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The Globe and Mail

U.S. recovery feels the pinch of austerity

A cash register displays a balance due for purchases at Target in Burbank, California in this November 22, 2012 file photo. The U.S. economy grew at an annual rate of 2.5 per cent in the first quarter of 2013.


Austerity is not just a European disease. It is infecting the U.S. economic recovery, too.

The U.S. "advance" reading on gross domestic product for the first quarter, released Friday morning, indicated GDP growth of 2.5 per cent annualized in the quarter – a solid improvement over the anemic 0.4 per cent in the fourth quarter, but considerably less than the 3.0 per cent economists had expected.

(This is the first of three GDP estimates the Commerce Department issues for the quarter; with two revisions to come, the estimates can often swing quite substantially from the advance to the final reading. But history suggests that on average, the final number is about as likely to be lower as higher.)

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The big culprit for the disappointing result: Washington's budget-tightening provisions, which are simultaneously slowing public-sector contributions to GDP and eroding consumers' disposable incomes.

Total government spending fell 4.1 per cent (annualized) in the quarter; the federal government's portion fell 8.4 per cent. Defence spending alone tumbled 11.5 per cent. All this comes on top of the 7-per-cent annualized decline in government spending in the fourth quarter.

"The decline in government spending over the past two quarters is the biggest six-month contraction since the Korean war ended," noted Paul Ashworth, chief U.S. economist for Capital Economics.

For Washington's austerity proponents, maybe the first-quarter growth pace will be viewed as a vote of confidence; after all, 2.5-per-cent annualized growth isn't so bad, and if government spending can be reined in while modest growth can be sustained, then the budget-slashing proponents may well win the day.

But the kicker is, the U.S. hasn't even come close to seeing the full impact of austerity yet.

Let's remember, the first-quarter spending contractions don't include the vast bulk of the $86-billion in so-called "sequester" cuts. They officially kicked in at the beginning of March but in practice didn't generally start until April, and in many cases will roll in gradually over several months.

Meanwhile, the 3.1-per-cent annualized growth in consumer spending in the quarter – a major contributor to the GDP growth improvement – came despite the fact that disposable income slumped at an annualized pace of 5.3 per cent, a result of the Jan. 1 expiration of a holiday on payroll taxes. This was only achieved by a drop in the savings rate, from 2.6 per cent from 4.7 per cent. With the payroll tax taking a lump out of every paycheque, and with the savings rate already significantly eroded, consumer spending's contribution to GDP growth looks all but impossible to sustain in the coming quarters.

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So the scars on GDP from Washington's austerity kick could well deepen – and the voices against austerity, at least in its most drastic and abrupt forms (as they have tended to come, by default, in the U.S. budget deadlock), will surely grow louder as a result. For the pro-austerity faction, the best hope is that the private sector's growth will pick up the slack left from reductions in public-sector contributions – but that might be tough to achieve with disposable income strained, too.

The key for lawmakers, though, may not be the GDP numbers, but the job numbers. If persisting with austerity at the expense of stronger economic growth translates to a stagnant labour market, those are unemployed voters we're talking about; anyone up for re-election will have only so much appetite for starving the economy of funds if it looks like they are foregoing jobs.

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