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Two Reasons Not To Tinker

News: Analysis & Commentary: THE ECONOMY


When Federal Reserve Board Chairman Alan Greenspan laid out for Congress the Fed's forecast for the economy on Feb. 24-25, he stressed two key areas: productivity and foreign trade. Why? Because both could have a major impact on how the economy and monetary policy unfold in 1998.

In the past, the current mix of strong domestic demand and tight labor markets would have set off inflation alarms. But Greenspan & Co. are betting that 1998 will be different. That's because the Fed's forecast of moderating economic growth and continued low inflation is founded on the belief that productivity gains will continue to offset rising labor costs and that the Asian crisis will widen the U.S. trade gap, helping to slow the economy and relieve inflation pressures.

But will it work out that way? BUSINESS WEEK reports that U.S. companies believe the Fed chief is right on the money. Businesses continue to squeeze efficiencies from their operations by various means, including continuing investment in new technologies. And with pricing power weak, rising labor costs only add an incentive to boost productivity further.

Moreover, the widening trade deficit now may no longer cause severe dislocations. True, imports are rising rapidly and will continue to do so. But some 40% of those foreign goods now originate from U.S. foreign affiliates, and many imports are capital goods, which increase productivity.

Here is BUSINESS WEEK's assessment of how the two critical forces will be felt in 1998.Return to top


It's getting tougher, but companies keep finding ways to squeeze more out of their operations

If you find yourself working harder, glued to your computer, don't take it too hard. In fact, you can give yourself a nice big pat on the back, because you're part of the productivity boom that Federal Reserve Chairman Alan Greenspan is counting on to keep the U.S. economy humming--without overheating.

Continued productivity gains are critical to maintaining a delicate balance between growth and inflation, and so far, things are looking good. Nonfarm productivity has increased 2% on average over the past two years, and manufacturing productivity increased 4.4% in 1997 alone.

All across America, executives and managers are burning the midnight oil to figure out how to wring further gains from their businesses. The challenge is getting bigger: With unemployment at a quarter-century low of 4.7%, wages are on the rise. Hourly compensation rose at a 4.9% annual pace in the fourth quarter of last year, and the minimum wage jumped from $4.25 to $5.15 an hour. Yet companies can't raise prices to offset their rising labor costs: The consumer price index is up a mere 1.6% over the past year, and the core producer price index is down slightly over the same period. With a tidal wave of low-cost imports washing up on American shores (page 30), the squeeze will only worsen.

The basic tactics are well-known by now: downsize, restructure, consolidate, tie compensation to company profits, and invest huge sums in high-tech equipment. But this time around, with low inflation giving managers little room to maneuver, the push is on to do more with less and strive for even greater increases in efficiency. "We are obsessive drivers of productivity," declares Daniel P. Burnham, vice-chairman of AlliedSignal Inc.

It's a sentiment that Greenspan applauds--in his unique Fedese. "The threat of rising costs in tight labor markets has imparted a substantial impetus to efforts to take advantage of possible efficiencies," Greenspan said during testimony before Congress on Feb. 24.

Witness the renewed emphasis on cost-cutting. In the fourth quarter, U.S. companies announced plans to eliminate 152,854 jobs, up 33% from the same period in 1996, according to Challenger, Gray & Christmas Inc., the international outplacement firm. The carnage continues. On Feb. 24, First Union Corp. announced it would eliminate 4,400 jobs as it digests its latest acquisition, Corestates Financial Corp.

Companies continue to shift manufacturing offshore, too. On Jan. 28, Phillips-Van Heusen Corp. closed down its G.H. Bass plant in Wilton, Me., and moved operations to Puerto Rico. In Maine employee pay averaged $9 an hour--a hefty premium over what Puerto Rican workers earn.

With an eye toward productivity gains, Corporate America continues to invest heavily in technology. From 1990 to 1996, companies spent more than $1.1 trillion on information-technology hardware alone, according to Stephen Roach, chief economist at Morgan Stanley, Dean Witter, Discover & Co. That spending should increase: A poll by the Federal Reserve Bank of Minneapolis in its region found that 45% of respondents planned on hiking capital spending this year, while only 26% said they would increase full-time employment. Says Sung Won Sohn, chief economist at Norwest Corp.: "The answer to labor shortages is to employ more modern technology."

THINKING SMARTER. St. Paul Cos., the giant insurer based in St. Paul, Minn., certainly agrees. It is aiming for productivity growth rates of 5% annually over the next several years, more than enough to cover its expected increase in labor costs, says Patrick A. Thiele, head of the company's worldwide insurance operations. One way to reach its goal is to increase info-tech spending some 10% to 15% a year. "We are continually replacing human capital with information-technology capital," says Healy.

Similarly, Howard Schultz & Associates of Dallas, an accounts-payable auditing firm, says it recovered more than $560 million in accounts-payable losses last year, up 32% over '96--and with the same number of people. Thanks to improvements in the information systems used by its customers and better software developed in-house, the company can do more work without adding employees. "We're in a position where we can do more and do it faster," says CEO Howard H. Schultz.

Sometimes, boosting productivity simply means thinking a little smarter. Take Southland Corp., the Dallas-based parent of the 7-Eleven convenience-store chain. Southland figures pay for store employees rose 4.8% in 1997. "The increase in the minimum wage combined with the tight labor markets is really sneaking up on people," says Rick Updyke, manager of planning at Southland. So Southland has developed a worksheet for store managers that helps them match such tasks as stocking shelves to employees' hours worked. Southland is far from alone. Says Mitchell S. Fromstein, chairman of Manpower Inc., the giant temporary-help provider: "Major companies are beginning to look just as much at the cost of labor downtime as machine downtime."

DROPPED SALADS. When squeezed between rising costs and a zero-inflation market, some companies must make tough choices. Anticipating Oregon's minimum wage hike to $6 an hour in January, Burger King Corp. franchisee Jack Eberly dropped prepared salads from the menus of his 11 restaurants in Eugene. The change let his restaurants operate with one less person in the morning shift because it cuts prep time.

Another factor in the productivity equation is training. Take AlliedSignal. The $14.5 billion industrial behemoth has an ongoing goal of achieving annual productivity gains of 6% a year by using what it calls the "Six Sigma" manufacturing quality program. Under Six Sigma, Allied is out to get defects down to 3.4 per million products coming off the assembly line. About 6,000 employees have already been trained in the program, and this year another 2,000 workers will be taught to apply Six Sigma in other areas. The bottom line: Fewer mistakes from beginning to end means better output per employee.

There is no question that companies face enormous profit pressures. Yet throughout the 1990s, economists have underestimated the ability of managers and workers to boost productivity by investing in high-tech equipment and restructuring the workplace. There's no sign of a letup. That's good news indeed for the economy. So, do your part. By Christopher Farrell in St. Paul, with Amy Barrett in Philadelphia, Gail DeGeorge in Miami, Wendy Zellner in Dallas, and bureau reportsReturn to top

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