US economy ends on a high; the UK less so

As we go into the Christian holiday break, the major stock markets of the world are reaching all-time highs. The US S&P-500 index has just had its 51st closing high of the year. The S&P 500 has now rebounded 11% since reaching a recent low in the middle of October, following the collapse of oil prices and a feared debt crisis in Russia (see my post, https://thenextrecession.wordpress.com/2014/12/08/oil-the-rouble-and-the-spectre-of-deflation/). After Janet Yellen, the head of the US Fed, announced that the Fed would not be hiking its ‘policy interest rate’ for at least six months, stock investors renewed their confidence in the continuation of cheap money to invest.

Now the final revision on US GDP growth for the third quarter of 2014 ending in September has been released. It came in at a 5% (annualised) rise over the previous quarter, the fastest quarterly growth in more than a decade. Naturally, this has been heralded by most analysts as a sign that the US economy is now set for sustained fast growth in 2015 onwards and at last we can talk about the end of weak ‘recovery’ since 2009.

Well, it can’t be disputed that the headline figure is impressive. But, as is often the case, the devil is in the detail. Yes, real household spending was up from a 2.5% annual rate in Q2 2014 to 3.2%. But business investment grew at a slower pace (albeit at 8.9%) compared to Q2 (9.7%). The joker in the pack was government spending, which rose 9.9% compared to a decrease of 0.9% in Q2. And the main reason for this was a huge increase in defence spending, from 0.9% in Q2 to 16% in Q3! Government spending contributed 0.8% points of the annualised increase of 5% in Q3. The average contribution from government since 2010 has been less than zero. Without this big jump in arms expenditure, real growth would have been slower than in Q2 2014.

And annualised quarterly figures are misleading. They tell the current pace of change but not how much higher real GDP is compared to, say, a year ago. By the end of September 2014, the US economy was larger in real terms compared to a year ago by just 2.7%. That’s not bad compared to other major capitalist economies, but hardly a staggering pace – and still under the long-term average.

Moreover, the forecast growth rate for the final quarter of this year ending on 31 December is expected to be much less than the 5% just announced. Data for the latest quarter on the US economy suggest a slower growth, with new home sales falling in November (as it is, investment in homes has been weak). Spending on business investment also fell in November. However, consumer spending picked up with the fall in gasoline prices from the oil price collapse. If we assume, say 2.5% yoy growth in Q4, then annual growth in 2014 will end up about 2.4%. The graph below shows that this is pretty much where US economic growth has been since the end of the Great Recession.

US YOY growth

And more or less at the same time, the UK announced its revised figures for real GDP growth Q3 2014. This came it at 0.7% up from Q2 (or an annualised 2.8%). Again not bad, but previous GDP figures going back a few years were revised down and as a result, UK real GDP was reduced from the previous estimate of 3.0% yoy to 2.7% yoy – exactly the same as US growth. It is now clear that the UK will not achieve Chancellor Osborne’s boast of 3% growth in 2014 when the Q4 data come in. Indeed, his claim that the UK economy will be the fastest growing of the top G7 in 2014 is now under challenge.

And it remains the case that the ‘recovery’ in the UK since the Great Recession remains the weakest of the last four recessions.

GDP quarter-on-quarter growth from peak for previous and latest economic downturns

UK recovery

Source: Office for National Statistics

Of course, most commentators expect faster growth in 2015 for both the US and the UK. But this forecast primarily depends on household consumption staying firm and business investment growth accelerating. In the UK, in Q3, business investment increased by 5.2% compared with the same quarter a year ago, but fell compared to Q2 by 1.4%, with a significant fall in so-called intellectual property products (-1.3%).

The reality is that UK economic growth remains skewed towards a consumer boom based on cheap credit and government subsidies to the residential housing market. Rising home prices and rock-bottom borrowing rates have encouraged a level of spending by those in work. As a result, real GDP growth has been mainly driven by construction (homes and offices). Construction activity grew at double the rate of services in the third quarter, while manufacturing and production lagged.

UK sector growth

UK house prices have grown at an annual rate of 8% or more for the last 12 months, according to Nationwide. This has pushed up land values and benefited the property developers who hire engineers and architects.

UK home price growth

Manufacturing growth has been weak and export growth has been terrible. In Q3, the UK racked up a huge deficit with the rest of the world (£27bn) as consumer imports outstripped exports and income and investment from abroad dropped off.

Most important, UK business investment, while rising in real terms, is not recovering relative to GDP.

UK bus inv-GDP

As a result, productivity remains below the level achieved before the Great Recession.

UK productivity

The US corporate sector has enjoyed record high profit margins.

US profit margins

But although margins are high, profitability is coming under pressure as businesses raise investment. Indeed, total corporate profits are now hardly rising, at just 1.4% yoy in Q3 2014. If they stop rising, then business investment growth, far from accelerating to sustain real GDP growth, will contract after a lag.

US bus inv and profits

By this time next year, US real GDP may be suffering from a fall in investment and rising interest rates (if the Fed keeps to its plan).

I’ll discuss the US and world economy in 2015 in more detail in my final post for this year, next week.

2 Responses to “US economy ends on a high; the UK less so”

  1. Boffy Says:

    Michael,

    You say,

    “And annualised quarterly figures are misleading. They tell the current pace of change but not how much higher real GDP is compared to, say, a year ago.”

    I find that odd because most economists and statisticians would say the exact opposite. The reason normally given for using annualised, Q on Q, GDP growth is that it removes the effects of distorting seasonal variations. So, for example, the growth figure of 2.7%, is a reflection of the fact that in 2014 Q1, the US suffered a very distorting 2.1% drop in GDP, due to the phenomenal effects of the polar vortex that literally froze economic activity for a large part of that period.

    A statistician would, therefore argue that a figure for annual GDP that is heavily influenced by such an outlier does not give a true picture of what is actually going on in the economy at that time. The annualised figure of -2.1% in Q1, for example, did give a more accurate picture of what was going on at that time – the economy being frozen up – than did the year of year figure suggesting the economy was growing at 1.9%.

    Normally, statisticians would remove such distorting outliers from the data for that reason, and concentrate on modal averages, rather than mean averages. On that basis, if we look at the annualised growth rate for Q on Q data, what we see is that 4 of the last 5 quarters have shown growth of more than 3.5%. It is only the rogue Q1 that does not conform to this pattern. In fact, 3 of the four non-rogue quarters have had growth figures of 4.5% or more! The last quarter was higher than the 4.5% figure recorded in the previous quarter, suggesting that the trajectory is higher.

    It seems particularly perverse, therefore, to try to present as typical, and an indication of the direction of travel a growth figure that is highly distorted by one rogue figure, and which does not reflect the fact that growth is on an upward trajectory, not just in relation to the current quarter, but in relation to the previous two quarters.

    I also found your previous comment also interesting. You write,

    “The joker in the pack was government spending, which rose 9.9% compared to a decrease of 0.9% in Q2. And the main reason for this was a huge increase in defence spending, from 0.9% in Q2 to 16% in Q3! Government spending contributed 0.8% points of the annualised increase of 5% in Q3. The average contribution from government since 2010 has been less than zero. Without this big jump in arms expenditure, real growth would have been slower than in Q2 2014.”

    That seems a fairly unadulterated acceptance of the role of Government spending, i.e. Keynesian fiscal expansion, as a means of increasing growth!

    But, at least there is a recognition now that rapidly falling oil prices act to stimulate consumer spending, rather than cause economic contraction or the Keynesian notion that they cause deflation. In fact, there is every possibility that not only will falling oil prices cause the rate of profit to rise, and release capital for further accumulation, but the noted rise in consumer spending, as consumers have revenue released through lower fuel prices, by causing economic activity to rise, may cause the low velocity of currency circulation to rise, thereby leading to rising commodity price inflation rather than deflation.

    Moreover, under current conditions, there is no reason why a high but falling rate of profit will cause investment to fall, for the reasons Marx set out. Firstly, capital tends to accumulate simply because that is its nature, as a rising population and expanded needs provides the basis for individual firms to see the potential to simply produce and sell more. But, secondly in order to sell more, and achieve competitive advantage, firms need to invest in the development of new products and so on. Quoting Richard Jones, Marx writes,

    “”All other things being equal, the power of a nation to save from its profits varies with the rate of profits: is great when they are high, less, when low; but as the rate of profits declines, all other things do not remain equal…. A low rate of profits is ordinarily accompanied by a rapid rate of accumulation, relatively to the numbers of the people, as in England … a high rate of profit by a slower rate of accumulation, relatively to the numbers of the people. Examples: Poland, Russia, India, etc.” (Richard Jones, An Introductory Lecture on Political Economy, London, 1833, p. 50 ff.)

    Jones emphasises correctly that in spite of the falling rate of profit the inducements and faculties to accumulate are augmented; first, on account of the growing relative overpopulation; second, because the growing productivity of labour is accompanied by an increase in the mass of use-values represented by the same exchange-value, hence in the material elements of capital; third, because the branches of production become more varied; fourth, due to the development of the credit system, the stock companies, etc., and the resultant case of converting money into capital without becoming an industrial capitalist; fifth, because the wants and the greed for wealth increase; and, sixth, because the mass of investments in fixed capital grows, etc.”

    (Capital III, Chapter 15)

  2. sartesian Says:

    “But, at least there is a recognition now that rapidly falling oil prices act to stimulate consumer spending, rather than cause economic contraction or the Keynesian notion that they cause deflation. In fact, there is every possibility that not only will falling oil prices cause the rate of profit to rise, and release capital for further accumulation, but the noted rise in consumer spending, as consumers have revenue released through lower fuel prices, by causing economic activity to rise, may cause the low velocity of currency circulation to rise, thereby leading to rising commodity price inflation rather than deflation.

    Moreover, under current conditions, there is no reason why a high but falling rate of profit will cause investment to fall, for the reasons Marx set out.”

    Remember these words from Boffy, because when when capital spending declines, when the economy slows, when devaluation and deflation continue, he won’t.

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