- The Washington Times - Thursday, July 31, 2003

Compared to the anemic 1.4 percent annual growth rate that prevailed during the previous two quarters, the U.S. economy accelerated during the second quarter, registering a pleasantly surprising 2.4 percent annual growth rate. That rate was a full percentage point higher than what was expected by economists surveyed by Dow Jones.

At this stage in the business cycle, any acceleration in growth is most welcome. After all, recovery from the 2001 recession has been so weak that the unemployment rate has increased from 5.6 percent in November 2001, when the recession officially ended, to 6.4 percent in June, 19 months after the lackluster expansion began.

A major source of economic growth during the second quarter was directly related to military activity in Iraq. Indeed, spending for national defense necessarily increased during the quarter by a 44 percent annual rate, the biggest quarterly leap since the nation was fighting the Korean War in 1951. According to the national income and product accounts, the annual rate of federal spending for national defense during the second quarter reached $517 billion.

Defense spending represented 1.7 percentage points of the 2.4 percent growth rate for the quarter, accounting for more than 70 percent of the second quarter’s overall annual growth rate of 2.4 percent. Absent the surge in defense, the nation’s economy, measured by its gross domestic product (GDP), would have increased at an annual rate of only 0.7 percent. If the impact of changes in defense spending is removed from GDP calculations, the non-defense 0.7 percent growth rate for the second quarter would be the lowest growth rate for the seven quarters since GDP began expanding again during the fourth quarter of 2001. During the previous six quarters of economic expansion, the average non-defense growth rate was 2.3 percent, or more than three times the non-defense growth rate registered last quarter.

One unqualified — and especially welcome — improvement in the economy during the second quarter relates to business investment, which increased for only the second time in 11 quarters. Overall business investment increased by an annual rate of 6.9 percent. Investment in equipment and software rose by 7.5 percent. Investment in structures, such as factories and warehouses, plunged by more than 16 percent last year and continued to decline at an annual rate of nearly 3 percent during the first quarter. Last quarter, however, investment in structures rose by nearly 5 percent.

With the federal budget fully entrenched in its counter-cyclical expansionary phase and with both short- and long-term interests rates at or near their lowest levels in 40 years, the economy needs to expand at a significantly swifter pace than the 2.4 percent growth rate registered during the second quarter. In the absence of fiscal expansion, including especially the administration’s aggressive tax cuts, the acceleration of second-quarter growth almost certainly would not have occurred. Economists in the administration, at the Federal Reserve and on Wall Street all forecast that growth will soon be exceeding 3.5 percent. In order for the unemployment rate to sustain any meaningful reduction, a growth rate of that size would be mandatory.

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