Is the 2022H1 GDP Decline...Fake?
The details of the data continue to be confusing and contradictory. But the economy is almost certainly slowing even if it hasn't yet started shrinking.
The price-adjusted value of the goods and services produced in the United States was 0.6% lower in April-June 2022 compared to the seasonally-adjusted peak in October-December 2021. Real Gross Domestic Product (GDP) has ostensibly been falling for two quarters in a row.
But Gross Domestic Income (GDI), which is published by the same government agency that compiles GDP, implies that the U.S. economy has been growing continuously since the end of 2021.
This disconnect is unusual, although there are precedents, especially around downturns. But for now, it poses a serious puzzle. (I have covered some of the issues in previous notes here and here.) Moreover, it’s not even the only thing amiss right now if you dive deep into the numbers. The main things to know:
The drop in GDP seems to be driven by troubles in manufacturing and energy, but those numbers seem to be inconsistent with the Federal Reserve’s separate estimates of mining activity and motor vehicle output.
Employee earnings and small business income were rising faster than prices, but not anymore.
The impact on total national income has been more than offset by the withdrawal of government subsidies to businesses since the end of 2021. (Slowing growth in take-home pay may not feel good, but the indicator that reflects overall economic activity is the amount of income generated organically by the private sector.)
Regardless of which measure you prefer, the pace of growth seems to be slowing, and some higher-frequency indicators imply that the economy may have already begun rolling over.
The Details of the GDP Decline
GDP is supposed to represent how much businesses and workers in a given country produced each quarter. (Hence the name “domestic product”.) Ideally, the government would add up all the revenues generated by businesses operating in the U.S. and then subtract total U.S. business spending on inputs purchased from others to avoid double-counting. Whatever remains should represent the true value of what was produced in the U.S. And, in fact, the Bureau of Economic Analysis (BEA) does do this, but the detailed figures are published only once a year after a long lag.
The most commonly quoted version of U.S. GDP is therefore a proxy of domestic production based on the accounting identity that sources = uses. For the world as a whole:
Production = Consumption + Fixed Investment + Changes in inventories
So for any individual country:
Domestic Production = Domestic Consumption + Domestic Fixed Investment + Changes in Domestic Inventories + Exports - Imports
The BEA estimates these components by looking at the monthly data the government collects on prices, inventories, international trade, retail and restaurant spending, home sales, construction spending, and manufacturers’ shipments of capital goods, as well as data on tax receipts and government spending. (Other data sources are less frequent and come out with longer lags, such as the quarterly services survey, which means they are used mostly to revise the initial estimates.)
In descending order of importance, the BEA believes that the real value of everything produced in the U.S. in 2022Q2 was 0.6% less than in 2021Q4 because of:
A sharp slowdown in the rate of inventory accumulation that has shaved off 0.59 percentage points of GDP so far this year, mostly in Q2. Motor vehicles and food-related products were responsible for the bulk of the slowdown.1 Inflation-adjusted inventories are still rising rapidly, but not as quickly as before. (What matters for GDP growth is the change in the change in the level of inventories.)
A large increase in the real value of imports of capital goods, motor vehicles and parts, and other consumer durables relative to exports of those items has cut 0.44 percentage points from GDP since the end of 2021, mostly in Q1. Imports aren’t bad, but they have to be subtracted from measures of domestic consumption and domestic investment to get an accurate estimate of domestic production.
Cuts in national defense and other federal spending, which reduced GDP by 0.21 percentage points in 2022H1.
A sharp slowdown in homebuying in Q2, which meant lower spending on “brokers’ commissions on the sale of residential structures and adjoining land, title insurance, state and local documentary stamp taxes, attorney fees, title abstract and escrow fees, and fees for surveys and engineering services.” That, along with the slight downtick in new housing starts for single-family homes and the ongoing drop in spending on “improvements” since the peak in 2021Q1 has taken off 0.18 percentage points over the past two quarters.
The combined impact of these four forces in the first half of this year (1.43 percentage points) more than offset the modest growth contributions implied by rising consumer spending (0.49 percentage points) and business investment (0.32 points).2
The implication is that the brunt of the downturn is being felt by America’s manufacturers (and, to a lesser extent, its farmers and miners). After all, they are the ones who produce the goods that other businesses buy to hold as inventories and they are the ones most exposed to global competition both through imports and exports.