- The Washington Times - Sunday, November 3, 2002

At last week's conference on productivity sponsored by the Department of Labor and the American Enterprise Institute, Federal Reserve Board Chairman Alan Greenspan began his comments with a rather startling observation. "The increase in nonfarm business output per hour over the past year," Mr. Greenspan declared, "will almost surely be reported as one of the largest advances, if not the largest, posted over the past 30 years." Given the fact that the four quarters through June, including the September 11 quarter (when the economy was in its third consecutive quarter of decline) and the first half of 2002 (when the growth rate of final demand fell in the first quarter and became negative in the second), that is a truly remarkable achievement. For the year ending June 30, nonfarm business output per hour of labor the technical definition of productivity increased by an astonishing 4.9 percent.
The recent acceleration of the rate at which productivity has been increasing in recent years requires some perspective. First, the rate of increase of productivity for the past year is double the annual change experienced during the go-go years of the second half of the 1990s, when yearly increases averaged 2.5 percent. Second, that 2.5-percent annual rate of increase from 1996 though 2000 represented a significant improvement over average annual changes in productivity experienced during the preceding 22 years (1974-1995), when the rate of increase averaged 1.5 percent a year. The 1974-1995 average annual rate of increase reflected a 50 percent plunge from average annual 3 percent rate of increase that prevailed from 1960 through 1973.
To be sure, nobody expects the unusual productivity surge of the past year to continue at its torrid pace. However, the fact that productivity has performed so well during the tail end of a recession and the beginning of a decidedly modest recovery is an important development. It has provided even more evidence supporting Mr. Greenspan's belief that the "significant step-up in the growth of productivity" that occurred during the second half of the 1990s "appears to have persisted." And it strongly suggests that the step-up will continue to prevail in the foreseeable future.
The importance of faster productivity growth cannot be overemphasized. As Federal Reserve Board Vice Chairman Roger Ferguson observed in his own speech about recent productivity trends last week in London, "[F]aster productivity growth raises real wages, stimulates growth in real incomes and contributes to an increase in our standard of living." Strong productivity increases also contribute to a non-inflationary environment, which is more conducive to higher long-term growth in the economy, in wages and in profits. There was a clear causal relationship, for example, between the impressive gains in productivity during the second half of the 1990s, on the one hand, and a five-year average annual economic growth rate of 4 percent, relatively robust increases in wages of non-supervisory employees and significant improvement in corporate profits on the other.
The long-term consequences of the 1 percentage point increase in productivity from 1.5 percent (1974-1995) to 2.5 percent (1996-present) are extremely beneficial. The 1-point increase means that output per hour of labor will double in less than 30 years rather than nearly 50. In addition, the Labor Department estimates that a 1 percentage point increase in productivity would reduce the cumulative budget deficit by $2 trillion over 10 years; and it would reduce the projected Social Security shortfall by 25 to 50 percent over 75 years.
Perhaps the best example of the impact of productivity can be gleaned from the manufacturing sector, where output growth has been especially impressive over the past 10 years. Total manufacturing output has increased by 44 percent over the past 10 years, during which time manufacturing employment has declined by 7 percent. That represents a 55 percent increase in productivity (output per hour of labor). In durable-goods industries, output has increased by 77 percent, while employment has declined by 3 percent, representing in increase in productivity of 82 percent over the past 10 years. In other words, if 100 workers produced 300 refrigerators a week in 1992, today 97 workers would be producing 550 refrigerators.
Milton Friedman once famously remarked that in economics "there is no such thing as a free lunch." True. But rapid increases in productivity probably come as close as any other economic phenomenon to approximating that ever-elusive free meal.

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