U.S. Economy Posts 3.7% Growth Rate

The U.S. economy grew at a slower-than-expected annual rate of 3.7% in the third quarter, the government said Friday in a report that underscored the economic challenges facing the winner of the presidential election.

The growth rate in the three months ended in September exceeded the second quarter’s 3.3% rate but fell short of the 4.3% that was the consensus forecast of economists.

Expansion was fed by businesses taking advantage of an expiring tax break for investment and by a jump in consumer spending. Restraining the growth rate were companies that met new orders by drawing down inventories rather than making new products.

The Commerce Department report, the last major piece of economic news before Tuesday’s elections, showed an economy that was growing steadily although not spectacularly. But job growth remains tepid, and bulging debts, high oil prices and other issues will challenge the next White House occupant.

The Bush administration emphasized the positive.

“We are encouraged by the ongoing strong performance of the American economy, with a noninflationary growth rate that is above the average for the past 10 years,” said Treasury Secretary John W. Snow.

Gene Sperling, an economic advisor to Democratic candidate Sen. John F. Kerry, shot back that “most middle-class families will find it hard to swallow the Bush administration’s spin that this is the best economy of our lifetime.”

Stephen Roach, chief economist at Morgan Stanley Dean Witter, said neither candidate had faced up to the serious problems ahead, much less considered the unpopular measures needed to deal with them.

“The campaign has barely paid lip service” to the huge problems that either President Bush or Kerry must face, Roach said. Just as the baby boom generation’s retirement is about to put huge pressures on the nation’s pension and medical systems, he said, the United States is running record budget deficits. The trade deficit is regularly breaking records.

And families are spending more and saving less. Friday’s Commerce Department report showed the pace of personal savings falling by two-thirds in the third quarter to an annual rate of $35 billion, or a mere 0.4% of disposable income.

Meanwhile, household debt is growing. Having overtaken annual disposable income just five years ago, household debt has since grown 20% larger.

“We’re an economy that’s been living beyond its means for the better part of a decade,” Roach said.

The federal deficit will serve as a brake on spending ambitions, no matter who is elected. “The key legacy from Bush will be that fiscal policy is constrained because of the huge deficits,” said Ian Shepherdson, chief U.S. economist for High Frequency Economics, a consulting firm.

Mark M. Zandi, chief economist for Economy.com in West Chester, Pa., said Kerry’s most expensive proposals, such as his plan for government health insurance for many of today’s uninsured, would not pass scrutiny thanks to budget circumstances. But even without the deficit, he said, Kerry would have little chance to move his programs through a House that Republicans are all but sure to control and a Senate that they probably will.

With the economy managing on its own and the budget leaving little room to maneuver, John Silvia, chief economist for Wachovia Securities in Charlotte, N.C., also sees little action from Washington.

“The government can’t do very much in an economy that’s mostly going sideways,” he said.

Just as households and the federal government are running up debt to unprecedented levels, so is the United States as a trading nation. The so-called current account, the broadest measure of America’s transactions with the rest of the world, has been in the red every year of the last 20 except 1991.

Foreigners have been awash in the dollars that Americans have paid for their goods and services. Thanks to the strength of American financial markets, foreigners have been willing to invest those dollars back in the U.S.

“But foreign investors’ ability to finance us is certainly not limitless,” said Nick Perna, an independent economic consultant. When they believe they have invested enough of their dollars in the United States, Perna said, “at a minimum you’ll get a spike in U.S. interest rates.”

Zandi noted that government fiscal policies alone were not responsible for today’s precarious economy. During the Bush years, the economy has been buffeted by the 2001 terrorist attacks, corporate accounting scandals, the Iraq war and, most recently, surging oil prices.

John H. Makin, an economist at the American Enterprise Institute in Washington, predicted a recession if oil prices did not retreat from their $50-a-barrel-plus rates of recent weeks.

“The family that has been pulling its SUV to the pump and paying $45, not $25, to fill it up will reduce spending elsewhere,” he said.

Economists said the higher oil prices took a significant chunk out of the third-quarter growth rate -- possibly enough to account for the margin by which it fell below forecasts.

Steve Cochran, another Economy.com economist, said some signs were downright bullish.

“The global economy is looking good now for the first time in 10 years,” Cochran said. “Not a single major economy is in recession. There’s strong potential for exports to expand.”

Business investment in new plant and equipment has been rising, Cochrane said. Much of that investment, however, has been encouraged by a tax break letting businesses take so-called accelerated depreciation. When that tax break expires at year-end, economists expect a sharp fall-off in business investment.

One of the biggest challenges facing the next president will be how to jump-start job creation. Hiring has been sluggish for an economy growing at nearly 4% a year, three years into a recovery. Some of the blame has fallen on labor-saving technologies and other business processes that have allowed employers to squeeze more productivity out of existing workers.

Those productivity gains have been a key factor in surging corporate profits. Cochran argued that such earnings should eventually lead to increased hiring, as they always has in the past.

Weighing against resurgent hiring are rising employment costs, driven by health insurance. A Labor Department report released Friday said employment costs had jumped 4% to 5% a year -- about twice the rate of consumer price inflation -- since 2000.

But there are signs that companies have finally stretched their current employees as far as they can go and are ready to expand their payrolls.

Consider the case of McLanahan Corp., a Hollidaysburg, Pa., foundry that traces its roots back to 1835. Its healthcare costs more than doubled in the last four years, from $520,000 to $1.2 million.

“When your business is going up 3% or 3.5% a year and your margins are being somewhat curtailed by both foreign and domestic competition, it’s a real problem if healthcare keeps rising by 15% or 20% or 25%,” said Chief Executive Michael McLanahan.

McClanahan expects a business upturn to do more good than either Bush or Kerry could. A few weeks ago the mining companies that are McLanahan’s principal customers began placing significant orders. Suddenly it was not enough that the foundry’s 175 workers put in overtime.

“We’ve hired about eight people, and are looking for seven more,” McLanahan said. “We think this economy has some legs to it.”

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Bush’s economic report card

A sampling of how some economic indicators have changed since President Bush took office:

*--* Improved Indicator When Bush took office Latest Economic growth -0.5% +3.7% (Growth in gross domestic product, annualized) Inflation +3.7% +2.5% (Consumer price index for all urban consumers, annualized) Mortgage rates 6.98% 5.77% (Average 30-year fixed) Wages $640 $642 (Median weekly earnings for full-time workers, adjusted for inflation) Worsened Employment 132,388,000 131,567,000 (Total nonfarm payrolls) Unemployment rate 4.2% 5.4% Consumer debt burden 1.01 1.20 (Ratio of household debt to disposable income) Federal budget $127-billion $413-billion surplus/deficit surplus deficit (For fiscal years 2001 and 2004) Stocks 10,587.59 10,027.47 (Dow Jones industrial average) Gasoline prices $1.47 $2.03 (Gallon of regular, including taxes)

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Sources: Commerce Department, Bureau of Labor Statistics, Census Bureau, Federal Reserve, Mortgage Bankers Assn., Energy Information Administration, Bureau of Economic Analysis