GDP is the most popular general measure of economic output. It started its contraction in the first quarter of the year, rapidly accelerated its fall in the second quarter, and came roaring back in the third quarter. We don’t have official fourth quarter results as of this writing, but it is likely to be another positive quarter.
If you look at the percent change in GDP per quarter below, it looks as though the economy has retracted, fallen, and then bounced back as much as it fell, putting things back to normal.
But that’s not what really happened. Yes, the second quarter crash was a decline of about a third, and the third quarter recovery was an expansion of about a third, but those facts can be a bit misleading on the surface, because when an economy shrinks by a large degree, then the percentage change back upward is against a smaller base.
Let’s look at a simple mathematical example. Not actual numbers, but round numbers to make things easy to see.
Let’s say one year the GDP is 20 trillion dollars, then the next year it shrinks down to 10 trillion. That’s a 50% decline. Then let’s say that the following year the economy expands 50%. That means that it went up to 15 trillion. Even though it went down 50% and then went up 50%, it’s not back to the same level, because the 50% decline from 20 trillion is a 10 trillion drop, whereas a 50% increase from a base of 10 trillion is a 5 trillion jump.
Those, aren’t the actual numbers, what happened last year is a bit smaller than that, but the principle is the same. A decline of a third and then an expansion of a third doesn’t quite get you back to normal and so although the third quarter roared back and the fourth quarter is expected to be about the same percentage up as the first quarter was a percentage down (about 4%), the symmetry in in percentage changes will not restore things to normal.
The same principle applies to percent change in profit, which we can see below:
Though you can see that the percent change of recovery so far reported have not remotely been of the same order of magnitude as the decline. In other words, profits are far from being restored to normal…so far. But when the economy is reopened, revenues, and along with them, profits are quite likely to surge.
Jerry Bowyer is a Forbes contributor, contributing editor of AffluentInvestor.com, and Senior Fellow in Business Economics at The Center for Cultural Leadership.
Jerry has compiled an impressive record as a leading thinker in finance and economics. He worked as an auditor and a tax consultant with Arthur Anderson, as Vice President of the Beechwood Company which is the family office associated with Federated Investors, and has consulted in various privatization efforts for Allegheny County, Pennsylvania. He founded the influential economic think tank, the Allegheny Institute, and has lectured extensively at universities, businesses and civic groups.
Jerry has been a member of three investment committees, among which is Benchmark Financial, Pittsburgh’s largest financial services firm. Jerry had been a regular commentator on Fox Business News and Fox News. He was formerly a CNBC Contributor, has guest-hosted “The Kudlow Report”, and has written for CNBC.com, National Review Online, and The Wall Street Journal, as well as many other publications. He is the author of The Bush Boom and more recently The Free Market Capitalist’s Survival Guide, published by HarperCollins. Jerry is the President of Bowyer Research.
Jerry consulted extensively with the Bush White House on matters pertaining to the recent economic crisis. He has been quoted in the New York Times, The Wall Street Journal, Forbes Magazine, The International Herald Tribune and various local newspapers. He has been a contributing editor of National Review Online, The New York Sun and Townhall Magazine. Jerry has hosted daily radio and TV programs and was one of the founding members of WQED’s On-Q Friday Roundtable. He has guest-hosted the Bill Bennett radio program as well as radio programs in Chicago, Dallas and Los Angeles.
Jerry is the former host of WorldView, a nationally syndicated Sunday-morning political talk show created on the model of Meet The Press. On WorldView, Jerry interviewed distinguished guests including the Vice President, Treasury Secretary, HUD Secretary, former Secretary of Sate Condoleezza Rice, former Presidential Advisor Carl Rove, former Attorney General Edwin Meese and publisher Steve Forbes.
Jerry has taught social ethics at Ottawa Theological Hall, public policy at Saint Vincent’s College, and guest lectured at Carnegie Mellon’s graduate Heinz School of Public Policy. In 1997 Jerry gave the commencement address at his alma mater, Robert Morris University. He was the youngest speaker in the history of the school, and the school received more requests for transcripts of Jerry’s speech than at any other time in its 120-year history.
Jerry lives in Pennsylvania with his wife, Susan, and the youngest three of their seven children.