Productivity and Prosperity

The received wisdom took a bit of a battering last week. That wisdom goes something like this: No one can be certain whether the economy is on a new growth path, or whether it will slow down again when the current inventory rebuilding process is completed. But both the cheerful and gloomy agree on one thing: whatever the overall economy does this year and next, profits will be hard to come by because firms lack “pricing power.” Consultants International Strategy & Investment (ISI) report, “Softness in pricing power remains a consistent theme in our conversations with company executives. Contacts continue to report little pricing power in areas ranging from technology to general manufacturing.”

From that fact—and it is a fact—it is an easy jump to the conclusion that pressure on prices means pressure on profits. Well, perhaps. But there is another path to higher profits: improved productivity. Get more output from existing staff and facilities, and unit costs fall. Presto: profits rise, slowly if the volume of sales remains at current levels, rapidly if sales are picking up.

That’s why there was so much excitement when the Labor Department announced that productivity rose at the seasonally adjusted annual rate of 8.6 percent in the first quarter. Rapid improvements in productivity enable the economy to grow without generating inflationary pressures, and provide room for increases in both real wages and in profits.

No one thinks that rate is sustainable, least of all Federal Reserve chairman Alan Greenspan, who cautioned, “The world just doesn’t work that well.” Most likely, firms are finding that they can fill rising orders by squeezing extra work out of existing staff and plants, or even while they continue to downsize. Result: rising productivity, not unusual in the early stages of a recovery.

Although the first quarter performance is unsustainable, even many skeptics are coming around to Greenspan’s view that something profound happened to the U.S. economy in the latter 1990s that “does give some confidence projecting forward.” There is talk of achieving a long-run increase in productivity of something like 4 percent which, added to a 1 percent increase in the labor force, produces a sustainable growth rate, or speed limit, of 5 percent. That’s more than twice as fast as we once thought the U.S. economy could grow, and well above the 2 percent that the Treasury now thinks the U.K. economy can manage.

Greenspan’s optimism is based in part on the fact that productivity continued to rise relatively rapidly even during the recent economic slowdown. That unusual performance is the consequence of several changes that occurred in the 1990s.

Deregulation of many markets increased the pressure on the financial, communications, transportation, and other sectors to get costs and prices down. The rise of the Internet has saved manufacturing firms billions of dollars. New technologies permit closer control of inventories, one reason that we passed from an excess-inventory situation into a restocking phase so quickly. Globalization creates increased possibilities for the international specialization of labor. And immigration continues to enrich the American economy: the Patent Office last week reported that in 2001 foreign-born, non-citizen residents of the United States earned nearly half of all patents awarded to inventors working in America.

Speaking of immigrants, when faced with some bit of good news my father was wont to say, “Only in America.” And it may be only in America—a country emerging from an economic slowdown, its stock markets on an almost daily roller coaster ride, its currency weakening, and its security threatened by terrorists—that we can talk of a new golden age, one in which productivity rises sufficiently to give workers higher real incomes, investors increasing profits, and Americans ever-higher standards of living.

If you want to know why such optimism is part of the way we Americans live now, cast your eye over the annual report of the Federal Reserve Bank of Dallas (www.dallasfed.org). Americans, with the possible exception of those in California, know they can’t live forever. But they know they are living longer, due to a decline in the rate of fatalities from natural causes (down from 1,349 per 100,000 population in 1950 to 826 in 1999), auto accidents (down from about 83 per billion miles driven in the years after World War II to under 16 in 2000), and disease (deaths from heart disease down by one-third from its 1963 peak, and from AIDS by five-sixths since that disease peaked in 1995).

Americans also are smart enough to know that we haven’t conquered the business cycle. But we know, too, that the monster has been tamed. Before World War II the economy was in recession 40 percent of the time; we lived through such bad periods only 10 percent of the time since 1975. And the magnitude of the drops during recessions has fallen from 13 percent to 7 percent.

The only new cloud on the economic horizon is an awareness of the nation’s vulnerability to terror attacks. But even here, there is reason for optimism. In the aftermath of September 11, the economy demonstrated that its geographic and sectoral diversification makes it extraordinarily resilient, and that its policymakers, or at least many of them, know how to facilitate a bounce-back.

The war will not be cheap. But economists at the Dallas Fed point out the U.S. economy is more than six times larger (adjusting for inflation) than it was when we fought World War II. We are rich enough to double our military budget with just one year’s economic growth. “It’s foolhardy to pick a fight with a rich nation [that] can sacrifice to fight its enemies while still attending to the needs and wants of its population.”

So whether the current recovery proves to be fragile or robust, profitless or jobless, history teaches Americans that in the long run they will be better off. John Maynard Keynes may have been obsessed with the idea that in the long run we are all dead. Americans know that somewhere before Keynes’s terminal date is reached, they will have longer, healthier, and even better lives than they now enjoy, in good part due to their rising productivity.



This article originally appeared in the Sunday Times of London on May 12, 2002, and is reprinted with permission.



___________________________________________________



Errata

The editors wish to note the following corrections in regard to the May 10 article "Don't Forget North Korea." Synghman Rhee was expelled from power in 1960, not in the mid-1950s. It should be noted that the reference to Rhee as a "stalwart leader" was not meant to obscure the fact that many Americans and Koreans perceived him as a failure. Lee Hoi Chang should have been referred to throughout the rest of the article as "Lee" rather than "Chang," as in Korea, family name comes first. This was an error by an editor, not the author. Finally, the Japanese occupation was 36 years; to refer to it as a half-century may have been misleading.

___________________________________________________