A Not-So-Widespread Downturn
When the business-cycle experts at the National Bureau of Economic Research define a recession, they say the depth of the decline in economic activity must be "significant" and that it must last "more than a few months." They also say the downturn must be "spread across the economy," and that may turn out to be the most crucial factor in whether or not the current period of weakness ends up being called a recession.
So far, the slump has been unusually narrow, confined mainly to housing and autos. That may explain why broad indicators, such as employment and household income, have not posted typical recession-size declines, and why overall growth has been so resilient in the face of stiff headwinds.
The economy may have more hidden strength than the puny top-line numbers for gross domestic product growth imply. The latest report says the economy grew at annual rates of 0.6% and 0.9%, in the fourth and first quarters, respectively. Help from tax rebates, foreign demand, and lean inventories raise the chances for another small plus in GDP this quarter.
Strong Service Sector
Digging deeper into the GDP data reveals that recent weakness is sharply skewed toward housing and autos. In the past two quarters, home construction has sunk 25% and 26%, while auto output has dropped 26% and 12%. Excluding these two categories, which make up only 7% of GDP and only 3% of payroll employment, the economy grew 2.8% and 2.5% during the past two quarters. That means 93% of the economy is still motoring along faster than the U.S.'s long-run growth rate, a pattern that was clearly absent in the early stages of the 2001 recession.
One source of that underlying strength is the service sector, which accounts for nearly 60% of GDP. Service GDP rose 3.1% in the fourth quarter and 3.5% in the first quarter. The resulting resilience in service employment, compared with past recessions, explains why overall job losses since the December peak in payrolls have been half the size of declines in the past two recessions.
The lopsided look of economic growth stems from the disproportionate impact of tight credit and soaring gas prices on the demand for homes and cars. Auto makers are taking hits from both. May sales of light vehicles fell to an annual rate of 14.3 million, the lowest in a decade. The 1% rise in consumer spending in the first quarter would have been nearly double that if not for the drop in auto sales, and car buying will be a big drag on second-quarter spending, too.
Also, the fall in auto output has accounted for more than half of the decline in industrial production since January's peak, with construction supplies contributing some, but not all, of the rest.
A Production Pickup?
The factory sector is genuinely weak, partly reflecting efforts by businesses to reduce excess inventories. Businesses liquidated stockpiles in the fourth and first quarters at the fastest two-quarter rate in six years, and a big chunk of that reduction was autos. April data on output, sales, and factory inventories suggest stock levels shrank further early in the second quarter.
However, those cuts have left inventories very lean relative to demand, which will help to prevent big output losses later on. Low stock levels could even generate a pickup in production, depending on the lift consumer spending gets from the tax rebates.
Industrial production is already getting major support from foreign demand. The Institute for Supply Management's May survey of manufacturing activity shows surprising buoyance, and its measure of export orders jumped to a four-year high. Over the past two quarters, foreign trade has offset about half of the drag on overall economic growth coming from the declines in housing and autos.
The current soft patch may yet qualify as a recession. Annual revisions to GDP data, due in July, could give growth a different look. For now, though, it appears the weakness has not spread widely enough to generate a sufficiently significant and lasting decline in economic activity.