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Two Ways To Read The Numbers

News: Analysis & Commentary


What's in a number? If it's the latest statistic on productivity, plenty. As the U.S. economic expansion progresses through its seventh year--with scarcely a sign of inflation--a growing chorus of economists and business leaders, including Federal Reserve Chairman Alan Greenspan, have concluded that the key to this scenario is increased productivity. Published productivity numbers have not supported the case for the New Economy--in which heavy investments in technology and other factors yield strong growth, low unemployment, and scant inflation.

But the latest numbers indicate a jump in productivity gains--to a 2.5% annual rate. Do they confirm the New Economy? Or are they, like past productivity gains, simply by-products of the business cycle that will disappear when growth slows? Here, James C. Cooper, Senior Economist/Business Outlook Editor, and Michael J. Mandel, Economics Editor, offer their interpretations.Return to top


Let's hope productivity optimists are right and that corporate efficiency is in a lasting upswing as a result of huge technology-based investments. A bright outlook for 1998 depends on it. Their argument: If productivity growth in the 1990s is faster than in the 1980s, then the economy can continue to enjoy 1997's ideal combination of strong economic growth, tame inflation, no tightening by the Federal Reserve, good profit growth, and a healthy stock market. The latest signs offer hope.

But are the recent gains lasting? A strong case can be made that the 2.5% growth in nonfarm output per hour during the past year--more than double the 1.1% trend since 1980--is only cyclical and not a revolution. Productivity rates have fluctuated with the economy in the past and will continue to do so.

DOUBLEHEADER. This 6 1/2-year expansion has behaved more like two separate business cycles than one long one. The first growth spurt peaked in 1994, as the Fed jacked up interest rates by 3 percentage points, slowing the economy sharply in 1995. The second upswing is now in progress, fueled by strong job markets and very stimulative financial conditions.

With the economy having grown 4% this past year, the recent jump in productivity is not at all stunning by historical standards (chart). That 2.5% pace was achieved three other times since 1980, only to fall off, and that same waning now appears set to unfold. That's because highly cyclical sectors--business equipment other than high-tech, consumer goods excluding computers and nondiscretionary items, plus housing and inventories--have accounted for nearly 40% of this year's growth.

For 1998, it's a simple case of "what goes up must come down." The economy's labor markets are stretched thin and a Nov. 12 interest-rate hike by the Fed was averted only because of global market turmoil and fears the Asian upheaval might slam U.S. growth. But one way or another, the economy is going to slow--and so will productivity.

The casualty may be profits. Already, productivity's lift to earnings is fading. The economy's yearly growth is 4%, with earnings per share for the Standard & Poor's 500 companies up 10%. But in 1994, a strong economy yielded a 40% profit gain with zero productivity growth.

Why is it harder to make a buck amid such supposedly strong productivity? For one thing, earlier robust earnings had more to do with massive layoffs than productivity gains. Now, wages are accelerating, especially in services, which are less affected by global competition. Service pay is growing at the fastest pace since 1989. If productivity does not offset that speedup, then either prices will rise, profits will fall--or, more likely, a little of both.

Without substantial productivity growth, unit labor costs will speed up and companies will feel pressure to lift prices to maintain profit margins. Also, the Fed will be more likely to lift interest rates to keep inflation in check. This double whammy of higher rates and weaker profits would roil an already-skittish stock market, especially since stock and bond prices reflect a belief in the high-productivity scenario.

The bottom line: Productivity growth this decade is still 1.1% per year for nonfarm industry, the same as in the '80s. For the nonfinancial corporate sector, the rate is 1.8% for both decades. At this point, the optimists can say only the data are wrong or anecdotes tell the true story or this year's falling inflation proves that productivity is surging--while ignoring other reasons, primarily a stronger dollar. But if they are wrong, the economy could face tough sledding next year.By James C. CooperReturn to top

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