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An Upbeat View of Productivity

The debate over the sustainability of America's recent productivity gains won't be settled anytime soon. But there's no doubt that the first quarter's 1.2% productivity plunge has shaken true believers in the productivity miracle of the late 1990s. With business activity fading and IT investment in a tailspin, many now fear that productivity will continue to hit the skids.

Not economist Maury N. Harris of UBS Warburg, however. Even with the first quarter's scant 0.7% growth pace, he notes, a decline in hours worked suggests that quarterly productivity will still be positive. More important, he predicts that the high-tech slump will hurt productivity and economic growth less than many experts expect.

For one thing, says Harris, there's no slowdown in the pace of technological change and innovation. He points out that patent activity, which slowed in the 1970s and 1980s, took off in the 1990s--foreshadowing the hefty pickup in productivity gains. With patent grants up sharply this year (and with research-and-development outlays also apparently up), innovations leading to higher productivity gains remain on track.

To be sure, the soft economy and the capital-goods slump will constrain their adoption. But Harris notes that spending on computer software is down far less than outlays for hardware. Moreover, the full productivity potential of much recent strong capital investment hasn't yet been realized. And some new productivity-enhancing ideas from patents require relatively little added capital spending to be implemented, he says.

In addition, the surge in patent activity is leading to the introduction of a constant stream of compelling products in the high-tech and health sectors. The continuing appetite for such products, says Harris, should soften the economic impact of the current sharp drop in business-technology investment.

Indeed, productivity could perk up in some unexpected areas. A recent analysis by economist Steven Wieting of Salomon Smith Barney observes that productivity growth in non-IT manufacturing industries (which have presumably been investing in technology) has actually improved in recent years. Since this occurred while they have been in recession, they should show even stronger productivity gains once their sales start to recover. During the stock market boom, hefty stock options for top executives were all the rage as a way of encouraging management to build shareholder wealth. Then, when many stocks took a dive, leaving options strike prices way under water, many companies began repricing such options. They needed to do this, they said, to retain valuable managers and keep them focused on their shareholders' interests.

If you think all this sounds a bit self-serving, you'll find support in two studies slated to be presented this month at the Academy of Management's annual meeting in Washington. In the first study, Timothy G. Pollock and colleagues at the University of Wisconsin at Madison looked at options repricing among a group of 136 software companies in 1998. They found that decisions to reprice a CEO's stock options were strongly affected by both the CEO's power within his company and by the concentration of stock ownership.

Specifically, companies that suffered sharp stock declines were far more likely to reprice the CEO's options if he or she were also the board chairman, a sign of entrenched executive power. But they were far less likely to do so if institutional owners or the CEO himself held big blocs of company shares.

In the second study, researchers led by Catherine M. Daily of Indiana University compared companies that repriced executive stock options in 1997 and 1998 with a matched group of companies that didn't reprice. They found little difference in the two groups' earnings in the year prior to repricing. But in the following year, companies that repriced saw much higher executive turnover (and sharper stock declines).

In sum, although powerful CEOs tend to favor repricing their options, institutions that hold big blocks of shares seem to take a dim view of the practice--as do CEOs themselves if they're already big stockholders. And using repricing to hold on to top execs doesn't seem like a very effective strategy. Notwithstanding its dependence on the U.S., Canada's economy is likely to continue to outperform its neighbor to the south through the end of next year, say economists Mark Chandler and Jason Daw of Goldman, Sachs & Co. As in the U.S., the manufacturing sector is mired in recession and the strength of the consumer is the main engine driving economic growth.

But with real retail sales up at a healthy 3% annual rate in the second quarter, Canadian consumers appear to be in a better position to weather the slowdown in employment growth. A big reason appears to be the early impact of heating-tax rebates and income-tax cuts that took effect in the first quarter. The tax cuts alone are equivalent to some 1% of gross domestic product this year (vs. roughly 0.5% in the U.S.).

Income-tax relief may also have muted the effect of Canada's sharp stock market decline on household spending. But Chandler and Daw spot another development that also has a parallel in the U.S.: While Canadian stocks were down 17% on a year-over-year basis in the second quarter, housing demand is robust, with existing home prices up by more than 5% at last count.

"Rising housing values," says Daw, "seem to be providing some offset to plunging equity values in shoring up household net worth."

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