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The business situation.

the BUSINESS SITUATION

THE pace of U.S. production picked up in the first quarter of 1987. Real GNP increased at an annual rate of 4 1/2 percent, following an increase of 1 percent in the fourth quarter of 1986 (chart 1).1

1. Quarterly estimates in the national income and product accounts are expressed at seasonally adjusted annual rates, and quarterly changes in them are differences between these rates. Quarter-to-quarter percent changes are annualized. Real, or constant-dollar, estimates are expressed in 1982 dollars.

The preliminary GNP estimates for the first quarter are based on the following major source data: For personal consumption expenditures (PCE), retail sales through March, and unit auto and truck sales through March; for nonresidential fixed investment, the same information for autos and trucks as for PCE, construction put in place for January and February, and manufacturers' shipments of machinery and equipment for January and February; for residential investment, construction put in place for January and February, and housing starts through March; for change in business inventories, book values for manufacturing and trade for January and February, and unit auto investories through March; for net exports of goods and services, merchandise exports and merchandise imports for January and February, and fragmentary information on investment income for the quarter; for government purchases of goods and services, Federal unified budget outlays for January and February, and State and local construction put in place for January and February; and for GNP prices, the Consumer Price Index for January and February, the Producer Price Index through March, and the unit-value index for petroleum imports for January and February. Some of the source data are subject to revision.

U.S. demand also picked up, but was weaker than U.S. production for the second consecutive quarter. Real gross domestic purchases increased 2 1/2 percent, following a 1/2-percent decline in the fourth quarter.

Inflation, whether measured by prices of U.S. production or by prices of domestic purchases, accelerated 1 percentage point in the first quarter. The GNP price index (fixed weights) increased 3 1/2 percent after a 2 1/2-percent increase; the price index for gross domestic purchases (fixed weights) increased 4 1/2 percent after a 3 1/2-percent increase.

Real GNP

The increase in U.S. production in the first quarter, for the most part, went into inventories. With the exception of net exports, the major components of real final sales of GNP declined in the first quarter. A substantial decline in government purchases was due to transactions of the Commodity Credit Corporation (CCC); other government purchases increased. Net exports registered a sizable increase due to a drop in imports; exports declined moderately.

Real inventory investment--that is, change in business inventories--increased $59 1/2 billion in the first quarter, as inventories swung from a decumulation of $28 1/2 billion in the fourth quarter to an increase of $31 billion in the first (table 1). Together, farm inventories and motor vehicle inventories accounted for more than four-fifths of the first-quarter swing in inventories. Most of the $22 billion swing in farm inventories was due to transfers of crops between farmers and the CCC; thus, for GNP, the farm inventory swing was nearly offset by a $21 billion swing in the opposite direction in CCC inventories in government purchases.

Largely reflecting the pattern of net crop placements with the CCC, farm inventories increased $3 1/2 billion in the first quarter after an $18 1/2 billion decrease in the fourth. In the fourth quarter, farmers had placed large amounts of crops with the CCC under the commodity loan program; in the first quarter, crop placements were substantially smaller. Commodity loan transactions are treated in the national income and product accounts (NIPA's) as a purchase by the CCC with an offset in farm inventories. Largely reflecting net crop placements, CCC inventories increased $1 1/2 billion in the first quarter after a $22 billion increase in the fourth.

Motor vehicle inventories increased $34 billion after a $6 billion increase in the fourth quarter. The increases came as motor vehicle output continued at a brisk pace despite sharp declines in sales. A discussion of recent developments in motor vehicles, in terms of units, follows.

Motor vehicles.--Sales of new cars fell to 9.4 million units (seasonally adjusted annual rate) in the first quarter from 11.5 million in the fourth; sales had been a record 13.2 million in the third quarter (chart 2). The first-quarter decline was about evenly divided between domestic and imported cars.

Sales of domestic cars fell sharply from 9.7 million in the third quarter to 7.9 million in the fourth and to 6.8 million in the first. Record sales in the third quarter had resulted primarily from extensive incentive programs offered

by automakers from mid-August through September; sales may have been "borrowed' from the fourth quarter and the first part of 1987. When the programs were eliminated at the end of the third quarter, sales fell sharply, although there was a rebound at yearend that may have reflected, to some extent, consumers' response to prospective changes in the Federal tax law. (Effective January 1, 1987, the Tax Reform Act of 1986 eliminated the deduction for State sales tax and began phasing out the deduction for interest payments on consumer loans.) First-quarter sales were dampened by the elimination of the tax advantages and the absence of extensive incentive programs. Further, some consumers may have postponed purchases, anticipating that extensive incentive programs may be offered again later in the model year.

Despite declining sales, domestic automakers maintained production levels; inventories, most of which are held by dealers, built up. Domestic car production increased slightly to 8.2 million units in the first quarter from 7.9 million in the fourth; production had been 7.3 million in the third. Domestic car inventories increased sharply to 1.71 million units in the first quarter from 1.30 million in the fourth; inventories had been 1.18 million in the third. Reflecting declining sales and rising inventories, the inventory-sales ratio rose to 3.0 in the first quarter, the highest level since the fourth quarter of 1981. The ratio had been 2.0 in the fourth quarter of 1986 and 1.5 in the third. Faced with the large buildup in inventories, manufacturers have scheduled a cutback in production in the second quarter.

Sales of imported cars declined to 2.6 million--the lowest level in 2 years--from 3.6 million in the fourth quarter. The decline was mainly in sales of Japanese cars, for which prices have increased rapidly, largely due to the depreciation of the dollar against the yen. Inventories of Japanese cars have also built up substantially.

Unit sales of new trucks declined to 4.4 million in the first quarter from 4.7 million in the fourth. Sales of domestic trucks were 3.7 million in both quarters; sales of imported trucks declined to 0.7 million from 1.0 million.

Personal consumption expenditures

Real personal consumption expenditures (PCE) decreased 1/2 percentage point in the first quarter, the same as in the fourth; in the third quarter, PCE had increased 6 1/2 percent (table 2). The recent quarterly changes in PCE have been dominated by large, erratic movements in motor vehicles, which were, at least in part, related to the timing of incentive programs. If total expenditures for autos and trucks during the past four quarters are spread evenly over this period, real PCE increased 2 to 2 1/2 percent in the third, fourth, and first quarters.

Expenditures for durable goods decreased 17 1/2 percent in the first quarter after a decrease of 11 percent in the fourth. Motor vehicles and parts dropped sharply in both quarters. Furniture and household equipment increased somewhat less than in the fourth quarter. Other durables decreased, following a sharp fourth-quarter increase that was partly attributable to purchases of the newly issued "American Eagle' gold coin.

Nondurable goods increased 1 percent in the first quarter after changing little in the fourth. This slight increase was the net result of larger, divergent movements in the major components. An acceleration in expenditures on food may have been related to a deceleration in food prices. Clothing and shoes increased strongly after a decrease of similar magnitude. Energy--gasoline and oil, and fuel oil and coal--plunged after a strong increase; these sharp changes may have been related to recent large fluctuations in energy prices. Other nondurables increased sharply after a moderate decrease.

Services increased 4 1/2 percent in the first quarter, following a 3-percent increase in the fourth. The acceleration was largely in transportation services, where the introduction of large discounts by many major airlines appears to have stimulated travel, and in other services, due to a sharp increase in brokerage commissions as stock market activity picked up. Housing services and medical care services each registered an increase similar to that in the fourth quarter. Household operation services decreased after changing little in the fourth quarter; electricity and gas declined in the first quarter because of mild winter weather in many parts of the country.

Nonresidential fixed investment

Real nonresidential fixed investment declined 13 percent in the first quarter, following a 3-percent increase in the fourth (table 3). Both structures and producers' durable equipment (PDE) registered sizable drops: Structures continued a downtrend, and PDE reversed itself after increases.

In structures, declines were widespread in the first quarter, but commercial and industrial buildings accounted for the bulk of the drop. Within commercial structures, office buildings once again were weak, reflecting previous overbuilding and high vacancy rates. Petroleum exploration and drilling declined, after increasing in the fourth quarter for the first time in seven quarters.

In PDE, motor vehicles--which account for about 15 percent of the total--accounted for about 40 percent of the decline; an increase in truck purchases was more than offset by a drop in automobiles. Declines were also substantial in information processing equipment and general industrial equipment. Some of the decline in nonmotor vehicle PDE appears to reflect efforts of businesses late in 1986 to accelerate purchases of equipment --i.e., to shift planned purchases from 1987 into the fourth quarter of 1986--in order to qualify for depreciation in 1986.

Residential investment

Real residential investment declined 7 percent in the first quarter, following a 5-percent increase in the fourth. Multifamily construction accounted for more than one-half of the decline; single-family construction dipped only slightly. Other residential investment--which includes major additions and alterations, mobile home sales, and brokers' commissions on house sales--also declined.

The sharp drop in multifamily construction followed modest declines in the previous two quarters. The weakness reflected the lagged impact of sharp declines in multifamily starts last year (chart 3). At 542,000 (seasonally adjusted annual rate) in the first quarter, multifamily starts were 24 percent below the year-earlier level. The drop in starts, in turn, represented a reaction to high vacancy rates, particularly in regions heavily dependent on energy production and agribusiness.

The slight dip in single-family construction followed eight consecutive quarterly increases and occurred despite a small increase in starts in the fourth quarter (according to revised Census Bureau data) and a large increase in the first. The dip reflected the lagged impact of weak starts in the third quarter of last year and a decrease in the average value of new houses in the first quarter. Mortgage interest rates continued to decline, but the pace slowed markedly during the quarter (chart 4).

The decline in other residential investment was largely accounted for by a drop in brokers' commissions. Sales of both new and existing houses declined from the fourth quarter to January-February.

Inventory investment

Real inventory investment swung to an increase of $59 1/2 billion in the first quarter, as inventories registered substantial accumulation after substantial decumulation in the fourth quarter (table 4). Both farm and nonfarm inventories contributed to the swing. Changes in farm inventories, as described earlier in the article, largely reflected net placements of crops with the CCC.

Nonfarm inventories accumulated $27 1/2 billion in the first quarter, following decumulation in the two preceding quarters. Most of the first-quarter accumulation was accounted for by retail auto dealers' inventories, which increased $24 billion after two quarters of decline.2 The accumulation in nonfarm inventories other than those held by retail auto dealers amounted to $3 1/2 billion in the first quarter after a decumulation of $8 1/2 billion in the fourth.

2. The estimates for inventories of retail auto dealers, which are derived from Census Bureau book value inventory data, cover most auto inventories--including inventories of new and used autos, domestic and foreign--but do not include those held by manufacturers and wholesalers. The data for retail auto dealers cover, in addition to autos, some trucks and other motorized vehicles, and also parts. The change in business inventory estimates for retail auto dealers differ in terms of sources and coverage from the changes in inventories of autos and trucks that are part of the motor vehicle output estimates.

The swing in other nonfarm inventories was accounted for by wholesale trade. Inventories of both merchant wholesalers of durables and nonmerchant wholesalers of nondurables accumulated after declining in the fourth quarter. The first-quarter accumulation for merchant wholesalers apparently reflected efforts to restock off-the-shelf machinery and equipment items, following a sharp runoff at the end of 1986. The accumulation for nonmerchant wholesalers was in inventories held in petroleum bulk terminals and stations. Manufacturing inventories continued to decumulate, but the rate slowed. The decumulation was largely in inventories of durable goods, mainly primary metals and nonelectrical machinery.

Reflecting rising inventories and declining sales, the constant-dollar ratio of total inventories to total final sales increased to 3.18 in the first quarter from a low of 3.13 in the fourth. A variant of the ratio that is adjusted for the impact of CCC inventory transactions on both inventories and final sales increased to 3.31 in the first quarter from 3.28 in the fourth. (See the August 1986 "Business Situation' for a discussion of this variant and a guide as to when it may provide useful perspective on the published ratio.) Both the ratio and the variant indicate that, from a historical perspective, inventories remained on the low side relative to sales.

Net exports

Real net exports of goods and services increased $14 billion in the first quarter, following an increase of $15 1/2 billion in the fourth. The first-quarter increase was more than accounted for by a substantial decline in imports; exports declined moderately in the first quarter. The fourth-quarter increase in net exports, in contrast, had been almost entirely accounted for by a substantial increase in exports.

Imports declined $15 1/2 billion, or 11 percent, in the first quarter, compared with a slight deline in the fourth (table 5). The dropoff was largely accounted for by merchandise imports, both petroleum and nonpetroleum products.

Imports of petroleum dropped $11 1/2 billion in the first quarter, following a decrease of $8 1/2 billion in the fourth; in the two preceding quarters, imports had jumped to unusually high levels. These sharp changes were largely responses to movements in world petroleum prices.

Imports of nonpetroleum products decreased $4 1/2 billion in the first quarter, in contrast to an increase of $5 billion in the fourth. The first-quarter decrease, which was largely in autos and in capital goods except autos, appears to reflect the effects of several quarters of increasing prices.

Imports of services were up less than in the fourth quarter. The slowdown was in both investment income and other services.

Exports decreased $1 1/2 billion, or 1 1/2 percent, in the first quarter, in contrast to double-digit increases in the two preceding quarters. The first-quarter decline was primarily in merchandise exports, both agricultural and nonagricultural. The decline in nonagricultural exports was largely in industrial materials and supplies and in capital goods except autos. Some major U.S. export markets continued to experience sluggish demand. Demand for U.S. exports by several Latin American countries remains constrained by their foreign debt burden, and that by oil-exporting developing countries by relatively low oil prices. Demand for U.S. exports by Canada, Mexico, and the newly industrialized Asian countries has not had price stimulus from a declining dollar, because its value has not changed appreciably against the currencies of those countries. Further, those countries provide stiff competition for U.S. products in other export markets.

Agricultural exports declined $2 billion, following strong increases in the third and fourth quarters. Although U.S. farm products have been more price competitive in foreign markets in recent quarters as a result of the decline in the dollar and the implementation of the Food Security Act of 1985, U.S. exports continued to be restrained by an oversupply of grains in the world market. Moreover, the U.S. dollar has not significantly declined against the currencies of some of its major competitors, such as Australia, Canada, and, more recently, Argentina and Brazil.

U.S. exports of services increased about the same as in the fourth quarter. Investment income was up slightly after a decline, and other services increased less than in the fourth quarter.

Government purchases

Real government purchases declined $12 1/2 billion, or 6 1/2 percent, in the first quarter, following an increase of $19 billion, or 10 1/2 percent, in the fourth (table 6). These changes reflected the pattern of net crop placements with the CCC; government purchases less CCC inventory change increased in the first quarter after declining in the fourth.

Federal national defense purchases increased in the first quarter after declining in the fourth. Both the increase and the decline were spread across the categories of durables goods, nondurable goods, and services other than compensation of employees. Federal nondefense purchases other than CCC inventory change continued a downtrend that has persisted for six quarters. The first-quarter decline was widespread among the categories of goods and services.

State and local government purchases increased more than in the fourth quarter. The pickup was due to a turnaround in highway construction, which increased $1 1/2 billion in the first quarter after a decline of that amount in the fourth.

Prices

GNP prices and gross domestic purchases prices both accelerated 1 percentage point in the first quarter (table 7). At 4 1/2 percent, the increase in the price index for gross domestic purchases remained 1 percentage point higher than that for GNP; the difference reflected the much larger increase in import prices than in export prices. (Import prices are subtracted out in deriving GNP prices but not in deriving gross domestic purchases prices; export prices are included in GNP prices but not in gross domestic purchases prices. For a discussion of conceptual differences between the two price measures, see the section on "Aggregate Price Measures' in the February 1987 "Business Situation.') A sharp acceleration in merchandise import prices in the first quarter was due to petroleum prices, which surged 138 1/2 percent after a 54 1/2-percent increase in the fourth quarter. The large increases came after OPEC members had agreed to reinstate production quotas in August. Other merchandise import prices increased at about the 7-percent rate registered in the fourth quarter.

The acceleration in gross domestic purchases prices in the first quarter was largely attributable to a sharp turnaround in energy prices, which increased 23 1/2 percent after six quarters of decline. Food prices increased about one-half as much as in the fourth quarter. The slowdown was evident in meat prices, which had increased strongly in the second half of 1986, and in milk and fresh vegetable prices.

Prices of other gross domestic purchases were affected in both the fourth and first quarters by developments relating to compensation of government employees. In the fourth quarter, prices were boosted a few tenths of a percentage point by a one-time employer contribution to a pension fund administered by Los Angeles County; this contribution is treated in the NIPA's as a temporary increase in the price of employee services purchased by State and local government. In the first quarter, prices were boosted about 1/2 percentage point by a 3-percent pay raise for Federal civilian and military personnel; such a pay raise is treated in the NIPA's as an increase in the price of employee services purchased by the Federal Government. If the volatile food and energy categories and the developments related to government employee compensation are excluded from gross domestic purchases prices, inflation in each of the past two quarters was about 3 1/2 percent.

The increase in PCE prices picked up to 5 percent in the first quarter; the acceleration was accounted for by energy prices--particularly gasoline and oil prices, and fuel oil and coal prices. Increases in the prices of the nonresidential fixed investment components remained small to moderate; residential investment prices accelerated to 5 1/2 percent. Prices paid by government again accelerated, but increases in both quarters were affected by the developments related to employee compensation. Excluding these developments, prices paid by government increased 3 percent in the fourth quarter and 3 1/2 percent in the first.

Personal Income

Personal income increased $57 1/2 billion in the first quarter, following a $29 billion increase in the fourth (table 8). Nearly all of the major components of personal income contributed to the step-up. Disposable personal income jumped in the first quarter, as the strong increase in personal income was augmented by a decline in personal tax and nontax payments. Personal saving increased after two quarters of decline.

Wage and salary disbursements continued to pick up in the first quarter --to a $32 1/2 billion increase from a $28 1/2 billion increase in the fourth quarter. All of the major private industry components except manufacturing strengthened, largely reflecting further gains in employment. Manufacturing wages and salaries were up less than in the fourth quarter, when they had been boosted $2 billion by special bonus payments to auto workers. The step-up in government wages and salaries in the first quarter was accounted for by the pay raise for Federal civilian and military personnel.

Federal agricultural subsidy payments again were a significant factor in farm proprietors' income, which increased $7 1/2 billion in the first quarter after increasing $1 1/2 billion in the fourth. In the first quarter, subsidy payments--largely final deficiency payments on the 1986 cotton and rice crops and initial deficiency payments on all 1987 program crops--amounted to $20 billion. (Deficiency payments are payments by the government to farmers when the market price of a crop is below the target price set by the CCC.) In the fourth quarter, subsidy payments--largely final deficiency payments on the 1986 wheat crop-- had totaled $9 1/2 billion. Farm income excluding subsidies declined for the fifth consecutive quarter; the $3 billion first-quarter decline reflected both lower production and lower prices. Nonfarm proprietors' income increased somewhat more than in the fourth quarter, reflecting pickups in construction, retail trade, and services.

Personal interest income turned around after four consecutive quarters of decline. The increase, which amounted to $2 1/2 billion, largely reflected the leveling off in the decline in interest rates.

The step-up in transfer payments-- to a $9 billion increase--was largely due to cost-of-living adjustments (COLA's) to benefits paid under social security and several other Federal retirement and income support programs. The COLA's, which became effective in January, added $3 1/2 billion to transfer payments in the first quarter.

First-quarter changes in most of the remaining components of personal income were relatively small. Among these components, rental income of persons and personal dividend income contributed to the step-up in personal income in the first quarter. Personal contributions for social insurance, which are subtracted in deriving the personal income total, increased considerably more than in the fourth quarter; first-quarter contributions were boosted $2 billion by an increase in the taxable wage base for social security from $42,000 to $43,800 and an increase in the monthly premium for supplementary medical insurance from $15.50 to $17.90.

A substantial decline in personal tax and nontax payments in the first quarter largely reflected direct and indirect effects of the Tax Reform Act of 1986. Estimates of these effects are shown in table 9. (For an analysis of major provisions of the act, see the article "The Tax Reform Act of 1986' in the March 1987 SURVEY.)

Federal tax payments dropped sharply, as the impact of the tax law change more than offset an increase in taxes due to growth in the taxable earnings base. A large reduction in Federal withheld income taxes in the first quarter came about in two ways. First, the tax act, on balance, lowered withholdings by reducing rates, by increasing the personal exemption, and by replacing the zero bracket amount with a standard deduction. Second, underwithholding occurred in the first quarter because the new Internal Revenue Service graduated withholding tax tables were applied to the number of allowances on file for 1986. The 1986 allowances were used by many employers in calculating the initial 1987 withholding because most employees had not yet filed a new Form W-4, which is designed to bring withholding closer to tax liability. In contrast, the tax act, on balance, raised declarations (estimated tax payments) and net settlements (final tax payments less refunds of the preceding year's taxes) in the first quarter. Declarations and net settlements were reduced to the extent that taxpayers, faced with a 2-year phased reduction in tax rates and the elimination --or limitation--of many deductibles, deferred income and/or accelerated deductions to minimize their tax liability in 1986; declarations and net settlements were raised to the extent that taxpayers shifted realization of capital gains into 1986 to take advantage of the lower tax rate. In addition, other tax act effects, particularly the repeal of the investment tax credit, raised declarations and net settlements in the first quarter.

State and local tax payments decreased in the first quarter, following an unusually large increase in the fourth. Fourth-quarter payments had included indirect impacts of the changes in the Federal tax law; payments were raised to the extent that taxpayers elected to pay State taxes on capital gains--as well as other State income taxes--in the fourth quarter in order to maximize the State income tax deduction on the Federal tax return for liability year 1986, when the Federal marginal tax rates were higher. In the first quarter, payments were lowered to the extent that taxpayers deferred income and/or accelerated deductions to minimize their tax liability in 1986.

Reflecting the strength in personal income and the decrease in personal tax and nontax payments, disposable personal income (DPI) jumped $69 billion, or 9 1/2 percent, in the first quarter, following an increase of $13 billion, or 2 percent, in the fourth. Without the special factors affecting income and taxes, DPI still would have accelerated--to a $29 billion increase from a $12 1/2 billion increase.

Despite some acceleration in prices, real DPI improved considerably after two quarters of deterioration. Real DPI increased 4 percent in the first quarter after a 1 1/2-percent decline in the fourth.

Personal outlays--largely PCE-- were up somewhat more than in the fourth quarter, but the difference paled alongside that for DPI. As a result, personal saving swung sharply --to a $35 billion increase from a $10 billion decline in the fourth quarter. The personal saving rate climbed 1.1 percentage points to 3.6 percent in the first quarter.

Corporate Profits in 1986

Profits from current production-- profits before tax plus inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $20 billion in 1986, the fourth year of economic recovery and expansion, following increases of $16 billion in 1985, $51 billion in 1984, and $63 1/2 billion in 1983 (chart 5).3

3. Definitions of IVA and CCAdj are available in a number of sources, including U.S. Department of Commerce, Bureau of Economic Analysis, The National Income and Product Accounts of the United States, 1929-82: Statistical Tables (Washington, DC: GPO, September 1986), pp. x-xi.

A little more than one-half of the 1986 increase--$10 1/2 billion--was in domestic profits of financial corporations, primarily insurance. Domestic profits of nonfinancial corporations increased $6 billion, reflecting a modest increase in real product combined with a small increase in unit profits (although profit margin--unit profits as a percent of unit price-- slipped slightly). The increase in unit profits reflected a slightly larger increase in unit prices than in unit costs. Profits from the rest of the world increased $3 1/2 billion.

Profits before tax (PBT) increased $14 1/2 billion in 1986; profits tax liability, $11 1/2 billion; and profits after tax, $2 1/2 billion. One-half of the relatively sharp increase in tax liability resulted from retroactive provisions of the Tax Reform Act of 1986.

The IVA increased $7 billion, from negative $ 1/2 billion to $6 1/2 billion. The last time the annual IVA was positive--indicating a decline in inventory prices--was 1963, and the last time a positive IVA amounted to more than 1 percent of PBT was 1938. The Producer Price Index, which is a major source for estimating the IVA, declined 2.9 percent.

A steep drop in petroleum prices dominated the decline in inventory prices. As a result, the increase in IVA was concentrated in industries with substantial stocks of petroleum and petroleum products, especially the refining, public utility, chemicals, and transportation industries. Together, these four industries accounted for about 80 percent of the increase in total IVA.

The CCAdj declined $1 1/2 billion, to $56 1/2 billion; it was the first annual decline since 1980. Two factors contributed importantly to the decline. First, 1986 was the first year since the enactment of the Economic Recovery Tax Act of 1981 in which a cohort of the 5-year-recovery class of assets was removed from the depreciation base. Second, prices of capital assets increased considerably less in 1986 than the average rate at which they had increased during the period that the capital stock had been acquired.

Profits by industry.--PBT with IVA and CCAdj is not available by industry; PBT with IVA alone, the best measure of industry profits available, increased $21 1/2 billion in 1986, to $244 billion. Domestic profits of nonfinancial corporations increased $9 1/2 billion; domestic profits of financial corporations, $8 1/2 billion; and profits from the rest of the world, $3 1/2 billion.

For nonfinancial corporations, profits of communications and utilities increased sharply; manufacturing profits increased $3 billion, with individual manufacturing industries registering changes ranging from negative $4 1/2 billion (petroleum) to $3 billion (chemicals).

In communications, the increase in profits was shared by both local phone companies and long distance carriers. Profits were boosted by productivity increases and by contributions of subsidiaries in fields ranging from publishing to finance.

The decline in petroleum prices contributed to smaller losses in primary metals and to higher profits in utilities and chemicals--industries that use large amounts of petroleum as boiler fuel and feedstock. In primary metals, a major producer's application for bankruptcy protection also contributed to profits by lowering costs of debt service and pension funding; in addition, a long strike at a major steel producer classified in the petroleum industry probably resulted in increased demand for steel from other producers that are classified in primary metals. In chemicals, profits were also boosted by higher rates of capacity utilization and increased foreign demand; profits in 1986 were the highest since 1981 and followed a very depressed 1985. Because many refiners are deeply involved in petroleum exploration and development, the large drop in crude oil prices was reflected in sharply lower refiners' profits --the fifth consecutive year of sharp decline. From a level of $36 1/2 billion in 1981, petroleum profits dropped to $8 1/2 billion in 1986.

Profits increased $3 billion in food manufacturing and declined almost as much in tobacco manufacturing. As a result of major merger and acquisition activity, a substantial portion of the tobacco industry (and tobacco profits) was moved into the food industry. The increased profits in food also reflected declines in prices of farm products. For example, prices received by farmers for food grains dropped 18 percent; for fruit, 8 percent.

The $8 1/2 billion increase in domestic profits of financial corporations was accounted for largely by property /casualty insurance companies, which recorded positive profits after 2 years of losses. In 1986, premiums increased 20 percent while claims and related expenses increased 13 percent, producing sharply lower underwriting losses and accounting for most of the improvement in profits; investment income (dividends and interest) increased moderately. The largest reductions in underwriting losses were registered in commercial multiperil, homeowners' multiperil, and automobile insurance. Premium increases were sharp for the first of these and modest for the second; for both types, claims fell, reflecting an unusually small number of natural catastrophes. In automobile insurance, most of the reduction in underwriting loss was attributable to commercial, as opposed to private, insurance. The only major line of property/casualty insurance not experiencing improved underwriting results was workers' compensation insurance.

The $3 1/2 billion increase in rest-of-world profits reflected both increased receipts and (more importantly) reduced payments. A decline in receipts from foreign petroleum subsidiaries of U.S. corporations was more than offset by an increase in receipts from nonpetroleum subsidiaries, especially those located in Europe and Japan. The drop in payments was concentrated in the third quarter, and was especially pronounced in petroleum, banking, and wholesale trade subsidiaries of foreign corporations; by area, payments to the six original members of the European Economic Communities and to Canada declined most, more than accounting for the drop in total payments.

Table: 1.--Recent Patterns in Real Business Inventories and Final Sales

Table: 2.--Real Personal Consumption Expenditures

Table: 3.--Real Gross Private Domestic Fixed Investment

Table: 4.--Change in Real Business Inventories

Table: 5.--Real Net Exports of Goods and Services

Table: 6.--Real Government Purchases of Goods and Services

Table: 7.--Price Indexes (Fixed Weights): Change From Preceding Quarter

Table: 8.--Personal Income and Its Disposition: Change From Preceding Quarter

Table: 9.--Personal Tax and Nontax Payments: Change From Preceding Quarter

Photo: CHART 1 Selected Measures: Change From Preceding Quarter

Photo: CHART 2 Retail Sales of New Cars

Photo: CHART 3 Housing Starts

Photo: CHART 4 Selected Interest Rates

Photo: CHART 5 Profits From Current Production
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Title Annotation:4th quarter, 1986
Publication:Survey of Current Business
Date:Apr 1, 1987
Words:5785
Previous Article:Constant-dollar inventories, sales, and inventory-sale ratios for manufacturing and trade.
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