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How GDP Reached 2% in Third Quarter

By Dirk van Dijk of Zacks.com

NEW YORK (TheStreet) -- In the third quarter, the economy grew at an annual rate of 2.0%, up from 1.7% in the second quarter, but down from the 3.7% pace in the first three months of the year. The growth rate was in line with consensus expectations, and frankly a bit better than I was expecting.

So how did we get to the 2.0% overall growth? What parts of the economy were growing and thus adding to growth, and which parts were acting as a drag on growth? Since the different parts of the economy are of very different sizes, and some tend to be relatively stable, while others can be very volatile, I will focus on the contributions to growth.

In other words: growth points, not the percentage growth rates. After all, a small percentage change in a very big part of the economy can have more impact than a big percentage change in a small part of the economy. I will follow the familiar Y = C + I + G + (X - M) framework, where Y = GDP, C= Consumption, I = Investment, G= Government, X = exports and M = imports.

C for Consumption

The biggest part of the economy by far is the Consumer or consumption, or to be more specific, Personal Consumption Expenditures (PCE). It represented 70.4% of the overall economy in the third quarter, and was the biggest growth driver. PCE contributed 1.79 growth points, up from 1.54 points in the second quarter and 1.33 points in the first quarter.

The increasing contribution to growth from C is generally a good thing, at least in the short term. Over the long term, though, our economy is already weighted far too much towards C, and that contribution has been rising over the years.

Goods vs. Services

Consumption can be broken down into two main categories: goods and services. Services is by far the biggest part of consumption at 67.15% of PCE and 47.30% of overall GDP. It was the real star of the show this quarter, chipping in 1.15 growth points -- up from just 0.75 points in the second quarter. In the first quarter, services were missing in action, adding just 0.03 growth points. This solid increase is very encouraging.

Services tend to be "produced" domestically, not in China, and also tend to be more labor-intensive than goods-producing jobs. Normally demand for services is more stable than demand for goods, especially durable goods.

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