Tag Archives: GDP

The Problem in One Graph

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Yesterday I said I was reluctant to get over-optimistic about the recent slight upturn in employment data. This year may truly be different from the last few, but there’s a nagging feeling that we’ve seen this movie before. I’m not alone in the feeling. As 2012 dawns, Tim Duy summarizes the problem in one graph (emphasis is mine):

I have been hesitant to embrace the recent positive data flow - once bitten, twice shy perhaps.  Something about the current dynamics that seems a little too familiar.  Indeed, I felt something of relief when FT Alphaville came to a similar conclusion in the waning days of 2011.  Cardiff Garcia reports on a Nomura research note that details a new bias in the seasonal adjustment process, noting:

Up next, writes Nomura, you can expect exaggeratedly strong readings from the Chicago PMI later this month and the next ISM manufacturing survey at the start of January.

I imagine it is premature to call the readings “exaggerated,” but both did surprise on the upside, as much data has of late.  Read the whole piece – it is worth the time.

Indeed, flirtations with either excessive optimism or excessive pessimism were not richly rewarded last year, as on average the economy simply edged upward in pretty unremarkable fashion:

Potential
It seems reasonable to expect the same in 2012, at least as a baseline – a slow “recovery” that is really more of an adjustment to what appears to be the economy’s new equilibrium path, one that is decisively subpar to the pre-recession trend.  I don’t believe that such an adjustment is necessary, as in my view it simply reflects a shortfall of aggregate demand.  That said, the longer the cyclical downturn grinds on, the more likely it is that we will indeed see a new equilibrium path.  A greater percentage of the cyclical unemployment will become structural unemployment or permanent shifts in the labor force participation rate.  In addition, investments will go unmade as firms hoard cash.  And, increasingly, policymakers will manage policy along the new equilibrium path, forgetting entirely the pre-recession path.

The gap in the above graph, the gap between the green trend line of what we’re capable of doing and the blue-red trend from Jan 2009 onward of we’re actually doing is the challenge.  We are slowly becoming an economy that simply cut-off 7% or so of our economy in 2008 and we aren’t recovering it.  Instead it increasingly appears that the 90-93% of the economy that survived, those of us still with good jobs, are simply going on our way leaving behind those who lost out a few years ago.

There are over 13 million unemployed workers. Over 5.6 million of them have been searching fruitlessly for a new job for more than 6 months.  These are the people who got kicked off the American economy bus some time ago.  Unfortunately, even at the recently improved rate of 150-200,000 new jobs per month, there won’t be any room on the bus for them again.  Instead, the bus is moving on and they are left behind.

This is new. This is not the normal pattern. In past recessions, public policy, both fiscal and monetary, was managed to restore full employment rapidly after a recession.  It didn’t always succeed but the effort was made.  Now it is not. Now we focus more on long-term debt issues and spending concerns.  Politicians run on platforms of fear of some future default or financial crisis. This despite the fact that the government is able to borrow at record low rates of interest.

We are on path to a “new normal”, a “normal” that says it’s OK to have millions of long-term unemployed who have no hope.  I don’t think I like the “new normal”.

 

November Employment and Revised 3rd Qtr 2011 GDP

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I’m a few days late but I wanted to note the latest employment (jobs) report and the first revision to 3rd quarter GDP.  There’s really not much news here – it’s the same old story. The economy continues to move along somewhat like  a zombie.  Not really dead, but definitely not anything you could call “living”.  That’s particularly true if you’re one of millions of unemployed who need a job to “make a living” but can’t get one.

CalculatedRisk Blog tells us:

From MarketWatch: U.S. economy adds 120,000 jobs in November

The U.S. gained 120,000 jobs in November and the unemployment rate fell to 8.6% from 9.0%, the Labor Department said Friday. The government also revised jobs data for October and September to show that 72,000 additional jobs were created. … Hiring in October was revised up to 100,000 from 80,000 and the job gains in September were revised up to 210,00 from 158,000. In November, companies in the private sector hired 140,000 workers … Government cut 20,000 jobs…

Employment Pop Ratio, participation and unemployment ratesClick on graph for larger image.

The following graph shows the unemployment rate. The unemployment rate declined to 8.6%.

Some of the decline in the unemployment rate was related to a decline in the number of workers in the labor force.

Percent Job Losses During RecessionsThe second graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

This was still a weak report, and slightly below consensus.

The headline unemployment rate declining from 9.0% in October to  8.6% in November is deceptive.  It is NOT because economic growth created enough new jobs to start making a significant dent in the millions of unemployed.  Instead it was almost entirely due to the labor force shrinking.  In other words, approximately 300,000 would-be workers abandoned their search in frustration and discouragement.  If the economy starts to grow briskly (not much chance of that happening) then these discouraged and “marginally attached” workers will likely renew their searches and rejoin the work force.

Calculated Risk also tells us how just before Thanksgiving the estimate for 3rd quarter real GDP growth was revised downward.

From the BEA: Gross Domestic Product, Second Quarter 2011 (second estimate

Real gross domestic product — the output of goods and services produced by labor and propertylocated in the United States — increased at an annual rate of 2.0 percent in the third quarter of 2011 (that is, from the second quarter to the third quarter) according to the “second” estimate released by the Bureau of Economic Analysis.

This was revised down from 2.5% and below the consensus of 2.4%.

The downward revisions was mostly due to a large decline in the “change in real private inventories ” – this subtracted 1.55 percentage points from the third-quarter change in real GDP (second estimate) as opposed to 1.08 percentage points in the advance estimate. Final domestic demand was mostly unchanged (the inventories will probably reverse in Q4). Still sluggish growth …

The relatively large revision came from having better data about the change in business inventories.  In GDP accounting, when a business produces goods it counts as “production” and part of GDP, even if the goods haven’t been sold yet to a final customer.  Additions to inventory then are considered to be a form of “business Investment”.  A decline in inventories tells us that businesses (in aggregate) sold more from their inventories (previous production) than they produced.  A large decline in inventories can be either a good or bad sign.  It’s good if it happens because sales were unexpectedly higher than managements expected.  That would suggest that production would be increased in the next quarter.  On the other hand, a decline in inventories can also be a sign that businesses expect future sales to be weak and so they didn’t produce as much in advance.  We’ll have to see which it is.  Regardless of why the inventory adjustment was so large, a 2.0% real growth rate is unacceptable.  It wouldn’t even be acceptable at full employment, but with 8.6% unemployment it’s totally unacceptable.

Update on Current Situation – October Jobs Report and 3rd Qtr GDP

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Two of the more important (U.S.) economic measures were reported in last week and half.  Yesterday the October jobs report came in.  The week before we got the flash report on 3rd quarter GDP.  Both measures were better than feared, not quite as good as consensus expectations of many forecasters, and overall still a disappointment.  First let’s look at the numbers and then I’ll comment. CalculatedRisk, as usual, reports the facts on the jobs report:

From the BLS:

Nonfarm payroll employment continued to trend up in October (+80,000), and the unemployment rate was little changed at 9.0 percent, the U.S. Bureau of Labor Statistics reported today.
…

The following graph shows the employment population ratio, the participation rate, and the unemployment rate.

Employment Pop Ratio, participation and unemployment ratesClick on graph for larger image.

The unemployment rate declined to 9.0% (red line).

The Labor Force Participation Rate was unchanged 64.2% in October (blue line). This is the percentage of the working age population in the labor force. The participation rate is well below the 66% to 67% rate that was normal over the last 20 years, although some of the decline is due to the aging population.

The Employment-Population ratio increased to 58.4% in October (black line).

Note: the household survey showed another strong gain in jobs, and that is why the unemployment rate could decline with few payroll jobs added – and the employment population ratio increase.

Percent Job Losses During Recessions

The second graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

Now we reach back to October 27 and CalculatedRisk again:

From the BEA:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.5 percent in the third quarter of 2011 (that is, from the second quarter to the third quarter) according to the “advance” estimate released by the Bureau of Economic Analysis.

The acceleration in real GDP in the third quarter primarily reflected accelerations in PCE and in nonresidential fixed investment and a smaller decrease in state and local government spending that were partly offset by a larger decrease in private inventory investment.

The following graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The dashed line is the current growth rate. Growth in Q2 at 2.5% annualized was below trend growth (around 3%) – and very weak for a recovery, especially with all the slack in the system.

So what’s happening.  Nothing much, really.  That’s the problem.  The economy is effectively going sideways.  Yes, we continue to grow, but the rate of growth is so slow that we aren’t really seeing any improvement in conditions.  For all of 2011 we have grown at a rate below the long-term historic trend of 3.0%.  We are struggling to keep up with population growth and not really doing anything to “put people back to work”.  hat’s not a recovery.  That’s society throwing 5% of our workforce off the bus 3 years ago and saying “so long” forever.  It should be unacceptable, especially when it’s possible to do much better.

UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

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First an update on a post I made a few days ago. When I commented last Monday on President Obama’s jobs proposal, I was less than excited. Having read more detail of the proposal, I should correct some statements I made.  I incorrectly left the impression that the payroll tax (Social Security/Medicare tax) cut that the President was proposing was only an extension of the present year cut that is scheduled to expire December 31, 2011.

In fact, the President is proposing not only a 1 year extension of this year’s temporary payroll tax cut, but an increase in the size of that tax cut.  Estimates are that for a median household income of near $50,000, it would result in a $1,500 reduction in payroll taxes compared to not having any payroll tax cut at all. However, the existing, this-year only, payroll tax cut had already cut payroll taxes by up to $500 per household.  So of the claimed $1,500 tax cut for next year for the median household, $500 is an extension of this year’s situation and  $1000 is new stimulus.  Today’s economy is weak even with the existing temporary $500 tax cut, so extending that cut won’t improve things. It will only prevent things from deteriorating further.  In my world, simply agreeing to not put on the brakes is not the same thing as actually hitting the accelerator.

But, the proposal does contain perhaps $1000 worth of tax cut stimulus to nearly all working households. That’s perhaps $150 billion of pure, new stimulus to economy.  It’s more than I estimated on Monday, so the plan will likely have some more stimulative effects than I thought.  But how much?  Let’s do a quick “back of the envelope” type calculation.  The proposal puts $150 billion in consumers’ hands that wouldn’t have been there without it.  But for this money to generate jobs, people have to spend the money.  Simply saving the money or paying down debt won’t cut it.  That improves individual household balance sheets but it doesn’t cause any firm out there to go “oh, more business! I need to hire people!”  In normal times like the 1960′s or 1970′s people would have spent 85-90% of the tax cut.  But these aren’t normal times. We live in high debt, high debt payments, and scared-of-the-future times.  More people save in these kind of times. (paying down debt is economically the same as savings – think of your debt as a negative balance in a savings account).  Let’s assume that people spend 2/3 of the money.  Both history and theory indicate that people save more of a tax cut when they know it’s temporary, but let’s be generous/optimistic and say 2/3 gets spent.  That’s $100 billion in new spending.

Now when it gets spent, it generates business demand and jobs.  Those people get paid and then they go spend the money again – the circular flow of money in the economy.  How much?  That’s a huge controversy in empirical macroeconomics.  This is the question of what the spending multiplier is.  Estimates vary widely, although often the studies are heavily biased by ideology to begin with.  Let’s be modestly optimistic and say the multiplier is 1.5 – 2.0.  This is a relatively high estimate given recent studies as far as I know, but let’s run with it.  That means that after some months, this initial $150 billion in tax cuts becomes $100 billion in new, initial spending which ultimately increases total spending by $150-$200 billion.  Total spending is another way of saying GDP.  This puts it in the range of 1.0% to 1.5% of GDP.

There’s a rule of thumb about the relationship between changes in GDP to changes in unemployment rate. It’s called Okun’s Law.  It’s not a law so much as a statistical regularity. There are many versions, but let’s use a real simple one: each 2 percentage point change in GDP equates to a 1 percentage point change in the unemployment rate.  So if we have GDP growth increasing by 1.5% points, we can count on unemployment rate going down by 0.75 to 1.0% points.

We’re currently over 9% unemployment rate and stuck there.  I’m not real excited about a proposal that aims to reduce the unemployment rate from over 9% to maybe 8%.  We know 4-5% unemployment is possible.  We did it in 2006 even with the slow-growth policies of the Bush administration.  We did better than that under Clinton. In the 1960′s we were even below 4%.   Why are we settling for tepid responses and setting goals of only getting to 8% unemployment and then calling this “bold”?  I don’t know.  But then maybe I’m just a grumpy old man.

The Mean and the Median Tell Two Different Stories

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Averages, if you’re not careful, can as easily mislead as enlighten.  It matters a lot which statistical measure of the “average-ness” that’s used.  A good example comes in the case of the U.S. long-term trend of economic growth.  What we’re interested in is to what degree the amount of GDP the average household has available has increased over time.  It’s the prime way economists measure whether not living standards are improving.  GDP, of course, is the measure we use to count output in the economy.  GDP is the total market value of all goods and services produced for final demand in a year.   Real GDP is the inflation-adjusted version of it so we can compare GDP from different years.   But of course, just because total GDP, or even real GDP, is going up from year to year is no assurance that living standards are generally increasing.  After all, if real GDP grows by 1% per year but the population grows by 2% per year, there’s less per mouth each year.

So we need to adjust the real GDP measure to account for population growth. We want a measure of average GDP per person or average GDP per household.  Those readers who didn’t fall asleep in statistics class might recall that technically “average” isn’t a statistical measure.  Instead there are several different ways of calculating what statisticians prefer to call “central tendency” instead of “average”.  The two most common calculations in economics are the mean and median.  And there’s a huge difference between them.  The mean is  what you probably learned in primary school as the “average”.  To calculate it we take the total and divide by the number of people in the population.  When economists cite GDP per capita, we are, in fact, calculating the mean Real GDP per person.  The mean, the real GDP per capita for the U.S. over the last 34 years has grown at around a 1.9% annual rate.  That might not sound like much, but remember the power of compounding means that at 1.9%, mean real GDP per person will double in less than 40 years – one working lifetime.  Sounds good, right?  Sounds like the American dream in action, right? Wrong.

Real GDP per capita when looking at the U.S. is highly misleading because most of the growth only goes to the top 1% income folks.  The vast majority of Americans, the other 99% of us, haven’t experienced anything like that growth.  To see the difference let’s consider real income of the median household.  Remember Gross Domestic Income is the same as Gross Domestic Product.  It’s just counted differently by counting income available to spend instead of actual spending.  Long run, they are the same.  Now let’s quick review what the median is. The median is the middle observation. It means that there’s as many observations with a lesser value as there are with a greater value.  In this context it means that there are exactly as many households with a smaller income as there are households with a larger income.  It’s another way of looking at the average.  In this case we’re looking for the most typical household.  Statistics note:  mean will equal median if both sides of the distribution are identical, but in income this isn’t true – millionaires, billionaires, and rich households are a lot richer than the $49,700 median income but the poorest households can only $49,700 poorer at most.

In the U.S. over the last 34 years, the median household income has only grown at less than 0.5% per year despite increases in education.  So real GDP per person grows at 1.9% per year, but real median income only grows less than 0.5% per year.  At 0.5%, it will take 150 years for income to double.  End of the American dream of doing a lot better than your parents. What accounts for the difference?  It’s the upper 1% of the income distribution, the rich folks, millionaires and billionaires, that have skimmed off the 65% of all of the GDP gains for 34 years.

Princeton economics professor Uwe Reinhardt explains in the NYTimes Economix blog:

So if an American macroeconomist — a specialist who tends to think of nations as people — or high-level government officials or politicians mimicking a macroeconomist boasted on a television talk show that “average family income grew by 3 percent during 2002-7, more than in most European economies,” about 99 percent of American viewers, reflecting on their own experience, would probably scratch their heads and wonder, “What is this guy talking about?”

The third chart, below, exhibits the growth path of real G.D.P. per capita in the United States over the period 1975-2009 and the corresponding path of real median household income. The data show that over the 34-year period, real G.D.P. per capita rose by an annual compound rate of 1.9 percent. Those data come from the Economic Report of the President to the Congress (Tables B-2 and B-34).

Sources: Economic Report of the President to Congress (G.D.P.); Census Bureau (income)

According to the Census Bureau data (see Table H-6), however, median household income in the United States rose by less than 0.5 percent a year. Other than national pride in league tables, that 1.9 percent average economic growth does not mean much for the experience of the median household in the United States.

GDP and GDI: Two Sides of the Same Coin (Theoretically)

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One of the starting points for understanding macroeconomics is to understand basic measures of the economy and what we call the “circular flow” of goods and services.  The “circular flow” refers to the idea that firms are the economic “agents” who produce and sell all our goods and services for sale, and that households are the folks who consume those goods.  Of course in reality, both groups are made up of the same people, but we divide up the activities into firms and household consumption.  Given this division of activities into two groups, the circular flow is the idea that the groups both buy and sell to each other.  Households buy the products sold by firms, but households also sell their labor to the firms.  This is all good and it shows how interdependent firms and households are.  Firms can’t hire and pay if they don’t sell products, but households can’t buy those products unless they are able to sell their labor to the firms.

We generally measure the size of an economy by adding up the total value of all the goods and services that are produced and then sold.  This is what we call GDP – Gross Domestic Product.  GDP is the accepted way to measure the size of an economy.  The GDP number as observed and estimated each period is what should technically be called Nominal GDP.  It’s the starting point for estimating Real GDP.  Real GDP is GDP adjusted for changes in the overall level of prices – it takes the inflation/deflation out of the GDP numbers so we can compare GDP from different time periods.

The GDP numbers as reported by the government agencies is generally computed by observing and at times estimating how much spending happened.  In other words, it’s an attempt to add up the value of all final sales by firms of the products they produced.  A “final” sale means the product has been sold to someone who intends to use it up or consume it as opposed to reselling it or making it into an even better product.

There is however another way to estimate GDP.  Since the total value of what firms produce is the money the firms receive, then we could look at how that money is disposed of by those firms.  Put in other words, instead of looking at what households spend to buy goods and services, we can look at the income households received.  We could look at the other side of the circular flow.  When calculated this way, we give it a slightly different name: Gross Domestic Income or GDI.  Because of the circular flow, the two sides shoudl be the same.  In other words, in theory GDP should equal GDI.  In general and over the long haul they do.

Of course theory and practice sometimes differ.  On a quarter-by-quarter basis, GDI and GDP differ slightly because of difficulties in measuring precisely – what we call statistical discrepancy.  Occasionally the discrepancy is bigger than other times for reasons economists don’t fully understand.  The first half of 2011 was one of those periods.  So was 2007.  But as you can see from this graph (thanks to James Hamilton at Econbrowser), in general GDP does equal GDI.

 

The Mess We’re In – Trillions of Dollars of Missing GDP

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According to the Congressional Budget Office (CBO) the U.S. has a cumulative output gap of $2.8 trillion so far since the recession began.  That’s trillion with a TR, as in a million millions.  This is the core problem in the U.S. today and for the next couple years.  The recession saw the economy shrink and we simply haven’t aren’t getting back to where we were, let alone to where we could be.

Two of the most basic concepts in economics are the idea of opportunity costs and the technique of the counter-factual.   Both play a part in this analysis.  First, opportunity cost is the idea of the real cost of something or some choice isn’t the money expended but rather what you could have done but didn’t/can’t because of your choice.  Analyzing opportunity costs involves using the other idea, the technique of the counterfactual.  A counterfactual is a hypothetical outcome that could have been or even would have been, but didn’t happen because of the choices made.  People use counterfactuals often, they just don’t call them such.  For example, if you imagine decide not to go to a party and you choose to stay home one night, you might imagine what would have happened if you had indeed gone to the party.  That’s a counterfactual.  It could be good and attractive (you would have had fun at the party and met someone very interesting) or it good be negative (you would have gotten drunk, tried to drive home, and got arrested for DUI).  Comparing actual events to counterfactuals is integral to economic analysis.

In the case of macroeconomics, we often use a counterfactual called “potential GDP”.  Potential real GDP is the amount of real GDP that would have been produced IF we had made policy choices that produced full-employment.  In practice potential real GDP is often estimated by a combination of extending the long-run trend line of GDP from previous decades and of calculating output per worker and multiplying times the number of potential workers.  In this case, the additional workers include not only those presently recorded as “unemployed” but also those workers or part of the population that used to work but are no longer working or classified as unemployed.  It’s a fairly involved statistical undertaking, but fortunately we have the CBO to do the heavy lifting for us.  The numbers and graphs are accessible via the wonderful FRED database at the St.Louis Federal Reserve bank.  The data series is called GDPPOT.

The CBO released it’s latest long-run estimates for GDP.  Here’s a graph comparing potential real GDP to actual Real GDP. It shows actual numbers for 2008- first half of 2011.  From then on it’s the CBO’s best estimates of future actual real GDP given present government policies.

Yeah, that’s an ugly gap between those two lines.  That’s the opportunity cost of lost potential.  We could have been $2.8 trillion dollars better off over the last 3 years (cumulative, not annual). We could have had tens of millions more working. But we didn’t.  More disturbing is that we will continue to underperform for many years.  The CBO doesn’t project getting back to full-employment and our achieving our potential output until the end of 2015 – four years from now.

But now here’s the catch.  The CBO estimates and analysis don’t offer any rationale or reason why they suddenly forecast a recovery in 2015.  Basically they are saying that surely something will happen in 2015 to bring recovery, but they can’t point to any policies or dynamics that will cause such a recovery.

My own sense is that this will take a lot longer to recover given the government’s current focus on debt, deficits, and cutting spending.  It’s the wrong policy mix to achieve full employment given this kind of output gap.  We will eventually get back to full employment – if nothing else, sooner or later people die off and equipment rusts away.  But we’re in the middle of an ongoing depression and current policies won’t change that.  (note I said depression, not a “Great depression”)

 

Hurricanes, Disasters, and GDP

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Ok, normally I’m writing about the disastrous effects of changes in GDP.  Today, though, I’m going to write about the effects of disasters on GDP. As I write this, it’s mid-day on Saturday, Aug 27.  Hurricane Irene has just hammered North Carolina and the Outer Banks. Irene is continuing in both it’s push up the Eastern seaboard toward New York City.  I have no idea at this moment how bad the damage will be.  What’s clear is that even if the storm weakens to a tropical storm strength, it will bring extensive flooding and wind damage across a very heavily populated area.

Major natural disasters generally do not have a major long-run effect on the economy and GDP.  This is largely because the U.S. is a really large nation and even the most severe natural disasters such as Hurricane Katrina only directly affect a small portion of the country.  So even if a hurricane or earthquake were to stop 40% of the economic activity in a region, as long as the region is only say 2-5% of the nation, the net effect is a short, temporary “blip” on the nation’s GDP.  Hurricane Irene could conceivably be different because the projected path includes over an estimated 65 million Americans – nearly 20% of the nation.

Asking what the effect of a natural disaster will be on GDP is probably the wrong question to ask.  What we’re really interested in is “what is the effect of the natural disaster on the economy and our living standards?”   It’s just that we are so accustomed to using GDP as a proxy measure for the size of the economy and our living standards.  Unfortunately, GDP as a measure of the economy and our welfare has some weaknesses.  These weaknesses are really important in the case of a natural disaster and interpreting it’s effects.  GDP measures economic production by counting the dollar value of all transactions where something new is produced and sold.  GDP doesn’t measure the value of what we own – our wealth. GDP doesn’t measure the value of services produced that aren’t sold (like charitable acts, household production, etc).  GDP doesn’t measure our capability to produce.  It only measures what we actually produce and sell.

The economic effects of a natural disaster are to change exactly these things that GDP does not measure. The primary economic effect of a major disaster such as an earthquake, hurricane, extensive flooding, or  a swath of destructive tornadoes is to destroy wealth and destroy our capacity to produce.  In macroeconomic terms, a natural disaster is a sudden reduction in our resources: capital equipment, buildings, and available labor. None of this is a good thing.  It reduces our ability to produce goods and services in the future and it reduces our welfare right now.  But that effect won’t show up in GDP measures.

What will show up in GDP measures after the natural disaster is a perverse reaction in the months after the disaster.  This comes because of the re-building activity that comes after the disaster.  Repairing buildings, cleaning up, rebuilding all require paid services, building supplies, labor, etc.  These transactions will show up in GDP measures in the months/quarters after the disaster as an slight increase in total GDP.  But it’s a deceptive increase in total GDP because we aren’t really significantly better off.  We’re just getting back to the condition before the disaster.  GDP counts the fixing, but not the damage done.  This is why we sometimes here commentators say that a “disaster is good for the economy”.  It isn’t really.  It’s good for GDP, but that’s not a perfect measure of the economy.  The mistaken idea that damage or disasters are good for the economy is what economists call the Fallacy of the Broken Window. It was first explained by Frederic Bastiat.

Normally the economic impact a natural disaster will be relatively short-lived so long as there is a mechanism to finance reconstruction and the real resources in the larger nation to do it.  Typically in a developed nation like the U.S., the financing for reconstruction comes from insurance company payouts and government, especially national government, loans and payments. In particular it is the responsibility of the national government to help rapidly restore infrastructure.  If adequate financing and national resources exist, then we rarely find a national impact on GDP or the economy lasting beyond perhaps a 6 months to a year.  The smaller the economy, the greater the potential for longer lasting damage and even a failure to rebuild at all.   That’s the problem in New Orleans five years after Katrina.  The city is now permanently smaller since large numbers of people chose not to return and rebuild.  At the U.S. level, though, it’s insignificant.

The lack of financing and resources can severely damage a very small or poor nation for a very long time.  That’s why Haiti, a small and poor nation, is so dependent upon outside help to rebuild. The other exception that can result in lasting damage and reduction of the economy is when the disaster brings permanent physical damage that cannot be repaired or rebuilt easily.  The nuclear disasters in Chernobyl and possibly Fukishima fall into this category.

So overall, a natural disaster is not likely to be a long-term significant

 

GDP for 2nd Quarter Revised Downward

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As is normal practice, the BEA released the second estimate of 2nd quarter GDP growth.  GDP growth was definitely even slower in 2nd quarter than previously reported.  CalculatedRiskBlog tells us:

From the BEA: Gross Domestic Product, Second Quarter 2011 (second estimate

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 1.0 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the “second” estimate released by the Bureau of Economic Analysis.

This was revised down from 1.3% and slightly below the consensus of 1.1%.

Exports subtracted more from GDP - as did changes in private inventories. Consumption of services and fixed investment were revised up slightly.

The following graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The current quarter is in blue.

GDP Growth RateClick on graph for larger image in graph gallery.

The dashed line is the current growth rate. Growth in Q2 at 1.0% annualized was below trend growth (around 3%) – and very weak for a recovery, especially with all the slack in the system.

Calculated Risk goes on to report on the breakdown of what sectors accounted for what part of the growth (or absence of growth).  The two most significant negatives were Personal Consumption of Goods and State/Local Government Spending.  Both contracted sharply and each had the effect of lowering the GDP growth rate by 0.34 points.  A 1.0% annualized growth rate is really not good at all.  It’s horrible in fact.  And that means it’s not the time to be cutting state and local government spending.  The federal government really could do something but there’s no political will in Washington.

Would a Balanced Budget Amendment Help or Hurt?

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One component of the deal to raise the debt-ceiling is a requirement that Congress vote later this year on a “Balanced Budget Amendment” to the Constitution.  Is such an amendment a good idea?  At first glance, the idea seems attractive to a lot of people for whom the debt and deficits are seen as the key problem facing the economy (I am not one of these people).  After all, if you believe debt is bad, and debt comes from having deficits, then why not just pass a law amendment to the constitution that prohibits deficits, right? Well there are several problems with the idea.  Some are strategic – it’s really not a good idea to force a balanced budget every year.  But other problems are practical – the amendment, particularly as proposed now, simply wouldn’t work and would set up perverse incentives. Let’s look at these problems.

First off, there’s a bit of false advertising on the part of advocates of the “balanced budget amendment”.  The reality of what has been proposed goes beyond requiring a balanced budget.  A balanced budget would simply require government revenues to equal government expenditures each year.  The currently proposed amendment is really a “balanced budget with a strict cap on spending amendment”.  It has two parts. Not only would the budget have to be balanced each year, but the government spending would limited to 18% of GDP unless overridden by a 2/3 majority of Congress. The spending cap would limit government expenditures even if the budget were balanced.  The advocates of the balanced budget amendment, most of whom are Tea Party Republicans, are really proposing to re-write the Constitution to make it impossible for a majority of the duly elected Congress to expand the government beyond the limits they want.  It’s a rewrite of democracy.

The amendment and the spending cap in particular are totally unworkable in a practical sense.  First, the amendment and spending cap assumes that GDP and government spending are independent variables.  They aren’t.  In fact, government spending (G) helps determine GDP both directly since it  is a component of GDP and indirectly since the other components, consumption spending (C) and investment spending (I) and net exports (X-M) are themselves partially functions of government spending.  GDP = C + I + G + (X-M) by definition.  If you cut G, you cut GDP.  Suppose GDP = 100 and G = 20.  That’s government spending is 20% of GDP.  That would be too high under the amendment and would require a cut of government spending – revenue increase would not be allowed.  So suppose government cuts it’s spending to 18.  Keep in mind such a cut would be monumental. That would be a 10% (2/20) cut in government spending and we just had a paralyzing debate in Washington over how to cut spending by only 2-5%.  Imagine trying to cut 10%!   But even if the government did it, it wouldn’t work.  Because cutting government spending from 20 to 18 would take GDP down also.  The cuts would reduce both numerator and denominator.  If spending were cut to 18, then GDP would be no higher than 98, still leaving government spending as 18.37% of GDP. It would still be above the limit and require even deeper cuts which would then also cut GDP.  The reality would be even grimmer because C, I, and net exports all are partially influenced by government spending.  If you cut government spending for example, the people who got paid that government money, be they defense contractors, Social Security beneficiaries, teachers, or Medicare doctors, experience lower incomes.  They then cut their consumption spending and investment spending.  This is called the multiplier effect.

The practical problems are even greater when revenue is considered.  Government revenue, or taxes, are effectively a % of GDP.  That’s because virtually all the money collected by the government comes from GDP-related activity. Virtually all government revenue is either income taxes, payroll taxes, corporate profits taxes, or excise taxes on things that are used in production like gas.  If GDP goes up, then taxes collected goes up. If GDP goes down, then taxes go down also. Government spending goes in the opposite direction. When GDP goes up, many spending categories decline like unemployment compensation, welfare, Medicaid, etc. When GDP goes down, those spending items go up automatically.  These are called automatic stabilizers and they’re a major reason why recessions after World War II had been so mild compared to the depressions experienced routinely before WWII.  A balanced budget amendment means getting rid of automatic stabilizers and making mild recessions into worse recessions or even depressions. As  Simon Johnson at Baseline Conspiracy  put it:

 It makes no sense to target, as a matter of constitutional process, two numbers that are both outcomes of deeper economic processes.

A second very serious practical problem is with measurement.  GDP, while it’s commonly used and accepted, is only an economic concept, not a legal one.  The definition and calculation of GDP is subject to interpretation and depends on the prevailing views of statisticians and economists during any such era.  Simon Johnson at Baseline Conspiracy explains:

But GDP is not a legal concept – rather it is an economic measure, the details of which change all the time, subject to the prevailing view of best practice among statisticians.  Just to take one example, the flow value of housing services for people who own their houses is “imputed” to create a number that is roughly equivalent to what renters pay.  The goal is to more accurately measure a key component of consumption, which comprises the largest category of spending within GDP.  But the emphasis here is on “roughly” – the models used are sometimes called into question and must be revised from time to time.  And imputed spending on housing is a big number – probably around $1 trillion in today’s economy (with total GDP at about $15 trillion).

If an enterprising future administration wanted to lower spending relative to measured GDP, they could convene a panel of experts that could duly find that our current practice of not valuing household services – like cooking and taking care of children – is a statistical aberration as well as an affront to people who work very hard.  That should add at least $5 trillion to our annual GDP.  Alternatively, a statistical adjustment in the other direction would force real and painful spending cuts.  The constitution is the wrong place to pursue such details.

GDP is too fuzzy and imprecise of a measure, with too much estimation involved, to be enshrined in the constitution.  As an analogy, suppose we decided that we wanted to avoid the recent acrimonious debate over raising the debt-ceiling.  Suppose we thought too many Congresspeople acted too childishly.  Imagine if there were a proposal for a constitution amendment that required only “mature and intelligent ” adults “with an IQ above average” be allowed to run for Congress.  How would mature be defined?  How would it be measured?  We would make Congress dependent on a test, an IQ test, that itself is subject to revision and interpretation.  Later administrations would pressure psychologists to change the IQ test to satisfy the needs of their party.  The same happens if we enshrine GDP as a requirement in the Constitution.

In policy terms, the balanced budget amendment is a very bad idea. A balanced budget requirement forces the government to act pro-cyclically instead of counter-cyclically.  This means instead of fighting a recession, the government’s actions would make the recession worse.  Granted there are provisions in the amendment to waive the balanced budget requirement if GDP drops 10%, but keep in mind how severe that is.  The Great Recession/Financial Crisis of 2007-09 was only a 6% drop in GDP.  Government wouldn’t have been able to counter it.  The stimulus program, which was too small to trigger recovery but did successfully stop the free-fall, wouldn’t have happened until the crisis had indeed become as bad as the Great Depression.  A balanced budget amendment means a return to the old days before World War II when the U.S. routinely experienced severe depressions and financial crises. Again Simon Johnson:

.. sometimes it makes a great of sense to apply an economic stimulus to an economy in freefall.  One such moment was 1930 (and 1931 and 1932), when no stimulus was applied.  Other moments were 2008 and 2009; both President Bush and President Obama initiated stimulus packages.  When credit for and confidence in the private sector evaporates, do you really want the government sector to be forced to make quick cuts – or raise taxes?..

The second policy objection to this balanced budget amendment is that it is really a back-door attempt to circumvent democratic debate and decision-making.  The amendment proposes to limit government as part of the economy to 18%.  But why 18%?  Supporters claim that is what the U.S. has spent on average in recent decades.  But why is that the right number?  The size of government is a political, democratic choice that is up to the population at the time.  If today’s population wants a smaller government, they can elect politicians to do that.  And if some future generation should decide that 18% is not the right number, that maybe they want a different set of priorities and to devote a larger share of the nation’s resources to public goods, why shouldn’t they be able to do that?  Many nations devote a much higher % of GDP to public goods instead of private consumption goods.  Their economies are successful and their people are satisfied with it.  Having the current crop of legislators set a limit on what future generations may choose or do is not consistent with the concept of responsive democratic government.  It makes no more sense to enshrine an 18% limit on government spending in the constitution than it does to constitutionally enshrine a fixed limit on the number of soldiers the government may have.  It should be up to the representatives of each generation.

I’m not the only one who’s opposed to a balanced budget amendment.  And, the opposition isn’t all “Keynesian Democrats” (I don’t qualify as one of those either).  Simon Johnson, the author I’ve quoted above, is a former Chief Economist for the IMF.  The IMF has historically advocated and pushed for balanced budgets, yet it opposes this kind of handcuffs of economic policy.  Further, a Republican economist, Bruce Bartlett, has articulated many of these same problems with the amendment.