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GDP gains 3.2% in first quarter, false spring for the middle class

By Dr. Peter Morici
web posted May 3, 2010

The Commerce Department reported GDP grew a modest 3.2 percent in the first quarter, further confirming the end of the recession and that the recovery is only moderate and disappointing. Half of the growth came from inventory adjustments, and the prospects for future growth and wage gains are only modest.

Separately, the March employment cost index was up 1.7 percent year over year. This broad measure of worker pay and benefits indicates that the typical American is not keeping up with rising prices, health care costs and taxes.

Unemployment will hang above 8 or 9 percent well into 2011, and most workers will continue to face a tough job market and declining living standards.

This recovery is decidedly anti-middle class. Wages will not keep up with rising prices, health care premiums and taxes. A good deal of the gains, so far, are going to Wall Street and the medical and intellectual property industries.

At 3.2 percent, first quarter GDP growth was pumped up by an end to inventory draw down and some rebuild--in the arcane world of GDP accounting, ending depletion of inventories adds to growth. Although the inventory rebuild has begun, the pace is slow reflecting tepid sustainable demand for U.S. goods and services.

Adjustments to inventories accounted for 1.6 percentage points of growth. Demand for U.S.-made goods and services--the key to sustainable growth—added only 1.6 percentage points to growth.

Backing out the inventory adjustments, real GDP increased about $162 billion since the second quarter of 2009, when the economy bottomed out. Wall Street for 2009 paid out bonuses of nearly $150 billion on profits twice that amount. The rest of the economy, on balance, went backwards.

New health care laws shift costs for services to the poor and low income workers to state and local governments through broader federal mandates, and onto insurance and drug companies. Resulting tax and premium increases fall heaviest on the middle class.

Hollywood and cable companies are boosting ticket prices and subscription fees, abusing ordinary Americans. Political contributions insulate their market power.

Looking ahead, data are not encouraging. After such a long and damaging recession, we should expect several quarters of 5 percent growth but poor and mistargeted economic policies will force Americans to settle for less.

A bullwhip effect on inventories added to first quarter growth--restocking a different selection of goods and services for a scaled back consumer, home buyers and auto buyers. However, retail sales indicate sustainable domestic demand is growing slowly, perhaps at an inflation adjusted rate of 2.8 to 3.2 percent.

Auto demand has recovered, pushing up production, but further increases are unlikely.

Appliance sales were pushed up by federal rebate programs but that program is winding down and has ended in several states.

New home sales and starts were boosted by the $8,000 first time home buyers tax credit but that is ending this month, and commercial construction remains very weak.

Weekly new jobless claims remain above 450K, when below 350K is considered healthy. Manufacturing is showing some ginger, thanks to stronger car production and leaner methods in technology-intensive industries. However, new car sales are not strong enough to drive further expansion of production, and factories appear able to make do with existing workers or even few workers in other industries. These days it takes a lot of new demand to cause anyone to hire.

Productivity may be expected to increase at least at a 2 percent annual pace, and the labor force grows about 1 percent a year. Hence, GDP growth greater than 3 percent is needed to significantly bring down unemployment.

Businesses need customers and capital to create jobs. The trade deficit is a major drag on the former and weakness at the 8000 regional banks won't be addressed by the president's bank reform proposals.

The trade deficit is nearly entirely oil and trade with China. The president's programs to increase domestic conservation and drilling are halfway measures and won't yield large results for many years. Talk on trade issues has failed with China—it will not meaningfully move on its currency, as the small revaluations being suggested won't dent the subsidy to Chinese products at the Wal-Mart provided by a 40 to 50 percent undervalued currency.

So far, President Obama's policies have not solved the problem of middle class decline because they fail to deal with systemic issues in the banks, trade, health care and competition in intellectual property industries. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.






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