Shrinking trade deficit leads to strong demand growth in second quarter
The Bureau of Economic Analysis (BEA) reported today that real gross domestic product (GDP) increased at an annual rate of 3.4% in the second quarter of 2005, down from a 3.8% growth rate in the first quarter. However, rising inventories cut a full 2.32% off of this quarter's growth rate. Final sales (a better barometer of growth in economic demand) grew 5.8% in the second quarter, up from 3.5% in the previous quarter.

The most striking change in this BEA report is the addition to GDP due to net exports. A shrinking trade deficit actually added 1.57% to GDP this quarter. This is the first positive contribution trade flows have made to GDP since the third quarter of 2003, and the largest positive contribution since 1996. Exports grew at a 12.6% annual rate while imports shrank at a rate of 2.0%.

Despite strong demand, this report shows continuing weakness in labor income, particularly private-sector wage and salary growth, can be seen in Figure 1. Since the recovery's start in the fourth quarter of 2001, (real) private wage and salary income is up only 7.3%. The average for all economic recoveries that have lasted at least this long is 18.8%, and even the "jobless recovery" of the early 1990s saw 8.3% growth by this point. Total labor compensation (including fringe benefits) is up 10.7% during this recovery, compared to the 18.9% average that has marked previous recoveries.

Figure 1: Growth in (real) labor compensation and private wage and salary income, current recovery vs. historical averages

Almost all measures of inflation remained modest this quarter. The GDP deflator grew by 2.4% in the second quarter, down from 3.0% the previous quarter. The index for prices of gross domestic purchases minus food and energy (a closely watched measure of "core" inflation in the economy) grew by 2.0%, down from 3.0% the previous quarter. This price data, combined with weak growth in labor incomes, signals an economy that is far from overheating. Personal consumption expenditures decelerated slightly, posting growth of 3.3%, compared to 3.5% in the first quarter. But non-inventory investment perked up, growing at 9.3% compared to 7.0% in the previous quarter.

On one important front, the news from today's BEA report is encouraging. Domestic demand growth (final sales to U.S. purchasers) increased at a substantially slower rate than total demand growth (final sales of U.S. product). The slack between these two measures was filled in by rising net exports (a shrinking trade deficit). This is exactly the sort of dynamic that will be needed to bring the U.S. trade account closer to balance without sacrificing economic growth.

By EPI economist L. Josh Bivens

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