Economy Grows for 8th Consecutive Year

According to a release from the Bureau of Economic Analysis, the nation’s real gross domestic product (GDP) slowed to a seasonally adjusted annual rate of 2.4 percent in the fourth quarter of 2017. Despite the slowdown, GDP growth over all of 2017 accelerated to 2.3 percent, faster than the 1.5 percent rate of growth in 2016. The annual increase in GDP over 2017 marked the 8th consecutive year of growth.

After declining in 2009, GDP growth returned in 2010. Moreover, the rate of growth in actual GDP exceeded the economy’s potential growth rate between 2010 and 2015. However, in 2016, while the economy registered its seventh consecutive year of growth, the rate of growth was less than its potential, a concern that was reflected in longer-term treasury rates. At 2.3 percent, GDP growth in 2017 exceeded its potential by 0.7 percentage points. A small portion of the excess growth reflected a slight deceleration in the economy’s potential growth as forecasted by the Congressional Budget Office, but a larger reason was the acceleration in actual GDP growth over the year.

Personal consumption expenditures accounted for the largest contribution to GDP growth in 2017. However, this largely reflects its 70 percent share of GDP. The main contributors to the acceleration of GDP growth over the year were gross private domestic investment, which includes residential fixed investment, as well exports. However, the growth in imports, which detracts from GDP growth, more than offset the contribution by exports.

The above table displays an expenditure approach to measuring the overall economy, but an income approach is another method of estimating GDP. The basis for the income approach is that each dollar of expenditure, as captured in the second figure above, results in a dollar of income earned. The figure above indicates that labor’s share of total income is sizeable. However, over the long-term the labor share of income has been falling. While changes to labor income will have an impact on GDP, the scale of these changes has eroded.

Y = C + I + G + (X-M)

Y = ALαK(1-α)

The first formula above represents the expenditure approach to estimating GDP; Consumption, Private Domestic Investment, Government Spending, Exports, and Imports, while the second one connects long-run production with productivity, A, the number of workers, L, and capital, K. Although Greek letters represent the exponents in the second formula, in practice, α is equal to the labor share of income illustrated in the third chart above and is associated with the number of employees, L, and the residual (1-α) is associated with capital.

The second formula above indicates that productivity, labor, and capital all contribute to economic growth, but as illustrated by the third figure, the impact of a change in the number of workers is relatively larger than a similar change in capital. Rising productivity will also contribute to increased production. Finally, while lower tax rates on businesses and individuals should raise consumption, C, and business investment, I, and potentially exports at the expense of imports, (X-M), leading to higher GDP, Y, the low unemployment rate suggests that growth in the number of employees, L, is constrained unless additional people enter the labor force.

The calculations of the labor share is an estimation. Research has noted that the data available for the calculation is not exact. Some caution is required when interpreting these trends.

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