March 2007

Vive la Différence

There are several disturbing similarities between the U.S. economy's recent behavior and its behavior in 2000–01, but also some reassuring differences.

One similarity is the drag on growth coming from investment. Chart 1 shows the combined contribution to annualized GDP (gross domestic product) growth from residential and business equipment and software investment, measured in percentage points. Note that in 2005–06, just as in 2000–01, this contribution dropped from a positive 1 percentage point to a negative 1 percentage point.

Back in 2000–01, of course, most of the decline was due to a collapse of equipment and software investment. This time around, the housing sector has been feeling most of the pain.

Despite nearly equal drags from investment, GDP growth slowed by 4 percentage points in 2000–01, versus only 2 percentage points in 2005–06.

Chart 2 shows the source of the difference: consumption growth. In 2000–01, consumption spending’s contribution to GDP growth fell by about 2 percentage points. Over the past couple of years, in contrast, consumption’s growth contribution has held comparatively steady.

Chart 3 slices the data differently: It compares monthly nonfarm payroll job gains in the goods-producing and service-providing sectors. It is striking that while goods-producing job growth has slowed by about as much as it did in 2000, service-providing job growth has held up much better than it did in the lead-up to the 2001 recession.

Neither residential investment nor goods-producing job growth seems likely to improve anytime soon.

In the residential sector, the 30-percent plunge in building permits and decelerating new-home prices we’ve seen since the fall of 2005 are an ill omen for future investment and job growth (Chart 4). Consistent with this glum near-term outlook, new-home sales resumed their slide in January, after an upward spike in December. Sales are now down 31.5 percent from their July 2005 cyclical high. Residential construction and associated specialty-trade jobs account for about 15 percent of employment in the goods-producing sector.

Recent data on new orders for durable manufactured goods give a similarly discouraging view of near-term prospects for investment and factory job growth (Chart 5). Factories account for about 63 percent of employment in the goods-producing sector.

The big question is whether the drags from housing and manufacturing will let up before weakness there begins spilling over to the rest of the economy.

—Evan F. Koenig