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The business situation.

NATIONAL income and product account (NIPA) estimates for the first quarter of 1991 paint a picture of the U.S. economy in recession. Real GNP declined 2.8 percent after declining 1.6 percent in the fourth quarter of 1990, and real gross domestic purchases declined 3.8 percent after declining 5.1 percent (chart 1). (1) The last time either of these aggregates registered two consecutive quarterly declines was in the recession of 1981-82.

The recession's impact is also apparent in NIPA estimates of income. Personal income posted its smallest quarterly increase since the 1973-75 recession, and real disposable personal income declined for the third consecutive quarter.

Inflation as measured by the (fixed-weight) price index for gross domestic purchases slowed to 3.6 percent in the first quarter from 6.3 percent in the fourth. However, the price index for gross domestic purchases less food and energy--which is frequently used as an estimate of the underlying rate of inflation in the economy--accelerated to a 5.5-percent increase from a 3.9-percent increase; about one-third of the acceleration reflected a pay raise for Federal military and civilian personnel.

The declines in GNP in both the fourth and first quarters were more than accounted for by drops in motor vehicle and construction output. In percentage terms, the weakness in motor vehicle output was especially pronounced; output declined 50.7 percent in the fourth quarter and 42.4 percent in the first. Growth of GNP less motor vehicles and construction was moderate (2.5 percent) in the fourth quarter and weak (0.8 percent) in the first (table 1). (2)

The major components of GNP will be discussed in the May "Business Situation." In summary, personal consumption expenditures, fixed investment, and government purchases declined in the first quarter.

* In personal consumption expenditures, motor vehicles accounted for the drop.

* In fixed investment, almost every major component declined.

* In government purchases, both Federal purchases and State and local purchases declined.

The declines in these three components were partly offset by a moderate increase in net exports and by a small increase in inventory investment (change in business inventories) that resulted from a slowing in the rate of inventory liquidation.

Motor vehicles.--The motor vehicle industry weakened further in the first


quarter. Both production and sales declined for the second consecutive quarter; in terms of units, they declined to the lowest levels since the end of the 1981-82 recession. Inventories remained low.

Domestic car production fell to 5.1 million units (seasonally adjusted annual rate) in the first quarter from 5.6 million in the fourth and 6.9 million in the third. (Manufacturers' production schedules call for a small increase in the second quarter.) Domestic car sales dropped to 6.0 million in the first quarter from 6.6 million in the fourth and 7.2 million in the third. The sharp cuts in production in the last two quarters have kept inventories low: Domestic car inventories declined to 1.1 million at the end of the first quarter from 1.3 million at the end of the fourth. The inventory-sales ratio edged down to 2.1 in the first quarter from 2.3 in the fourth (the industry target is about 2.4).

Car sales to both businesses and consumers declined in the first quarter; most of the weakness was in consumer purchases. The decline in consumer sales reflected the weakness in many of the general factors usually associated with consumer spending. Real disposable personal income declined for the third consecutive quarter, the unemployment rate increased--to its highest level in 4 years--for the third consecutive quarter, and the Index of Consumer Sentiment (prepared by the University of Michigan's Survey Research Center) remained low, despite its first increase in five quarters.

In addition, the decline in consumer sales reflected several factors specific to the motor vehicle industry. New-car prices jumped in the first quarter, at least partly reflecting a scaling back of sales-incentive programs offered by domestic manufacturers and the imposition of a tax on luxury cars in January. Moreover, some consumers appear to have purchased used cars instead of new cars. Manufacturers made available to consumers many of the cars that they had repurchased from businesses as part of attractive fleet-marketing programs offered in the second half of 1990; these repurchased vehicles, known as program cars, have fewer miles and more optional equipment than most used cars and are less expensive than most new cars. Inventories and sales of program cars have become so important in recent quarters that one domestic manufacturer plans to establish dealerships, on a trial basis, that offer only program cars.

Sales of imported cars fell to 2.2 million units in the first quarter from 2.4 million in the fourth.

Sales of new trucks fell to 3.8 million in the first quarter from 4.3 million in the fourth. Light domestic truck sales accounted for most of the decline, but sales of other domestic trucks and of imported trucks also declined. Inventories declined for the third consecutive quarter, reflecting a sharp cutback in the production of domestic trucks.


The price index for gross domestic purchases and the price index for GNP (both with fixed weights) show different pictures of inflation in the U.S. economy in the first quarter. The price index for gross domestic purchases increased 3.6 percent, down from a 6.3-percent increase; in contrast, the price index for GNP increased 5.1 percent, up from a 4.7-percent increase (table 2).

For many applications, the price index for gross domestic purchases is preferable to the GNP price index as a measure of U.S. inflation because it measures prices of goods and services purchased. (Export prices are included in GNP prices but not in gross domestic purchases prices; import prices are subtracted out in deriving GNP


prices but not in deriving gross domestic purchases prices.) For the past four quarters, larger-than-usual differences between the increases in these two price indexes have reflected large, erratic movements in import prices; export prices have increased moderately. The sharp movements in import prices are largely traceable to petroleum prices, which surged following the Iraqi invasion of Kuwait.

The first-quarter deceleration in gross domestic purchases prices was largely attributable to the plunge in energy prices. Food prices accelerated. As was mentioned earlier, gross domestic purchases less food and energy prices, which may be viewed as a measure of the underlying inflation rate in the U.S. economy, increased 5.5 percent after increasing 3.9 percent (chart 2).

Prices of personal consumption expenditures (PCE) increased 3.2 percent after increasing 7.1 percent. The deceleration was more than accounted for by energy prices. PCE food prices increased 6.5 percent, up from a 4.9-percent increase, partly reflecting an increase in Federal excise taxes on alcohol that took effect in January. "Other PCE" prices increased 5.3 percent after a 4.2-percent increase; the pickup partly reflected an acceleration in the price of new cars and an increase in postal rates.

Among the components of fixed investment, the prices of nonresidential structures and of producers' durable equipment increased about the same as in the fourth quarter; prices of residential structures edged up after a small decline.

Prices of government purchases slowed to a 4.8-percent increase after increasing 6.1 percent. Prices paid by the Federal Government increased 7.7 percent after increasing 5.7 percent; the step-up was more than accounted for by a 4.1-percent Federal pay raise for military and civilian personnel. (Such increases in employee compensation are treated in the NIPA's as an increase in the price of employee services purchased by the Federal Government.) The pay raise accounted for 0.5 percentage point of the first-quarter increase in the price indexes for gross domestic purchases and for GNP. Prices paid by State and local governments increased 2.9 percent after increasing 6.4 percent; the deceleration reflected lower energy prices.

Personal income

Real disposable personal income declined 1.6 percent in the first quarter after declining 3.5 percent in the fourth and 0.7 percent in the third (chart 3). Personal income, which in the NIPA's is only available in current dollars, increased $16.7 billion in the first quarter, much less than in the past several quarters (table 3). Personal income excluding transfer payments declined.

Wage and salary disbursements increased only slightly in both the first quarter ($2.4 billion) and in the fourth ($4.7 billion). Except for services, all the major private industry components of wages and salaries declined in both quarters; weakness was particularly evident in construction and in motor vehicle manufacturing. The declines reflected drops in employment and in average weekly hours. (The number of payroll jobs has declined by 1.3 million since September 1990, and hours in the nonfarm business sector have declined for three consecutive quarters.) Government wages and salaries, boosted $4.8 billion by the pay raise for Federal civilian and military personnel, increased more than in the fourth quarter. Operations Desert Shield and Desert Storm added about $0.9 billion to military compensation (mainly pay to reservists and hazardous duty pay) in the first quarter, a little more than in the fourth.

Farm proprietors' income declined $1.8 billion after increasing $6.4 billion. The downswing was entirely due to Federal farm subsidy payments. Subsidies declined $3.9 billion after jumping $10.7 billion in the fourth quarter, when Conservation Reserve payments and deficiency payments registered strong increases. (Conservation Reserve payments compensate land owners who devote their land to conserving uses under a long-term contract; deficiency payments are made when the market price of a crop is, or is projected to be, below the Federal target price.) Farm income excluding subsidies increased $2.1 billion in the first quarter after declining in the three preceding quarters; the turnabout largely reflected an upswing in crop prices. Nonfarm proprietors' income declined, reflecting weakness in residential construction and in wholesale and retail trade.

Transfer payments increased $29.7 billion after increasing $18.7 billion. The step-up was due to cost-of-living adjustments (COLA's) to benefits under social security and several other Federal retirement and income support programs; the COLA's, which became effective in January, added $17.8 billion to transfer payments.


Among the other components of personal income, other labor income increased about as much as in the fourth quarter, and personal dividend income was unchanged. Personal interest income declined, reflecting recent drops in interest rates. Rental income declined after an increase; the decline mainly reflected a drop in royalty income that resulted from lower oil prices.

Personal contributions for social insurance, which are subtracted in deriving the personal income total, increased $8.2 billion after increasing $0.3 billion. The first-quarter increase was largely due to several program changes:

* An increase in the social security taxable wage base for employees from $51,300 to $53,400,

* Increases in the rate and taxable base for social security contributions paid by the self-employed,

* An increase in the medicare taxable wage base from $51,300 to $125,000, and

* An increase in the monthly premium for supplementary medical insurance.

Personal tax and nontax payments increased $1.7 billion after increasing $7.1 billion. The slowdown reflected both slower growth in the taxable earnings base and an adjustment to the 1991 withholding tables for Federal income tax to reflect the indexing provisions of the tax law.

Personal outlays (largely PCE) increased slightly more than disposable personal income, and thus personal saving declined. The personal saving rate dipped 0.1 percentage point to 4.1 percent.

Corporate Profits and

Property Income in 1990

Profits from current production--profits before tax plus inventory valuation adjustment and capital consumption adjustment--declined $13.3 billion in 1990, to $298.3 billion, after declining $26.0 billion in 1989 (table 4). The last time profits declined for 2 years in a row was in 1969-70.

Profits of domestic nonfinancial corporations dropped $21.5 billion after dropping $25.0 billion. Both declines reflected drops in unit profits that resulted from smaller increases in prices than in costs. Unit prices increased 3.7 percent in both years; unit costs increased 5.3 percent in 1989 and 4.8 percent in 1990.

Profits of domestic financial corporations increased $2.1 billion after declining $8.6 billion. Profits of insurance companies rebounded somewhat after having been hard hit in 1989 by claims arising from Hurricane Hugo and the Loma Prieta earthquake. Profits of savings and loan associations improved, largely reflecting the transfer of insolvent thrifts to the Resolution Trust Corporation.

Profits from the rest of the world increased $6.0 billion after increasing $7.6 billion. Much of the change in 1990 reflected a drop in profits earned by U.S. affiliates of foreign corporations, which are subtracted in calculating rest-of-the-world profits.

Related measures.--Cash flow from current product, a profits-related measure of internally generated funds available to corporations for investment, declined $4.1 billion in 1990 after declining $14.1 billion in 1989. As a percentage of nonresidential fixed investment, cash flow was 75.4 percent in 1990, down from 78.0 percent in 1989. In 1986-89, cash flow averaged 85.6 percent of nonresidential fixed investment.


Profits before tax (PBT) declined $3.0 billion after declining $9.0 billion. The much smaller declines in PBT than in profits from current production in both 1989 and 1990 reflected declines in the capital consumption adjustment (CCAdj) that were only partly offset by increases in the inventory valuation adjustment.

The CCAdj is the difference between the predominantly tax-based depreciation measure that underlies PBT, on the one hand, and BEA's estimate of economic depreciation, on the other.

The CCADj declined $20.6 billion in 1990 after declining $22.3 billion in 1989. These declines reflected the continuing impact of the Tax Reform Act of 1986 (TRA) on the calculation of depreciation for tax purposes; the TRA mandates that longer service lives be used in calculating tax-based depreciation. (However, these service lives are still shorter than those used in estimating economic depreciation.) As


assets subject to the TRA have replaced assets with shorter tax service lives in the stock of depreciable assets, the CCAdj has declined. Most of the assets in the stock of depreciable assets are now subject to the TRA, and the downtrend in the CCAdj is expected to reverse itself in the next year or two.

The inventory valuation adjustment is an estimate of the inventory profits that are included in PBT, with the sign reversed. Inventory profits declined $10.3 billion in 1990 after declining $5.3 billion in 1989. The declines reflected a slowing in the rate of increase of prices of inventoried goods held by corporations using non-LIFO inventory methods. For example, in 1990 the increase in the Producer Price Index, a major source of information on inventory prices, slowed to 3.7 percent from 5.0 percent.

Property income

Corporate property income consists of net interest payments as well as profits from current production. For domestic nonfinancial corporations, net interest payments increased $7.9 billion in 1990 after increasing $22.5 billion in 1989.

Chart 4 and table 5 provide a perspective on the recent increases in both types of property income. From 1970 to 1990, both types trended up, but the upward trend in net interest--an average annual rate of increase of 10.6 percent--was stronger than that in profits--an average annual rate of increase of 7.2 percent. As a result, the share of net interest in property income rose from 23.6 percent in 1970 to 36.7 percent in 1990. It is also worth noting that profits showed more sensitivity to the business cycle than did net interest: Profits declined markedly in the recession years of 1974, 1980, 1982, as well as in 1989 and 1990, when economic growth slowed; in contrast, net interest increased in each of these years.

A perspective can also be gained by examining property income in relation to the net reproducible assets and domestic income of domestic nonfinancial corporations. (Net reproducible assets consists of fixed capital stock and inventories, both measured at current replacement cost; domestic income is property income plus compensation of emplyees.) The ratio of property income to the value of net reproducible assets is the rate of return on these assets--that is, the rate of return, or yield, on "capital." A rate of return


calculated in this way is an estimate of the profitability of new investment (assuming no change in the mix). The use of property income, rather than profits alone, as the numerator of this ratio reflects the assumption that a corporation's decision to invest in plant, equipment, and inventories depends on its estimate of the income stream that will flow from that investment. Given that estimate, the decision on whether to finance the investment out of equity or debt--that is, whether the income stream will take the form of profits or of interest--is a separate question, one presumably determined by financial considerations. (Rates of return can be calculated in many other ways; several are discussed in some detail in the April 1989 SURVEY.)

The ratio of property income to domestic income is property income's share of domestic income--that is, the fraction of domestic income that is not used to compensate labor. Property income's share is related to the rate of return by a third ratio--the ratio of domestic income to the value of net reproducible assets, which measures the average annual product per dollar of capital. (It should be noted that this ratio is not appropriate for use in productivity analysis; for productivity analysis, the denominator should measure capital services, not capital stock.)

The three ratios are plotted for 1970-90 in chart 5 and are reported, along with related ratios, for 1948-90 in table 6. From the table, it seems clear that shifts in the rate of return (column 1) and in property income's share (column 6) occurred around 1970. The rate of return fell from an average of 12.6 percent in 1948-69 to an average of 8.6 percent in 1970-89; property income's share fell from an average of 21.4 percent to an average of 16.4 percent. These declines are traceable to profits; net interest's rate of return (column 5) and its share of domestic income (column 8) increased. The occurrence of the shifts at about the time that the ratios would be expected to fall for cyclical reasons complicates both the dating and the explanation of the shifts.

In 1990, property income's rate of return and its share of domestic income fell to the lowest levels since 1983 and 1982, respectively. Lower profits were responsible for the declines in both ratios.

(1) The regularly featured estimate of real GNP is based on 1982 weights. An alternative estimate of real GNP growth based on more current weights can be calculated using the change in the chain price index, which is published in table 8.1 of the "Selected NIPA Tables." This alternative measure declined 2.4 percent in the first quarter after declining 2.6 percent in the fourth Growth of real GNP in 1987 dollars, another measure based on more current weights, will be published in "Reconciliation and Other Special Tables" in the May SURVEY OF CURRENT BUSINESS.

(2) The output of the motor vehicle industry is derived by summing auto output (table 1.18) and truck output (table 1.20). The output of the construction industry may be approximated by "structures," shown in table 1.4 of the "Selected NIPA Tables." This approximation excludes maintenance and repair construction and includes brokers' commissions on the sale of structures as well as mining exploration, shafts, and wells; nevertheless, it probably tracks movements in construction output closely. The value of motor vehicle and construction output includes the value of inputs, such as steel, obtained from other industries and from foreign suppliers as imports.
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Title Annotation:first quarter of 1991
Publication:Survey of Current Business
Date:Apr 1, 1991
Previous Article:U.S. international transactions, fourth quarter and year 1990.
Next Article:Gross national product by industry, 1987-89.

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