Monday, February 24, 2014

The Contribution of the Expenditure Components of GDP to its Growth in Canada and the US

Gross domestic product is the value of all the goods and services produced by the residents of a country or a region. These goods and services are consumed by households, acquired and used by businesses to produce other goods and services, and purchased by the government and the rest of the world. These various expenditures are called in the economic jargon: household consumption, private investment, government spending, and net exports.
Both the share in GDP of each of these four expenditures and their respective growth rates are important in explaining GDP growth rate. I have analyzed the behavior of these macroeconomic variables over the period 1981-2013 in Canada and the United States (US).

The average growth rate of real GDP over the sample period is .6 % in Canada and .68 % in the US. Household consumption explains 59 % of this growth in Canada and 73 % in the US.

Household Consumption – It consists of all the expenditures made by households on non-durable goods (food), semi-durable goods (clothing), durable goods (household appliances and vehicles), and services (healthcare, education). In Canada and the US, it is the most important component of GDP. Figure 1 below plots the share of consumption in GDP for both countries. This share is also known as the average propensity to consume.

Historically, the average propensity to consume is higher in the US than in Canada. At least, 61 % of the goods and services produced in the US are consumed by households whereas in Canada it is at most 57 % of the GDP that is consumed each quarter. The average propensity to consume tends to increase over time in both countries.

Figure 1: Share of Real Household Consumption Expenditure in GDP, Canada (1981:Q1-2013:Q3, Source: Statistics Canada), US (1981:Q1:20113:Q4, Source: Federal Reserve of St Louis)

Figure 2 below plot the growth rates of household consumption. 

Figure 2: Growth Rate of Real Household Consumption Expenditure, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)
The average rate of growth of household consumption over the sample period is .69 % in Canada and .76% in the US. This growth is positively correlated with real GDP growth rate in both countries as one can see in the table at the end.  

Private Investment – It comprises the expenses made by firms on the acquisition of residential structures (housing), non-residential structures (offices, factories), machinery and equipment (computers, furniture), and intellectual property products (licence).

In Figure 3 below I have plotted the share of private investment expenditure in GDP. This share is also known as investment-output ratio. Canada invests a higher share of its output in the production of new goods and services than the US. The investment-output ratio is trended upward but sharply fell between 2008 and 2009 during the financial crisis Canada, the US and many other countries experienced. 

Figure 3: Share of Real Private Investment in GDP, Canada (1981:Q1-2013:Q3, Source: Statistics Canada), US (1981:Q1:20113:Q4, Source: Federal Reserve of St Louis)
Private investment is the component of GDP showing the highest growth rate.  Its average growth rate is .83 % in Canada and 1.23 % in the US.  Besides, it is the most volatile component of GDP. The standard deviation of its growth rate is 2.61 in Canada and 4.18 in the US. The values of the correlation coefficient between the growth rates of private investment and that of GDP are almost the same as those between the growth rates of consumption and GDP.
Figure 4 below depicts the evolution of the growth rate of this expenditure.

Figure 4: Growth Rate of Real Private Investment, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)
Government spending – It include both government defense and non defense consumption and investment. Figure 5 plots the share of government spending in GDP. The downward trend in this share means the Canadian and the US governments are reducing over time their intervention in their respective economies. However during periods of recession (early 1980s and 1990s, 2008-2010) when private investment was falling due to uncertainty and bankruptcies, the Canadian and US government increased their spending to boost their economies.

The share of government in the economy activity has always been more important in Canada than in the US. It is a minimum of 22 % in Canada versus 18 % in the US of the goods and services produced that are acquired by the government.  

Figure 6: Growth Rate of Government Spending, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)
Figure 6 below plots the growth rate of government spending.

Figure 6: Growth Rate of Government Spending, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)

The average growth rates of government spending are respectively .52 % and .44 % in Canada and the US. The correlation between the growth rates of government spending and GDP is positive but very low in the two countries. It is almost nil in Canada.

Net Exports – It is the difference between the goods and services sold to the rest of the world (the exports), and those purchased from the rest of the world (the imports). Net exports are also called commercial or trade balance. Positive net exports are known as trade surplus and negative net exports are called trade deficit.

The trade balance of Canada showed surplus until the end of 2007. As for the US, its trade balance has always shown deficit except in the first two quarters of the sample, which is the first half of 1981. In the third quarter of 2006, trade deficit reached the off-peak of -5.57 % of the US GDP. 

Figure 7: Share of Net Exports in GDP, Canada (1981:Q1-2013:Q3, Source: Statistics Canada), US (1981:Q1:20113:Q4, Source: Federal Reserve of St Louis)

Figure 8 below show the behavior of the growth rate of net exports over the sample period in both Canada and the US.

Growth Rate of Exports and Imports, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)
Figure 8: Growth Rate of Exports and Imports, Canada (1981:Q2-2013:Q3, Source: Statistics Canada), US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)

  Table: Dynamic Behavior of Real GDP and its Components, 
Canada (1981:Q2-2013:Q3, Source: Statistics Canada), 
US (1981:Q2:20113:Q4, Source: Federal Reserve of St Louis)