January 26, 2021
We will see a strong but more normal rate of growth in the fourth quarter, however that is a misleading picture of the overall state of the economy.
After falling at a 31.4 percent annual rate in the second quarter shutdown, and then rising at a 33.4 percent rate in the third quarter, we will see a strong but more normal rate of growth in the fourth quarter, however that is a misleading picture of the overall state of the economy. With growth likely coming in a bit over 5 percent for the quarter, the economy is still going to be around 2.0 percent smaller than in the fourth quarter of 2019.
There are two main points worth taking away from the fourth quarter data.
First, there are sharp differences across sectors. The other point, which I will come back to, is that there is a major issue in the timing of spending that we have to keep in mind in reviewing the data.
Output in several major sectors is already well above its year-ago levels.
Housing is the leader here. Housing starts have been strong since summer; starts in December hit their highest level since the housing bubble. In the third quarter, residential investment was already 5.7 percent above its fourth quarter 2019 level. We will likely see a double-digit growth rate in the fourth quarter, pushing residential construction even further above the year-ago level.
Spending on nonresidential investment presents a mixed picture.
Investment in intellectual products has held up reasonably well in the pandemic, with the third quarter level just 0.4 percent below the fourth quarter 2019 level. It will almost certainly surpass that level in the new GDP report. Spending on equipment also held up reasonably well, with the third quarter level down by just 2.2 percent from the pre-pandemic level. Fourth quarter growth should bring it close to the year-ago level.
By contrast, nonresidential construction has been very weak in the Pandemic Recession, as we have seen especially large falloffs in the construction of hotels, manufacturing facilities, and office space. The third quarter level was 14.7 percent below the level from the fourth quarter of 2019. We will certainly see a further drop in the fourth quarter.
Consumption spending also shows a very mixed picture.
Spending on cars and other durable goods has been very strong. The third quarter level was 12.0 percent higher than in the fourth quarter of 2019. We will likely see another strong growth figure in the fourth quarter.
Spending on nondurable goods was also somewhat higher in the third quarter than in the fourth quarter of 2019, showing a gain of 4.5 percent. This increase is in spite of a sharp fall in gasoline consumption and a smaller decline in spending on clothes. The big increases were in areas directly related to the shutdowns. There was a big jump in spending on store-bought food, as people spent less on restaurants. There were also increases in spending on games and hobbies, as well as newspapers and magazines, and pets. We will likely see a further gain in the fourth quarter in this category.
By contrast, spending on consumer services is down sharply from its level in the fourth quarter of 2019, with a falloff of 7.7 percent. This largely reflects declines in spending on restaurants and travel, as well as sports and other forms of live entertainment. Spending on medical services is also down sharply, as many people put off check-ups and other nonessential care. We will at best see modest growth in spending on services, with the fourth quarter figure almost certainly still well below the year-ago level.
Trade has also been a major factor in the drop in GDP in the pandemic, with exports down far more than imports.
We should expect to see further widening of the trade deficit in the fourth quarter as the trade deficit hits levels not seen since before the Great Recession. This will be a major drag on the quarter’s growth rate. The story here is that most of our trading partners have seen weaker growth than in the US, which means their imports have dropped more than ours. Also, tourism is one of the areas in which the United States had enjoyed a large surplus before the pandemic. The collapse of this sector has added to the trade deficit.
Turning to government spending, at the federal level, expenditures were roughly 1.5 percent higher in the third quarter than in the fourth quarter of 2019. By contrast, spending at the state and local level was almost 4.0 percent lower. We are likely to see a continuing decline in state and local spending in the fourth quarter (it also dropped in the third quarter) as cash starved governments have no choice but to cut back spending. If the federal government does not make additional assistance available, we will see further cutbacks in this sector, which will be a major drag on growth.
Returning to the point on timing, much of the growth that will be reported in Thursday’s fourth quarter data actually took place in the third quarter. The economy was growing rapidly at the end of the quarter and into October, but has since slowed sharply as the renewed spread of the pandemic led businesses to cut back operations or shutdown altogether.
The timing story is the same with consumption, which is more than 70 percent of GDP. If consumption had just remained at its September level throughout the fourth quarter, it would have led to a 4.3 percent annual growth rate. While consumption did rise modestly in October, it fell in November and almost certainly fell again in December.
We are still likely to end up with modest consumption growth in the quarter, but this will be entirely due to the growth in the third quarter and the start of the fourth quarter. For the last two months, consumption spending has been shrinking, and the economy has likely been shrinking as well.
The timing issue means the fourth quarter GDP numbers will be giving us a misleading picture of the overall state of the economy. We will likely be looking at a figure that, in other times, would be viewed as very strong growth, even though the economy is actually shrinking at the start of 2021.
The Gross Domestic Product, 4th Quarter 2020 (Advance Estimate) is scheduled for release by the Bureau of Economic Analysis on Thursday, January 28, 2021 at 8:30 AM Eastern Time. CEPR produces same-day analyses of government data on inflation, employment, GDP and other topics.
Follow @DeanBaker13 on Twitter to get his quick-take analysis of government data immediately upon release.