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The business situation.

the BUSINESS SITUATION

SOURCE data that became available for the 75-day estimate of the fourth quarter of 1985 rounded out the view of economic developments provided by the national income and product accounts (NIPA's).1 Data on domestic corporate profits become available for the fourth quarter at the time of the 75-day, rather than the 45-day, estimate because most corporations' fiscal years end in the fourth quarter and additional time is needed to complete their end-of-year reports. This information, in combination with information on international investment income from surveys and other quarterly reports, provided the basis for the first direct estimate of fourth-quarter corporate profits on a NIPA basis. The corporate profits estimates, in turn, made it possible to estimate profits taxes and thus to complete the estimates of the receipts side of the government sector accounts, providing --in conjunction with the expenditures side--a full view of the government fiscal position. Fourth-quarter developments in corporate profits and in the government sector are discussed in the first two sections of the "Business Situation.'

1. The "flash' estimate of GNP, which had been prepared at the same time as the 75-day estimates, has been discontinued.

December data on merchandise trade on the revised statistical month basis became available for the 75-day estimate of the net exports component of GNP. (These data more than accounted for the revision from the 45-day to the 75-day estimate of GNP; see table 2 at the end of the "Business Situation.') In addition, the estimate of net exports incorporated the information on investment income already mentioned and newly available information on other services. This information is initially assembled for the international transactions accounts-- often referred to as the balance of payments accounts--and incorporated in the NIPA's after several adjustments. (See table 1 on page 6 for a reconciliation of NIPA net exports and the corresponding measure in the balance of payments accounts.) The article "U.S. International Transactions' in this issue provides an in-depth review of the fourth quarter and year 1985 in terms of the balance of payments. The third section of the "Business Situation' uses NIPA aggregates to provide a longer run overview of international developments in a NIPA framework.

Corporate profits

Profits from current production-- profits before tax plus inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)-- were unchanged, at $309 billion, in the fourth quarter, following a $21 billion increase in the third. A decline in domestic profits of nonfinancial corporations offset increases in domestic profits of financial corporations and in profits from the rest of the world.2

2. Quarterly estimates in the NIPA's 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.

Domestic profits of nonfinancial corporations declined $5 1/2 billion in the fourth quarter, following a $21 billion increase in the third, as the effect of a 2-percent increase in real gross corporate product was more than offset by that of a drop in profits per unit of product. The drop in unit profits, in turn, reflected a smaller increase in unit prices than in unit costs; unit labor costs fully accounted for the cost increase, as unit nonlabor costs were unchanged.

Domestic profits of financial corporations increased $1 billion in the fourth quarter, following a $1 1/2 billion increase in the third. Profits from the rest of the world increased $4 1/2 billion, following a decline of $1 1/2 billion.

The current quarterly estimates of profits from current production and the other measures of profits estimated in the NIPA framework are prepared by extrapolation using tabulations of samples of corporate financial reports. Special adjustments to account for charges not attributable to current production were unusually large in the third and fourth quarters; they are discussed in the note at the end of this section.

Profits before tax.--Profits before tax (PBT) increased $11 1/2 billion in the fourth quarter, to $240 billion, following a $10 billion increase. The contrast between the flatness in profits from current production and the increase in PBT reflects changes in the IVA, which declined $15 billion to negative $10 billion, and in the CCAdj, which increased $3 1/2 billion to $79 1/2 billion; both of these adjustments are reflected in the current production measure but not in PBT.

The IVA converts the value of inventory withdrawals from the mixture of historical and replacement costs that underlie PBT to current replacement costs. When, as in the fourth quarter, current replacement costs of inventory withdrawals are higher than the costs that underlie PBT, the IVA is negative in order to remove the resulting capital-gains-like element.

The CCAdj converts depreciation charges from those that underlie PBT to a consistent accounting basis (i.e., straight-line depreciation and uniform service lives) and to current replacement costs. The fourth-quarter increase in the CCAdj was largely due to the effect of the Economic Recovery Tax Act of 1981, which allowed shorter service lives for depreciable capital. The increase was considerably smaller than in many earlier quarters, reflecting depreciation charges that corporations reported in the fourth quarter.

Profits with IVA but without CCAdj.--The measure of profits available by industry declined $3 1/2 billion in the fourth quarter, following a $12 1/2 billion increase.

An $8 1/2 billion drop in the profits of nonfinancial corporations was fully accounted for by a drop in trade profits. Both wholesale and retail trade registered large declines because of increased inventory prices; without the IVA, both would have registered increases. In manufacturing, large changes were recorded for producers of motor vehicles and chemicals. Motor vehicles profits increased $3 billion, partly reflecting reduced costs of sales-incentive programs. Chemicals profits dropped $2 billion; the decline was industry-wide, affecting producers regardless of firm size or type of chemical produced.

A $1 billion increase in the profits of financial corporations reflected an increase in profits of depository institutions that was partly offset by increased losses of insurance carriers.

Profits from the rest of the world increased $4 1/2 billion, reflecting, in roughly equal amounts, increased profits of foreign affiliates of U.S. corporations and decreased profits of U.S. affiliates of foreign corporations.

Special adjustments.--Special adjustments relating to the extrapolation of current quarterly estimates on the basis of corporate financial reports were unusually large in the third and fourth quarters. As a result, the differences between the NIPA measures of profits and the corresponding measures in corporations' financial reports were unusually large.

Corporations typically report the bulk of their charges for items such as asset writedowns and anticipated expenses associated with plant closings and corporate restructurings-- the discontinuation of product lines, the divestment of subsidiaries, etc.-- in the fourth quarter. In 1985, as in 1984, many such charges were reported in both the third and fourth quarters. A number of explanations, not necessarily mutually exclusive, have been offered for the unusually large amounts of special charges recently. They have been interpreted as a reaction to what are viewed as the excesses of the conglomerate movement of the late 1970's, as a defensive strategy aimed at fending off hostile corporate takeovers, and as an effort to take advantage of the third-quarter 1985 upturn in the stock market.

These charges substantially reduced profits in financial reports. Because these charges are not attributable to current production, BEA adjusted the tabulations of samples of financial reports, where necessary, to remove their effect from NIPA profits. Without these adjustments, NIPA profits from current production would have been 5-10 percent lower in both the third and fourth quarters.

Government sector

The fiscal position of the government sector in the NIPA's deteriorated in the fourth quarter of 1985, as the combined deficit of the Federal Government and of State and local governments increased $20 1/2 billion (table 1). The deterioration was due to an increase in the Federal deficit; the State and local surplus increased $2 1/2 billion.

In 1985, the fiscal position of the government sector registered sharp quarterly fluctuations, reflecting an unusual pattern of refund payments on 1984 Federal personal income taxes. Refund payments, which are netted against tax payments in calculating personal tax and nontax receipts, were delayed in the first quarter by $27 1/2 billion due to computer problems at processing centers, and personal tax payments were unusually large in the quarter. In the second quarter, the catchup in refund payments led to a large decline in tax payments. The catchup also affected the third-quarter change, but not the level, of tax payments. A comparison with a year earlier removes the effects of these fluctuations: The fourth-quarter 1985 combined government sector deficit of $165 billion was $38 billion higher than a year ago, due to a $31 1/2 billion increase in the Federal deficit and a $6 1/2 billion decline in the State and local surplus.

The Federal sector.--The Federal Government deficit increased $23 billion in the fourth quarter to $224 billion, as expenditures increased more than receipts.

Receipts increased $15 1/2 billion, compared with $36 billion in the third quarter. All categories of receipts increased in the fourth quarter. The increase in personal tax and nontax receipts ($7 billion) and in contributions for social insurance ($5 billion) reflected strong gains in incomes. The increase in indirect business tax and nontax accruals includes $1 billion from an increase in the alcohol excise tax to $12.50, from $10.50, per gallon of 100-proof liquor, effective October 1.

Expenditures increased $38 1/2 billion, compared with $28 billion in the third quarter. Purchases of goods and services, which amounted to slightly more than 35 percent of total expenditures, accounted for over 50 percent of the fourth-quarter increase. Nondefense purchases increased $17 1/2 billion; defense purchases, $2 billion. Purchases of agricultural commodities by the Commodity Credit Corporation (CCC) accounted for the increase in nondefense purchases. The CCC's net acquisition of agricultural commodities was a record $30 billion ($33 1/2 billion in real terms) and included $13 1/2 billion of corn, $5 1/2 billion of soybeans, and $3 billion of cotton. (The previous high net acquisition was $15 1/2 billion ($17 billion in real terms) in the fourth quarter of 1982). The small increase in national defense purchases followed a $14 billion increase in the third quarter; the sharp deceleration was more than accounted for by purchases of military hardware. These purchases declined $5 1/2 billion in the fourth quarter, in contrast to an $8 1/2 billion increase in the third.

All other expenditures combined increased $18 1/2 billion. Of a $10 billion increase in subsidies less the current surplus of government enterprises, subsidy payments to farmers accounted for $6 billion; an increase in the CCC enterprise deficit accounted for the remainder. Net interest paid increased $6 billion, reflecting an increase in borrowings to finance the deficit. Grants-in-aid to State and local governments increased $1 1/2 billion; grants for sewage treatment plant construction and for medicaid accounted for the increase.

Cyclically adjusted surplus or deficit. --When measured using cyclical adjustments based on middle-expansion trend GNP, the Federal fiscal position moved from a deficit of $206 billion in the third quarter to a deficit of $227 billion in the fourth (see the article later in this issue for revised and updated estimates of the cyclically adjusted budget). The cyclically adjusted deficit as a percentage of middle-expansion trend GNP increased from 5.2 percent in the third quarter to 5.6 percent in the fourth.

The State and local sector.--The State and local government surplus increased $2 1/2 billion in the fourth quarter to $59 1/2 billion, as receipts increased more than expenditures. The increase in the total surplus was shared by social insurance funds and other funds.

Receipts increased $8 billion, compared with $12 billion in the third quarter. All categories of receipts increased. The increase in personal tax and nontax receipts reflected a strong increase in incomes, and that in indirect business tax and nontax receipts largely reflected an increase in property taxes.

Expenditures increased $5 1/2 billion, compared with $12 billion in the third quarter. The deceleration was largely accounted for by purchases of goods and services; they increased $5 billion in the fourth quarter, compared with $10 1/2 billion in the third. Compensation of employees more than accounted for the increase in the fourth quarter; all other purchases combined declined $1/2 billion. Purchases of structures declined $4 billion, an $8 billion shift from the third-quarter increase. Declines in all major types of construction purchases were paced by a $3 billion drop in highways.

All other expenditures combined increased $1/2 billion. The increase in the current surplus of government enterprises was the result of a lottery started on October 1 in California.

Real net exports

In the fourth quarter of 1985, real net exports reached a record low of negative $141 billion. From their peak of $74 billion in the third quarter of 1980, net exports declined $215 billion. Over this period, declines were registered in most quarters (chart 1).

Most of the decline in net exports was in 1983-85. From their peak in the third quarter of 1980 to the fourth quarter of 1982, when the trough of the 1981-82 recession was reached, net exports declined $62 1/2 billion.3 Exports declined $47 1/2 billion, at an average annual rate of 5.7 percent, accounting for about three-quarters of the decline in net exports. Imports increased $14 1/2 billion, at a rate of 2.1 percent. Over the next 3 years, a period coincident with the current recovery and expansion, net exports plummeted, turning negative in the second quarter of 1983 and registering a decline of $152 1/2 billion by the fourth quarter of 1985. During this period, imports were by far the more dynamic component; they increased $175 1/2 billion, at an average annual rate of 15.5 percent. By contrast, exports increased only $23 billion, at a rate of 2.3 percent.

3. The trough in real GNP was reached in the third quarter of 1982. The National Bureau of Economic Research places the reference business cycle trough in the fourth quarter.

The divergence in movements of exports and imports led, in turn, to a divergence between rates of growth of real GNP, which includes exports and excludes imports, and real gross domestic purchases, which includes imports and excludes exports. (The quarterly NIPA tables now regularly include a reconciliation of GNP and gross domestic purchases; see NIPA table 1.6.) When net exports are positive, GNP exceeds gross domestic purchases. The gap between the former, a measure of U.S. production, and the latter, a measure of U.S. demand, narrowed from the third quarter of 1980, as net exports declined, but remained positive. After net exports turned negative in the second quarter of 1983, gross domestic purchases exceeded GNP, and the gap between the two generally widened (chart 2). Gross domestic purchases increased at an average annual rate of 5.4 percent since that quarter, and GNP increased at a rate of 4.0 percent.

U.S. demand outpaced U.S. production during most of the 1983-85 period, and an increasing portion of U.S. demand was met by imports. Imports, which met 11 percent of U.S. demand in the second quarter of 1983, met 13 percent by the fourth quarter of 1985.

Another comparison related to net exports is that of real GNP and real command-basis GNP. Command-basis GNP, because it is adjusted for changes in the terms of trade, measures command over goods and services resulting from current production. (The quarterly NIPA tables now regularly include command-basis GNP; see NIPA table 1.11)4

4. The differnece between the two measures stems from the difference in the deflation procedures used for their net exports components. To obtain the constant-dollar measure of net exports for GNP, BEA deflates the current-dollar value of exports by export prices and the current-dollar value of imports by import prices and then subtracts deflated imports from deflated exports. In contrast, to obtain the constant-dollar measure of net exports for command-basis GNP, BEA deflates both current-dollar exports and imports by the implicit price deflator for imports. For a detailed exposition of command counterparts of BEA production measures and their derivation, see Edward F. Denison, "International Transactions in Measures of the Nation's Production,' SURVEY OF CURRENT BUSINESS 61 (May 1981): 17-22.

The difference in the quarterly movements of command-basis GNP and GNP, shown in chart 2, mirrors the impact of changes in the terms of trade. The terms of trade, calculated in this context as the ratio of the exports implicit price deflator to the imports implicit price deflator (multiplied by 100), affect the quantity of foreign goods and services that the United States could buy with its exports. As shown in chart 3, the terms of trade declined in the first half of 1980, continuing a slide under the impact of the 1979 petroleum price increase, and then moved irregularly higher to the fourth quarter of 1983. From the third quarter of 1980 to the fourth of 1983, the exports deflator increased steadily, at an average annual rate of 3.7 percent, while the imports deflator drifted down at a rate of 0.3 percent. The result was improvement in the terms of trade at an average annual rate of 4 percent. Beginning in the fourth quarter of 1983, the improvement slowed sharply: The exports deflator changed little while the imports deflator declined slightly, resulting in improvement at an average annual rate of 0.3 percent.

Over the early part of the 1980-85 period, when the terms of trade registered strong improvement, command-basis GNP increased at an average annual rate of 2.4 percent, and GNP increased at a rate of 1.9 percent. Since then, when the rate of improvement in the terms of trade was much less, the average annual rates of growth of command-basis GNP and GNP were about the same. Thus, only in the early part of the period did U.S. command over goods and services increase faster than production.

Fourth-quarter NIPA revisions

The 75-day revisions of the NIPA estimates for the fourth quarter of 1985 are shown in table 2.

Table: 1.--Government Sector Receipts and Expenditures: Change from Preceding Quarter

Table: CHART 1 Exports, Imports, Net Exports, and Merchandise Trade Balance

Table: CHART 2 GNP, Command-Basis GNP, and Gross Domestic Purchases

Table: CHART 3 Terms of Trade

Table: 2.--Revisions in Selected Component Series of the NIPA's, Fourth Quarter of 1985

Table: 1.--Relation of Net Exports of Goods and Services in the National Income and Product Accounts (NIPA's) to Balance on Goods and Services in the Balance of Payments Accounts (BPA's)
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Title Annotation:Fourth Quarter 1985
Publication:Survey of Current Business
Date:Mar 1, 1986
Words:3157
Previous Article:Plant and equipment expenditures by business for pollution abatement, revised estimates for 1973-83; estimates for 1984.
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