Are Corporate Profits the GDP’s Odd Man Out?

The latest data from the U.S. Bureau of Economic Analysis confirm that the nation’s economy barely grew in the fourth quarter of 2012. However, despite the weak economy, corporate profits as a share of GDP hit their second highest level ever.

Based on the latest data, the BEA revised fourth-quarter real GDP growth upward from an annual rate of 0.1 percent to 0.4 percent, still the second-slowest quarterly growth since the recovery began in 2009. The following table compares the latest revision to the second estimate released last month:

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Consumer spending was weaker than previously reported, with durable goods accounting for most of the growth that did take place. Fixed investment was a relative bright spot, led by business equipment and computers…

However, growth of fixed investment was almost wholly offset by a decrease in non-farm inventories. The BEA data provides no direct indication of the motive for inventory change, but it is easy to imagine that at least some businesses were showing caution about restocking in view of anticipated tax increases and cuts in government spending for early 2013.

In fact, as the table shows, fiscal tightening had already started in the fourth quarter. Decreasing government consumption expenditure and gross investment contributed a negative 1.41 percentage points to GDP growth in the quarter. A decrease in defense spending accounted for most of that, but falling state and local spending also accounted for -0.18 percentage points.

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As the following chart shows, government spending (more exactly, government consumption and gross investment) has been a negative factor throughout much of the recovery. In view of the outcome of the fiscal cliff negotiations and sequester, that trend will almost certainly continue in 2013.

The BEA report confirmed that exports fell in the fourth quarter of 2012 for the first time since the first quarter of 2009, although the decrease was not quite as great as previously reported. The positive contribution of net exports to GDP growth was entirely due to a decrease in imports. (Imports are entered in the GDP accounts with a negative sign, so the positive 0.73 percentage point change shown in the table indicates a decrease.)

Despite the generally downbeat GDP data, corporate profits were strong in the last quarter of the year. As the next chart shows, both before-tax and after-tax profits, stated as a percentage of GDP, reached their second-highest level ever recorded, falling just short of their all-time highs of the fourth quarter of 2011.

The ability of corporations to squeeze out increasing profits in the face of a stagnating economy has no doubt been one of the factors supporting the strong performance of the stock market. Evidently, investors are expecting that trend to continue in the first quarter of 2013.

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As the BEA press release states, the latest revision of fourth-quarter data does little to change the overall picture of the economy in the period. We will get to see the next batch of data, which will provide a much-anticipated advance look at the first quarter of 2013, on April 26.

Ed Dolan is Wall St. Cheat Sheet’s in-house economics professor. He is the author of an acclaimed series of textbooks Introduction to Economics and Ed Dolan’s Econ Blog.

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