Analysis: Did third of economy really vanish in just three months?

The Commerce Department opened Thursday morning’s announcement of second-quarter economic growth with an eyeball-blistering observation: “Real gross domestic product (GDP) decreased at an annual rate of 32.9% in the second quarter of 2020.”

That 32.9% represents the loss of a third of the economy. Let that sink in. Now let it wriggle back out again—it is not exactly true. Why? The Commerce Department reports quarterly GDP at an annual rate to allow easy comparisons to other time periods. Remove the annualization, and we see the economy contracted a still-abysmal 9.5%.

In other words, 32.9% is how much the economy would shrink if the business closures and spending cuts of the second quarter increased at a compounding 9.5% for an entire year, after adjusting for seasonality.

Think of what an apocalypse that would be. Annualization assumes the businesses closed this quarter would remain closed and that just as many more would close for the first time in the third quarter. And we’d expand the closures again in the fourth quarter and again in the first quarter of next year.

In other words, take the devastation you saw in the past three months and multiply it by four. That is essentially what annualizing does, though compounding means the actual math is a bit more complicated.

The Commerce Department’s affection for annualization does not stop at percentage change. It also reports quarterly GDP totals at an annualized rate—when Commerce says GDP was at $17.2 trillion in the past quarter, it means GDP would be at $17.2 trillion if this quarter’s $4.3 trillion in output continued for a full year.

A 32.9% drop would mean a loss of about $1.6 trillion from last quarter. In fact, the economy shrank $0.45 trillion in the second quarter, on the heels of a $0.06 trillion (1.3%) decrease in the first quarter of 2020.

To see a third of the economy truly vanish, look at the Great Depression. From 1929 to 1933, GDP contracted about 36%, according to data collected by economists Nathan Balke and Robert Gordon. That is the actual contraction—no annualization in sight.

Commerce Department data, which start in 1947, show that this is the worst quarter since 1958, when the economy contracted 2.6%. That contraction just happened to coincide with the “Asian flu” pandemic, which claimed about a million lives worldwide.

With Balke and Gordon’s data, we can also establish that a drop of 9.5% makes this quarter the worst since at least 1875. The next worst were in 1893, when a legendary panic and run on the banks resulted in a long, painful depression, and 1937, when the Great Depression took a turn for the worse. Then, we saw drops of 8.4% and 7.2%, respectively.