U.S: A Dimmer Past. A Brighter Future?

New data show improving prospects for second-half growth

Not only are companies restating their earnings but the Commerce Dept. is restating economic growth. Thanks to Commerce's latest barrage of data on gross domestic product, including a bevy of revisions going back to 1999, we now know a lot more about where we have been in this business cycle. More important, the data give us a better idea of where we are going.

As was true in the original data, the recession was exceptionally shallow by historical standards. However, the new data show that the downturn began earlier and lasted longer than first thought (chart). Real GDP fell in each of the first three quarters of 2001 instead of only in the third quarter, but the peak-to-trough decline is about the same as the one in the 1969-70 recession, which was the smallest in the postwar era.

The numbers also clearly show that a solid recovery began in the fourth quarter, despite the impact from September 11. After three quarterly declines averaging 0.8%, growth in the final quarter of last year was 2.7%, a percentage higher than first reported. Growth in the first quarter of 2002 jumped to 5%, although that was 1.1 points slower than the original. The economy's pace cooled to only 1.1% in the quarter just ended, but the underlying second- quarter data, along with recent monthly numbers, look favorable for healthy growth in the second half.

SO WHAT DOES ALL THIS SAY about the future? First of all, progress toward righting one of the economy's biggest imbalances, excess production capacity caused by overinvestment, has been greater than first thought. Second, the numbers show that productivity gains remain exceptionally strong and continue to support both the rebound in profits and healthy gains in household purchasing power. And third, the data for the second quarter are a lot more encouraging than the top-line GDP number suggests.

Much of the slowdown last quarter reflected payback for the first quarter's exaggerated strength, some of which was "borrowed" from the second quarter as a result of an unusually mild winter that distorted the patterns of car sales, housing, and inventories. The 3% average growth rate for the first two quarters is more indicative of the economy's true performance.

A sharp widening in the trade deficit last quarter, caused by the largest quarterly increase in imports in 18 years, lopped off 1.8 percentage points from the quarter's overall growth rate. The import surge is hardly a sign of domestic weakness, but imports are subtracted from GDP because they are not U.S. output. Overall domestic demand, which includes purchases of imports, rose a healthy 2.8% last quarter.

Consumer spending and housing also posted good gains in the second quarter, although smaller than in the first quarter, and consumer outlays are set to grow at a faster pace in the third quarter. The stock market drop did sap consumer confidence. The Conference Board's index fell to 97.1 in July from 106.3 in June, but that's far from a distressed level.

Remember that consumers don't always spend the way they say they feel. Confidence surged in the second quarter, even though spending growth slowed. And in July, despite the market drop, car sales appear to have rebounded strongly from June's level. July mortgage applications remain at a high mark, suggesting strong home buying, and refinancing activity is surging, which always puts extra cash in people's pockets. Confidence may well rebound if the 1,000-point rally in the Dow Jones stock index holds up.

Perhaps the best news from the second quarter was a 2.9% advance in business outlays for equipment and software. The gain, while modest, was the largest in two years. Of note, outlays for information processing and other high-tech gear increased for the second quarter in a row. Plus, despite a June drop, second-quarter orders for capital goods rose for the second quarter in a row, suggesting further gains to come (chart).

THE REVISIONS TO PAST DATA also bear glad tidings for the future. They show that the downturn was led even more forcefully by cutbacks in business investment. Declines in outlays for new equipment and buildings came sooner and went deeper. Plus, the runup in business investment prior to the falloff was not as great as first thought. All this helps to clear the way for a pickup in capital spending.

Commerce's data reconfirm another key trend in this business cycle: Productivity gains and low inflation, which helped to cushion the recession's blow, are still at work fueling the recovery. Taken by themselves, the downward revisions to GDP imply that productivity growth last year was only slightly less than the 2.1% advance originally reported.

The Labor Dept.'s productivity data, due on Aug. 9, will be revised based on the new Commerce numbers, but it will also include updated employment data. The true productivity trends will not be known until then, but it appears that the revisions will be small. Productivity's performance last year will still rank far above that during past recessions.

THE BENEFITS OF PRODUCTIVITY are already showing up in profits. BusinessWeek's survey of the second-quarter earnings of some 900 companies shows profits up 8% from a year ago, the first advance in six quarters. Profits are recovering even though weak pricing power held the sales gain to only 1%. That's because unit labor costs have been falling during the past year, reflecting both slimmer payrolls and increased productivity, especially in the fourth and first quarters, when productivity zoomed.

Workers, too, are seeing a plus from strong productivity growth. With unit costs down, companies don't have to squeeze pay as much as they have in past periods of weakness. The Labor Dept.'s employment cost index, a gauge of hourly wages and benefits, increased at a 4% yearly clip in the second quarter.

Wages and salaries alone climbed 3.6% from a year ago, and real take-home pay, adjusted for inflation, is up 2.5%. Amid declining inflation, consumers who are on the job are enjoying a boost in purchasing power (chart). And now, labor markets are slowly starting to improve.

This summer's stock market drop will almost certainly cause households to save more of their income. However, the new data show that real aftertax incomes in the second quarter were up a strong 5% from a year ago, thanks to tax breaks, low inflation, and productivity. That means consumers have the wherewithal to save more and spend more at the same time.

To be sure, government rewrites of history can be maddening for anyone trying to divine the path of the economy. But on balance, Commerce's latest set of data is more reassuring than many past revisions: It suggests that the recovery is on solid ground.

By James C. Cooper & Kathleen Madigan

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