How GDP growth overstates case for recovery

John W. Schoen Senior producer • Profile • E-mail

Last week's news that the economy is growing again produced a number of reports that "the Great Recession is over." Even if that were true, what follows may be more painful that any economic recovery in living memory.

If the recession is over, then why does consumer confidence continue to fall, home sales are going south again and unemployment continue to inch up and up?  
— Greg, Smyrna, Ga.

There are two possible explanations. One is that the recession isn’t over.

Despite the high-fiving among economic forecasters over last week’s report that the economy began expanding again in the third quarter, one quarter of growth is not enough to mark the end of a recession. And when you take a look inside the report, the 3.5 percent advance in the gross domestic product doesn’t exactly point to an economy on the mend. (Keep in mind this the government’s first attempt at estimating the latest quarter of GDP. This number will be revised twice before it’s considered “final.”)

The biggest gain, roughly 1 percentage point, came from vehicle sales, which surged during the wildly popular, now-ended Cash for Clunkers program. The rebound in the housing market, thanks to the first-time homebuyer tax credit that expires in November, added another 0.5 percentage point. Direct government spending added another 0.5 percent.

Third-quarter GDP also got a big boost — 0.9 percent — from a change in the level of inventories. To avoid getting stuck with piles of unsold goods, businesses continued cutting inventories in the third quarter. But because they've already cut to the bone, they did so at a slower pace in the third quarter. According to GDP math, that's a good thing.

So if you take out the growth that was directly or indirectly paid for by the government, along with the way GDP accounts for changes in inventories, the economy grew by just 0.4 percent. That’s roughly the size of a typical revision by the time the final data is released.

All of which means that most of the “recovery” in the third quarter was essentially a sugar high from one of the most aggressive government interventions in history. If the jolt from the stimulus simply moved up sales of cars and houses that would have happened later this year and next, all we will have done is created a hole in future GDP numbers.

It also turns out that the stimulus — as big as it was — may not have been big enough. About one-third of the $787 billion total went to tax cuts, much of which has only helped offset lost wages. Much of the rest is essentially going to fill a giant, $360 billion hole in state budgets this year and next. That leaves about $140 billion in incremental government spending, or 1 percent of GDP.

When the impact of that government spending begins to wane next year, the hope is that other sectors of the economy such as consumer spending and business investment will kick in. But consumers don’t yet seem ready or able to do a lot of spending. Two separate measures last week showed consumer confidence fell in October. Businesses continue to try to squeeze more profits from the same dollar of sales by cutting costs, which means they're spending less, not more.

Even if they get in a spending mood, consumers don’t have a lot of extra income to go shopping.

The latest data show that overall income was flat in September, despite the tax refund portion of the government’s stimulus program. Without those transfers, wages and salaries fell 0.2 percent.

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