Defense Share of GDP at Its Highest Level since 1993

GDP grew at a 3.5 percent annual rate in the 3rd quarter, driven by a 22.4 percent jump in car sales, the result of the Cash for Clunkers (C4C) program.  This increase in car sales accounted for 42.0 percent of the growth in the quarter.  Consumption as a whole, which grew at a 3.4 percent annual rate, added 2.36 percentage points to growth.  Other components making large contributions to growth were inventories, which added 0.94 percentage points; national defense, which added 0.45 percentage points; and residential construction, which added 0.53 percentage points, its first positive number since the fourth quarter of 2005.

The surge in car buying will be reversed in the current quarter, as the main effect of the C4C was to pull car purchases forward.  As a result, the auto sector will be a substantial drag on growth in the current quarter.  Apart from the auto sector, consumption grew at a 1.0 percent annual rate.  With disposable income falling due to continued job losses and declining hourly wages, and the reversal of the surge in car sales, consumption growth will almost certainly be negative in the 4th quarter.

The growth from inventories came in spite of the fact that inventory levels are still falling at a rapid pace.  However, the pace of inventory depletion was slower in the 3rd quarter than in the 2nd quarter, therefore this component added to growth.  Inventories will add more to future quarters’ GDP growth.  If inventories were to simply stabilize next quarter, it would add over 4 percentage points to the GDP growth rate for the quarter.

Defense spending continues to be an important factor pushing the economy as it has grown rapidly even as the economy has shrunk.  Defense spending now accounts for 5.6 percent of GDP, the largest share since the first quarter of 1993.  By comparison, it peaked at 7.6 percent in the 3rd quarter of 1986, at the height of the Reagan build-up.  In its last pre-September 11th projections, the Congressional Budget Office projected defense spending for 2009 as 2.4 percent of GDP.

The turnaround in residential construction is noteworthy after the collapse in this sector following the housing boom.  Housing fell from 6.3 percent of GDP in the 4th quarter of 2005 to just 2.4 percent in the second quarter of this year.  Housing is likely to edge up slightly from its current low levels, but it will not be a substantial source of growth for at least a couple of years.

Non-residential investment contracted at a 2.5 percent annual rate, with a 9.0 percent decline in structure investment more than offsetting a 1.1 percent increase in investment in equipment and software.  Structure investment will continue to contract in future quarters.  There was substantial overbuilding in most sectors during the years 2006-2008.  This sector will be a drag on growth at least through 2010.

Net exports subtracted 0.53 percentage points from growth in the quarter as a 16.4 percent rise in imports outweighed a 14.7 percent rise in exports.  The falling dollar will help to even out trade in future quarters, but this sector is unlikely to be a strong contributor to growth in the immediate future unless the decline in the dollar accelerates.

State and local government spending contracted at a 1.1 percent annual rate.  The stimulus pending did lead a modest increase in investment spending at the state and local level.  However, this was more than offset by spending cutbacks that states implemented to meet balanced budget requirements.

While the growth shown in this report allows us to pronounce the recession ended, it does not provide much basis for optimism about the future.  Consumption spending is virtually certain to shrink in future quarters.  The same is true of structure investment and state and local government spending.  We are unlikely to get much boost from the trade sector or much further boost from defense spending.  The only sector that is likely to be a source of substantial growth in the next year is inventories, as the rundown eventually reaches an endpoint.  However, with so much weakness elsewhere in the economy, inventories fluctuations will not turn the economy around.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C.  This article was published by CEPR on 29 October 2009 under a Creative Commons license.

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