Tuesday, May 24, 2011

US Manufacturing – Global Jack Rabbit?

In my last post (May 17) I made some comments about US manufacturing noting that output of manufacturing companies had grown in the last 10 years. I said I wanted to focus on output for that post and would see how comments might bring up some additional questions.  If US manufacturing output is rising then a couple questions arise. First, how did the US compare to other countries? Second, what are the sources of the output increases?

To answer the first question I found data at the U.S. Bureau of Labor Statistics http://bls.gov/news.release/pdf/prod4.pdf . The second question can be answered many ways but a first step is to recall that that output growth can always be decomposed into two parts – (1) the contribution from labor utilization plus (2) the contribution from the productivity of labor. Luckily the data source at the BLS had information for the years 2000 to 2007 for 19 countries and for manufacturing output, labor hours, and output per hour. Viola.   

The bottom line is that US manufacturing growth stood out when compared with 18 other countries.  The US was in a pack of countries (the Jack Rabbits) that had very high manufacturing output growth. Among those countries the US distinguished itself with respect to the relative contribution of manufacturing productivity growth to manufacturing output growth.  The Muddlers and the Brinkers had slower manufacturing output growth than the Jack Rabbits but in all cases would have done even worse had it not been for productivity growth. That is, productivity growth was important to all 19 countries.

This brings us back to macroeconomic policy. The data show that replacing labor with capital was common among almost all countries from 2000 to 2007. (The BLS also presents data for these countries for the 30-year time period from 1979 to 2009. The story is basically the same – virtually all countries had declines in manufacturing employment that were offset by increased productivity. I focus on the 2000 to 2007 time period to keep things current and simple.)
  • The   US was typical in the sense of having negative annual average growth in labor hours.
  •   It also shows that to attain strong growth in manufacturing output it will take continued strong growth in productivity.
  •   Finally, productivity growth will come only within a business environment that is conducive to investment with sanguine expectations.
Below are the details of the analysis and a presentation of the figures for the 19 countries.  I assign each of these countries to one of three groups with respect to growth: Jack Rabbits, Muddlers, and Brinkers.

How did US manufacturing output fare compared to other countries?
·         US output growth from 2000 to 2007 averaged 2.9% per year – the seventh highest rate among the 19 countries.
·         The rates ranged from 7.4% per year for the Czech Republic to -0.6% for Canada.
·         Notice that the top 8 countries were diverse – high income Nordic countries (Finland, Sweden, and Norway); Asian countries (Taiwan, S. Korea, and Singapore); and finally one Central European transforming nation (the Czech Republic).
·         The slowest growing manufacturing sectors were generally from high income European countries and Canada

% Change in manufacturing output, average annual 2000 to 2007
Czech Rep
S. Korea

Next we examine how much of this output growth was the result of changes in labor hours, labor productivity, a combination of the hours and productivity.

The results for labor hours are as follows.
·         Singapore was the only country to increase labor hours from 2000 to 2007. Singapore’s strong output rate of 5.5% per year was very much the result of strong employment growth of 3.5% per year. Singapore is the only country among these 19 to generate most of its manufacturing growth through more labor input.
·         The UK and the USA led the 19 countries in labor input reduction with average annual decreases of 3.9% and 3.1% respectively. Other rich nations had similar patterns – Denmark, France, the Netherlands, Canada, and so on.

% Change in labor hours, average annual 2000 to 2007
S. Korea
Czech Rep

Productivity growth helps explain the ability of countries to grow their manufacturing output despite these reductions in employment hours.
·         South Korea led this group of 19 countries with productivity growing of almost 8% per year.
·         US productivity growth averaged 6% per year.
·         S. Korea was followed by Taiwan, the Czech Republic, Finland, Sweden, and the USA
·         Countries with the slowest productivity growth were Italy, Canada, and Spain.

% Change in manufacturing productivity, average annual 2000 to 2007
S. Korea
Czech Rep

Below is a summary of the key points.
Because employment was shrinking in all countries except two, productivity is the key explanation for output growth.

Singapore is unusual because it had strong growth in employment – thus employment growth (3.5% per year) explained a great deal of that country’s growth of 5.5% per year.

The Jack Rabbits: Several countries with strong output growth had stellar productivity growth as the source of their manufacturing expansions – Sweden, South Korea, Taiwan, Norway, Finland and the Czech Republic

The US leads the Jack Rabbits – This group had strong productivity growth behind very strong output growth The US leads that group by virtue of the percentage contribution of productivity to output growth. In the US the productivity contribution of 6% per year was double the output growth of approximately 4% per year.  Several countries had stronger output growth than the US. Others had stronger productivity growth. But the US contribution of productivity to output deserves recognition.

Brinkers on the Edge – Canada, UK, Italy, France, Belgium, and Denmark were countries with very slow or negative manufacturing output growth. Without the productivity changes the labor reductions would have led to declines or larger declines in output.

Muddlers – had average to below-average manufacturing growth sparked by just enough productivity growth to offset the negative impacts of labor growth on output. Muddlers include the Netherlands, Germany, Japan, Spain, and Australia

In all three groups productivity was the key to manufacturing growth. Productivity is costly and requires significant investment. Investment requires financial markets that efficiently channel the supply of national savings to risk-taking firms. Some governments may use industrial policy to pick winners and funnel or incent financial flows to the chosen few but such policies have been shown to be risky and often wasteful. What is not controversial is that all business firms must have the freedom, flexibility, ability, and desire to take considerable risks. Congress and the President need to take that to heart.

Tuesday, May 17, 2011

Misunderstanding Marvelous Manufacturing

Today is a big day for the debt ceiling. So I am going to avoid that topic for a little while. My last posting brought out a couple of issues so I would like to focus on those. First, what is up with manufacturing? I will show below that while manufacturing output has become a smaller portion of the US economy in the last 60 years – the sector has grown tremendously and there is an apparent change in trend toward increasing relative importance since about 1998. This posting is about the data and leaves little space for what it all means. I hope you help me get to that in the comments. Second, who reads this blog? Some of you have asked so I will say a little about that. 

One on my reasons for starting this blog in March of 2010 was that I wanted to have a way to stay connected to friends, students, colleagues, relatives, neighbors, high school girl friends, etc. Being newly retired in 2010 I also wanted to have something to do that kept me connected to the world of economics . So there you have it – a blog about econ that harasses a wide range of people.  As far as I am concerned it has worked. Whenever I say I am working on my blog, Betty does not ask me to take out the trash or weed the garden. The weekly blog postings have also led to lots of nice communications with old friends and new – and most of which have little to do with economics. For example, one student from a macro class I taught in 1986 wrote and asked me to change his grade.  The rough edge is that since the audience is so varied in background and interest it makes it difficult to really connect with any or all of you. So if you were thinking that you were alone in this regard, then you can quit thinking that. But I am undaunted. I will continue to try to write about econ and hope that some of you get the main gist of what I am saying. If not, you can always send me notes about other topics and just stay in touch.

Now let’s get to manufacturing. I think there is a lot of misunderstanding about manufacturing in the USA and I want to get started on that topic. In my last blog I wrote about US business competitiveness and I singled out the recent news regarding growing strength in manufacturing output. Clearly manufacturing is important to the USA so I want to dig deeper into what’s true and what isn’t so true about manufacturing. I am going to use some data to back-up what I say. If you are skeptical about data then you won’t be much convinced. 

So let’s start with a word about data. One constant about data is that it never really adequately measures the item of your interest.  There is always something lacking. How many cars crossed the bridge today? That sounds easy but we might have a disagreement about what constitutes a car. For example, is a Kia Soul really a car or is it a vehicle from outer space?  Anyway, I think you know what I mean. The key question about data is whether or not it is good enough to indicate something about the subject. The scale says I gained 18 pounds in Italy (Did I tell you that we went to Italy for 19 days?). Okay, so another scale says I gained 28 pounds. Who cares if it is 18 or 28 pounds, I ate enough to fill three Rhinos in mating season and I had to buy new pants with elastic fabric. So long as the data is good enough for the purpose at hand and is not purposely biased in one direction or another – then we collect and use data and don’t worry too much about it not being perfect.

In this post about manufacturing I am not going to focus on employment.  There are few major misunderstandings about manufacturing employment. It is down. Period. Down.  I would rather concentrate on output of manufacturing companies. There is some belief that we are producing less in the way of manufacturing in this country and we have become a nation of burger flippers. Having eaten at 5 Guys lately I see nothing much wrong with being a national of burger sellers, but let’s not get back to my weight right away.  My point is that while there is a smidgen of truth about manufacturing output, it is a bit misleading. So let’s get a t it.

The source of the data is the Bureau of Economic Analysis – GDP by Industry found at http://bea.gov/industry/gdpbyind_data.htm  There are several tables available at the site – the data I am quoting comes from what is called value added in chained 2005 dollars. In short, this data tells you what each industry produced and it purges price changes. Changes discussed below are totally the result of changes in output. Because of the distorting effects of the last recession, I am going to use data from 2007 and backward. In 2007 GDP was $13.23 trillion and manufacturing output was $1.69 trillion. Thus the output of manufacturing companies amounted to about 12.8% of US GDP (output produced within the borders of the USA).  Sixty years before in 1947 manufacturing output was $62.4 billion and was about 25.6% of that year’s GDP. What can we learn from that?

·        First, manufacturing output, sans prices, grew from $62.4 billion to $1.69 trillion in 60 years.  It grew by a factor of 27 times.

·         Second, even back in 1947 when the US was producing much of the world’s manufactured goods, it represented only a little more than a quarter of the nation’s output. Back in 1947 wholesale and retail trade accounted for about 20% of US GDP and various services sectors (finance, insurance, real estate) accounted for another 16%.  So even if we go back to when I was a cute little tyke in Roy Rogers PJs, manufacturing in the USA was never the only dog in the race – the US was already a major producer of sales and services.
    ·         Third, in proportional terms, manufacturing output grew slower than Real GDP so its share of GDP fell from 25.6% to 12.8%. It’s share roughly halved in 60 years.
      ·         Fourth, the reduction in manufacturing’s share of GDP was gradual over these 60 years. Since globalization did not really begin in earnest until after about 1990, much more than half of the share reduction occurs before significant globalization during the Cold War. By the early 1990s the share had already fallen to about 16%. So it fell from 26% to 16% in the first 45 years and then from 16% to about 13% in the next two decades.

        Now let’s focus on more recent changes – from 1998 to 2007. In the table below I present changes in output of manufacturers, first in dollars and then in percents: The clear result is that the last 10 years have seen manufacturing keep up and compete. In those years manufacturing output rose in real terms by $445 billion – a 36% increase. That compares to real GDP rising by 29%. Thus during that period of economic growth between 1998 and 2007 the share of manufacturing output rose from 12% to 13% of GDP. While manufacturing did not rise as much as FIRE (Finance, Real Estate, and Insurance), it clearly grew more than many of the other key services sectors. Notice that while Retail Services increased, in dollar terms manufacturing increased three times more and at a much faster pace.

        NOTE: It may appear that I was enjoying a little JD this morning while editing these tables but I assure that nothing could be farther from the truth (burp) and that the fault for the wavy columns is totally this website. These columns look perfectly straight to me in edit mode. 

                                                                      Output Change: 1998 to 2007
        GDP                                                           $2.95 trillion         29%
        Manufacturing                                          $445 billion          36%
        FIRE                                                         $772 billion          39%
        Professional & Business Services  $391 billion          34%
        Education, health and Social assist.        $218 billion          28%
        Retail                                                        $162 billion          23%

        Not all sectors of manufacturing rose by 36% between 1998 and 2007. I list below the biggest winners and losers in manufacturing sectors in terms of dollar change between 1998 and 2007:

        Computer and electronic Products           $208 billion
        Chemical Products (includes pharma)             55
        Petroleum and Coal Products                        33
        Food, Beverage and Tobacco Products         32
        Motor Vehicles and Parts                              31
        Misc Manufacturing                                       25
        Fabricated Metal Products                            14
        Paper and Printing                                         -6
        Nonmetallic minerals                                      -6
        Textiles                                                          -6
        Apparel and Leather                                      -7
        Primary Metals                                             -17

        Other manufacturing sectors with positive growth of at least $3 billion but not in the table include: electrical equipment and appliances, machinery, wood, and plastics.

        In short, despite what you might have thought manufacturing output is larger and is growing. Before the last recession hit, the manufacturing sector was showing a reversal in long-term trend and from 1998 to 2007 had shown both absolute and relative growth. It has grown in terms of output produced and in terms of its relative position with respect to GDP. Manufacturing has grown because of success in some key sectors but clearly the successes have been widespread. Lost output was clustered in six manufacturing sectors and amounted to a total of $42 billion, with much of that coming from primary metals (mostly declines in US production of steel).

        One final dimension of manufacturing competitiveness is exports from the US to the rest of the world. Between 1998 and 2007 US real exports of goods rose from $670 billion to $1.16 trillion -- an increase of 73%. Only a very minor portion of those goods are non-manufacturing foods and feeds. Thus US manufacturing is thriving when you measure our ability to compete in world markets. If the USA has a trade deficit it is not because of deficient exports—it is because of our increased desire to consumer caused imports to rise even more than exports.  

        Tuesday, May 10, 2011

        US Competitiveness and Charlie the Tuna

        Charlie the Tuna was a figure in a Starkist commercial many years ago (circa 1961). Charlie confused tuna’s with good taste (culturally adept) with those that taste good. Anyway, we affectionately nicknamed one of our childhood friends Charlie the Tuna. Charlie is a regular reader of this blog and generally lambasts me about my negative attitude toward US manufacturing. Charlie is a devoted cheerleader for US manufacturing and he should have been proud when the US announced productivity figures this week.  More will be said about US productivity below.

        But first, let’s discuss US competitiveness. While the “C-word” can probably mean different things to different people, we often associate national competitiveness with an ability of a given country’s products and services or its firms to duke-it-out with firms from other countries. China’s export success is often taken as evidence of that country’s increased competitiveness.  Persistent and growing trade deficits of the US are considered to be evidence of the opposite.

        Competitiveness in the above sense can be affected by many things. For example, the US often argues that China unfairly depreciates its currency or gives unfair subsidies to its firms as a means to improve competitiveness. Of course, fundamental factors are also important, factors that relate to the ability of a nation’s firms to produce high quality and innovative goods at the lowest possible prices.  That is where the recent announcement of the Bureau of Labor Services (BLS.gov) comes in.  On May 5, 2011 a news release announced data for productivity and costs for Q1 2011. While this was ignored by most outlets that cater to normal people, Bloomberg had a story titled something like “Productivity advanced by a measly 1.6% while business costs increased in the first quarter of 2011.” Even that headline failed to be as interesting as other stories nearby like “Babies who stop bottle feeding at one year are prone to be really fat” and “Physicists at the University of Alabama uncovered a bio-marker for athlete’s foot.”

        If you actually read the government press release you understand why this critical information essentially gets blown in a black hole in some distant universe.  I read it and found myself quickly adrift with sea nymphs and cheerleaders.  After my nap I decided to go to the BLS website and see if I could discern a story from the actual data and sure enough it was all there. There is a story and it basically says a couple of things. First, Charlie the Tuna should be very proud since manufacturing is clearly leading us out of the wilderness. Second, the numbers suggest that the government has to STOP stimulating the economy. If there is any way to improve US competitiveness, it is by keeping inflation low and government debt in control. Since neither of these points is obvious on their own merits, let me try to convince you they are true.

        The first bit of data in the release is something called UNIT LABOR COSTS. This is like naming your kid Ora. No kid wants to be called Ora. No economic variable wants to be called Unit Labor Costs. So let’s just rename it ULC. ULC is a measure of how much labor cost is changing in a typical unit of output.  If ULC change is zero, it means that labor involved with producing, e.g. bagels, are not causing change in the cost of producing one bagel.  If ULC for bagels is increasing by say 10% that tells us that labor costs are responsible for a 10% increase in costs of making a bagel. Companies become better competitors when their ULC is slowing – or better yet, decreasing. So ULC is an important aspect of a company or a country’s competitiveness.

        After increasing at a rate of about 1.8% per year from 2003 to 2007 ULC of the non-farm business sector increased by only about 0.3% in 2008 and 2009 and then declined by about 0.2% afterward. The experience of manufacturing companies was very different. During the strong growth period from 2003 to 2007, ULC grew by only about 0.2% per year. During the recession ULC grew at an annual rate of almost 5% only to decline again in the recovery quarters to -3.6% per year. While the experiences were different the outcome for the last seven quarters is the same – manufacturing and other non-farm businesses have seen ULC decline.

        One conclusion is that the US is experiencing improved business competitiveness in the recovery period – and this improvement has been especially strong in the manufacturing sectors. What explains this? The most straightforward answer comes from the definition or calculation of ULC. There are two key factors that determine changes in ULC: labor compensation per hour and labor productivity per hour. Recall that ULC has to do with labor costs embodied in the average unit of output. So clearly, a change in labor compensation per hour will impact ULC. If the Bagel Workers of America obtain a 10% per hour wage increase and if they work the same number of hours you can see how this will raise business costs and ULC.

        But how much ULC increases depends on productivity change – or what we call output per labor hour. Let’s suppose workers get 10% more wages per hour but also are able to produce 10% more output per hour? Total costs would rise – but the costs per unit of output would not. So now you see that both output per hour and wages per hour must be brought together to understand ULC.  And we learn the following:

        o   Wages per hour growing faster than output per hour --- ULC rises
        o   Wages per hour growing slower than output per hour --- ULC falls
        o   Wages per hour growing the same as output per hour --- ULC constant

        In the expansion years from 2003 to 2007, manufacturing compensation per hour was rising at about 3.5% per year. But output per hour was growing by 3.7% per year so ULC hardly grew at all.
        When the recession hit in 2008 manufacturing compensation actually increased to an average annual rate of about 4.8% per. Productivity declined at a rate of -0.4% per year and therefore ULC was rising at about 5.2% per year.  While rising wages contributed to ULC rising it was the decline in output per hour that really hurt competitiveness.

        Coming out of the recession in 2010 (Technically the recovery begins in the third quarter of 2009) and early 2011 manufacturing productivity recovered dramatically averaging about 6% per year. Wages per hour have slowed to a rate of a little over 2%. Thus coming out of the recession ULC is falling at a rate of about -3.6%. Of course, this is exactly what you want to see if the US is going to grow through exports. Moreover, this enhanced competitiveness gives firms the ability to provide more goods at low prices within the US – improving both national output and inflation.

        The following table summarizes the key numbers discussed above.

                                                        Average Annual Percentage Change
                                                        Manufacturing companies
                            Compensation       Output                     ULC
                                  per hour               per hour

        2003 to 2007       3.5                      3.7                        -0.2
        2008 to 2009       4.8                     -0.4                         5.2
        2010 to 2011       2.5                      6.1                        -3.6

        So what does this mean for policy? First, the usual business cycle factors will mean that compensation will probably soon increase by more than 2.5% per year and productivity will not continue rising at 6% per year. Thus ULC will probably increase.  The role of policy, then, is to slow this normal cyclical process as much as possible in two ways: (1) provide an economic climate such that wage growth does not quickly rise and (2) ensure that output per hour does not quickly decrease.

        Here is where the stimulus and national debt come in. Monetary and fiscal stimulus raises inflation expectations. The Treasury and the Fed keep reminding us that inflation is subdued. But it won’t be forever. Signs of inflation are around us everywhere. If we want competitiveness and manageable ULC, then we have to effectively and credibly convey a strong disdain for inflation. If workers do not believe that stimulus will be removed in a timely manner then they will quickly and decisively pursue faster wage growth.  I buttress this forecast by looking at the real value of hourly compensation. Since 2002 the buying power of the hourly compensation in manufacturing companies has grown by less than 1% per year. While manufacturing workers during those years got hourly wage increases – they were barely enough to meet inflation. They are more than ready to make up for lost time.

        But wages and inflation are only part of the story. The rest concerns productivity or output per hour. To maintain competitiveness, US firms must continue to invest in new equipment, structures, training, etc. To do that they need abundant and well priced capital. With government finance sucking up more money than US households can supply from their meager savings, this reduces the pool of available resources and significantly raises interest rates and the cost of capital. Any further indications that the US will not be able to pay its obligations will lead to a hasty departure of foreign funds and even higher costs of borrowing and/or raising capital.

        Quick progress to reduce deficits and national debt will go a long way to improving productivity, the cost of labor, ULC, and US competitiveness. You would think that our goofs in government would come to understand this and stop playing with ideological bombs and class warfare.  The below chart shows (found at (http://research.stlouisfed.org/fredgraph.png?g=pj ) how important manufacturing ULC is to the health of the US economy. Notice how significant upward trends in ULC led to recessions after 1990 and 2000. While ULC was well-behaved before the last recession we all know the important role of finance in that one. But also notice that the recent recession has left us with historically high ULC. Despite recent improvement it is clear that ULC has a long way to go before it reaches more normal levels. Until then our competitiveness AND our national economic growth are in jeopardy.

        Note – if you cannot see the below graph properly, please try the above link.

        Tuesday, May 3, 2011

        GDP, Macroeconomics, and Spinach

        I admit it – I teach macroeconomics. If I was a botanist I probably would have taught Spinach 101. Hardly anyone really likes macro despite the fact the Department of Commerce feeds us a big heaping bowlful of GDP every quarter. We feed our kids spinach too and tell them they will grow up to be like Popeye but they hardly ever like it.

        Through much of my teaching career the economy performed pretty well so announcements of quarterly GDP were much like weather announcement s in Arizona in February. EVERYONE knows that the weather forecast in February in Arizona will be sunny and warm. It gets boring. “Hi Fred did you hear that GDP rose 3.23496% last quarter?” Yes, Martha, I did. How lovely. Please pass the spinach will you?”

        Luckily for macroeconomists there are times when all the wheels start coming off the economic wagon and people get VERY interested in GDP. While I won’t exaggerate and say that GDP information becomes more interesting than Donald Trump’s hair or high school basketball in Bedford IN, I do hear people talk about GDP at Kroger and the Crosstown Barber Shop.

        Last week the US Department of Commerce announced the GDP number for the first quarter of 2011. Here is the link to the press release --  http://bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
        It was not a good number. While 1.8% would be a good quarterly weight gain for me, apparently the world would have been happier if US GDP grew by more than 1.8%. The government press release was chocked full of information presented in black and white in words that only a chronic sleep-deprived owl could stay awake through. Luckily your favorite TV programs animated the information and provided graphs in full color with subliminal photos of Rush Limbaugh and Nancy Pelosi in Las Vegas.

        After having several email interchanges with some of you, I decided that you guys needed a little review about GDP. Since I just taught a macro course in Italy (it is hard to type the words Italy without a giant smug multi-toothed grin overtaking my face – yes ITALY the one over there near Slovenia) this information is fresh in my mind and it reminds me of how the press release can be helpful but can sometimes be downright incomplete or misleading.  The general tone of the release and much of the following colorful interpretations was that 1.8% growth in Q1 2011 was low, disappointing, and proved beyond a shadow of a doubt that (1) the US economy either needs more stimulus or (2) needs less stimulus.  The slowdown, according to the reports, came from slower government spending and exports to the world.

        Below I will try to explain two reasons why one should ignore most of what has been said about GDP Q1. First, one month’s reading – sort of like weighing yourself once a month on the 27th, can be very misleading. To usefully understand what is going on in the economy and how it will behave in the future, we should integrate the information from the latest month into the experience of several. Additionally, keep in mind that this first publication will be revised several times before we land a number for Q1 2011 that gets written in indelible ink. Unfortunately the usual press releases don’t provide this kind of perspective and most talking heads don’t spend time trying to say reasonable things. “Ladies and Gentleman – GDP fell off the top of the Empire State Building nude and landed on top of a hotdog cart that was trying to parallel park in a space the size of a peanut. Next we turn to a commercial for soap.”

        Second, most discussions of GDP assume that we know only one equation that describes GDP and nothing else. There are a few easy subtleties, however, we can discuss that help us better understand what is happening to our nation’s economy. 

        Let’s start by defining this thing we call GDP. Some things to emphasize are:      
                        GDP is a measure of output produced within the borders of the country, regardless of the nationality of the country of the companies producing it. So when GDP rises by 1.8% in Q1, imagine a huge pile of stuff* coming out of our companies being stacked on trucks, transported, and subsequently dumped in Dallas. The pile in Q1 2011 was about 1.8% higher than the pile in Q4 2010. *Stuff is a very technical term that includes all goods (autos, clothing, medical marijuana, vibrators, etc) and services (telecommunications, business assistance, Turkish steam baths, and medical marijuana consulting) produced.

                        To measure the pile, we put it in dollars. Thus we say GDP was $13.4 trillion in Q1. To make sure it measures only volume changes – changes in the size of the pile – it keeps the prices constant. We all know that sales can increase because of prices or volume – but this $13.4 trillion number is based on only volume increasing. So the 1.8% was NOT CAUSED BY PRICES. The load of stuff produced gave us 1.8% more stuff than we had in Q4 2010. This volume measure is sometimes called REAL GDP or GDP in constant dollars.

        So let’s put this 1.8% increase in perspective: The recession lasted six quarters and in those six quarters the percentage change in GDP was negative in all but one quarter. These recession quarters were followed by seven consecutive quarters of growth which have averaged about 3% annually. Through these seven quarters (and typical for any seven quarter time period), GDP changes fluctuated. The largest increase of 5% came in Q4 2009. The smallest of 1.6% was Q3 2009. I do not think that the 1.8% in Q1 2011 tells us much of anything except the economy continues to recover and expand.

        It is worth pointing out that despite the average 3% growth the entire seven quarter period tells us that this is a VERY lackluster recovery. GDP had attained a high value of $13.4 trillion in Q2 2008 and it subsequently fell to $12.8 trillion within a year.  It took six quarters to dig out of that hole and today we find ourselves just back to where we started from in 2008. In other words, the 3% average real GDP growth since the recession only got us back to ground zero. If we had not had a recession and GDP had grown by 3% through the last 13 quarters, GDP would have reached $14.5 trillion in Q1 2011. So we might say that we are about $1 trillion behind now. 

                        To me – that’s the story that should be written. It is one thing to say that GDP grew by 1.8% last quarter – it is another to focus on the fact that seven quarters of recovery leaves us $1 trillion behind normal!

        Let’s change gears to my second point. EVERYONE who has ever taken a macro course and actually went to the class and stayed awake during the first hour of the first day knows that

        GDP = C + I + G + NX

        Hidden in this highly complicated equation that only advanced physics and physical education students would know is that this equation says that only two things can be done with a nation’s output:
         (1) Output that is finished goes to sales to the final user or into unsold inventories of finished goods or
         (2) Output that is not finished goes into inventories of materials or intermediate goods

        The usual explanations of the ups and downs of GDP focus on sales to final users – households, business firms, and the foreign sector (including interplanetary visitors and Justin Bieber). The logic is that if GDP grows slowly, then it must be because one or more of these groups of buyers decided to take a pause from buying and mediate or save or punish their really bad kids by not yet caving in to buying them an Ipad. In Q1 2011 the main culprits seemed to be state, local, and federal governments and foreigners.

        What was mentioned but perhaps not really explained very well in the press release was that about half of the 1.8% increase was accounted for by increases in inventories. That is, if you decompose the GDP change – you find that half of the increase was because of sales to final users and the other half went to sitting on shelves. More precisely what we call Final Sales of Domestic Product rose by 0.8% in Q1 2011. You may be kicking your pet turtle right now, but the one quarter figure is not the one to focus on. If you look at final sales for the last seven quarters you may want to move to China or Rio. In the past seven quarters final sales increased an average of 1.8% -- implying that much of the increased GDP we have seen in this recovery has simply been goods going to restore inventory levels. In the recovery, final sales have grown by a mere 1.8% per year – much lower than the 3% increase in output.

        Let me add one more wrinkle. The Commerce Department reported that consumer spending increased by 6.7% during the last two quarters and that gives the impression of relative strength coming from the household sector. But this is misleading because the C component of GDP includes goods that are sold but not produced in the USA. Something called Final Sales to Domestic Purchasers measures what is happening to sales of US produced goods and services to domestic buyers. In the last two quarters that figure increased by about 4.1%. That’s considerably less than the 6.7% growth in consumer spending.

        To summarize, the US economy cooled to about 1.8% growth in GDP in Q1 2011. A closer look at the data suggests that while that creates a pause for concern, even worse is that the seven quarter recovery has been slow, averaging about 3% per year for almost two years. Our economy is today barely producing the amount we sold two years ago and is a trillion dollars off where it might have been without the recession. This slow recovery is the result of a very weak rebound in the demand by US buyers for goods produced in the US with much of the production simply boosting inventory levels and much of the sales coming from goods that were produced abroad.  So while the US household seems to be driving the recovery, the actual numbers reported for consumer spending overstate how much of that spending goes for US output. About the only parts of the GDP final equation that look good for now and the near future are exports and business spending on equipment.  But even export growth has slowed. After a rapid pickup of US exports in the first year of the recovery (14% annual rate) export sales slowed to about half that rate, or a 7% annual pace in the last three quarters ).

        This longer term picture is not good. Households are not moving quickly to buy US goods. Governments are stressed and reducing their demands for goods and services. Foreigners continue to buy US products but despite a falling dollar have their own concerns that may limit how much they buy from us.  Real estate is still in the toilet and a rebound in business spending on equipment can only take us so far.

        It is no wonder that our Keynesian friends want to continue to stimulate demand. But it isn’t that easy. We are beyond the day when we can sustain skyrocketing government debt and monetary explosion. We tried that and it didn’t get the job done. Now we are in a pickle. It seems odd that in the this time when spending is so fragile and clearly related to business hiring that our administration is so prone to finding enemies and relishing punishment to the corporate world. Let’s tax those rich oil producers. Let blame those speculators. Let’s take those profits away from bankers. The vicious cycle of jobs and spending will only end when business firms judge the future optimistically. We need rhetoric and a policy stance that recognize jobs are created by entrepreneurs and investors who take risks and expect commensurate returns.