Here’s how he ended a major speech in May: “With all our concerns about the next several quarters, there is still–in my judgment–ample evidence that we are experiencing only a pause in the investment in a broad set of innovations that has elevated the underlying growth rate in productivity…” Despite the convoluted syntax, the message was emphatic: keep the faith.
Productivity is the crux of the matter. From 1973 to 1994, nonfarm labor productivity (output per hour worked) rose at an average rate of 1.4 percent annually. From 1995 to 2000, the rate doubled to 2.8 percent. In 2000 the gain was an astounding 4.3 percent. These are huge improvements that inevitably get passed along in higher personal incomes (wages, salaries) or corporate profits. Consider how. With annual productivity gains of 1.5 percent, average incomes take 46 years to double. With 3 percent gains, the doubling occurs in 23 years. There are similar effects on profits and projected federal budget surpluses.
As Greenspan knows, psychology matters–and, to a large extent, today’s popular attitudes about incomes and profits are the creatures of buoyant productivity. If people view the present economic slowdown as only a temporary setback, then they will stay fairly optimistic. But suppose they decide that technology-driven productivity gains were passing flukes, mere artifacts of the economic boom. Then people would become more pessimistic. Stock prices (already down) might plunge further, because expectations of future profits would decline. Consumer spending might weaken, because people would be less upbeat about income increases. A slump could become self-fulfilling. Greenspan knows this, too.
There are essentially two ways to improve productivity. First, you can cut the cost of producing something by doing it quicker, cheaper or with less waste. Second, you can expand your market so your fixed costs–product development, overhead–are spread over a larger sales base. Computer and communications technologies arguably allowed companies to do both. With more information, companies reduce design cycles, control inventories more tightly and can sell to more customers, both at home and abroad.
Greenspan’s message is that the process is real and ongoing. Ample opportunities remain for more improvements in productivity and profits. This implies that the present drop in computer and communications investment won’t last. Among economists, Greenspan’s position is widely shared. In its latest 10-year forecast, the Congressional Budget Office assumes average annual productivity growth of 2.7 percent. And optimism extends beyond economists.
In an interview with Wired magazine, Intel chairman Andy Grove says he expects business-to-business electronic commerce to flourish. Intel uses the Internet to make almost all its sales and about half its purchases, he reports: “Other companies are one stage behind us… What’s going to happen in the next five years is that companies that are behind are going to get where we are today.” Grady Means, of the consulting firm PricewaterhouseCoopers, agrees: “In major industries–chemicals, automobiles, financial services–companies think they can make money by leveraging the Internet.” The dot-com collapse, he says, was misleading, because it obscured older companies’ growing commitment.
Sounds plausible–but it might not be true. The best-known doubter is Robert J. Gordon, an economist at Northwestern University. Gordon has argued that computers and the Internet don’t compare with many earlier new technologies (steam power, railroads, electricity, automobiles) in their impact on living standards. In addition, he contends that recent productivity growth has been skewed upward by the economic boom. This is clearly possible.
Labor productivity–the statistic–is simply long division: total economic output divided by labor input (measured by hours worked). During a boom, fixed costs (and the hours they represent) are spread over more sales. Productivity benefits. Once the boom collapses, extra productivity gains vanish. Ironically, computers, software and communications equipment may compound this effect. These sectors themselves experienced huge productivity gains. Chips and networks got much faster. The improvements counted heavily in overall productivity statistics, because computers and software represented nearly 20 percent of economic growth from 1995 to 2000, says Commerce Department economist Barbara Fraumeni. (Now the computer slump reverses this effect. In the first quarter of 2001 productivity dropped at a 1.2 percent annual rate.)
Who’s right in this debate? The answer is: no one knows. I’m closer to Gordon than Greenspan, in believing that companies have overinvested in computers and communications networks. The pure technology may have raced ahead of practical applications, but in times of rapid change uncertainty and disagreement are normal. Greenspan is right to try to put his spin–an honest view reflecting his own analysis and experience–on the present confusion.
Optimism deserves the benefit of the doubt, because if people act on their worst fears, the Fed’s interest-rate cuts (another is expected this week) will have scant chance of averting a recession. But all therapies have limits. Although they can help us cope with exaggerated dangers, they cannot protect us from stubborn realities. If the boom left consumers and businesses overextended, no amount of talk will prevent a painful reckoning.
