"Importantly, the favorable underlying trends in productivity have continued . . . [providing] support of household incomes."
-- Alan Greenspan, chairman of the
Federal Reserve Board,
in congressional testimony Feb. 11
We go through these fads -- these fixations with certain economic statistics, which are imbued with immense significance -- and productivity remains one of them. Superficially, the news is reassuring. In 2002 labor productivity bounded ahead by an astounding 4.8 percent, which is the best performance since 1950 (8.5 percent). This suggests that the U.S. economy is fundamentally sound and that, once war uncertainties lift, it will roar ahead. What could be simpler and more reassuring?
A lot. Over the long run, better productivity signifies higher living standards through new products, technologies and management methods. But at any one time, productivity depends on prevailing economic conditions -- which may not be favorable. The present productivity surge reflects bad news more than good: layoffs, bankruptcies and cutbacks. The ruthless elimination of the least efficient plants and companies may improve productivity. But it doesn't necessarily signal a robust recovery.
The Darwinian process is apparent everywhere. McDonald's is closing more than 700 of its poorest-performing restaurants. In personal computers, Dell is stealing market share and forcing rivals, such as Gateway, to cut back. (In 2002 Dell had 28 percent of U.S. personal computer sales, up from 24 percent in 2001, reports Gartner Dataquest.) American steel companies are undergoing yet another wave of mergers and shutdowns; employment dropped about 15 percent in 2002.
It's tempting to believe that productivity -- especially improved technology -- will rescue the economy. The grounds for skepticism start with history. In the Great Depression some industries experienced rapid productivity gains, as economic historian Michael A. Bernstein of the University of California, San Diego, has pointed out. Food marketing was one. Small grocery stores gave way to new supermarkets; there were 300 in 1935 and almost 5,000 by 1939. Refrigerator sales boomed -- from about 800,000 in 1930 to 2.3 million in 1937. Electrification raised light-bulb sales sharply. But these and other gains couldn't overcome otherwise dismal economic conditions.
We also need to remember that economic statistics are just numbers. Their significance depends on what causes them to move. Productivity -- the statistic -- is simply a bit of arithmetic. Total output is divided by the hours people work. If output rises faster than work hours, productivity increases. This is what usually happens, and it suggests better technology, better management and better workers. It's a beneficial process that promotes economic expansion. With lower costs, companies can increase wages and profits. Higher incomes then drive higher spending.
But productivity -- the statistic -- also increases if work hours drop while output only sputters. That's what actually occurred in both 2001 and 2002. Americans in private businesses (excluding government and nonprofit organizations) worked 187.61 billion hours in 2002, which was 2 percent less than in 2001. In turn, employment hours in 2001 were 1.3 percent less than in 2000. There was more unemployment; people with jobs worked slightly fewer hours. Since 1947 there have been only 15 years when employment hours have dropped and only three other instances of consecutive annual declines (1957-58, 1970-71 and 1991-92).
Few subjects are studied more and understood less by economists than productivity. Consider the late, lamented New Economy. Greater productivity growth defined its advertised glory. From 1996 to 2000, productivity growth leaped to 2.6 percent a year, up from an average of 1.5 percent from 1973 to 1995. This is a huge change. It corresponds, roughly speaking, to a 26 percent rise of incomes and living standards over a decade, as opposed to 15 percent. None of this was foreseen.
Prophets of the New Economy then told us that computers and the Internet had opened a new epoch. Oops. Who foresaw all the dot-com and telecom bankruptcies? How could their huge losses be reconciled with the promised gains of the New Economy? Although the prophets never said, there is an explanation: Some productivity gains of the late 1990s were more statistical than real. The efficient production of what's unneeded (many computers for dot-coms and many fiber-optic networks) is still wasteful. Productivity statistics, temporarily puffed up, were somewhat misleading. Similarly, the boom itself puffed up productivity figures through higher overall sales levels.
What we're hearing now is that, in effect, the New Economy lives. Companies continue to streamline through, among other things, information technologies. The process is portrayed as a painless miracle cure that's laying the groundwork for a stronger recovery after the Iraq crisis. Perhaps. But the outlook for productivity may depend more on the economy's general health than the reverse. If the economy stagnates, productivity may also stagnate. There is a country, once the world champion of productivity improvements, where this theory has been tried and confirmed. It's Japan.