Dean Baker – US GDP Growth in Second Quarter Slows to 1.5%, No Evidence of AI Productivity Boom

There is still no evidence of an AI-driven productivity boom after three consecutive quarters of weak productivity growth.

Dean Baker is a Senior Economist at the Center for Economic and Policy Research (CEPR)

Cross-posted from CEPR

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GDP grew at just a 1.5 percent annual rate in the second quarter. While consumption grew at a healthy 3.2 percent rate and non-residential investment grew at a 8.4 percent rate, a big jump in the trade deficit subtracted over a percentage point from growth in the quarter. This is largely explained by the fact that many of the chips for the AI boom are imported. A large decline in non-defense federal spending also subtracted 0.34 percentage points (PP) from growth.

Perhaps the most striking aspect of this report is that we continue to see zero evidence of any AI-driven productivity boom. Productivity data are extraordinarily erratic and subject to large revisions. But we have seen three consecutive quarters of weak growth. Productivity grew at a 1.6 percent rate in the 4th quarter of last year and at just a 0.3 percent annual rate in the first quarter of this year. Hours growth was likely close to zero in the first quarter (there was a big fall in reported self-employment), but with GDP growth at 1.5 percent, productivity growth will almost certainly be under 2.0 percent. Perhaps we will see a different story in future quarters, but thus far there is no evidence of a big productivity dividend from AI.

Consumption Growth Driven Largely by Spending on Cars and Drugs

Real spending on durable goods rose at a 6.8 percent annual rate. Spending on new vehicles and parts was the biggest factor in this rise, increasing at a 10.5 percent rate. There was also strong growth in spending on household furnishings, which rose at a 12.0 percent rate. Spending on drugs grew at a 13.1 percent rate, adding 0.35 percentage points to the quarter’s growth.

Spending on services was weaker, growing at just a 2.2 percent annual rate. Real health care spending grew at just a 1.3 percent rate after being nearly flat in the first quarter. This likely reflects the reduced number of people covered by Medicaid or in the ACA exchanges.

Spending on food services and accommodations increased at a 4.4% annual rate, driven in large part by World Cup-related spending (spending on spectator sports grew at a 51.4 percent rate). But even with the second quarter jump, spending in this category was less than 0.1 percent higher than it had been in the third quarter of last year. Spending at fast food restaurants was 2.0 percent lower than it had been in the third quarter. This likely reflects the sentiments on the financial prospects of less-wealthy people.

AI Boom Might be Weakening, Factory Construction Plummets

Real spending on information processing equipment grew at just an 8.3 percent rate in the second quarter, down from a 39.9 percent rate in the first quarter. Spending on computers actually fell in the quarter. This could reflect some caution in building AI capacity, or it may simply indicate shortages of chips and other inputs. The price index for computers rose at a 29.8 percent annual rate in the quarter, which would support the shortage view.

Investment in non-residential structures fell at a 5.0 percent rate. Factory construction fell at a 17.2 percent annual rate in the second quarter. It is now 26.3 percent below its peak in the third quarter of 2024. Investment in intellectual property products grew at an 8.8 percent rate, down from a 13.8 percent rate in the first quarter, with all of the decline due to slower growth in spending on software.

Jump in Trade Deficit Subtracts a Percentage Point from Growth

The nominal trade deficit increased by $49 billion to $869 billion in the second quarter, after rising by $35 billion in the first quarter. The biggest factor in this rise is imported computer chips and other items needed to fuel the AI boom.

It is worth noting that foreign tourism continues to fall, even with the boost from the World Cup in the quarter. Real spending by foreign tourists fell at a 16.4 percent rate in the quarter and is down by 15.4 percent from its level in the fourth quarter of 2024. Real medical spending by foreigners is down by 14.2 percent over this period.

Sharp Fall in Non-Defense Federal Spending Subtracts 0.34 Percentage Points from GDP

Non-defense federal spending fell at a 12.9 percent rate in the second quarter, reversing much of the gain from the first quarter. It is not obvious what would explain this drop. The drop was all on the consumption side, investment rose slightly, which would be primarily the salaries of government employees.

Most of the DOGE layoffs took effect at the end of the third quarter of 2025. The government shutdown lasted almost halfway into the fourth quarter, but even with the shutdown spending in the fourth quarter was only 0.7 percent lower than in the second quarter of this year. Presumably this is due to some less publicized layoffs in the quarter or quits. Non-defense federal consumption spending is down by 13.3% from its level in the fourth quarter of 2024.

State and local government spending grew at a 1.1 percent rate, after rising 1.5 percent and 1.6 percent in the prior two quarters. It had risen by just over 3.0 percent in 2024. Cutbacks in federal aid are likely forcing state and local governments to limit spending. The pressure will increase with the cuts to Medicaid taking effect in the new fiscal year.

Inflation Picks Up in the Second Quarter

The overall PCE rose at a 5.1 percent rate, the core PCE at a 3.4 percent rate. On a year-over-year basis the overall PCE is up 3.8 percent, while the core is up 3.3 percent. This is not a story of spiraling inflation, but with the AI boom driving computer prices sharply higher, there definitely is some inflationary pressure in the economy. At the least, we are clearly not on a downward path at the moment.

Overall Picture: AI Boom is Supporting Growth, Inflation is an Issue

The overall growth rate is somewhat on the slow side, but that would not be an issue if it were not so dependent on AI-related spending. The weakness in fast-food consumption growth suggests that most people are not feeling very good about their economic prospects. This is not surprising since wages have barely been outpacing inflation.

The current inflation is largely war and tariff driven, which could mean that it will weaken if the war ends and there are no further increases in tariffs. But neither of those outcomes are certain, and in any case, inflation has been well above the Fed’s 2.0 percent target for more than five years now.

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