Why GDP Growth Has Been so Slow

In light of today’s reports of poor GDP growth, we can surmise that the Great Recession was far worse than previously reported. In short, the hole we fell into is deeper than we have realized, and the economy’s pace—once over the edge of the hole—has weakened.

The sharp downward revisions in GDP growth for the first quarter of 2011 to 0.4% from 1.9% were not expected. Indeed, this was a huge reduction. The weak 1.3% growth estimate for the second quarter was somewhat expected. This was primarily due to the Japanese tragedy—which interrupted major supply chains to the U.S. auto and other industries—higher prices for energy, and serious U.S. floods and other natural disasters. When combined, of course, we have an unsettlingly weak first half, which means that GDP growth for the year cannot be expected to hit the recent 2.8% growth estimates made by major forecasters.

A look at the details reveals two major weaknesses. First, consumer spending is in the cellar, and personal income is not rising. This is driven by high unemployment and low employment growth. Second, state and local government spending is falling at a high rate, and is expected to continue falling. Business investment is also growing but at a diminished rate. 

Because of all this, we should expect lower GDP growth rates in 2011 and 2012, perhaps now in the 2.0% to 2.5% range. The best thing Congress could do at this point would be to make a long-term commitment to reducing future year deficits, reduce tax rates, and revise healthcare legislation to reduce costs.