By Dirk van Dijk of Zacks.comNEW 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.
Within the consumption of goods, consumption of non-durable goods is about twice as large as the consumption of durable goods. However, since people can defer the purchase of a durable good like an auto from Ford ( F)more easily than they can defer purchase of a box of corn flakes from Kellogg's ( K), durable goods demand is very volatile. As a result, durable goods tend to "punch above their weight" in determining is the economy is booming or slumping. Durable goods consumption added 0.44 points to growth, down from an addition of 0.49 points in the second quarter and 0.62 points in the first quarter. The downward trend in contributions from durable goods is a bit disconcerting, but is not too bad. The sector is only 10.45% of PCE and 7.36% of overall GDP, yet it contributed 22% of the overall GDP growth in the quarter. Non-durable goods are 22.4% of PCE and 15.78% of overall GDP. The sectors contribution to growth fell to just 0.20 points in the third quarter from 0.31 points in the second quarter and 0.67 points in the first quarter. I suspect that its growth contribution will rebound a bit in the fourth quarter as demand for non-durable goods tends to be pretty steady and its contribution to growth this quarter was below its overall share of the economy. Overall, the Consumer is doing his and her part in getting the economy rolling again. Unfortunately as we will see later, too much of that consumption is going to things that are made abroad, and not enough to things made here. The strong contribution from the consumer service sector is encouraging.
The addition to inventories accounted for almost all the overall contribution from GDPI. Inventory investment added 1.44 points to growth up from 0.82 points in the second quarter and a whopping 2.64 points in the first quarter. This is very low quality growth, especially coming on several quarters where it has made a significant positive contribution to growth. This is the fifth straight quarter where inventories have been adding to growth, but that comes after eight quarters in a row where inventories were a drag on overall growth. The big positive contribution from inventories this time around is both disconcerting and was the major reason that overall GDP growth came in higher than I was looking for. I would look for a much smaller contribution from inventory investment in the fourth quarter, and it would not shock me if it actually proved to be a drag on growth.
This was a bit better than I expected. Vacancy rates are still extremely high in almost all areas of the country, and in almost all major types of non-residential real estate. We simply don't need to be putting up a lot of new commercial buildings right now. I would expect it to revert to being a small drag on overall economic growth in the fourth quarter. Investment in E&S is what we really want to see to power future growth, and there the news continues to be good, but not quite as good as earlier in the year. E&S investment added 0.80 points to growth, which is not a bad showing since it is only 7.11% of the overall economy. It is down, however, from a 1.52 point contribution in the second quarter and a 1.24 point contribution in the first quarter.
State and local governments were a 0.03 point drag on the overall economy, down from a 0.08 contribution in the second quarter, but much better than the 0.48 point drag in the first quarter. Frankly, given the severe fiscal problems that most states are facing, and since they cannot borrow legally to cover operating deficits, the 0.03 point drag is a major positive surprise. A big part of the ARRA has gone to helping state and local governments to avoid having to either cut spending drastically or raise taxes. The ARRA funding is starting to dry up. I would expect that S&L government spending will be a bigger drag in fourth quarter GDP than it was in the third quarter.