Productivity has been the source of most of the changes. Jobs data get revised too, but we haven’t seen revisions near the size as we’ve seen for GDP, and GDP growth is the sum of employment growth and productivity growth.

Recently, the initial estimate for 2011’s third-quarter GDP growth was revised downward from a 2.5 percent annual growth rate to only a 2.0 percent annual growth rate.

Still, even a 2.0 percent growth rate represents a nice pickup from the extraordinarily weak first two quarters. Unfortunately, much of that improvement came in the form of productivity growth rather than job growth.

It confirms our judgment last summer, when we expected the Country to avoid the second dip so many forecasters expected after the August data revisions to the first two quarters’ GDP data.

That doesn’t mean we’re out of the woods yet. The probability of one of both of two very serious events that we’ve been warning about for months seems to be increasing daily.

A significant interruption in oil supply from the Middle East would have catastrophic impacts on Western economies. The probability of such an interruption is becoming alarmingly high, in our estimation.  A week or so ago, there were headlines that a natural gas line in Egypt was sabotaged, the Kuwaiti government has collapsed, and Syrian atrocities are continuing, perhaps increasing. The likelihood of an oil-supply interruption is high, and the economic impacts of an interruption are very serious. Economic recession will affect all developed economies.

The other risk is a financial crisis associated with the breakup of the Eurozone. While the markets are giddy today with the prospect of yet more Eurozone bailouts, the bailouts are only bandages.

Fundamentally, the Eurozone is a contradiction that cannot be sustained. Some countries will have to leave it. When they do, there will be losses. Financial institutions and governments will face stresses not seen since September 2008. The resulting recession will be serious and widespread.

Productivity used to have a cyclical component. It fell early in a recession, and it rose early in the recovery. The early-recession fall resulted from falling sales and no employment change. The idea is that businesses see the sales decline, but don’t know if it is temporary. So, they don’t layoff for a while and productivity falls.

The early-recovery productivity growth is similar. A business sees increasing sales, but is unsure if it is permanent. So, they avoid adding to payroll until they are confident that the higher sales will be maintained.

All that went away with the past two recessions. In these recessions, productivity growth was relentless, increasing quarter after quarter. Consequently, our models cannot effectively use the new productivity information. (Don’t ask why. It is a statistical answer.)

Some, very few actually, are discounting the new jobs data, because it included the Verizon strike. We note that it also included the return of Minnesota’s government workers, significantly reducing the Verizon impact.

There are other reasons to be concerned about the new jobs data. A big one is that the previous two months were revised down. June was revised down 26,000 jobs (56 percent) to only 20,000, while July was revised down a whopping 32,000 jobs (27 percent) to 85,000. These revisions imply that the initial estimate is currently biased high, implying in turn that we actually lost jobs in August.

The combination of falling productivity and job losses is a powerful indicator that the second dip may be here or coming very soon.

Dan Hamilton
October 28, 2010

The first estimate of United States third quarter Gross Domestic Product came out today. The preliminary estimate of third quarter real GDP growth was 2.0 percent, which follows a 1.7 percent growth rate during the third quarter. This preliminary estimate of third quarter economic growth is not very different from the previous quarter’s growth rate. However, one aspect of the composition of growth changed dramatically from the previous quarter, which was residential real estate investment. This measure, which grew 26 percent during second quarter, fell 29 percent during the third quarter.

I have argued in this blog-space that the 26 percent second quarter growth was a temporary, stimulus driven result, and not a sustainable recovery in residential real estate. This data release supports that argument and is congruent with our September 27 United States Economic Forecast of a contraction in this investment segment.

I should say that with respect to the recently ended recession and the currently weak recovery that we are now experiencing, “it’s the residential real estate, stupid!”, and we see continued weakness for that sector for some time. There are too many homes yet to be foreclosed on and too many unemployed that cannot consider a home purchase at this time. The stock of ownership housing is too large for demand, and it will remain too large for demand this same time next year.
Other aspects of the data release are counter to my forecast, namely stronger consumption expenditures, stronger inventory investment, stronger government expenditures, and stronger commercial real estate expenditures. Stronger consumption expenditures boost GDP now, but given that household sector debt levels are still too high, I worry about the long-term consequences of such consumption. Continued consumption growth, if it occurs, will be accompanied by rapid inventory investment.

I continue to be surprised by the strength of government expenditures. The preliminary estimates show federal spending growing with such strength to offset state and local weakness. I continue to expect that state and local expenditure weakness will be a greater drag on growth during the next few quarters than the previous couple of quarters.

Third quarter GDP was reduced by trade as was the case in second quarter, although this effect was weaker this time, 200 basis points, versus 350 basis points during second quarter. These results are driven by extraordinary import strength, which most forecasters, as well as I, do not believe is sustainable. Once this import strength subsides, GDP growth will benefit.

I do not see many fundamental support factors for United States economic growth at this time other than trade, technology, and manufacturing. However, these are not large enough to create a strong economic recovery from the Great Recession. The next couple of quarters might see offsetting factors that create moderate growth for some time to come. The positive factors will likely be: federal government expenditures, equipment and software investment, and import growth reductions. The negative factors will likely be: state and local government expenditures and real estate.

A major difficulty with forecasting at this time is the question of how households will behave during the next couple of quarters. Will they save for the future or consume? There are economists on both sides of this question. We have been thinking that they would save, and we will probably continue to forecast this.

New unemployment claims also rose to 444,000, again exceeding “consensus expectations.”

There was also a report that will receive much less attention, but it is important. Inventories increased in November, the most recent month for which data are available. If inventories were increasing over the Christmas shopping season, and sales were declining, retailers ended the year with excessive inventory. That means reduced production in the first and second quarters of 2010.

2009’s third quarter output (GDP) growth was positive, and many expect a very impressive positive number for the fourth quarter, some as high as five percent. If the fourth quarter does come in with a strong GDP growth rate, it will be hailed as the harbinger of a soon-to-be-realized vigorous recovery.

Don’t buy that, and you won’t be disappointed.

That vigorous recovery may eventually come, but it is unlikely to come in 2010. Whatever growth generated in second-half of 2009 was government-supported consumption, ephemeral, not a solid foundation for economic growth, certainly not the basis for sustained vigorous job growth.

A vigorous recovery will be a result of investment, technological growth, and improved productivity. Recent productivity numbers have been encouraging, but in large part, they are probably the result of firms downsizing. Technological growth and solid job growth require investment, and that is the problem.

Our banks are in no condition to fund any vigorous expansion. Indeed, bank loans have been declining since October 2008. Businesses and consumers remain over-leveraged, unable to increase spending on consumption, unable to invest, desperately trying to reduce debt.

We won’t see a vigorous recovery until balance sheets are improved and banks can lend.

Government programs haven’t helped. Most of the spending programs have been consumption based instead of investment based. Some have been outright counterproductive, programs such as foreclosure-delay, paying interest on bank deposits at the Fed, and cash for clunkers. Even worse, the banking problem has been ignored, and now new taxes on banks are being discussed. That is as bad an idea as I’ve heard in a long time.

GDP is the broadest measure of economic activity, and the first estimate of fourth quarter GDP will not be out until the end of January. By far the largest component of GDP is personal consumption expenditures. It is fairly certain that fourth quarter durables consumption growth will fall – it was artificially boosted during quarter 3 by the Cash-for-Clunkers program. Non-durables and services consumption will likely be weak, but slightly positive, in part due to an expected weak holiday shopping season.

While quarter-on-quarter GDP growth was positive, year-on-year growth was negative, see the chart below. The year-on-year growth data is more stable than the quarter-on-quarter growth data as can be seen by comparing the second chart which shows the latter growth data. In addition, the year-on-year growth data is conceptually linked more closely to annual percent changes than the quarter-on-quarter growth data. The year-on-year growth data show the economy has, in fact, not recovered at all.

Residential real estate investment is a wild card, but not a particularly big one. It surged in quarter 3 due to the Federal Homebuyer’s Tax Credit. Congress is likely to extend this tax credit prior to the December 1 expiration date. The billion dollar question is: how many families remain who will take advantage of that credit? If there are few, then fourth quarter residential real estate investment will fall relative to the third quarter, weakening fourth quarter GDP.

While Cash-for-Clunkers has expired, the Federal Homebuyer’s Tax Credit is likely to be expanded and extended. A bill is moving through the Senate. Once the bill gets to the House, prospects for passage are high. In addition to extending the $8,000 credit to first-time homebuyers, a new $6,500 credit for returning homebuyers will be available for applicants who have lived in their home for at least five years.

Going forward, the extended and expanded Federal Homebuyer’s Tax Credit could provide additional stimulus to the economy through residential fixed investment, and to a lesser extent, consumer durables. We wonder how much of the related home purchases are adding debt to the household sector. Part of the reason the housing market collapsed was excessive leverage. If the debt levels are still too high, and they may be, this tax credit may be creating more future pain in housing.

We expect motor vehicle sales to be noticeably weaker in fourth quarter, because third quarter sales included purchases that were moved forward from fourth quarter. We expect high unemployment rates, high mortgage defaults, and high foreclosure rates will persist through the fourth quarter and beyond. These will imply at least some weakness in all consumption categories.