Big Test Ahead For Productivity
With first-quarter gross domestic product bursting out of the starting gate at an estimated 4.2% annual pace--and with price pressures still subdued--the thesis that the U.S. economy has entered a new era of strong, steady, inflation-free growth has never seemed more solid. Indeed, many forecasters believe that the expansion, which is already seven years old and counting, could well surpass the nine-year record chalked up in the 1960s.
One critical element in such a scenario, however--the belief that U.S. productivity growth has moved to higher ground--is about to be tested. "True believers in a productivity revival may feel a lot less confident a year from now," predicts economist Paul Kasriel of Chicago's Northern Trust Co.
Kasriel notes that productivity growth plunged from a 3.6% annual pace in the third quarter of last year to just 0.2% in the first quarter of 1998 (chart). Further, this occurred while growth in business output surged from a 3.7% rate to 5.3%. "Waning productivity gains in the face of rising output," says Kasriel, "suggest that a more protracted slowdown in productivity growth lies ahead."
Such a development would put a large dent in the new economy paradigm. That's because America's vaunted productivity renaissance of 2% growth is just two years old. As economist Stephen Roach of Morgan Stanley Dean Witter & Co. observes: "Productivity growth from 1993 through 1995 was unusually low. In fact, annual productivity gains over the past five years as a whole have actually averaged a mere 0.8%."
Roach and other economists worry that productivity will revert back close to the 1% pace recorded in the latter half of the 1980s, setting off an inflationary wage-price spiral. At the very least, says David Hale of Zurich Group, productivity faces a number of formidable hurdles in the year ahead.
One is that business has exhausted the supply of skilled labor and is now drawing on new workers with less immediate productive potential. Another is the likelihood that the economy will slow sharply from its 3.8% pace in recent years, exerting downward cyclical pressure on productivity.
Still a third problem is a shift in the economy's growth engine from manufacturing, which has enjoyed record productivity gains but is now being hurt by the Asian crisis and a strong dollar, to sectors where productivity has been less vibrant. Finally, heavy business spending on Year 2000 computer software problems promises to eat into outlays for genuine capital investment.
Among those who think productivity may be on a new roll is Federal Reserve Chairman Alan Greenspan, who has cited this possibility as a reason to forgo monetary tightening. If productivity stays robust despite the hurdles ahead, business should be able to offset rising wage costs, and the Fed can stay on the sidelines. But if it flattens, talk of a productivity renaissance will fade, and Fed forbearance will end. Stay tuned.