Is This Recession Different? Well, Yes And No

In the analysis of business cycles, similarities are sometimes just as important as differences. All the discussion about the atypical characteristics of the 1990-91 recession has covered up a crucial point. Despite the economy's unique array of structural problems in debt, banking, and real estate, the downturn is unfolding in fairly classic fashion. That means the recession's grip--while apparently easing--isn't likely to let go completely for a few more months.

Traditionally, consumer retrenchment sets the downswing of the business cycle in motion. Inventories pile up, businesses liquidate the excess by cutting output and jobs, and companies slash their capital budgets. All this leads to further weakness. Following that script, consumers have taken the first big hit, largely the result of tight monetary policy at the Federal Reserve. The oil shock added a hammer blow.

The hope was that the similarities would end there. This cycle would be different, economists thought, because of better inventory control, because of the need to keep up investments in new equipment in order to compete in global markets, and because of strong exports. All this was supposed to contain the damage.


They had better think again. Although the biggest declines in consumer spending are past, the economy hasn't escaped the classic secondary effects. Through the first quarter, inventory liquidation is already larger than in many past recessions. It has occurred faster than usual because of companies' quicker reaction to falling demand. And more cuts seem assured, especially since the fundamentals for consumer spending, and demand generally, show no signs of strengthening.

Indeed, the latest data from durable-goods manufacturers show new weakness in capital spending. And despite stunning progress on exports, foreign demand is also at risk because of global economic weakness and the dollar's greater value.

The Commerce Dept.'s downbeat report on first-quarter corporate profits also weighs heavily on the outlook. Corporate earnings before taxes fell to $282.7 billion in the first quarter from $304.1 billion in the fourth quarter. Operating profits, which exclude earnings from inventory values and depreciation allowances, also dipped, and they remained below their year-ago level for the ninth consecutive quarter.

The profits numbers accompanied Washington's first-quarter revisions to gross national product, which showed a 2.6% decline, at an annual rate, in real GNP--little changed from the 2.8% drop originally reported.

The recession's grip continues to squeeze profit margins, which measure the efficiency of companies at generating earnings per dollar of output (chart, left). The steady erosion of margins puts added pressure on businesses to cut costs. The sacrifices will be further job losses and forgone capital outlays.


To be sure, businesses will have to see consumer spending improve before adding to payrolls or moving ahead with any new investments in inventories or capital projects. For now, at least, consumers seem pretty wary about the economy's future. So although the worst of the losses in consumer spending seem to be history, that pessimism implies that buying will remain lackluster.

The index of consumer confidence dropped to 74.2 in May, from 79.4 in April, according to the Conference Board (chart, right). In March and April, postwar optimism had boosted the index, especially consumers' feelings about the future.

But in May, reality began to set in once again. In particular, consumers are more pessimistic about the economy's prospects over the next six months. The index of consumer expectations dropped to 93.5, from 99.7 in April. A larger number of consumers now expect fewer jobs and smaller paychecks in the months ahead.

Consumers also remain downbeat about their present situation. According to the Conference Board, 38.6% of those surveyed think jobs are hard to get, compared with just 22.1% who felt that way in July, when the recession started. And 37.9% describe overall business conditions as bad in May, almost twice the 20.7% who used that adjective in July.

The worries about job prospects seem justified, given the high level of filings for state jobless benefits. New claims have fallen since March, when they routinely topped the half-million mark. But in the week ended May 11, they stood at an annual rate of 454,000. That's high enough to suggest that the May employment report, to be released on June 7, will show that the jobless rate increased from the 6.6% rate posted in April.

The darker mood among shoppers means major purchases are being postponed. Buying plans for houses, cars, and appliances were all lower in May than in any of the previous three months.


Plans to postpone home purchases in May could be a sign that the recent rise in long-term interest rates is scaring off some consumers just as housing begins to show a pulse. In April, sales of existing homes rose by 3.4%, to an annual rate of 3.33 million--the third increase in a row.

In addition, the National Association of Realtors reported that home prices have begun to firm--another sign that demand is picking up. The average price of an existing home stood at $128,400 in April, up by 8.9% from 12 months ago. At the end of 1990, prices were falling below their levels of a year earlier. Even so, a full recovery in homebuilding will depend on a sustained increase in sales to clear out the huge inventory of unsold homes.


In traditional business-cycle fashion, the consumer-led slump in the overall economy has preceded the downturn in capital spending. So far, the weakness in investment in new plants and equipment has been mild compared with past recessions, but that might be changing.

The unrelenting stream of disappointing reports on corporate profits, the still-high cost of borrowing, the continuing decline in the utilization rate of capacity already in place, and uncertainty over the timing of the recovery all appear to be causing many businesses to rethink their spending plans.

Despite a 2.9% increase in overall orders coming into durable-goods manufacturers in April, which was the first increase in four months, private-sector bookings for capital goods, excluding the military, plunged by 10.3%. Although the month's drop reflected a big decline in the volatile aircraft industry, capital-goods orders have fallen in five of the past six months. Smoothing out the monthly ups and downs, the three-month average is headed due south (chart).

The April report from makers of machine tools, which are used to make other capital goods and are thus a leading indicator of equipment spending, offers little encouragement. Orders slipped 5.3% from their March level, to $194.7 million, according to the Association for Manufacturing Technology. April orders hit a 14-month low, and they were 33% below last year's pace.

Until the first quarter, the weakness in capital spending had been concentrated in business structures, where past overbuilding will continue to take a toll for some time. But in the first quarter, outlays for equipment also fell sharply, and they are on track to post another drop in the second quarter. April shipments of nondefense capital goods edged up, but they remained below the first-quarter average.

As in most past downswings in the business cycle, weak demand--particularly among consumers--is the bane of the economy. The structural problems are important, but they are more likely to weigh on the strength of the recovery than on the depth and duration of the recession.

When demand strengthens, largely in response to the Fed's easing of monetary policy, the economy will turn up. Right now, judging when the recovery will begin may well depend more on how similar this recession is to past downturns than on how different it is.