The startling figures for the third quarter that were released last week must surely undermine the Democrats' hope that the economy will help them in 2004. The 7.2 percent rise in the gross domestic product may not be all it seems (quarterly numbers never are), but even after allowing for special factors and trying really hard to find bad news in there somewhere, you still have an economy that is growing very strongly and therefore is helping George W. Bush. At this rate, "It's Iraq, stupid" may well turn out to be the Democrats' best bet.
Professor Brad DeLong of the University of California (Berkeley) points out on his Web site that the third-quarter surge was fueled by the last of the tax rebates sent out over the summer. This is apparent from the monthly data for personal incomes and spending in September that were published the day after the GDP figures. Consumer incomes and spending were sharply higher in July and August but then fell abruptly in September as the rebates ended. Incomes rose faster than spending on the way up (some of the rebates were saved) and fell faster than spending on the way down (as consumers saved less to cushion the drop)—just the pattern you would expect if the rebates were driving the numbers. So much for the claim that poorly designed tax cuts would fail to deliver the needed economic stimulus.
With the rebates spent, GDP growth in the fourth quarter and beyond is likely to be far lower, although you can come down an awfully long way from 7.2 percent and still have excellent growth. DeLong also argues, by the way, that the revised figures for the third quarter will be lower as well. His reasoning is that the first estimate of quarterly GDP, published last week, relies heavily on data for the first two months of the quarter. The revised numbers will give fuller weight to the slowdown in September. A couple of the economists who posted replies on DeLong's site think he is mistaken about this, but DeLong reckons that the final figure for third-quarter growth might come down to around 6 percent.
However you look at it, GDP is performing well. To find bad news for the Bush administration in all this, you have to focus on unemployment. Impressively powerful advances in productivity are driving the strong underlying trend in American output: The economy can do more with less. Labor is one of the expenses that companies are squeezing. Other things equal (which they rarely are), rising productivity pushes output and incomes up, and employment down. So one story line for the Democrats is that this is an unbalanced and unjust expansion, with many Americans being left behind.
How persuasive is this argument? Not very, I'd say. Trend growth in GDP of 3 percent a year or better, which is what the United States now has, will perceptibly raise the living standards of most Americans. Many people will undoubtedly feel sympathy for the unlucky minority who are out of work —but that does not mean they will vote for a Democratic alternative who may jeopardize their own living standards.
Politics aside, it is muddled economics to believe that "good news on productivity is bad news for labor." When you consider the changes in industry and commerce that underlie the economy's recent productivity performance, it is remarkable that American unemployment has stayed so low. Europe should be so lucky. America is combining profound labor-saving shifts in the technology of production with (by global standards) extremely high levels of employment.
How is this possible? Because demand has broadly kept pace with rapidly increasing supply (thanks partly to those tax rebates), and because the American economy is so good at moving people out of old jobs and into new ones. Europe is bad at moving people out of old jobs and is even worse at moving them into new ones. It also has slower productivity growth—yielding, please note, lower incomes, not lower unemployment.
The gap between supply and demand is what puts short-term pressure on employment. Only to the extent that demand falls short is there a risk that rising productivity will push unemployment higher. This could happen, but things can be done to avoid it. Keep fiscal policy loose; keep interest rates low; let the dollar depreciate (which raises demand for domestically produced goods by making imports more expensive). All of this is being done.
To turn it around: If American productivity growth was weaker, would that be so good for employment? Probably not. If supply were lower in relation to demand, the Fed would have to worry about the risk of rising inflation—especially if the dollar kept drifting lower against the euro and other currencies. Before long, it would need to curb demand by pushing interest rates back up, and not by a little. As this column went to press, the Bank of England was poised to raise interest rates in Britain. Demand there is too strong in relation to supply, and inflationary pressures are mounting. If Britain had productivity growth to match America's, its interest rates could be going down, not up.
Higher interest rates in America would hit investment and consumer spending—and that would be bad for jobs. Strong growth in productivity postpones any such reckoning; in the meantime, it also delivers higher living standards for the great majority of Americans.
Over the longer term, though, how secure is this higher trend of growth in productivity and output? Sorting out the factors that determine productivity, separating the temporary from the enduring, is something that can be done only by looking backward and after an interval of many years. Nonetheless, each passing quarter increases confidence that the American economy is undergoing a lasting change for the better.
In the productivity boom of the late 1990s, progress was confined to a narrow segment of the economy. Studies by productivity mavens such as Robert Gordon of Northwestern University showed that the surge in potential supply was concentrated in the bits of the economy that produce information technology. In the wider economy, meaning all of the industries that use IT rather than supply it, there was little or no sign of a productivity uplift. This raised doubts about the supposed productivity miracle and America's "New Economy." If the surge in productivity was concentrated in IT production, and if that rise itself largely resulted from a temporary surge in investment in IT-producing technologies, then the whole thing might fizzle out pretty quickly.
This has not happened, as Gordon has acknowledged. As he continues to track the productivity record, he finds that the acceleration in the trend has lasted longer than his earlier findings led him to expect, and, equally important, that it has now spread beyond industries that produce IT to industries that use IT. The continuation of the faster trend since 2000 is particularly striking: Following the bursting of the dot-com bubble, investment in IT fell sharply during this period.
This timing and the broadening pattern of improvement lend support to the view that it takes time for the effects of profound shifts in technology—the arrival of electric power in the 19th century, for instance—to spread. The reason is that such deep changes in technology cannot be assimilated at the margin. If producers are to exploit these improvements to the fullest effect, they have to recast nearly everything about the way they work, from the top to the bottom of their companies. Whole industries are created and destroyed in the course of this transition.
This is very difficult, and it may take years or even decades to do. Conceivably, the IT revolution will work the same way and thus prove as dramatic in its longer-term economic effects as did electric power. The numbers no longer rule that idea out, although Gordon in fact still doubts that the long-term productivity improvement will be on that scale. Even if it fails to rise to that mold-breaking level, the IT breakthrough of the 1990s does seem to be driving a substantial (and sustained) long-term improvement in productivity growth.
Few of the things that economists worry about will be left unaffected by this wonderful prospect. The burden of public and private debt, to name just two, will be much easier to carry in outlying years if economic growth is higher. One or two decades from now, the transitional costs of Social Security reform, for instance, or the ongoing costs of publicly supported universal health insurance, would be far more easily supported.
Faster growth will not close the huge long-term budget gap. Nor will it abolish the business cycle. Whatever happens, America's trend of economic expansion will be punctuated by recessions. But readers in Washington must look on the bright side: This is good news for politicians. Neither Democrats nor Republicans can plausibly claim credit for the trend—but blaming each other for the interruptions will always be a steady business.