The New Golden Age Of Productivity

Is the U.S. in the middle of a productivity revival or not? The answer will affect American living standards, inflation, and global competitiveness for years to come.

The data give the productivity believers plenty of ammunition. Of course, not everyone agrees with the numbers. Some argue that the recent improvement in productivity is no better than in past upturns and that measurement problems overstate the recent gains. However, by examining the dramatic changes in the U.S. economy in recent years, it's easy to see why the optimists are probably right.

Defined as output per hour worked, productivity is influenced by everything from the skill levels of workers to the technology they use to the way a company is organized and managed. Thanks to Corporate America's restructurings and high-tech investment, the long-term trend of productivity growth is on a path not seen since the 1960s. In the 1970s, productivity limped along at 1% annually. The 1980s were worse. But in the first 41/2 years of the 1990s, it has rebounded to nearly 2%. Of course, the decade is only half done. And productivity surged after the recessions `f the '70s and '80s, only to dive later.

INVESTMENT BOOM. The infidels say the same thing will happen this time. "We see no evidence that the rise in productivity in this expansion is anything more than a normal cyclical rebound," says David A. Wyss, research director at DRI/McGraw-Hill. Productivity usually pops up early in a recovery. Later on, however, as companies have to hire new workers who need to learn the ropes, it begins to slip. Indeed, second-quarter productivity fell 2.5%, as a million workers found jobs.

But this time, even as the cyclical gains fall away, the data strongly suggest that the structural improvement remains in place and that the short-term drop-off will be less steep. Even with last quarter's dip, productivity is still up 2.3% from a year ago. Its pace for the entire expansion is above that of the recoveries of the '70s and '80s. And productivity gains have made the largest contribution to growth in any expansion since the 1960s.

The most compelling argument for the productivity revival is the staggering rate at which companies are making efficiency-enhancing investments. Since the investment boom began, equipment outlays have soared 43.2%, the fastest nine-quarter growth ever. The boom isn't abating, as businesses increase their 1994 budgets yet again. Outlays are slated to rise 9.4%, after adjusting for capital-goods prices.

But that price adjustment is where the argument gets hot. Wyss and other disbelievers say the upturn in business investment is also normal. They say the Commerce Dept.'s adjustment for quality improvements in computers results in sharply declining prices, causing an overstatement of price-adjusted investment. Wyss argues, for example, that a laptop computer is not "bigger and better" than the old mainframe it replaces, as Commerce suggests, because often it's only a glorified typewriter.

However, arguments abound on the other side. Commerce says the price of telecommunications equipment is rising. But it's obvious that prices are declining for a wide array of such hardware, from fax machines to computer modems, hinting that investment in this fast-growing area is understated.

Moreover, the government is probably underestimating service productivity. Commerce doesn't even measure it in many service industries--unlike manufacturing, you can't just count the widgets. It's hard to believe that service productivity fell as badly in the first half as the numbers imply, especially when manufacturing efficiency soared 5.6%. Indeed, services account for 75% of 1994's planned outlays for new plants and equipment.

HARD FACTS. "If you really want proof of the productivity revolution, look at manufacturing," says Bruce Steinberg at Merrill Lynch & Co. There, he says, no doubt exists about what we are measuring. Factory productivity is up a stunning 5.4% during the past year. With factory wages up only 2.7%, unit labor costs have plunged 2.7%. That means many factories can easily absorb the recent uptick in prices of materials while barely feeling the effect on their bottom lines.

Extend that phenomenon to properly measured service productivity, and it's easy to see why the inflation outlook remains so good (chart) and why the '90s will be looked back on as a watershed in the advancement of U.S. competitiveness and living standards.

Before it's here, it's on the Bloomberg Terminal.