With most of the crucial data needed to estimate third-quarter economic growth now in hand, economists are coming up with a result considerably different from what they expected only a month or two ago. Not only is the projected gain in real gross domestic product stronger, but the composition of growth is also tilted much more toward a broad pickup in demand and away from output gains resulting from businesses adjusting their inventory levels. That mix is much more favorable for continued growth.
The fear had been that the economy was embarking on a demandless recovery. That is, real GDP would get a boost in the second half solely because businesses had slashed their output in the first half far faster than demand was falling. Even if overall spending only stopped declining, companies would still be short of inventories, causing additional ordering that would temporarily lift output. But without new growth in demand, ordering would fall off once inventories were back in alignment, and the economy would stall.
The report on third-quarter GDP, to be released on Oct. 29, will help to allay those fears. The median forecast of 18 economists surveyed by Bloomberg expects a gain of 3.1%, the strongest in two years. Based on available monthly data, some two-thirds of that advance will come from increased spending. At the same time, businesses continued to liquidate their inventories at a rapid rate, probably helped by the sudden turn toward stronger demand. The combination of overly thin inventories and increased spending is a classic combination that will propel economic growth well into 2010.
The pickup in demand last quarter was widespread. The GDP data are expected to show that consumer spending rose at about a 3% annual rate, which would be the best showing in 2 1/2 years. And it wasn't just cash for clunkers. The strength in nonauto retail sales in August and September suggests that more than half of the advance came from outside the boost to auto sales.
Plus, businesses have pared their outlays for equipment and software so deeply that some catch-up spending is necessary. Increased outlays by homebuilders also added to economic growth—the first contribution in 3 1/2 years. Government surely gave a dollop of support, and both exports and imports rose strongly, showing solid demand both at home and abroad.
Last quarter's bounce in demand, coming after a record inventory liquidation in the second quarter and another large drawdown in the third, means businesses now have even more incentive to boost output in order to bring inventories into better balance with sales. Many economists believe inventory realignment by itself could add some two percentage points to GDP growth in both this quarter and next.
For a lasting recovery, though, the coming gains in GDP will have to create jobs that fuel income growth and keep consumers spending. That outcome will depend partly on how businesses achieve their increased production. In the third quarter, companies relied on a huge productivity gain of nearly 6%, with GDP rising some 3% and hours worked falling about 3% as payrolls declined further.
But productivity growth at that unusually high rate is hard to maintain. It eventually strains existing employees and facilities, and businesses have to add workers and equipment. Job gains may not be far off, if only because businesses have been overly aggressive in purging payrolls. Including the Labor Dept.'s latest benchmark revisions, the level of private-sector employment is back to where it was a decade ago. As GDP picks up, current payroll levels should quickly prove to be unsustainably low.
The broader message from the upcoming third-quarter GDP report will be that financial-market healing is promoting economic healing. The data will not completely calm fears of a double dip, but they will show that the time-honored business cycle forces that drive recoveries are falling into place.