Productivity Growth Has Not Ended

Late converts to the higher productivity/faster economy paradigm are beginning to bail out. The first-quarter drop in productivity and jump in unit labor costs has some Wall Street economists and Washington pundits crowing that the New Economy was, in the end, nothing but a bubble. Pay them no mind. A single-quarter decline in productivity is hardly a sign of fundamental change. Instead, it happened because of a sudden and unexpected cyclical downturn in the economy that led to a dramatically swift reduction in output. Once they caught on, managers began to adjust fast, but not fast enough to prevent work hours for the quarter from rising. That's why productivity dropped. This will not continue. Indeed, productivity may return to its higher trend line even faster than in past downturns.

Why? Speed is a powerful force shaping this cyclical business downturn. CEOs reacted with unusual quickness in cutting inventories and curbing capital spending once they realized just how bad it was going to get. They are now shedding excess labor with the same kind of dispatch, desperately seeking to trim costs and revive profits. Indeed, the rise of a flexible contingent labor force in recent years is making management's job much easier than in the past. Layoff announcements are running at a record level and the unemployment rate is rising sharply. Once companies shrink their labor forces to be in synch with production, increased productivity growth will begin again. As unemployment rises, so will productivity. This short-term cyclical swing in productivity is nothing new. It happens, to one degree or another, in virtually every business cycle. Even in the high-productivity '60s, there were quarters when productivity growth went negative.

But the short-term cyclical rise and fall of productivity should not be confused with the more important long-term trend. BusinessWeek believes that the fundamentals for productivity haven't changed. The spread of information technologies and globalization has raised the trend rate for productivity. Nonfarm productivity rose by 2.8% between 1995 and 2000, nearly twice the rate of the previous 25 years. This is not likely to be reversed.

The volatility of this high-tech-driven business cycle is proving problematic for economists and Washington policymakers alike. There may well be more quarters ahead that show weakness, but Washington policymakers should not worry that the gains in productivity growth are ending. They should base policy on the long-term fundamentals, and those still look good for productivity.

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