1st Quarter 2019 GDP Growth of 3.2% Is Not What it Seems?
GDP Growth by Quarter for President Obama and Donald Trump
1st Quarter 2019 Economic Growth was a Surprise!
Consensus from those who are expert in these things was that economic growth would slow to 2.1% for the 1st Quarter in 2019. They had many reasons to think so. Among them are:
- 1st Quarters are normally the worst of the year
- The federal government was shut down for almost all of January
- Subsidiary businesses who rely on the federal government were severely impacted
- The negative effect of the tariffs on agriculture and other export related businesses
- Bad weather for most of the quarter
In spite of all these downward pressures, the annualized growth clocked in at a strong 3.2%. These economists frequently do not get the growth exactly right, but they are rarely far off. To be this far off is almost unheard of. So what did they miss?
Getting Down Into the Weeds
As someone says, "the devil is in the details" and that is exactly where things went awry. As it turns out their predictions about consumer spending and exports weren't too far off. It was the "other" things that go into calculating the Gross Domestic Product (GDP) that threw them a curve ball.
The GDP is made of four components (many on the Right say one of them, government spending, doesn't matter):
- Domestic Spending
- Domestic Business Investment (including that from outside the U.S.)
- Government Spending
- Net Trade (Exports - Imports)
Further, Domestic Business Investment includes buying inventory and government spending includes local and state government spending - and therein lies the solution, as it turns out. It was changes in these two items, as well as an increase in net trade.
Domestic (Consumer) Spending followed expectations. Analysts predicted consumer spending would continue to slow down and estimated a 1% annualized increase. The actual increase (1st estimate anyway) was 1.2%. Keeping this number low was a decrease in spending on durable goods (more expensive, longer-lived items).
Domestic Business Investment
This sector has three major components:
- Domestic investment, including that from foreign entities, in non-inventory items
- Residential Construction.
The increase in non-inventory business investment fell substantially when compared to increases from previous quarters., as did residential construction.
On the other hand, inventories increased substantially. This can be good or bad, depending on whether the economy is growing, is flat, or is declining. In the former case, increasing inventories are a sign of businesses anticipating increased sales. In the latter two scenarios, businesses are not being able to sell their inventory as fast as they planned (which goes hand-in-hand with slowing consumer spending). This is the situation today. Inventories added 0.65 points to the GDP while the other components added only 0.27 points.
This is an interesting category because there are many people on the Right who firmly believe that government spending does not contribute to economic growth. All I can say is they are wrong for it contributes about 17% to total GDP.
For this quarter, initial estimates found that, mainly because of the government shutdown, the Federal government overall did not contribute to the increase in GDP. Estimates are that the shutdown itself caused a 0.3 point drop in GDP.
Making up for that are state and local governments not being able to wait on the federal government to pass an infrastructure bill and began investing on their own. In this case, they added a sizable 0.41 point increase in GDP.
This is a very tricky component because there are so many variables that determine how much America buys from others (Imports) and how much we sell to other countries (Exports). Conventional wisdom states we always want exports to exceed imports, but that is an urban legend. In reality, within bounds and absent aberrant factors, it doesn't make any difference whether a country runs a positive or negative trade balance. In spite of Donald Trump's pronouncement on the subject, it simply "is what it is".
For this quarter, Exports increased 3.7% while Imports decreased 3.7% leading to a net increase in GDP of 1.03 points - a full third of the increase in GDP.
What does that mean? It means other nations bought more goods and services from America than America bought from them. "Normally" this situation is reversed. So what does this imply - American consumer spending is slowing down - our third indicator that this is happening.
Comparing With Other Similar GDP Growths
To highlight how much things have changed recently, I decided to compare the 3rd Quarter 2018 change in GDP (3.4%) with the current period (3.2%). To make the comparison, it is useful to look at the "contributions" to the change from each of the sub-components of the GDP.
For starters, lets look at the very top level.
Top Level Comparison Between Three Similar Quarterly GDP Growths
1st QTR 2019
2nd Quarter 2015
Percent Change (annualized) from the Previous Period
Percent Contribution to the Change
From Table 1, it should be very easy to see something different is happening in the 1st Qtr, 2019 when compared to a quarter in the Obama era with similar growth.
First, notice that government spending contributed very roughly the same amount in each quarter. So, in aggregate, nothing much changed here (although there was significant movement when you get below the top numbers.
Next, consider Net Trade. Historically, Net Trade contributes, on average, 0.27 points toward the annual GDP. In our two example quarters, this contributed 1.03 and -0.01 points, respectively. This explains, at the top level, the wide difference in the percent contribution toward their respective total GDP.
WHY, this happened is important to our story. In 2015, Exports increased from the previous quarter which raises the GDP. Imports also increased at about the same amount which decreased GDP. Combining the two results with Trade contributing almost nothing to GDP.
On the other hand, and this is one reason why GDP reached 3.2% in the 1st Qtr, 2019 even though the more important factors pointed toward lower growth. What makes Q1, 2019 different from Q2, 2015 are Imports. While the change in exports and imports were almost identical in magnitude with Q2, 2015, Imports were of the opposite sign; the change in Imports in Q1, 2019 decreased - which adds to GDP. The result, then, means Net Trade had an outsized impact on GDP.
The question, therefore, is why did Imports decrease so much from the previous quarter? Why did Americans stop buying foreign goods; which only happened three times in the last 16 quarters. Two reasons suggest themselves: 1) people are less willing to spend their money and 2) Trump's campaign to reduce imports is working.
Domestic Business Investment
One of the strange things about Business Investment is one of its components - change in business inventories. What makes it strange, or ironic, is that this change is generally less than 5% of total GDP yet it often drives the overall change in Investment. I'll show the effect of this when we drill down into the detail on Business Investment.
Domestic Consumer Spending
This component is normally the one that contributes the most to GDP. It is composed of three major sub-components: durable goods, non-durable goods, and services. The percent contribution to GDP for Q2, 2015 is typical of its historical contribution. Q1, 2019, at 25.8% is a distinct outlier. Simply put, Americans from Jan 1, 2019 through Mar 31, 2019 chose not to spend their money. This is true for domestically produced products and services (which adds to GDP) and for foreign goods and services (which effectively added to GDP as well).
Putting It Together
While the 3.2% growth in GDP was a pleasant political surprise for Donald Trump and his followers, it is something like a Trojan Horse. Inside is bad news for the future of our economy.
Consumer spending, the engine of economic growth is slowing. As businesses start having sales to get rid of excess inventory, that may goose spending for awhile, but it will result in lower profits for business. The big increase in local and state spending is something like a "one-time-good-deal" - meaning it won't last.
Neither will the bump we got for exporting more than we imported. That is just not the normal state of affairs and will trend back to normal - reducing GDP.
This is why experts are still predicting annual growth to fall to between 2% and 2.5% by the time all is said and done by the end of the year.
© 2019 Scott Belford