Curb your enthusiasm: Rapid third-quarter GDP growth won’t mean the economy has healed

On Thursday, the Bureau of Economic Analysis (BEA) will release data showing the growth rate of gross domestic product (GDP) in the third quarter of 2020. GDP is the broadest measure of the nation’s economic activity, and this is the last major data release before the presidential election, so it would be a big deal even in normal years.

But it’s obviously not a normal year, and the GDP data released on Thursday will be for a quarter following the single fastest contraction of GDP in history, when the economy shrank at an annualized rate of 31.4% in the second quarter of 2020 due to the COVID-19 shock. The third-quarter data will show historically fast GDP growth—it could conceivably even see growth at a 31.4% annualized rate, for example. Some might be tempted to take too much solace in this rapid growth, and if growth in the third quarter looks to match the pace of contraction in the second quarter, some might even be tempted to declare the economic crisis nearly over.

This post highlights some reasons to temper enthusiasm (some that overlap with points made in this excellent Vox post), even in the face of a very large third-quarter growth number. There are five main reasons that I detail further below:

  • The enormous contraction of GDP in the second quarter means any growth in the third quarter is coming off of a significantly smaller base of GDP.
  • The COVID-19 shock caused rapid contraction of the economy even in the first quarter of 2020—so it’s not just the record-setting contraction of the second quarter that needs to be clawed back.
  • It’s not just the level of pre-shock GDP that needs restored to make labor markets healthy; it’s the level this GDP would be at if it had continued to grow at its pre-shock rate.
  • Because the COVID-19 shock has been so centered in low-wage sectors, any given dollar value of GDP lost translates into far more people who have lost jobs.
  • Third-quarter growth was driven by the momentum of economic reopening and occurred with the tailwind of the generous recovery measures included in the CARES Act. Neither of these boosts will help in the future, absent radical policy change.

The second-quarter GDP disaster means growth going forward is off of a much smaller base

U.S. GDP shrank at a 31.4% annualized rate in the second quarter of 2020 (this means the economy shrank by 9% in that quarter—if that same pace was sustained for an entire year, the economy would be 31.4% smaller than it started). Say that the third-quarter GDP data shows growth at a 31.4% annualized rate, would that mean the economy is back to the pre-shock status quo? No, because the third quarter’s growth is being measured against a smaller base GDP (the greatly eroded GDP of the second quarter). Concretely, 31.4% growth in the third quarter would still leave GDP that was about 2.5% smaller than it was before the second quarter COVID-19 shock hit.

The COVID-19 economic shock hit in the first quarter, too

While the economy shrank at—by far—the fastest pace in recorded history in the second quarter of 2020, COVID-19 inflicted a large shock in the first quarter as well. In fact, the 5% annualized pace of contraction in the first quarter of 2020 was one of the worst quarters in recorded history for GDP. Since 1947—the first year of quarterly data available—293 quarters of GDP data have been recorded. The 5% contraction in the first quarter of 2020 is tied for the eighth worst in history. The Great Recession and financial crisis of 2008–2009 lasted six quarters and was widely considered the worst economic shock since the Great Depression of the 1930s. Only the single worst quarter during that crisis (the third quarter of 2008) saw a faster contraction than what the U.S. economy felt during the first quarter of 2020.

So, again, say that Thursday’s GDP data indicates that growth proceeded at a 31.4% rate in the third quarter. This would mean that the economy in the third quarter of 2020 was still 3.8% smaller than it was in the fourth quarter of 2019.

The GDP baseline is growth, not stasis

This 3.8% gap between GDP in the fourth quarter of 2019 and what would occur even if growth proceeded at a 31.4% rate in the third quarter of 2020 is still an underestimate of just how damaged the economy remains. GDP grows consistently outside of recessions, it doesn’t stand still. A conservative measure of growth that would have happened without the COVID-19 shock is 2%. In this case, even if growth proceeded at a 31.4% pace in the third quarter, the “output gap”—the gap between actual GDP and GDP in an economy with the same unemployment rate as what prevailed in the last quarter of 2019—would be closer to 5.2% of this potential GDP.

In the COVID-19 shock, more jobs are lost for each dollar of GDP lost

If the jobs lost due to the COVID-19 shock were of average labor intensity, then a 5.2% output gap would translate into a jobs gap of 5.2%, or roughly 7.5 million jobs (this is actually better expressed as total hours of work, not jobs, but for now we’ll stick with the slightly more intuitive concept). But we know that COVID-19 was felt most acutely by economic sectors that provide face-to-face services (restaurants, travel accommodations, personal services, and retail). These jobs are low-paid and far more labor-intensive than the economywide average, with each dollar of income generated in these sectors being associated with far more jobs. This means that the jobs gap associated with any given “output gap” based on GDP is going to be much larger.

In the real world, GDP is a pretty abstract concept. Jobs and paychecks are not. If a given GDP shortfall is associated with a larger jobs shortfall (as it is during the COVID-19 shock), this means the human welfare implications of this output gap is larger than normal.

Sources of third-quarter growth are spent

It is possible GDP in the third quarter of this year grew at a 30% annualized rate or even more. The cautions above are mostly about the arithmetic of this growth. But the economic sources of rapid third-quarter growth are obvious: momentum from reopening following coronavirus-driven shutdowns and income growth buoyed by the generous relief measures included in the CARES Act. Neither of these sources of growth will recur going forward, unless there are radical policy changes. The virus is resurgent across much of the country, and smart public health measures are needed to allow many aspects of life to continue safely in the face of this resurgence. The income support of the CARES Act has completely evaporated, and very soon growth will become throttled by income-constrained households forced to cut back spending. This household pullback in spending will be quickly followed by pullbacks in public spending from state and local governments. Policy can relieve this demand gap stemming from both household and state and local public-sector constraints, but if this demand gap is not addressed, then growth will falter badly in coming quarters.

Given all of this, what is the best summary measure of how far the economy still has to go before it reaches anything like pre-COVID health? I’d say that a good rough barometer is the employment levels that prevailed in February 2020, plus at least 100,000 jobs for each month thereafter to account for trend growth that should be generated in normal times. By this measure—which is much more relevant for the vast majority of Americans who need to find work to economically survive—the U.S. economy was short by a staggering 11 million jobs or more at the end of the third quarter of this year, and nothing about GDP data released this week will change that grim story. The need for aggressive policy action to help families through this horrible period and to spur a faster recovery once it begins remains critical.