With the comeback in financial markets this year, we probably should have seen it coming. But the headline rebound in first quarter growth to 3.2% reported Friday is still a pleasant surprise that shows again that the U.S. economy is remarkably resilient when government doesn’t get in the way.
The Keynesians who predicted an imminent recession are pointing out flaws in the GDP details, and they’re right that volatile categories like net exports (1.03%), inventory growth (0.65%) and state and local government (0.41%) contributed substantially to growth. Strip out those categories and growth would have been 1.3%.
Yet the government shutdown took some 0.3% off growth and that won’t be repeated in the second quarter. Auto sales took 0.49% off GDP in the quarter, but sales rebounded in March heading into the second quarter. Overall consumer spending contributed a relatively small 0.82% to GDP, perhaps due to the fall in consumer confidence after the stock market swoon in the last months of 2018. With job growth strong and wages rising, consumers should contribute more to the expansion the rest of this year.
Private business investment kicked in a relatively measly 0.27% in the quarter, which is disappointing. But the nearby chart shows how much private capital investment has driven the rebound in growth since 2017. Business investment fell through the floor in the last half of 2015 and 2016, offset in part by a robust housing market. But that has reversed since Donald Trump took office, with business investment taking the lead as housing slowed and moved into negative territory in late 2018 and the first quarter of 2019.
What changed? Well, the economic policy mix. The Trump Administration lifted the threat of new regulation and harassment of business in 2017, which liberated long-stifled animal spirits. Then came the Trump tax reform with its sharp reduction in business tax rates and immediate 100% expensing of new investment. This was targeted precisely to stimulate the weak capital investment that had stymied growth in the Obama years.
This has also kept the U.S. expansion going even as growth in the rest of the world has slowed markedly. U.S. growth over the last four quarters year over year is now above 3%. Politicians in Germany or France would be elated, and maybe faint dead over, if they could keep growth above 3% for 12 months.
Unlike the years leading up to the last recession, the current economy isn’t as dependent on the housing market. Many economists consider housing to be a form of consumption, while capital investment in equipment, intellectual property and new plants pays off for years to come in better productivity and higher wages. This is the tax-reform gift that keeps on giving as lower tax rates that are fixed in law raise the return on capital that encourages more investment. In other words, tax reform isn’t a “sugar high.”
The first quarter was also notable for the slowdown in inflation, with the price index for gross domestic purchases rising 0.8%. That’s the slowest pace since the first quarter of 2016. Even with the recent rise in oil prices, there’s no inflation case that the Federal Reserve should resume raising interest rates.
With the Fed on hold, the biggest remaining obstacle to new investment continues to be U.S. trade policy. This is less about specific tariffs, though those are problems, than about the uncertainty over whether tariffs will be lifted or new ones imposed and whether global supply chains will have to be revamped.
President Trump can go far to eliminate this uncertainty by concluding a trade deal with China, lifting the steel and aluminum tariffs on Canada and Mexico that he promised to lift in 2018, and taking tariffs on European and Japanese cars off the table (see the editorial nearby). These decisions are all at Mr. Trump’s discretion and don’t rely on Congress. House Speaker Nancy Pelosi hasn’t said whether she’ll hold a vote on the revised U.S., Mexico and Canada trade pact, but that won’t hurt the economy unless Mr. Trump withdraws unilaterally from the original Nafta deal that is still in effect. He’ll have more leverage on that score if he wins re-election, which depends on continued economic growth this year and through 2020.
In addition to judges, the biggest success of the Trump Presidency has been the economy. The left will never give him credit, but at least the “reformacons” on the right who derided deregulation and corporate tax cuts as an out-of-date agenda should admit how wrong they were. Had Mr. Trump taken their advice, we wouldn’t be seeing a growth rebound that is lifting wages for everyone.
—The Wall Street Journal