April 28, 2006
Economy’s growth is strong, but workers wouldn’t know it
The release of two government reports this morning provides a compelling look at what is right and wrong with the U.S. economy. The nation’s gross domestic product (GDP), the broadest measure of the economy’s strength, rose at an annual rate of 4.8% in the first quarter of the year, the fastest growth rate since the third quarter of 2003. At the same time, worker compensation rose only 2.4%, the slowest growth rate in seven years and well below inflation. The economy is doing fine, but most of the people working in it aren’t faring so well.
The Commerce Department reported today that real (i.e., inflation adjusted) GDP grew in the first quarter of 2006 at 4.8%, up from 1.7% growth in the previous quarter. Strong contributions to growth were seen in all categories of personal consumption expenditures (durables, non-durables, and services)—which accounted for 3.8 percentage points of the growth—as well as in investment in equipment and software (1.2 percentage points) and federal government spending (0.73 percentage points).
The rising trade deficit once again pulled down GDP growth substantially, even though export growth was only slightly behind import growth (12.1% vs. 13.0%). Declining net exports (i.e., the trade deficit) knocked off 0.84 percentage points off of GDP this quarter. This reflects the fact that the level of imports is now more than 50% higher than that of exports, requiring the latter to grow more than 50% as fast as the former for the trade balance to contribute positively to growth. Despite widespread agreement that the current trade deficit (6.2% of total GDP in this quarter) is not sustainable, the trade deficit will continue to grow and put a drag on growth until exports grow much faster than imports.
The 5.9% growth in domestic demand (i.e., final sales to domestic purchasers) was also the highest rate since the third quarter of 2003. This report, combined with data released by the Bureau of Labor Statistics today on employment costs that show falling real compensation in the latest quarter, raises a question: how sustainable is this domestic demand in the medium-term? The negative savings rate in this quarter (-0.5%) marks a full year of consecutive negative savings rates, and reinforces the notion that more robust growth in wage and salary income is needed to sustain the recovery when other sources of demand (home equity withdrawals supporting consumption purchases, for example) inevitably fade.
Some evidence of this cool down in housing consumption can be seen in the slowdown in residential investment growth. As Figure A shows, this growth has slowed markedly in the last year, and, there is evidence that its contribution to total GDP is beginning to flatten out. In short, the economy may not have the housing sector to lean on as much in the future.
In short, this strong quarterly report does nothing to allay concerns about how the economy will navigate an inevitable adjustment that lowers the trade deficit and sees climbing savings rates. This adjustment will require strong growth in net exports and strong wage and salary growth. No evidence of either of these can be seen in today’s data releases.
Core annualized inflation (i.e., inflation in market-based personal consumption expenditures minus food and energy prices) fell to 1.6% for the quarter, compared to 1.9% the previous quarter. This tame inflation, combined with substantial weakness in the broader economy, argues strongly for the Federal Reserve to stop its campaign of interest rate hikes. While some inflation stemming from rising energy costs is almost surely coming down the road, rising interest rates cannot stem this cost-push inflation without unacceptable consequences on labor markets that still seem incapable of generating sustained wage growth.
Figure B below shows nominal (not inflation-adjusted) yearly growth in compensation and wages for all workers, along with inflation. Wage growth has been decelerating since 2000, and it has leveled off in recent months at around 2.5%, well below the historical average for this series (and below the inflation rate since 2004). Compensation has slowed as well since 2004, largely due to flat wage growth in tandem with declining benefit costs. For the last three quarters, compensation has lagged inflation as well.
Taken together, these two reports provide stark evidence of the stubborn gap between growth and the living standards of working families. They also reveal little inflationary pressures from labor costs, which are decelerating even as the economy picks up. These growth and wage dynamics should persuade the Federal Reserve to pause to allow the economy to grow faster, create more jobs, and spur stronger wage and benefit growth.
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