July 26, 2023
We will likely see growth of close to 2.0 percent in the second quarter, roughly the same as in the first quarter. This is close to most estimates of the economy’s potential, indicating that it is growing at a pace that is sustainable and should not be associated with rising unemployment. The composition of growth this quarter will be quite different from the first quarter, when slow inventory growth was a major drag, while booming car sales helped drive GDP growth.
Second Quarter Will Show Strong Productivity Growth
Quarterly productivity data are always erratic, but this has been even more the case than usual in the pandemic and recovery. In the first quarter, productivity was reported as falling at a 2.1 percent annual rate. That’s a bad story, but much better than the 6.0 percent rate of decline reported for the first quarter of 2022.
Given the likely rate of GDP growth for the second quarter, productivity growth should be at least 2.0 percent. The index of aggregate hours from the establishment data was essentially flat in the quarter, while self-employment was down from the first quarter. This will put the rate of productivity growth since the start of the pandemic very slightly above the 1.0 percent rate from the prior decade.
We have seen massive changes in the structure of work since the pandemic with the increase in work-from-home and the replacement of many in-person contacts with Internet meetings. More recently, workplaces are beginning to introduce AI on a substantial scale. There are plausible stories where the net impact of these changes on productivity can be either positive or negative. It is far too early to make any definitive statements at this point, but it does seem that the pandemic changes have been a small positive to date.
Consumption Growth Slows to a Sustainable Pace
A big surge in car sales caused consumption to grow at a 4.2 percent annual rate. Vehicle sales alone added 1.06 percentage points to GDP, accounting for more than half of the growth in the quarter. That will not be repeated in the second quarter, as car sales have slowed sharply and will likely be a drag on growth. This is a sector where higher interest rates have had a large effect.
Consumption of services has been growing at roughly a 2.0 percent rate, while sales of non-durable goods have been close to flat. This should mean that overall consumption will increase at close to a 1.0 percent rate.
Non-residential Investment Continues Rapid Growth Driven by Factory Construction
Non-residential investment will likely grow at more than an 8.0 percent rate driven by double-digit growth in structures. Structure investment grew at a 15.8 percent annual rate in the last two quarters.
Part of the story is that construction of office buildings had bottomed out earlier in the recovery, and has little room to fall further. But the more important factor is that factory construction has been soaring as a result of the CHIPS Act and the Inflation Reduction Act. Real construction of manufacturing facilities was more than 50 percent higher in May of 2023 than a year earlier.
Equipment investment was a major drag on investment growth in the first quarter, falling at an 8.9 percent annual rate. That will not be the case in the second quarter, as it will likely show modest growth. Investment in intellectual products should also show modest growth, although the strike by the writers guild will be a drag on growth in the quarter.
Residential Investment Will be Little Changed
Residential investment has fallen by more than 20 percent since its peak in the first quarter of 2021. It was a major drag on growth in the last three quarters of 2021, knocking an average of more than 1.1 percentage point off of growth in these quarters. However, this fall is largely over. In the first quarter, residential investment fell at a 4.0 percent annual rate, subtracting 0.16 percentage points from growth. In the second quarter, residential investment will likely be close to flat, having little impact on GDP growth.
The First Quarter Drop in the Trade Deficit Will be Reversed
Exports grew in the first quarter, while imports shrank. As a result, the nominal trade deficit fell by $54.8 billion in the first quarter, with trade adding 0.58 percentage points to the quarter’s growth. This story will be largely reversed in the second quarter, with the deficit increasing roughly back to its level at the end of last year.
Inventory Growth Will Return to a More Normal Pace, Providing a Modest Boost to Growth
Inventory growth fell to just a $3.5 billion annual rate in the first quarter. As a result, inventories subtracted 2.14 percentage points from growth in the quarter. Inventory accumulation will return to a more normal pace in the first quarter. This is partly a result of higher imports, much of which end up in inventories. In any case, inventories are likely to add 0.5-0.6 percentage points to second-quarter growth.
Government Spending Will Add at Least 0.5 Percentage Points to Growth
Government spending has added an average of more than 0.7 percentage points to growth in the last three quarters, as growth has averaged 4.2 percent. We are likely to see some slowing in the second quarter as spending associated with pandemic programs is winding down. Nonetheless, growth will likely still be close to 3.0 percent, which would add more than 0.5 percentage points to GDP in the quarter.
GDP Growth Is Looking Balanced and Sustainable
The second quarter GDP data should show a picture of an economy that has largely put the gyrations of the pandemic recession and recovery behind it. Consumption is increasing at a moderate and sustainable pace. Supply chain issues have largely been resolved so the swings in purchases, as well as the soaring prices, are over.
Investment is now the leading factor driving GDP growth, as factory construction associated with the energy transition and reshoring of semiconductor production is booming. Spending in other investment components is growing at a more modest pace. Residential construction has slowed from its recent peak, but the big falloff is in the past. On the whole, the second quarter report will be very good news with the economy growing at a pace that can sustain full employment, but is not facing inflationary pressure on the demand side.