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Productivity: Trading Places

Notwithstanding the optimistic views of Alan Greenspan, the extent to which America has achieved a sustainable increase in productivity growth is likely to be debated in economic circles for years to come.

What seems indisputable, however, is the size of the productivity gains the U.S. racked up in the past half-decade and how much they have contributed to its lead in living standards at a time when its major industrial rivals were losing relative ground.

As a new Conference Board analysis by economists Robert H. McGuckin and Bart van Ark makes clear, the U.S. and Europe virtually changed places in the productivity sweepstakes during the 1990s. In the first half of the decade, European productivity on average actually grew three times as fast as that of the U.S. But in the second half, U.S. growth more than tripled while European productivity growth fell by 50%. (Japanese productivity growth stayed at a steady 1.8%.)

This reversal is not a simple saga of Europe losing its way as America hit pay dirt in the new economy. In the first half of the 1990s, says McGuckin, European productivity was rising rapidly in part because high wages and rigid labor market policies were limiting employment gains and forcing employers to substitute traditional capital for labor. Meanwhile, U.S. productivity was held back partly because companies were in the painful initial phase of adopting new information technologies.

In the second half of the 1990s, U.S. companies finally began to reap the productivity payoffs from widening investment in IT output and use. At the same time, Europe began tackling labor market rigidities, causing productivity to slow sharply as relatively inexperienced workers found jobs. Further, some European nations are starting to go through the same throes of IT adjustment that held back U.S. productivity in the early 1990s.

America's living standards as measured by per capita income exceed those of Europe not only because of its higher productivity but because more Americans work and put in longer hours than Europeans. Thus, Europe's recent progress on employment growth could eventually help it to close its per-capita income gap with the U.S.--if such progress is followed by productivity gains sparked by greater flexibility in labor, capital, and product markets.

That, however, is a big if. At last count, America's lead in living standards vis a vis other leading nations had widened considerably. According to McGuckin's and van Ark's estimates, its relative per capita income rose between 1995 and 2000 from 37% above that of Europe and 18% above that of Japan to 45% and 34%, respectively. If the storm clouds currently threatening America's productivity achievements dissipate soon, Europe may have a hard time catching up. When clean air regulations were first proposed for California several decades ago, some experts worried that the poor and minorities would end up paying a big part of the tab. In this view, the have-nots would have to spend more to operate their cars, could lose jobs as industries moved away to save costs, and might face higher rents as better local air quality drove up real estate prices.

As it happens, none of these fears was borne out, reports economist Matthew E. Kahn of Tufts University in Regulation magazine. Local air quality regulations in the Los Angeles area appear to have had little if any effect on employment, and home prices in areas with improved air quality did not rise disproportionately. More important, for a variety of reasons including legal loopholes, tighter emission rules did not force the poor to junk high-polluting older cars. Rather, big drops in vehicle pollution seem to mainly reflect the fact that newer cars have significantly lower emissions.

In sum, the middle and upper classes who are shelling out as much as $2,000 extra to cover the cost of pollution-fighting equipment in newer cars are shouldering much of the burden--implying that "air pollution regulation costs are distributed progressively." In addition, Kahn's analysis of air quality changes in 1,800 census tracts in California between 1980 and 1998 indicates that the gap in pollution levels experienced by rich and poor residents narrowed sharply over the period, with both poorer people and Hispanics experiencing greater overall improvement in air quality. Until March, the monthly survey of small businesses by the National Federation of Independent Business showed little slack in labor markets. Last month, however, the share of respondents reporting hard-to-fill openings fell from 32% to 26%, suggesting that layoffs and lower hiring in larger companies are finally starting to affect their smaller brethren.

Since small business accounts for much of the nation's employment growth, the drop in openings could be seen as ominous. However, finding qualified labor continues to rank as the second biggest problem faced by owners, and 27% said they planned to expand employment vs. 5% planning reductions. On a seasonally adjusted basis, this represented a slight decline but, with a near record 32% recording wage hikes, it's clear that any job market easing hasn't yet affected rising labor costs.

The slippage in small business optimism and the drop in job openings probably portend a rise in unemployment and further weakening of business activity, says NFIB economist William C. Dunkelberg. Still, he expects economic growth in the current quarter to come in around 1.5%.

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