As is so often the case recently, the headline GDP number for the third quarter is less impressive once we look under the hood at the components. Real GDP increased at a 2.8 percent rate in the first estimate of the third quarter, a welcome increase from the 2.5 percent rate increase in the second quarter. Yet the major components of GDP, such as consumption spending and fixed nonresidential business investment spending fell far short of the aggregate increase. What made up the difference? Once again inventory accumulation played a major role as did the foreign trade numbers, both of which must be interpreted with caution.
An intentional increase in inventories based on rising sales and prospects are a welcome addition to total business investment and GDP. Unintentional increases based on slowing sales leaving inventory on the shelves are not so good. While they count as investment in the current period, they are likely to result in slower orders and inventories in subsequent quarters. Given the persistently weak economy in recent quarters, I think the latter explanation is more likely than the former.
Real final sales—GDP minus the change in inventories—increased at only a 2.0 percent annual rate in the third quarter, down from 2.1 percent in the second quarter. Except for inventories, the third quarter was a tad weaker than the second.
Interpretation of the foreign trade data may be even trickier. Export increases, which add to the GDP number, were 6.4 percent for goods and 0.6 percent for services in the third quarter. However, both these numbers were smaller in the third quarter than in the second, when exported goods increased at a 9.4 percent annual rate and exported services increased at a 4.8 percent rate. Exports supported third quarter GDP increases, but not as much as they supported second quarter GDP increases.
Imports of goods and services were a larger factor going from the second to the third quarter than exports. In the third quarter, imported goods increased at a 1.9 percent annual rate, but that was down substantially from the 6.9 percent increase in the second quarter. Imported services increased at a 2.2 percent annual rate in the third quarter, but that was down from their 4.0 percent increase in the second quarter. Since imports are treated as a minus in GDP accounting, the smaller minuses in the third quarter gave a significant boost to the third quarter GDP number.
The minus sign on imports give many casual readers the impression that, since imports are a negative, they are bad, while exports are good. Imports are not “bad.” In fact, imports are our benefit from foreign trade while exports are the cost. The reason imports are subtracted is that the other components of GDP spending, consumption, investment, and the like, already contain an import component. This means that spending on consumption, for example, generates income both at home and abroad, to the extent that the consumption spending was on imported goods and services. It is easier to ignore the import component of the other spending categories and then subtract total imports from the total than it would be to try to separate out imports from each component separately.
Repeat: imports are not a negative in any real sense. It’s simply a matter of arithmetic.
Just as inventory accumulation must be analyzed carefully in the context of GDP accounting, so must an increase in GDP based on a fall-off in the rate of growth of imports. A decline in imports is usually the result of weakening domestic demand, in which case the positive impact on GDP sends a false signal of strength. On the other hand, a slow-down in oil imports resulting from the success of domestic fracking would be a very positive development longer term.