By Margaret Popper
As the colossal U.S. economy lurches through its first significant drop in a decade, economists are debating whether it's the New or the Old Economy that's driving the slowdown. With so much at stake, it seems crucial to uncover the existence of something new -- some key relationship that seems to work differently than it has in the past that could help avert a recession. One key force economists and the Federal Reserve are focusing on is productivity, which seems to be behaving a bit differently than it did, say, 30 or 40 years ago.
Indeed, the experts are starting to believe that productivity growth won't collapse during this slowdown -- a welcome change from previous postwar contractions. Starting in the mid-'90s, productivity -- output per worker -- began to pick up steam after more than 20 years of subpar growth. As the decade ended, productivity gains, fueled by huge capital expenditures on technology and automation, were increasing at better than 6% annually. Federal Reserve Chairman Alan Greenspan cautioned more than once that such gains were unsustainable. And he was right. Productivity growth slowed to a 2% annual pace in the final quarter of 2000. Small wonder Greenspan seemed so confident in his appearance before a Senate panel on Jan. 25.
REAPING THE BENEFITS.
But he and others are cautiously optimistic that productivity growth could stay positive in 2001, helping cushion the pain of the economic downturn. Corporate America continues to reap the benefits of the recent rapid productivity gains, even as the economy stumbles. In addition to helping keep inflation in check, stronger productivity helps create more flexible corporate structures for dealing with a slowdown. Companies that have invested heavily in technology to improve productivity will be able to cut costs by laying off workers without necessarily suffering a huge drop in production.
"Companies are able to pull back on labor in response to [declining] sales, something they didn't do in the '60s," says Lehman Brothers Chief Economist Ethan Harris. For one thing, layoffs are easier to accomplish, partly because far fewer union contracts are around to impede management's ability to reduce labor. Particularly in manufacturing, which accounts for about half of what's produced in the U.S. economy, corporations have already begun cutting overtime and temporary-worker hours in response to a drop in demand. In December, the manufacturing sector cut 62,000 jobs and reduced the workweek to 40.4 hours from 41.2 hours in November.
Overall, average weekly hours worked dropped from 34.4 per week in September to 34.1 in December. A lot of that reduction was achieved because workers had been putting in more overtime than they wanted to during 1999 and early 2000, according to Harris. "So far, it's clear that companies are doing a good job of controlling costs, even if it's not perfect," Harris says.
INCREASING FIXED COSTS.
Clearly, the hope is that in the tightest labor market in three decades, companies will be able to cut costs dramatically through layoffs without triggering a collapse in demand or cratering production, both of which would worsen the slowdown. Of course, this doesn't mean Main Street will sail through the slowdown unscathed. Most companies have increased their fixed nonlabor costs with investments in technology and automation, says Milton Ezrati, senior economist and strategist at fund manager Lord, Abbett. That was no problem when the economy was booming. But "on the way down, it makes [corporate] margins more vulnerable," he says.
Ezrati doesn't think a recession is in store in 2001, but he expects what he calls a "profits recession" as corporations find themselves unable to cut costs deeply enough to match declining revenues. "It's the dark side of the New Economy," he adds. Companies are beginning to feel the pinch in their margins and are planning significant cutbacks in capital spending for 2001, a trend the Fed will try to reverse by continuing to cut short-term interest rates. Capital expenditures are expected to grow 10% to 15% in 2001, vs. 20% to 25% last year.
Of course, no one is arguing that productivity's role in the economy has been dramatically altered. "Eighty percent of productivity growth is cyclical," says Steven Wieting, U.S. economist at Salomon Smith Barney. And during an economic rough patch, productivity definitely slows. Some experts predict that after final data are available for the last quarter of 2000, the government will revise the 2% productivity-growth figure down as low as 1%.
Cyclical booms and busts notwithstanding, it seems the productivity trend in the new century's first decade is to continue growing faster than it did in the '70s and '80s. "From time to time, there will be economic pauses," says Jack Malvey, global chief fixed-income strategist at Lehman Brothers. "But we believe the U.S. productivity story is still strong."
When the Fed cut short-term rates by half of a percentage point on Jan. 3, it seemed even the central bank was acknowledging that the productivity gains born of the tech revolution are far from over, despite an unexpectedly rapid deterioration of the economy. "To date, there is little evidence to suggest that longer-term advances in technology and associated gains in productivity are abating," the Fed's statement said.
In his most recent testimony before the U.S. Senate on Jan. 25, Greenspan reiterated -- in typical obfuscating Fedspeak -- that he believes productivity gains are here to stay for the foreseeable future. "Though hardly definitive, the apparent sustained strength in measured productivity in the face of a pronounced slowing in the growth of aggregate demand during the second half of last year was an important test of the extent of the improvement in structural productivity," he said.
Greenspan also estimated that growth in output per hour, which dawdled along at a 1.5% annual rate from the early '70s to 1995, would likely continue at a 2.25% to 2.5% pace through the decade. "There is a distinct possibility that much of the development and diffusion of new technologies in the current wave of innovation still lies ahead," he added.
That will help in the long term, but in the short term, investors and CEOs are hoping the Fed will continue to goose the economy with more rate cuts. The consensus on Wall Street is that the Fed isn't finished lowering rates. That helps explain why economists are generally predicting a capital-spending revival in the second half of 2001, setting the stage for renewed productivity (as well as economic and earnings) growth in 2002.
Of course, New Economy naysayers may then have to admit that the stunning productivity gains of the last few years were solid, which can no longer be said of the sky-high stock market valuations for many dot-com and tech startups. "The debate in the mid-'90s about whether these [productivity] numbers are for real is over," says Thomas Madden, chief investment officer for U.S. equities and high-yield debt at fund manager Federated Investors Inc. "We are in a sustained period of productivity growth." Amen. Without it, we would almost surely be looking at a downturn that would be deeper and longer lasting.
Popper covers financial markets for BW Online in New York
Edited by Beth Belton