Commentary on Today’s GDP by Rex Nutting.

ECONOMIC REPORT
U.S. economy suffers fourth-quarter contraction Revisions show spending slower, profits higher than previously thought

By Rex Nutting, MarketWatch
Last update: 9:01 a.m. EDT July 31, 2008Comments: 59WASHINGTON (MarketWatch) —

The U.S. economy contracted in the fourth quarter of 2007, the first quarter of negative growth since the 2001 recession, the Commerce Department said Thursday in its annual revision to gross domestic product.

Real GDP fell 0.2% in the quarter; a 0.6% increase had previously been reported. Many economists who think the economy is in recession believe it began in the fourth quarter.

Growth in the first quarter of 2008 was revised down a tenth of a percentage point to 0.9%. The economy grew 1.9% in the second quarter, the department said. See full story.

It’s a common (but mistaken) belief that a recession is defined by two consecutive quarters of negative GDP. The revisions encompass better and more up-to-date data from sources not available when the government fixes its quarterly estimates. Read the full report.

Recession redefined

It’s a common (but mistaken) belief that a recession is defined by two consecutive quarters of negative GDP. The actual working definition is “a significant decline in economic activity lasting more than a few months,” usually seen in GDP as well as monthly data on job growth, income growth, industrial output and business sales.

All four of the monthly indicators are flashing recession signs.

The fourth quarter was particularly weak. Gross domestic purchases — a gauge of domestic demand — fell at a 1% annual rate, the biggest drop in 17 years. Another measure of domestic spending — final sales to domestic purchasers — fell 0.1%, the first decline since 1991. Consumer spending rose at a 1% annual rate, the slowest growth since 1995, while investment in housing fell at a 27% annual rate, the worst decline since 1981.

Modest growth

The annual revisions don’t change the overall view of the economy: From 2004 through 2007, the economy grew at an annual rate of 2.6%, a tenth of a percentage point slower than earlier estimates. Growth was revised lower in all three years covered by the annual revision, with 2007 now coming in at 2%, rather than 2.2%.
Most economists believe the economy’s long-run sustainable growth rate is 2.5% to 2.75% per year. Eight of the 12 quarters were revised lower, three were revised higher, and one was unchanged.

Some of the details look a little different. Over the past three years, consumption was a bit weaker than assumed, while business investment was slightly better. The housing collapse was worse than thought. Profits and income from assets were higher, while wages and salaries were lower.

Consumer spending has averaged 3% growth over the past three years. Business investment was revised up to a 6.5% pace from 6.1%. Disposable personal incomes rose 2.6%, unrevised. Profits were revised higher for all three years, by a cumulative $237.1 billion. Profits in the financial industries were lowered by a cumulative $61 billion, while profits from nonfinancial companies were revised up by $254 billion over the three years.

Before the revisions, profits had been at historic highs in relation to national income. Some of those profits flowed through to the owners. Income from assets was revised up by a total of $61 billion for the three years. Meanwhile, the compensation of workers was revised lower by $47 billion. Most of the decrease in compensation was accounted for by smaller health-care benefits due to lower-than-assumed medical payments made by bosses on behalf of their employees.

Taking a slightly longer view, the revisions show that the recovery after the 2001 recession, already the weakest post-World War II expansion, was even weaker than believed. Growth averaged 2.6% — not 2.7% — since the recession, compared with the average of about 3.2% in typical recoveries.

Rex Nutting is Washington bureau chief of MarketWatch.