Productivity has been better longer than you think. That was the crucial subtext of Federal Reserve Chairman Alan Greenspan's remarks in his recent Humphrey-Hawkins testimony before Congress.
Recognizing that the conventional ways of measuring productivity are flawed, to put it mildly, the Federal Reserve has been busy constructing its own new methods of assessing productivity. It focuses on the real capacity and profit improvements generated by new investment in capital. The Fed's startling finding is that the rate of return generated by each new dollar's worth of investment began rising five years ago. Greenspan said, "Starting in 1993, capital investment, especially in high-tech equipment, rose sharply beyond normal cyclical experience, apparently the result of expected increases in rates of return on the new investment." As a result, productivity growth in nonfinancial corporations--one of Greenspan's preferred measures--has averaged 2.2% in this business cycle, compared to only 1.5% in the late 1980s. All this means that the productivity revolution in America began much earlier and is stronger than the conventional measures have been showing.
Greenspan's analysis offers new insights into the reasons for America's unprecedented growth in the second half of the `90s. It's an insight that the bond market missed when it tanked on the day that he testified. The Fed's work on productivity strongly suggests that Greenspan is willing to risk keeping U.S. rates stable in the face of strong growth, and thereby to help out Europe and Japan, far longer than most analysts now anticipate. It appears that the U.S. still has leeway to grow without inflation. Wall Street should do a better job of reading Fed tea leaves and interpreting Alan-speak. The man is saying something quite profound.