Why Productivity Won't Plummet

At a time of bioterrorism and war overseas, it is difficult to address the long-term economic health of the nation. But we must. Will the double shock of higher spending for national defense and corporate security plus the bursting of the high-tech stock bubble end the productivity gains of the 1990s? To a remarkable degree, the consensus answer among economists and policymakers is "no." Half of the huge gains in productivity made in the '90s will stick. That means productivity can grow at around 2% a year, permitting the economy to expand at 3% a year. It is now clear that the low-productivity era between 1973 and 1995 was a historic anomaly: The U.S. is now returning to its long-term trend. And for a nation feeling that it's under siege, this is good news indeed.

Productivity will certainly suffer a one-time hit as corporations shift spending toward securing their employees and operations. Terrorism is throwing sand in the efficient, just-in-time global system that is at the heart of so much productivity growth. Goods, services, and even money are moving more slowly around the world as security checks are made. But corporations are already reconfiguring their supply-chain-tracking software to ensure security across borders. This process doesn't have to take long. The greater fear is that higher defense spending will act as a tax on the economy, reduce the budget surplus, raise interest rates, and curb investment. The "peace dividend," which came with the drop in defense spending from 8% of gross domestic product in the 1980s to 3.9% in the '90s, was linked to a surge in productivity.

Despite big increases, military spending isn't about to approach its cold war levels. Information more than missiles, and squads of commandos rather than battalions of infantry, are the tools of the war on terrorism. If defense spending rises by $50 billion, the maximum being discussed in Washington, it would boost military expenditures to 4.5% of GDP. That would slice perhaps 0.1% off the underlying growth rate of productivity. A smidgen.

The greater threat to productivity growth may be the more mundane erosion of competition and innovation. A recent McKinsey & Co. report argued that the spread of information technologies was a necessary, but not sufficient, factor in boosting productivity. Deregulation, for example, helped open markets and create the competitive environment that technology-toting managers used to create new products and lower costs worldwide. Productivity could suffer if Washington begins to bail out too many industries under the guise of national security or if tax-and-spend policies eviscerate the budget surplus.

The bottom line: Productivity gains in the decade ahead may be more muted than during the hyper '90s, but they appear to be substantial nonetheless and sustainable. Not bad.

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