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July 31, 2003

Mixed signals for a stronger recovery


Investment regains long awaited strength, while trade deficit soars to new high

The economy exhibited mixed signs for a possible stronger recovery, as inflation-adjusted gross domestic product (GDP) rose 2.4% in the second quarter of 2003, according to today’s report from the Bureau of Economic Analysis. Although the growth rate accelerated from a slower 1.4% in the previous two quarters, second quarter growth remains too low to lower unemployment. For a sustainable recovery in the labor market, economic growth will need to be above 3.0% due to productivity growth and trends in labor force growth. But there are some signs that a stronger recovery may lie ahead as growth in the second quarter was carried by a variety of factors: a lift in consumption, increases in investment, a strong residential housing market, and more spending by the federal government. In comparison, though, the trade deficit remains the trouble spot of the economy, growing to a new record high.

The latest report shows a small recovery in consumption. Personal consumption expenditures increased by 3.3% in the second quarter, up from a low 2.0% in the first quarter. Much of this increase resulted from more spending on consumer durables, such as cars, which grew by 22.6% and was once again supported by low financing options.

As was already the case throughout the recession and the recovery, household spending on new houses and on renovations (classified as residential investment) remained strong. With a second quarter increase of 6.0%, after rising by 10.1% in the first quarter, the residential housing sector continues to support economic growth. Residential investment contributed 12.0% to the second quarter’s overall growth.

For the first time in almost three years, business investment shows signs of recovery. After declining for nine out of the last 10 quarters, business investment grew by 6.9% in the second quarter, after a decline of 4.4% in the first quarter. This is the highest growth rate of business investment since the second quarter of 2000. Investment in equipment and software, which fell for the first time in a year in the first quarter of 2003 grew again by 7.5% last quarter. And investment for structures grew for the first time in almost two years as it climbed by 4.8% in the second quarter after six straight quarters of decline.

The financial troubles of states and localities dampened growth in the second quarter. State and local expenditures declined by 1.5% in real terms after growing by a mere 0.2% annualized rate in the first quarter.

It is important to keep in mind that the government spending on the state and local level has a substantially larger impact on growth than federal spending. State and local spending on consumption and investment equaled $1.1 trillion compared to $669 billion in federal spending on consumption and investment. Put differently, although federal spending increased by 25.1%, overall government spending grew by only 7.5% in the second quarter (and only by 0.4% in the first quarter). To a large degree, federal spending increases are just compensating for the loss of growth on the state and local level, where the fiscal crisis is likely to worsen in coming quarters.

The trade deficit remained the trouble spot of the economy as it grew to a new record high in the second quarter. The fall in the dollar in the first half of 2003 spurred some hopes for stronger export growth and declining import growth. The figures for the second quarter show that these hopes have not materialized. Exports fell for the third quarter in a row as they declined by 3.1% in the second quarter, compared to a decline of 1.3% in the first quarter. In comparison, imports rose by 9.2% in the second quarter after dropping by 6.2% in the first. As a result, the trade deficit jumped to a new record high of $554 billion at the end of 2002. Slow growth in overseas markets and a limited decline of the dollar against many trading partner currencies have contributed to the worsening of the U.S. external economic position

With no signs of stronger growth in sight, the labor market’s recovery will continue to be forestalled. In order to see improvements in the labor markets, the economy will have to grow well above 3.0%. To reach this goal, increases in business investment have to be sustained in the coming quarter. Furthermore, a recovery of government spending on the state and local level and an improving trade balance (which could be achieved by letting the U.S. dollar slide against the currencies of its trading partners) could boost growth enough to spur a labor market recovery.

—by Christian E. Weller


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