Business Is Too Busy Bailing To Set A Long Term Course

Higher productivity. It's every economy's mantra, because it gives everyone a bigger slice ef the pie. And it's sure to be a phrase that politicians intone often in a Presidential race that hinges so much on economic issues.

The way to achieve better productivity: long-term investments in job training, state-of-the-art machines, new buildings, and advanced technologies that generate more output per hour. Unfortunately, that's not the way America is going about it right now.

Instead of looking long-term, many companies are just trying to survive in the here and now. Three and a half years of economic stagnation have placed tremendous pressure on businesses to keep expenses in line in order to shore up earnings. So outlays for productivity-enhancing programs are often shunted aside in preference for cost cuts that help to boost profits.

The risks to corporate survival are real. Business failures jumped 16.8% in the first half of 1992, after setting a record in 1991, according to Dun & Bradstreet Corp. D&B says that failures, a lagging indicator, will rise further in 1992 as the weak economy continues to take its toll.


In this tense environment, productivity gains seem to be the by-product of corporate decision-making rather than a goal. Indeed, productivity is posting some impressive gains this year, but that's mostly because companies are keeping the lids on their payrolls.

Output per hour among nonfarm businesses rose at an annual rate of 2.3% in the second quarter, following a 3.8% pace in the first quarter. But in both periods, hours worked fell, as many companies continued to shed workers. Output is up a meager 1.8% during the past year, while hours worked are down 0.7%.

So far, the economy's productivity gains look like the usual cyclical advances that occur during and after a recession. But over the long haul, these gains are likely to fade because of America's poor record on investment. In the past decade, investment in new plants and equipment as a percentage of gross domestic product has fallen from 14% to 10%. Meanwhile, such investment in Germany, for example, has risen from 11% to 14%. Clearly, global competition requires more than lean payrolls.

For now, the combination of cost-cutting and productivity gains does have one major benefit: lower inflation. Unit labor cost determines the underlying pressure on companies to raise prices. And the productivity report shows that the cost of workers producing a single unit of output barely rose for the third consecutive quarter.

The numbers are impressive. Growth in wages and benefits has slowed from a yearly pace of 5% in the second quarter of 1991 to just 3.3% last quarter. At the same time, productivity growth has taken a 180 degree turn. It was declining by 0.6% a year ago, but since then has risen by 2.6%. The result of these two trends: The pace of unit labor costs has plummeted from 5.6% a year ago to a scant 0.7% in the second quarter - the slowest yearly pace in more than eight years.

The slowdown in unit labor costs makes inflation in the 2%-to-3% range for 1992 and 1993 a real possibility. In fact, bond investors are lowering their inflation expectations. Bond yields at 7%-and 30-year mortgage rates below 7 1/2% now look likely.

The latest price reports look tame. Producer prices of finished goods rose 0.1% in July. During the past year, inflation for factory goods is running at a cool 1.8%. The core rate, which excludes food and energy, is only 2.6% (chart, left). Moreover, the Commodity Research Bureau's futures index of commodity prices hit a six-year low on Aug. 11.

With pricing power so weak, Corporate America's recent success in boosting profits is largely the result of fatter margins. While economywide inflation - measured by the GDP fixed-weight price index - has slowed, unit-labor costs have decelerated even more sharply (chart). That means businesses can make more money even when sales are weak. However, sustained profit growth requires stronger demand.


But there's the rub. Businesses are putting themselves into a great position once the economy picks up. But right now, job growth is suffering greatly as businesses try to get by with fewer workers. This structural change is the biggest reason why consumers remain skeptical that the U.S. is in a recovery - and that's why their purse strings are so tight.

True, the employment picture looks better now than it did on July 2, when the Labor Dept. released a stunningly bleak report on June employment. in a rosier-looking July report, Labor said that nonfarm payrolls grew by 198,000 slots last month, and the drop in June jobs, originally reported at 117,000, was revised to only 63,000. In addition, the unemployment rate edged a bit lower last month, down to 7.7%, from June's 7.8%.

But the cheerier news only masked the churnings in the labor markets caused by cost-cutting. One-third of the new jobs were in the government sector, and most of those came from an expansion of federal programs that provide temporary summer jobs for teenagers. When these youths head back to school, government payrolls will show a big drop, probably in September.

Private employment added 110,000 jobs in July, barely reversing 82,000 jobs lost in June. After a sharp drop during the recession, payrolls have gained almost no ground (chart). Factory employment was up by just 1,000 jobs in July, as a loss of 17,000 defense-related positions offset gains elsewhere.

Even as manufacturers hold the line on hiring, though, they are keeping the workweek at a fairly high level. The factory workweek was unchanged from June, at 41.5 hours. Long hours are another sign of the compaign to get the job done with fewer workers.

That's even truer among the ranks of white-collar workers. Companies are making serious, structural changes by eliminating many managerial positions. During the past year, for example, 69% of factory job losses have been in nonproduction workers. More than likely, these are not layoffs but permanent job cuts.

In another move toward belt-tightening, businesses are meting out smaller pay increases. Nonfarm wages were unchanged last month, at $10.58 per hour, and factory pay rose 1 cent, to $11.45. Nonfarm hourly pay is growing at its slowest rate in five years.



The weak gains in income are putting a squeeze on consumer spending. And the debt buildup of the 1980s means that many households are unable to use credit. Less borrowing is another reason why consumers aren't providing their usual post-recession spending boost.

Consumer installment credit fell by $1 billion in June, its fifth drop in a row. The nearly two-year decline in installment debt outstanding is the steepest on record.

But not all of that decline reflects an aversion to borrowing. Home equity lines of credit are replacing some of the traditional installment debt. Since early 1990, home equity loans have risen by some $8 billion, while other types of installment credit has slipped by $12 billion.

Even with the growth of home equity loans, households are paring down their debt burden. Installment debt plus home equity loans stood at 18% of aftertax income last quarter, down from a record high of 19.9% in the third quarter of 1989 (chart). That trend will continue in an era of job insecurity and miserly pay raises.

Increasing the efficiency of workers could alleviate some of these worries, because higher productivity would mean better wages without higher inflation or lower profits. However, generating greater efficiency will take a bigger commitment on the part of corporations to invest in technology and training. Right now, though, business executives are concentrating on short-term survival rather than long-term prosperity.

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