October 28, 2024
(The quarterly Gross Domestic Product (GDP) is scheduled for release by the Bureau of Economic Analysis on October 30.)
We should again see very healthy GDP growth in the third quarter, with the number likely to come in at over 3.0 percent, with consumption and non-residential investment both showing solid growth. This would further raise GDP above the growth path projected before the pandemic.
Second quarter growth already placed GDP more than 2.0 percentage points higher than the Congressional Budget Office (CBO) had projected in January of 2020, before the pandemic. If growth comes in at 3.0 percent, it would increase the gap between actual GDP and the CBO projections by roughly 0.4 percentage points (the gap in annual growth rates has to be divided by four, since this is only a single quarter.) The recovery in the United States is an outlier among wealthy countries; we are the only country that has seen growth at or above the pre-pandemic pace.
A Sustained Uptick in Productivity Growth and Its implications
The reason for the faster than projected GDP growth is the unexpectedly rapid labor force growth from the surge in immigration. But a big part of the story is that productivity growth has remained strong in spite of the disruptions caused by the pandemic, albeit slightly lower than what CBO had projected.
Cumulative productivity growth since the fourth quarter of 2019 has been roughly 7.8 percent, compared to the 8.3 percent growth projected by CBO before the pandemic. (This adjusts for the 800,000 downward revision to payroll employment in the preliminary benchmark revision reported by the Bureau of Labor Statistics in August.) That translates into growth of 1.7 percent annually, well above the 1.1 percent pace we saw in the decade prior to the pandemic.
Hours grew at roughly a 1.0 percent annual rate in the third quarter. If GDP growth comes in above 3.0 percent, this would mean productivity growth for the quarter is over 2.0 percent, slightly faster than the 1.9 percent rate that had been projected by CBO before the pandemic. (The most recent productivity projection from CBO for the third quarter is just 1.7 percent.)
Productivity is highly erratic and has proven incredibly hard to predict – but if the economy can sustain a faster pace of productivity growth, it has enormous implications. First and foremost, a more rapid pace of productivity growth means workers can see a faster pace of real wage growth, even without reversing the shift from wages to profits in the pandemic.
Faster productivity growth will also mean that there is less basis for concern about inflation. If we have 2.0 percent productivity growth it means that 4.0 percent nominal wage growth (roughly the current pace) is still consistent with the Fed’s 2.0 percent inflation target, even without any reversal of the pandemic increase in profit shares.
Faster productivity growth also translates into faster GDP growth. If this growth is sustained, the interest burden of the national debt, relative to income, would decline through time. Given the history of the last half century, it is difficult to project with confidence the future course of productivity growth, but more quarters with strong growth does brighten the picture.
Consumer Spending Remains Strong
All signs indicate that we should see another strong quarter for consumer spending. With employment growth and real wage growth continuing at a healthy pace, consumer spending is likely to grow at between a 2-3 percent annual rate in the quarter.
Service consumption will provide the bulk of this increase. We have already seen service consumption largely revert back to its pre-pandemic share of consumption, after falling sharply during the shutdown period. The share should continue to grow in both real and nominal terms.
The growth in real terms is due to the fact that consumption of items like housing and health care is rising more rapidly than consumption of items like clothes and cars. However, the growth in the nominal share of services has also been driven by higher inflation in services than goods.
A hugely underappreciated story of the last 15 years is the slower growth of healthcare costs. Healthcare costs have barely risen as a share of GDP since the passage of the Affordable Care Act. The share actually has fallen slightly since the pandemic. If this trend continues, it frees up money to be spent in other areas.
Non-Residential Investment Likely to Remain Strong
Non-residential investment has been consistently strong throughout the recovery, although the composition of the growth has shifted substantially. In the second quarter, it grew at a 3.9 percent annual rate, although the bulk of this growth was attributable to equipment investment, which rose at a 3.9 percent rate. Structure investment increased at just a 0.2 percent rate, and investment in intellectual products rose at just a 0.7 percent rate.
This was a very different picture from the first quarter, when structure investment and investment in intellectual products increased at 6.3 percent and 7.5 percent annual rates, respectively. The investment in structures in turn has been driven by extraordinary growth in factory investment. Real investment in factories is now well over double its pre-pandemic level. We will likely see some reversal in the third quarter data, with faster growth in structures and intellectual products than in the second quarter.
Housing Likely to be a Small Drag on GDP
Housing construction is likely to be a small negative in the third quarter, as high interest rates slowed starts. There was a small surge in refinancing when interest rates fell in the late summer, which will help to offset this drop, but we should still see a small negative.
Saving Rate Likely to Show a Small Dip
There was a lot of attention given to the reported decline in the saving rate in 2023 and the first half of this year. This decline was largely eliminated by the GDP revisions reported last month. It is likely that the third quarter data will again show a small drop in the saving rate. It is important to remember that saving data is generally revised upward. It is therefore likely that any reported decline will disappear when we see fuller data.
The Economy Looks Good
The election is a huge source of uncertainty in the economy, but all the signs we can see for now paint a very positive picture of strong GDP and wage growth and continued low unemployment. But as we know, things can change quickly.
