News Analysis

The Beginning of the End of the Recession?


Could it be true? Is the end of the worst U.S. recession since the 1930s finally at hand? Recent data, including the July 31 report on second-quarter real gross domestic product, make a strong case that the economy hit bottom last quarter and an upturn is already under way. It won't feel much like a recovery, because the job markets are sure to remain weak until businesses gain confidence in the upturn's sustainability. But a shift to positive GDP growth—after four quarters of contraction—will be an important first step in that direction.

Real GDP fell at an annual rate of only 1% in the second quarter, according to the Bureau of Economic Analysis (BEA), a much slower rate of decline after plunging 6.4% in the first quarter, 5.4% in the fourth, and 2.7% in the third. The details of the report showed a record $141 billion liquidation of inventories, along with a stabilization in overall demand led by a sharp narrowing in the trade deficit and stronger government outlays. Consumer spending fell after posting a gain in the first quarter, while housing took another big bite out of growth. Business cutbacks in capital spending were significantly smaller than in the first quarter.

The inventory plunge bodes well for third-quarter GDP growth. Stockpiles have shrunk so much in relation to demand that many businesses now have to reorder, which will boost third-quarter production. As a result, most economists anticipate a shift to positive growth this quarter and next. "We expect GDP to post a modest increase in the third quarter, as the pace of inventory liquidation slows and government spending enjoys another big fiscal-related surge," says Paul Ashworth at Capital Economics.

GDP Growth, Then Jobs Continued weakness in the labor markets is sure to limit the strength of the recovery, especially in the second half, but it will not prevent an upturn from taking hold. History shows why. In each of the past four recessions, GDP growth has always turned up before payrolls have. In fact, the lag has been increasingly greater since the 1973-75 recession, when payrolls hit bottom one quarter after real GDP did. In both the 1981-82 and 1990-91 downturns, employment didn't hit bottom until three quarters after real GDP's nadir. And after the 2001 recession, it took seven quarters for jobs to stop falling.

The latest GDP report is actually a two-part story. The BEA also issued sweeping revisions to past data as part of its benchmark revision, which the Bureau undertakes every five years or so in order to update source data, definitions, classifications, and calculation methods. The revisions contained both good news and bad. The biggest minus: The new data show that the recession was much deeper than previous data showed. Real GDP is now said to have shrunk 1.9% during 2008, 1.1 percentage points more than first thought. Plus, the peak-to-trough drop during the recession now stands at 3.9%, by far the largest drop in any recession since the 1930s. That decline is now more consistent with the steep rise in the unemployment rate than the old data had shown.

But that's water under the bridge. The revisions also held some positive implications for the coming quarters for both consumers and businesses. First of all, the BEA revised the household saving rate substantially higher in previous years. As it turns out, consumers had more income, but they spent less of it. That means households are farther along in the process of shoring up their balance sheets than earlier data had suggested.

The Push for Productivity Moreover, the new data also confirm that nonfinancial businesses have been successful at avoiding a steep erosion in their profit margins during the recession, a point confirmed by the surprising strength in second-quarter earnings. Margins, which stood at 10.5% when the downturn began in the fourth quarter of 2007, held at 10% in the first quarter of 2009. That's quite an accomplishment during such a severe recession. Efforts to keep productivity up are a key reason. The GDP data suggest productivity growth in the past couple of years will be revised lower, but it still should remain positive. That would be unusual, since productivity typically falls in a downturn—and highly unusual in a slump as bad as this one.

To be sure, the defense of profits has come at the cost of 6.5 million jobs so far. However, the latest GDP data show that policy efforts by the Federal Reserve and Congress are lending support to demand and laying the groundwork for a return to growth.
Cooper is BusinessWeek's senior editor and senior economist and writes the influential Business Outlook column.

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