The latest GDP revisions underscore how subpar the current recovery is.
The good news is that the Commerce Department’s second-quarter GDP report shows that the U.S. is richer and the economy larger than previously believed. The bad news is that this has nothing to do with anything that has happened lately, and certainly not in the last nine months. The current not-so-great economic recovery trudges on.
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This past week’s second quarter report is especially interesting because it includes economic revisions based on new assumptions that re-measure the size of the U.S. economy going back to 1929. The Bureau of Economic Analysis does this every five years or so, and the crucial change this time is the recognition of intellectual property.
The long-overdue idea is to better measure the contribution of intellectual capital in our modern information economy. The Commerce gnomes will from now on include research and development spending, and even such artistic creations as movies, as part of U.S. economic output. This appropriately broader definition of GDP increased the size of the current U.S. economy by $551 billion—to $16.6 trillion in goods and services.
In other words, the U.S. is more prosperous and productive than we had previously been told. This is a tribute to the powerful engine of private American ingenuity that has powered growth for so many decades.
The revised GDP numbers also sharpen the historical understanding of the policies that have promoted robust growth—and those that haven’t. Annual real growth in the U.S. averaged 3.3% from 1929-2012, and a slightly faster 3.4% from 1959 to 2002. These impressive rates mean that the economy has roughly doubled in size and income every generation.
We also learn from the revisions that the stagflationary 1970s—in particular the Nixon years—generated even less growth than originally recorded. This was an era of the 70% top marginal tax rate made worse by inflation that hit 13% and a huge expansion of the welfare and regulatory state.
By contrast, growth in the 1980s was even faster than we thought, averaging 4.4% a year from 1983-1989. This was the era by and large of tax cuts, deregulation, disinflation and government spending restraint. The recession of 1990, portrayed as a catastrophe at the time, turns out to have been minuscule, as the Reagan boom flowed into the prosperity of the 1990s. The Clinton tax increase of 1993 slowed growth from the robust recovery of late 1992 (3.6% for the year), but the Clinton-Gingrich policy mix and stalemate let the private information economy expand.
If only the economy had kept doing so well. As the nearby table shows, the last decade has been a major departure from the American growth norm. This is largely because of the 2008-2009 recession and the slow recovery since, and the revisions reveal important insights about the last 10 years.
One is that the economy grew faster in the five years following the 2003 investment tax cut than previously measured. The five-year average was 3%, and over 2004-2005 growth averaged a robust 3.6%. The housing bust and financial panic ruined what was otherwise an economy growing at close to post-1929 norms.
It also turns out that the 2008-2009 recession wasn’t as great as advertised. Instead of GDP tanking by -4.7% as first measured, the contraction in real output was -4.3%. That’s awful, but it’s not close to the Great Depression. By contrast, GDP declined by some 2.9% in the 1981-82 recession and by 3.7% in the 1957-58 downturn.
The tragic difference is how poorly the economy has emerged from this last recession. In the 1980s, growth averaged about 5% in the first four years of expansion compared with 2.2% since the current recovery began in mid-2009. If this had been a normal post-World War II expansion, the economy would be $1.3 trillion larger now.
The Commerce calculators found that the beginning stages of the Obama recovery were stronger than first estimated, but growth dipped to 1.8% in 2011, rising to 2.8% in the election year, only to decelerate again in the last nine months to average about 1%.
The question is why the setbacks? In a blog post Wednesday, chief White House economist Alan Krueger blamed 2011 on Japan’s tsunami and the more recent stall on “declining federal spending.”
The tsunami did damage global supply chains for a time, but global growth was still more robust than in the U.S. As for the 2012-2013 slump, Commerce reports that government spending only reduced GDP in the second quarter by 0.1%. So even on Keynesian terms in which all government spending is considered a contributor to growth, the drag on GDP was minimal.
The data suggest that a major cause of the recent slowdown has been the Obama tax increase. The uncertainty about whether and how much taxes would rise caused business to seize up in 2012’s fourth quarter, and the arrival of the increase in January has slammed business investment. Residential investment has rebounded with the housing recovery, but real nonresidential fixed investment fell by 4.6% in the first quarter and rose a modest 4.6% in the second, for a net of zero in the first half.
Without business investment, wages and incomes won’t rise. The tax hike raised rates on capital gains, dividends and small-business income—that is, on the returns from investment—at a time when nurturing more private investment and risk-taking should be a priority. In other words, the growth gap on President Obama’s watch is best explained by policy blunders that have added risk, uncertainty and new tax and regulatory burdens on investment, hiring and risk-taking.
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One reason to be more upbeat about the prospects for the second half of 2013 is Mr. Obama’s inability to pass major new growth inhibitors. House Republicans will (we hope) block any new tax increase or spending outburst. Mr. Obama’s regulatory offensive and the onset of ObamaCare will raise costs and reduce hiring, but legislative gridlock is a blessing compared with 2009-2010.
As the GDP revisions remind us, the challenge for the U.S. economy is to get back to the prosperous 3.3% growth rate that had been the American norm. Many economists are predicting that growth will revive in the second half, perhaps assuming that the second quarter results mean the Federal Reserve will maintain its current policy for even longer. We hope they’re right about growth, because by any measure the Obama years and policies ought to make Americans nostalgic for the good old days.
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This article appeared in The Wall Street Journal.