That Sinking Feeling
By now, the definition of a recession, as stated by the experts at the National Bureau of Economic Research (NBER), has become hardwired into the minds of the business press. Repeat after me: "a significant decline in economic activity spread across the economy, lasting more than a few months." So based on the Commerce Dept.'s revised numbers on real gross domestic product, what the U.S. has so far is an insignificant decline in activity, concentrated in housing and autos and lasting only three months. But if it's not a recession, at least not yet, why does it look and feel like one?
For starters, the NBER, which concentrates on the big picture, says real GDP is the single best measure of overall activity. However, in order to see what's happening right now, you have to look separately at domestic U.S. performance, setting aside the enormous contribution to growth from net foreign trade—exports minus imports. The GDP numbers say the economy contracted 0.2% in the fourth quarter, but expansion resumed in the first and second quarters, with growth of 0.9% and 1.9%, respectively. Plus, the pace outside of homebuilding and auto output—only about 6% of real GDP—has been a sturdy 2.7%.
But look at the domestic economy, which is a lot sicker than the top-line GDP number implies. Over the past three quarters, while real GDP growth has averaged 0.9%, gross domestic spending, which is GDP excluding net foreign trade, has shrunk 0.5%. Without foreign trade, real GDP would have contracted 1% in the fourth quarter, idled in the first quarter, and fallen 0.5% last quarter.
Trade's influence is also evident in corporate profits. Revised Commerce figures through the first quarter show operating earnings, which exclude writedowns, fell $24 billion from a year ago. However, domestic profits plunged $125 billion, while a $100 billion rise in overseas earnings cushioned the blow. Receipts from abroad now account for 35% of total earnings.
Profit margins also have declined from their record levels, but they remain high by historical standards. That's partly because productivity growth, which typically falls in a downturn, has held up well. Once again, foreign trade, lifted by booming U.S. exports, is a key reason: Export industries tend to be very efficient. Trade's boost to profits is one reason why companies have not cut back on capital spending and payrolls to the same extent as in past recessions.
But there are downsides to this foreign dependence. Overseas profits are skewed toward big multinationals, while small businesses must cope with weak U.S. demand and rising costs. Also, many companies, and not just exporters, are making do with fewer full-time workers, as seen in the weak July jobs report. Even though jobs and hours worked fell throughout the first half, real GDP continued to rise, meaning productivity gains accounted for all of the economy's growth.
So is it a recession or not? Despite trade gains, the domestic economy may well be weaker than the GDP data now show. When the NBER in October 2001 declared the last recession began in March 2001, the GDP numbers showed only a single quarterly contraction in the third quarter of 2001. Nine months later, Commerce's revisions showed three straight declines beginning in the year's first quarter.
Such revisions may be in the offing again. All four monthly indicators the NBER follows to determine when the economy has turned down have started to fall. Real personal income minus government handouts and real business sales peaked last October. Employment hit its apex in December, and industrial production topped out this January. Given that pattern, it would be unusual for the current period not to end up being called a recession.
Moreover, while foreign trade has helped ease the pain of domestic weakness, there's a catch for the coming year: Growth overseas is now slowing, and so will U.S. exports. With homegrown demand likely to remain frail, that would only prolong the recessionary feel.