The deadweight of deficit

A disappointing first quarter GDP report came out last week and reignited discussions about the strength of the economy. Similar to the inflation subject addressed a couple weeks ago, there is a little something for everyone in the data, and nuances that are more important than attempts to extract a political narrative.

Look at the numbers: The latest report from the Bureau of Economic Analysis revealed +1.6 percent annualized real GDP growth in the first quarter of 2024. Analysts had been expecting +2.5 percent growth, and in Q4 of 2023 the number had been +3.4 percent. Two things need to be clarified right off the top: First, these numbers are adjusted for inflation and thus represent real GDP growth. Second, all numbers shown are always annualized, so when we speak of a quarterly number of 1.6 percent, it was actually 0.4 percent on the quarter, but 1.6 percent annualized.

So the data speaks to an economy that grew less than anticipated and less than it has been growing, but does it speak to an economy in trouble?

The answer requires nuance and both a short-term and long-term approach. On one hand, in the short term, the 2.5 percent full year real GDP growth in 2023 was significantly higher than had been expected. (No less than 85 percent of economists surveyed at the beginning of the year predicted a recession by the end of the year). Economic growth last year not only outperformed expectations, but by the end of the year was showing the strongest growth we had seen in years (outside of COVID bounce-back quarters during reopening). Q1’s more recent result reflects more of a normal quarter, normal being defined by the expectations of the last decade or so, than it does a real cooling off. It was the second half of 2023 that would be considered irregular.

What explains the drop off in the first quarter of 2024? The two primary detractors were in trade, as net exports decreased taking away -0.86 percent, and then inventories decreased taking away -0.35 percent.

As a supply-sider who believes production drives sustainable economic activity, I primarily focus each quarter on Fixed Investment. Inventories and trade data can be sporadic and “lumpy,” and personal consumption (the largest weighting in the GDP calculation) is pretty reliably strong, given the U.S. consumer’s penchant for spending. Production tends to be the economic activity that determines where growth is and where it will go, and Fixed Investment in structures, equipment, construction, intellectual property, and so forth are, to me, the heart of economic activity.

That number did not speak to anything substantially wrong in Q1 economic growth, but nor did it reflect a high margin of optimistic activity. Its moderate measurement reflects what appears to be a moderately growing economy, and I expect both of those components to continue in 2024. In other words, our economy is growing, yes, but not at our normal or full capacity.

And this brings me to the longer-term perspective that I believe is so crucial. Real GDP growth continues to be less than 2 percent annually since the financial crisis of 2008, over 15 years ago. Prior to the financial crisis, our real economic growth was 3.13 percent for 70 years! This substantial reduction in economic growth and in economic growth expectations is the single biggest story no one wants to talk about.

Why is a completely new trendline in economic growth not generating more stories? For one thing, the short-term captivates the media and the political news cycle more than the long-term does. I do not say this as a compliment. But additionally, to discuss the clear and present compression of long-term economic growth (down by 40 percent since the financial crisis) would force politicians of both parties, and the people who elect them, to recognize that massive government spending and deficits are not boosting economic growth; they are diminishing it.

This is the reality of our times. Budget deficits we used to run only when the economy was weakening are now standard even in normal economic times, and the explosion of government debt has weighed on economic growth substantially. If that is not addressed, and I have no confidence that it will be any time soon, the worry about one quarter to the next GDP number will be the least of our concerns. One quarter’s reduction in net exports is not a substantial economic story, but a decade of lower trendline growth, is.