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The business situation.

PROFITS from current production fell $21 1/2 billion in the first quarter. of 1989-the largest decline in 7 years.' Profits before tax (PBT), in contrast, declined only $'/2 billion. Domestic nonfinancial corporations accounted for these declines; profits of domestic financial corporations and of the rest of the world registered very small offsetting movements.

The following discussion focuses on nonfinancial corporations, where unit profits from current production fell sharply, more than offsetting the effect of a slight increase in real product. The decline in unit profits reflected a smaller increase in unit prices than in unit costs; both labor and nonlabor unit costs increased (table 7.18 of "Selected NIPA Tables").

Nonfinancial corporations.-Profits from current production includes two adjustments that are not included in PBT-namely, the inventory valuation adjustment (IVA), which declined $15 billion, and the capital consumption adjustment (CCAdj), which declined $6 1/2 billion.

The decline in the IVA, to negative $34 billion, mirrored an increase in inventory profits that resulted from an acceleration in inventory prices. For example, theProducer Price Index, whose components are major sources for estimating inventory prices, increased 9 percent (annual rate) in the first quarter, following a 2-percent increase in the fourth. Although the most dramatic step-up in prices was in crude materials (reflecting an almost 150-percent increase in crude petroleum prices), step-ups were substantial in all major stages of processing and in many industrial commodities.

The CCAdj is the difference between historical-cost depreciation based largely on tax accounting and replacement-cost economic depreciation as estimated by BEA. The first-quarter decline in the CCAdj reflected the continuing impact of the Tax Reform Act of 1986, which lengthened the service lives used in calculating most depreciation allowances for tax purposes. The CCAdj-which, in the first quarter, was $25 1/2 billion for domestic nonfinancial corporations (and $331/2 billion for all corporations)-is expected to tum negative in the early 1990's.

The sum of the IVA and the CCAdj turned negative in the first quarter of this year; consequently, for the first time since 1982, profits from current production fell below PBT (table 1). PBT exceeded profits from current production through the 197 O's and into the 1980's. In 1983, however, the situation reversed as a result of sharply lower inflation rates and the accelerated de preciation provisions of the Economic Recovery Tax Act of 1981. In the first quarter of this year, a higher inflation rate and the effect of the Tax Reform Act of 1986 combined to produce another reversal.

Although PBT declined $1/2 billion, profits tax liability increased $1 billion, resulting in a $1 1/2 billion drop in profits after tax, Net dividend payments increased $14 1/2 billion, and undistributed profits declined $16 billion. The increase in dividends constituted a rebound from a decline in the fourth quarter of 1988, when net payments had been depressed by a sharp increase in receipts of dividends from the rest of the world. Undistributed profits with IVA and CCAdj and capital consumption allowances with CCAdj comprise cash flow from current production-a measure of internally generated funds available for investment; cash flow declined $32 1/2 billion, the third decline in four quarters. (For all corporations-that is, including domestic financial corporations and the rest of the world sector--cash flow had increased moderately in the preceding three quarters before dropping $21 billion in the first quarter of this year.)

Gross Product by Industry-Special Revision

As previously announced, gross product by industry estimates will not be included in the annual revisions of the national income and product accounts to be presented in the July SURVEY (tables 6.1 and 6.2). They will be delayed until later this year in order to revise the estimates beginning in 1977 to incorporate several improvements.

The revised current-dollar gross product estimates will reflect the estimates of factor payments and nonfactor costs for 1986-88 to be presented next month, The constant-dollar gross product estimates will be revised beginning in 1977 and will reflect the following improvements:

* The use of the double-deflation procedure, in which gross product is derived as the difference between constant-dollar gross output and constant-dollar purchases of materials and services, will be expanded in nonmanufacturing industries.

* The composition of purchase materials and services will be updated in both manufacturing and nonmanufacturing industries.

* The identification of purchased services will be expanded and more appropriate prices used for deflation.

* The import share of purchased materials will be estimated and deflated separately using import prices.

Much of the information for the improvements will be derived from information underlying BEA's published input-output tables for 1977-83 and partially completed tables for 1984-86.

In the comprehensive NIPA revision scheduled for the end of 1990, these improvements will be carried to the estimatesfor earlier years, and additional improvements will be incorporated.

1. The improvements were discussed in 'Gross Product by Industry: Comments on Recent Criticisms," SURVEY OF CURRENT BUSINESS 68 (July 1988): 132-133.

Looking Ahead...

* Computers. An article reviewing the concepts and statistical procedures used by BEA in measuring the output of computers will appear in an upcoming issue of the SURVEY.

*Annua Revisions National Income and Product Accounts. Revised estimates will be presented in the July SURVEY. The revisions cover the 3year period beginning with the first quarter of 1986. Selected data will be available as of July 27. (See also the note on page 2 about the estimates of gross product by industry.)

* U.S. Affiliates of Foreign Companies: Benchmark Survey Results. Data on the operations of foreign-owned U.S. companies in 1987, based on preliminary results of BEA's latest benchmark survey of foreign direct investment in the United States, will be presented in the July SURVEY. Comparable estimates of key items for 1986, analysis of changes in affiliate operations in 1987, and a discussion of the share of the U.S. economy accounted for by affiliates will also be presented.

* Annual Revisions of State Personal Income. State personal income for 1986-88 will be presented in the August SURVEY.
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Title Annotation:first quarter of 1989
Publication:Survey of Current Business
Date:Jun 1, 1989
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