You Decide: Did one-third of the economy disappear?

Published 12:33 pm Monday, August 17, 2020

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By Dr. Mike Walden

The headlines were eye-popping. “Economy shrinks by one-third.”  “All economic growth from the last five-years wiped-out.” “Worse than the Great Depression of the 1930s.” These were some of the reactions to the recent release by the federal government of GDP numbers for the second quarter (April, May and June) of this year.

Before I go any further, what in the world is “GDP?” GDP stands for “gross domestic product.”  Think of GDP as an aggregate production value for the country. It is a number that represents all the economic value generated by all types of businesses – farmers, manufacturers, service companies, educators, etc. and even government – during a specific time period. It is measured in dollars, but those dollars are always adjusted for inflation so the value doesn’t rise just because prices increase.

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There are several uses of GDP. GDP allows us to track the economic size of the country even though the composition of the economy might be changing. GDP is also calculated for most other countries of the world. This allows easy comparisons and rankings of countries using the size of their GDP values.

One of the most significant uses of GDP is in determining recessions and measuring their size. The major condition for a recession to occur is GDP falling for two consecutive quarters (six months). Then, once a recession is designated, the size of GDP’s contraction gives an indication of the recession’s severity.

GDP declined modestly in the first quarter of 2020. With the blockbuster drop in GDP during the second quarter, we have an official recession spanning at least the first half of 2020.

Now let me get back to those headlines. The report from the U.S. Bureau of Economic Analysis (BEA) said GDP fell by 32.9 percent in the second quarter, just a hair under 33 percent, or one-third. With the economy having a GDP of $19 trillion at the end of the first quarter, does this mean we lost a third of that – amounting to $6.3 trillion – in April, May and June of 2020? If that kind of loss continues, will we even have an economy left by the end of the year?

Fortunately, the economy did not lose $6.3 trillion of GDP in the second quarter of 2020; the loss was much less. Here’s the somewhat complicated reason why. First, the BEA likes to post most of its numbers on an “annualized basis.” What does this mean? It means the numbers are quoted as if they continue to occur for an entire year. BEA does this because users like to make comparisons in annual terms.

Indeed, if you closely read the press release from the BEA announcing the second quarter GDP results, you’ll see it says “. . . GDP decreased at an annual rate (my emphasis) of 32.9 percent during the second quarter of 2020.” Translated, this means if whatever decrease actually occurred in the second quarter were to continue for an entire year, the total drop would be 32.9 percent.

So what was the actual decline in GDP in the second quarter? It was 9.5 percent. When BEA says the annualized decline was 32.9 percent, it means that if the 9.5 percent drop happened for four consecutive quarters, then after adjusting for typical seasonal differences in the economy during the course of a year, the total annual contraction would be 32.9 percent.

Wow, there’s a big difference between 9.5 percent and 32.9 percent. But the story doesn’t stop here. The $19 trillion GDP number at the end of the first quarter is also an annualized figure. The actual GDP created in the first three months of the year was $4.8 trillion. Applying the decline of 9.5 percent to $4.8 trillion gives a GDP loss in the second quarter of $0.46 trillion, or $460 billion.

So, yes, the economy did shrink in the spring, but not by the multi-trillion-dollar amount implied by the BEA’s “annualized” numbers. What kept the losses more modest? It was the gigantic federal help, including the household stimulus checks, the boost to unemployment payments and the loans and grants to businesses. Without these, consumer and business spending would have been much weaker. Of course, all the federal money has been borrowed, and the costs of this borrowing will be faced in the future.

Here’s one more point. There have been numerous comparisons of the 2020 economic downturn to the Great Depression of the late 1920s and early 1930s. The actual 9.5 percent GDP decline in the second quarter of this year does exceed any quarterly pullback during the Great Depression.  However, the difference is the Great Depression went on for years, and the economy actually did shrink by almost one-third. Economists today don’t think the economy will actually contract by one-third and they expect today’s recession won’t continue for years.

The lesson here is economic headlines and details may not paint the same picture. Sometimes you have to dig to get the real meaning. In a year both you and I will be better able to decide how bad the economy really was during the virus.

Dr. Mike Walden is a William Neal Reynolds Distinguished Professor and Extension economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.