Friday the Bureau of Economic Analysis released the preliminary estimate of the first quarter, 2010, U.S. gross domestic product. The good news is that total production of goods and services grew 3.2% in that quarter (seasonally adjusted at an annual rate). For better or worse, nearly half that growth (1.57%) was caused by expansion of business inventories. I’m going to dig into the GDP numbers, an exercise that often puts readers to sleep. Hang in there – I promise it will be worth the effort.
Before I begin, there’s one important point to be made. This is the preliminary estimate for the first quarter. There will be two revisions released near the end of the next two months. Revisions are often significant. As several writers have discovered, basing significant economic analysis on the preliminary estimate can lead to wildly incorrect conclusions.
Caveat emptor. You have been warned. Read on at your own risk!
Far and away the most interesting data for the first quarter comes from the B.E.A.’s table 1.1.2 (“Contributions to Percent Change in Real Gross Domestic Product”). From that we learn that 2.55% of the 3.24% growth came from consumer spending. About 40% of that (1.15%) was attributed to growth in consumer spending on services. This is actually a good sign. It means that consumers are, among other things, going out to restaurants and beginning to purchase services they might have performed themselves a year ago. Not surprisingly durable goods spending contributed 0.79%, down sharply from the 2009 second quarter of 1.36%. The “cash for clunkers” program did exactly what economists predicted. It shifted consumer spending from future quarters into the second quarter of 2009. Mind you, this is a good thing. The economy needs more spending sooner.
Gross Private Domestic Investment
Far more problematic is the behavior of gross private domestic investment. Consumer spending stimulates output this year. Investment spending creates the new physical capital to increase output in the future. The overall contribution of gross private domestic spending was 1.67%. However, only 0.1% was from business fixed investment. The remaining 1.57% was growth in business inventories. Let’s dissect those numbers.
Business fixed investment includes nonresidential structures, nonresidential equipment and software, and residential construction. Nonresidential and residential constructions together reduced GDP by 0.73%. That means spending to build new structures fell compared to the fourth quarter of 2009. Blame this on the first-time homebuyer’s tax credit which shifted demand for residential structures into the last two quarters of 2009. However, these decreases were more than offset by increased spending on nonresidential equipment and software which contributed 0.83% to GDP. The net change in gross private domestic investment masks larger changes in the underlying components.
The 1.57% contribution of inventory growth has been hailed by many economists as evidence that businesses are rebuilding inventories anticipating higher future sales. Not so fast, folks. Let’s review J.M. Keynes. He pointed out that there are two sources of inventory change: planned and unplanned. Economic analysts are assuming the inventory increase was intentional. But suppose the change was unplanned. That would mean production exceeded spending. Remember, businesses have to plan production in advance of spending. When their demand forecasts are too high, production will exceed spending and inventories will rise. But that’s not a positive sign for the economy – in fact, it’s a negative because businesses will have to liquidate those inventories in future quarters.
Was the inventory increase planned or unplanned? I don’t know and I suspect many of the economists mentioned in the previous paragraph don’t know, either.
However, another B.E.A. table contains some valuable insights. Table 5.6.6B is the “Change in Real Private Inventories by Industry, Chained Dollars.” This table is in billions of constant 2005 dollars, not percentages. The growth in business inventories was $31.1 billion. As always, inventories in some industries grew while others shrank. The main positive contributions came from Manufacturing, nondurable goods industries ($10.3 billion), Wholesale trade, nondurable goods industries ($10.3 billion, no this is not a typo), and Motor vehicle and parts dealers ($23.1 billion). In other words, nondurables and vehicles were the source of the inventory growth. The growth in motor vehicle inventories is nothing more than rebuilding depleted inventories after the end of the cash for clunkers program. Don’t expect that to continue into future quarters. The two nondurable increases are largely a result of the increased consumer demand for services. (Remember, consumer spending on services includes meals eaten away from home. Restaurants hold inventories just like most businesses that make something. Consider this a bit of an anomaly in the national income accounts.)
Let’s not bother with foreign trade since exports and imports are mainly included to convert total spending into production. Instead, take a look at government spending.
The contribution of government spending to first quarter growth was -0.37%. You read that correctly. Government spending was actually a drag on the economy.
“Wait,” you’re saying. “What happened to the government stimulus program?”
Good question. Once again we can look at the details to see what happened. Federal government spending contributed +0.11% to GDP growth. But state and local government spending dragged GDP growth down by 0.48%. This lends support to the calls by several economists for the federal government to bail out state governments.
That’s the story. The news is good, but perhaps not as good as the media would have you believe.
 See, for evidence, the failure to spend economic stimulus funds from the ARRA program at a fast enough rate.
 I believe Paul Krugman has advocated this position, but I’m too lazy to look up the citation.