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Just How Productive Are U.S. Workers?

By David Friedman
Senior Fellow

Los Angeles Times
July 9, 2000

Behind the Federal Reserve Board's interest-rate deliberations and months of sluggish stock-market performance lies a nagging question: Why did U.S. productivity, the nation's economic output per labor hour, suddenly accelerate in 1995 after decades of stagnation? The answer will determine whether America is truly leading the world into a new, prosperous era, or whether its good times reflect unique circumstances that can, and likely will, change for the worse.

The benefits of productivity are indisputable. When more products and services can be created from less labor, capital and raw materials, the economy can expand without inflation. Demand and supply roughly balance. Prices stabilize. Unprecedented levels of employment, wealth creation and consumption become jointly sustainable.

"New economy" enthusiasts claim that information technologies like the Internet and computers explain America's recent productivity spurt. In the early 1990s, these technologies spread throughout the economy. By the middle of the decade, business was wired for success. America's digital rebirth supercharged everything from the nation's stock markets to once-moribund manufacturing sectors.

This happy story is a staple of the business and news media. But it's supported by surprisingly weak evidence. Some of America's apparent productivity gain is attributable to changes, adopted in 1995, in the way government keeps its statistics. In fast-growth periods, moreover, capital investment usually rises faster than work hours. This artificially boosts output relative to labor and overstates real productivity improvements.

When adjusted for such factors, the productivity data present a bigger paradox. It turns out that during 1995-99, all America's real productivity gains were achieved by durable manufacturing industries: makers of cars, furniture and computer hardware. According to Northwestern University economist Robert J. Gordon, productivity growth rates actually declined in the nearly 90% of the U.S. economy outside these sectors. But nondurable industries like trade and financial services are by far the most avid consumers of computer and information technology. Why did their productivity fall?

Skeptics suggest that new-economy sectors merely repackage, rather than create, high-value information; functions like retail sales are displaced, not better ones invented. The Internet is counterproductive if it encourages personal e-mailing or shopping while on the job. Real productivity gains as a result of automating typing or databases were realized years ago when computers were first introduced. Developments since then have added increasingly marginal benefits. Even business-to-business Internet links, thought to boost productivity by improving interfirm information flows, may prove disappointing if they duplicate, rather than enhance, fax, telephone and other existing options.

This may help explain the productivity declines suffered by most of the U.S. economy. But can information technology account for the productivity gains in durable manufacturing? Or do other factors, such as historically low component and raw-material costs and an increasingly servile labor force, better explain what's happening?

Part of the productivity story in manufacturing is unquestionably about the decline of working-class power amid the pressures of globalization and the rise of nontraditional labor markets. Recent Federal Reserve studies, for example, show that America's true manufacturing work force is twice as large as officially reported because of the skyrocketing use of "temporary" employees. This boosts apparent productivity by severely undercounting actual labor hours in an industry and by reducing benefit and wage burdens. During the 1990s, in fact, real hourly manufacturing wages rose more slowly relative to productivity growth than at any time in the last 40 years.

The unprecedented price stability of commodities and raw materials during the 1990s also played a big role. After the Gulf War, energy prices annually rose by an average of just 1%, compared with more than 13% a year in the previous two decades. Energy and material costs are deducted from U.S. gross output to calculate productivity. When global or political conditions keep such key prices low, domestic productivity automatically rises.

Then there's the problem of determining which countries and what workers actually generate the reported improvements in productivity. The way productivity is measured in the import-dependent high-tech sectors, which account for the vast majority of U.S. growth, greatly complicates matters.

To measure the "true" output of U.S. computer makers, the government uses a novel technique: It adjusts values according to product characteristics like processor speeds or hard-drive capacities. For example, if $ 1,000 buys a 200 MHz machine in 1997 and an otherwise identical 400 MHz computer a year later, manufacturing productivity is said to have doubled even though market prices did not change.

This technique can grossly overstate the value of U.S. manufacturing. Does doubling processor speeds, for example, really make a computer twice as valuable? Until late last year, moreover, when the data were partly revised, all U.S. productivity growth since 1995 was attributed to computer production alone.

Computers, like most durable sectors, are heavily dependent on imports. As much as 80% of all computer imports are transfers between foreign producers and U.S. companies like Apple or Compaq. Sophisticated components like microprocessors are shipped from country to country for manufacturing purposes before they are assembled into a finished product.

Suppose that the reason why a U.S. company can sell a 400 MHz machine today for the same price as last year's 200 MHz model is that overseas suppliers were unable to raise prices on the faster processor. The cost to the U.S. company stays the same for a better-performing crucial component. But unless the "true" cost of the imported processor is adjusted for quality, just as the value of the finished product is increased to reflect better performance, reported U.S. productivity will be too high. The actual productivity increase would have been achieved almost entirely by the overseas supplier's manufacturing skills or overseas pricing constraints.

There is good reason to think that the U.S. economy may, in large part, be benefiting from productivity subsidies of this sort. During the last decade, worldwide overcapacity caused manufacturing and high-tech component prices to plummet. Then the Asian fiscal crisis forced some of the world's most sophisticated high-tech producers to cut prices even more to earn dollars and shore up their countries' weakened currencies. Coupled with virtually limitless low-cost manufacturing opportunities in the Third World, in the 1990s U.S. producers could obtain the most advanced components and technology at unbelievably low cost.

Statistically, there is no difference between productivity generated by brilliant innovations like the Internet or by squeezing lower prices from labor and suppliers of raw materials and components. Each story implies, however, dramatically different future prospects for the U.S.

If the happy story is correct--productivity and technology go hand in hand--Americans can expect that current worries about an overheating U.S. economy will be pushed aside by a tidal wave of productivity-led growth. Tight labor markets and soaring trade deficits may cause some short-term difficulties, but the U.S. can literally produce its way out of these and other potential growth bottlenecks. As other nations copy U.S. innovations, moreover, a worldwide productivity boom will ensue.

Should it turn out that U.S. productivity gains come more at the expense of domestic groups, like the working class, which is disproportionately affected by globalization, or foreign producers suffering from adverse financial conditions, the future is far less rosy. It is true that working-class political power is at its lowest point in decades. Also, countries like Japan, China and most of the middle- and lower-income world appear locked in investment and trade patterns that, for the time being, provide the U.S. with both high-quality, low-cost products and the capital to consume them.

The problem with building wealth from economic inequity is that, eventually, something bad happens. Even now, Asian opinion makers are discussing ways of eliminating their increasingly unattractive dependence on the United States. Blue-collar labor may now be docile, but should the economy slow and the brunt of any hardship fall, as appears likely, on the nation's "temporary" work force, social unrest will follow. Over time, it's difficult to appease the less privileged and avoid conflict while preserving the unbalanced domestic and international relationships that feed upscale U.S. wealth. That's why the markets cheer adverse employment data at home and stable, but unspectacular conditions abroad.

Uncertainty about the reasons for U.S. productivity growth thus drives marketplace and policy anxiety. It's possible that the data may yet prove a harbinger of a beneficent economic era. Yet, the chance that they chronicle an all-too familiar, potentially explosive social reality cannot be discounted. Everything depends on getting the story straight.

Copyright: 2000 Los Angeles Times

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