A Close Look at How the Economy's Growing

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The U.S. economy grew 2.2% in the first quarter. At least it wasn't a decline, as most of Europe would say these days.

What should you make of it?

An important caveat is in order before we get into the details. Like all economic numbers, initial releases are subject to revision, and those revisions are sometimes huge. In early 2008, initial GDP reports showed the economy grew by about 1%. That was later revised to a decline of about 2%. Healthy grains of salt are necessary when talking about these numbers.


More important than the headline number of 2.2% GDP growth is where that growth came from. The exact breakdown looks like this:

Consumer expenditures2.04%
Private investment0.77%
Net exports(0.01%)
Government spending and investment(0.60%)
Total GDP growth2.2%

Source: Bureau of Economic Analysis.

Consumer expenditures were one of the only bright spots in the report. The growth, however, might not be sustainable. Average wage growth has tracked below the rate of inflation over the last year, leaving the average American worker with less spending power. The growth in spending last quarter was fueled in large part by a decline in the personal savings rate, which fell from more than 5% a year ago to 3.7% earlier this year. Consumers spent more in the first quarter because they saved less, in other words. That can't go on forever.

Government transfer payments have been a big boost to consumer spending for the last few years, as I wrote last week. But on the whole, government's role in providing economic growth is not only waning, it's turned into a drag. From 1950 to 2007, government spending and investment added an average of 0.56% a year to GDP growth. Last quarter, it subtracted from GDP by almost the same amount. Indeed, in what might be a mind-blower to those who spend their days watching cable news, federal government spending declined over the last year, from an annual rate of $3.73 trillion a year ago to $3.71 trillion today. Yes, that's a small drop. But it's a drop nonetheless, and in fact it's the first annual decline in government spending in the last half-century:

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Defense was the largest contributor in the economic drag, making up two-thirds of the government's 0.6% hit on growth. That drag may only grow larger going forward as defense cuts mandated as part of last summer's budget deal take effect.

Some good news: Private investment in equipment and software continued to chug along, growing 1.7% in the quarter. Total private investment as a whole is still below the prerecession peak, but investment in equipment and software has jumped by one-third in the last three years. With global growth still weak, businesses are eager to plow money into anything that will make them more efficient in order to keep corporate profits intact. So far, it's worked wonderfully.

Residential construction (part of private investment) added 0.4% to GDP growth in the quarter, one of the largest contributions of the last five years, and higher than the 50-year average contribution. New housing starts are estimated to hit 700,000 this year, up from 550,000 two years ago (though still a fraction of normal levels). That tends to add momentum to the broader economy. As Warren Buffett estimated last year: "We will come back big time on employment when residential construction comes back ... you will be surprised, in my view, how fast employment changes when that happens."

How nice it will be when it does. At current growth rates, however, the economy isn't growing fast enough to bring down unemployment in a big way. This is becoming a familiar story: We are moving in the right direction, but not nearly fast enough.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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