11.03.2017 0

Average annual GDP growth is not what you think it is

By Robert Romano

One of the greatest disappointments with the U.S. economy since the turn of the century has been its consistent underperformance, not growing above an inflation-adjusted average annual rate of 4 percent since 2000, and not above 3 percent since 2005.

What has come in its stead the past 10 years is the slowest economic growth rate in U.S. history — even slower than the Great Depression.

Restoring the U.S. to 3 percent or maybe even 4 percent growth has been one of President Donald Trump’s major goals, but getting there will not be so easy.

Just take 2017. On an inflation-adjusted, annualized basis, there was 1.2 percent growth in the first quarter, 3.1 percent in the second quarter and 3.0 percent growth in the third quarter, according to data compiled by the Bureau of Economic Analysis.

So, to get to 3 percent growth for the year, we’d need 4.7 percent growth in the fourth quarter, right?

Wrong. The actual answer would be 14.5 percent. Why? How is that possible?

Because annual GDP growth is calculated by the taking the four readings of the real GDP using chained dollars for two consecutive years, averaging each year out and then calculating the growth rate.

I’ll show you the work because I didn’t believe it myself the first time I worked it out — and like millions of Americans I want to see the economy start growing again robustly. Apologies for the complexity but I’ll attempt to keep it as simple as practicable. This is a highly technical matter.

Just a few notes before we get started. First, the GDP numbers that follow below are not the nominal (non-inflation adjusted) current-dollar GDP that is often published, now currently at $19.5 trillion.

Second, annualized real GDP growth on a quarterly basis is calculated by taking the growth rate and multiplying it by 4. For example, a 1 percent actual growth rate in a quarter works out to 4 percent annualized growth you’d see reported in the news.

Finally, average annual growth (calculating the average GDP figures for each year based on each quarter’s number) is not the same thing as fourth quarter to fourth quarter growth (calculating the GDP figures at the end of each year).

Now, let’s solve for 3 percent growth in 2017.

In the first quarter, real GDP in chained dollars was $16.9032 trillion, $17.0311 trillion in the second quarter and $17.1569 trillion in the third quarter. So far, that’s an average of $17.0304 trillion.

But because the average annual GDP in 2016 was $16.7162 trillion, to get a 3 percent growth rate for the year, the average annual GDP in 2017 needs to be $17.2177 trillion, and we’re nowhere near that right now. To get there, the GDP will need to grow by another, ludicrous $622.6 billion in the fourth quarter to $17.7795 trillion, or 14.5 percent annualized growth.

To check. $16.9032 trillion in the first quarter, $17.0311 trillion in the second quarter, $17.1569 trillion in the third quarter and $17.7795 in the fourth quarter averages out to $17.2177 trillion for the year, or 3 percent growth above 2016’s $16.7162 trillion.

Ridiculous? You bet! Especially since if you instead simply flip the hypothetical 14.5 percent growth in the fourth quarter and say it happened in the first quarter, and take the disappointing 1.2 percent growth from the first quarter and put it in the fourth quarter, you’d wind up with an average annual GDP of $17.642 trillion with 5.5 percent growth for the year.

Got it? The same exact quarterly growth rates, depending in which order they occur gives you an entirely different average annual growth rate. It almost reminds you of that episode of the “Twilight Zone” where that poor fellow survives a nuclear war and solaces himself with the fact he’ll have all the time in the world to read all the books he missed out on, only to break his glasses at the end of the episode.

This appears to give disproportionate weight to the first quarter of each cycle, as it sets the tempo for the rest of the year in terms of calculating the average.

But here’s the wrinkle, in the first case with the strong fourth quarter, it will be far easier to achieve 3 percent growth in 2018 than it will in the second case. Why?

Because in the former, the average annual GDP for 2017 was $17.2177 trillion and needed to get to an average annual $17.7342 trillion — when you already started out the year at $17.7795 trillion after the fourth quarter. You read that right. After that monster, hypothetical 14.5 percent growth for the fourth quarter, you could experience absolutely no growth the following year and still get a 3.3 percent average growth rate for 2018.

Whereas in the latter, the average annual GDP for 2017 was $17.642 trillion and needed to get to an average annual $18.170 trillion. Not impossible, but it illustrates that a strong fourth quarter makes it easier on the following year.

Clear as mud? Good.

So, what does all this mean? The average annual GDP growth rate that is often reported is not what you think it is. And even if the U.S. does not reach 3 percent average growth for the year, don’t worry, because it all averages out. As long as growth in the fourth quarter in 2017 is fairly strong, followed by a strong first quarter in 2018, the Trump administration will be well on its way to keeping its promise to get the U.S. economy moving again above 3 percent.

Robert Romano is the Vice President of Public Policy at Americans for Limited Government.

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