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When the Commerce Dept. releases its first look at fourth-quarter gross domestic product on Jan. 30, the report likely will show solid growth in consumer spending, government outlays, homebuilding, and perhaps a small gain in inventories. But real GDP probably grew at an annual rate of 1% or so, the slowest quarterly pace in 2002. Some economists even expect a decline in real GDP. Is this another case of fuzzy math in Washington?
Hardly. What occurred in late 2002 exemplifies a long-term trend in the U.S. economy: Foreign trade, once an ignorable sector, can now significantly alter quarterly growth. Real GDP, after all, is a tally of domestic output, so when a bigger chunk of spending is satisfied by foreign suppliers, it's a drag on economic growth, especially in the manufacturing sector (chart).
Although Commerce must make estimates for some December data, the monthly numbers available show that fourth quarter domestic demand expanded at a healthy clip but that a widening of the net-exports deficit subtracted about one percentage point from real GDP growth. In a way, the fiscal and monetary stimulus of the past two years has helped global producers as much as U.S. companies.
Luckily, the trade gap may not deteriorate as rapidly in 2003 as it did last year, thanks to the recent fall in the dollar and faster economic growth abroad. But in the long run, more manufacturing facilities will keep leaving the U.S. And now, even service jobs are heading overseas (page 50).
In addition, U.S. companies will continue to find it difficult to raise prices as long as their foreign competitors hold prices steady to defend market share. That's causing a diverging inflation outlook between goods and services.THE WEAK GDP DATA surely will add fuel to the ongoing tax debate. The White House will use the report as evidence that the economy needs immediate stimulus, while Democrats will argue the plan does not give the economy what it badly needs: new jobs.
The report, however, won't hold much sway with members of the Federal Reserve. Policymakers will be more focused on the outlook for 2003, which calls for stronger growth. The Fed is very likely to keep interest rates steady at its Jan. 28-29 meeting.
Trade's drag on the fourth-quarter economy was skewed by last year's dock strike on the West Coast. Because ships could not move for most of October, the trade deficit for that month shrank to $35.2 billion, from $37.1 billion in September. Dockworkers began to catch up with loading and unloading cargo in November, causing the trade gap for goods and services to surge to a record $40.1 billion. Imports jumped by 4.9%, to $123.3 billion, while exports rose 1.1%, to $83.2 billion.
Even before the dock strike, though, imported goods were growing at a faster clip than exports (chart). The runup mostly reflects the stronger growth in the U.S. economy vs. the rest of the world. U.S. consumers increased their spending by about 2.5% in 2002, creating a bigger market for foreign goods. This trend won't change in 2003.
Foreign manufacturers have also benefited from the strong U.S. dollar, which makes many imports cheaper. From 1995 to early 2002, the dollar jumped by 41% compared with a trade-weighted basket of other currencies. The average price of nonpetroleum imports fell by 11% over the same period. Since March, 2002, the dollar has dropped by 12% on exchange markets. Import prices have stopped falling, but they have yet to rise in any meaningful way.TAKEN ALONE, an increase in imports isn't a problem. In fact, since it's a sign of healthy domestic spending, a rise in imports is positive news for most economies. But in the case of the U.S., exports are doing little to offset the advance of imports. Because the dollar value of imports outnumbers exports by a nearly 3-to-2 margin, exports must grow one-half faster than imports just to keep the trade deficit unchanged.
Export growth in 2003 may pick up if, as expected, overseas economies recover. In particular, the euro zone may grow about 2%, more than twice its 2002 pace. And Japan might expand instead of contracting as it did in 2002. A reduction of geopolitical risks will also help the trade gap. Oil prices should fall sharply when the strike in Venezuela ends and if the tensions between Iraq and the U.S. are resolved quickly.
For now, though, domestic goods-producers are back in trouble. Industrial output fell 0.2% in December, the fourth drop in five months. Manufacturing activity alone slipped 0.3%. Most of the decline was in auto production. Excluding vehicles, factory output was up 0.2%. But the sector still has not gotten the traction needed to launch a full-fledged recovery.
Manufacturers would benefit from better pricing power. Rising profits would lift their own bottom lines and enable more companies to expand their capital budgets. A decline in shipments of nondefense capital goods and a drop in the output of business equipment indicate business investment on equipment and plants was probably a drag on real GDP growth last quarter.UNFORTUNATELY, widespread pricing power has not returned. Total consumer prices rose 0.1% in December from November, or only 2.4% from a year ago. Core prices, which exclude food and energy, increased just 1.9% for the year, the slowest rate since 1999.
Look beneath the numbers, and you'll see another example of foreign trade's effect on the economy. Core goods prices have fallen 1.5% over the past year, while core services are up 3.4%. Not surprising, goods production is where foreign competition is the greatest. The service side of the economy faces fewer inroads from foreign rivals. In fact, the U.S. enjoys a monthly trade surplus in services to the tune of about $4 billion.
The split between goods and services prices is pushing and pulling consumers' budgets. New items consistently cost less. But maintaining those goods keeps squeezing household budgets more and more (table). For example, a television set is 10.6% cheaper than it was a year ago, but monthly cable service is 7.3% more expensive.
The Fed is watching the areas of falling prices to formulate ways to guard against widespread deflation (page 37). On the plus side, the recent slide in the dollar may open the way for goods producers to begin raising their prices. But that could mean falling goods prices will no longer offset the increase in service inflation.
Even so, the lack of U.S. pricing power is another example of how foreign trade has become a huge influence in this economy. The fourth-quarter drag from the trade deficit may not be repeated in this quarter or even the second, but U.S. monetary and fiscal policy must now be made with an eye toward the global consequences of domestic decisions. By James C. Cooper & Kathleen Madigan