Productivity surges; 'new economy' lives

Federal Reserve Chairman Alan Greenspan has long been a poster boy for the "new economy" – a place where new technology enables companies to make things faster and cheaper – quickening the economic pace without fueling inflation.

It now appears that Greenspan's productivity Shangri-La – instrumental to the strong economic gains of the 1990s – is on track, even picking up speed as the economy pulls out of the recession.

Yesterday, the Labor Department reported that productivity rose at an 8.6 percent annualized rate for the first quarter of 2002 – its fastest pace in 19 years.

This means the business sector produced a lot of goods and services and used fewer man-hours of labor to produce it.

The sharp increase in productivity means that the Federal Reserve, which met yesterday to discuss interest rates, does not need to worry immediately about inflation.

It also means that US corporations may begin to show the level of earnings that justify higher stock prices.

"This is an exciting number for the stock market and the economy," says Paul Kasriel, chief economist at Northern Trust Co. in Chicago.

Economists had expected a good first-quarter gain for productivity, especially as orders for goods rebounded.

"You don't fire everyone, you still have labor around and as soon as orders come in they shift their time and efforts to filling orders," says Mr. Kasriel.

However, the productivity gain was greater than expected. One of the reasons appears to be an increase in orders for durable goods, such as computers and other high-tech equipment.

According to the government's report on the first quarter's gross domestic product (GDP), technology spending rose at a 7.5 percent annual rate, while spending on industrial equipment rose at a 15.6 percent rate.

Computer companies have been among the leaders in automation and other ways that companies are employing to produce their goods faster and cheaper.

"Companies have been forced to increase productivity with the strong US dollar and tough competition," says David Wyss, chief economist at Standard & Poor's in New York.

However, there may still be gains in the future as users of the machines try to figure out ways to produce their goods and services more efficiently.

Last month, Mr. Greenspan, in testimony before Congress, reflected that there is still a lot of technology that has yet to be exploited. "This suggests that, all other things being equal, that the growth rate is likely to be quite measurably stronger than it was for example over the quarter century prior to 1995."

But economists expect the productivity gains to begin to slow.

In the second quarter, Mr. Wyss expects a 6 percent increase. Then, it will begin to get closer to its trend of about 2.5 percent per year.

This would be much better than the 1970s and 1980s, when productivity averaged about 1.4 percent. But it would be less than the big gains of the 1960s, when productivity rose almost 3 percent a year as companies made use of World War II inventions.

Even during the downturn, Greenspan says productivity has been "quite remarkable." In past downturns, productivity has declined as companies stop spending money on new plants and equipment in order to save money. However, in the fourth quarter of last year – even while the economy was at the tail-end of the recession – productivity rose 5.5 percent.

As is typical of economic rebounds, the boost in productivity comes even as the unemployment rate is rising and companies are continuing to lay off workers.

Yesterday, the Chicago-based outplacement firm Challenger, Gray & Christmas said that lay-off announcements showed a 10 percent increase in April over March as telecommunications firms, auto manufacturers and service companies said they would reduce their payrolls.

In fact, the latest productivity numbers show that worker hours actually fell 1.9 percent in the first quarter.

"This shows the first order of business is the bottom line: Companies have to turn around some really bad earnings from last year, and they are in a major restructuring mode," says Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York.

Last year, corporate earnings fell 30 percent – the worst performance since the 1930s. However, Mr. Steinberg says that based on the strong productivity gains, he is expecting earnings to rebound by 21 percent this year.

As companies repair their bottom lines, they are likely to be slow to hire new workers. In fact, the April unemployment report showed sluggish job growth. Unemployment rose to 6 percent and economists expect it will probably continue higher in the months ahead.