THE GREAT PRODUCTIVITY DEBATE.

• Author: Millman, Gregory J.
• Position: Panel Discussion

Recent data suggests that the sharp productivity gains of the late 1990s may have fallen off. If that's true, what does it mean for economic growth, stock valuations and business strategies?

No one knows where it comes from, everyone agrees that it's hard to measure, and its most important moves defy explanation. Yet, judging from its influence on the Federal Reserve Board chairman the stock market and the national budget, the productivity number may be the single most important item in the economist's analytical kit.

American productivity growth had lagged around 1 percent for over two decades when suddenly, in 1995, it more than doubled. Although an increase from 1.2 percent to 2.5 percent may not seem huge, the magic of compounding makes it very big potatoes. Moreover, the rise fit nicely with the Internet boom, sparking talk that higher productivity levels might be a permanent condition brought on by wider connectivity and lower technology costs.

Productivity tends to fall as economic growth slows, and that is happening. Still, as measured by the U.S. Labor Department, nonfarm productivity -- expressed as the amount of goods and services workers produce each hour -- roset 2.1 percent in the second quarter, down slightly from the 2.5 percent forecast but still relatively strong.

Of course, any number that Fed Chairman Alan Greenspan hangs his hat on has to matter. And Greenspan clearly believes in the productivity miracle. Fed economists attribute most of the improvement in productivity to the widespread adoption of new technologies throughout the economy. Greenspan clearly thinks the productivity improvement is here to stay -- in fact, he's gone so far as to say so unambiguously, more than once. And Fed Governor Laurence H. Meyer has been even more forceful and clear than Greenspan on the subject. These top Fed decision-makers clearly believe not only that the recent productivity slowdown is temporary, but that productivity is holding up reasonably well despite the slowdown in the economy.

If they're right, the implications for stocks, interest rates and even the national budget are enormous. But are they right? New figures released in the summer showed that productivity growth during the booming 1990s was less than people (including Greenspan) had thought. The revision blew a chill through an already uncomfortably cold summer stock market, but warmed the hearts of New Economy skeptics.

Jack Grayson, chairman and founder of the American Productivity and Quality Center in Houston, dismisses the productivity optimists' claims. "I think people got euphoria," he says. "When you're starving and see food, anything looks good. People called it the 'productivity miracle.' But this had happened before."

Grayson, who ran President Nixon's wage and price control program, remembers growth rates during the 1960s higher than anything the recent New Economy generated. And he remembers well that productivity growth fell from as high as 4.5 percent in the mid-60s to only about 1 percent during the late '70s, '80s and early '90s. "The technological revolution is over-hyped. To date, it has not produced the sustained growth rate people had hoped for," he concludes,

The productivity story is not about a single number -- it's about expectations that will determine stock prices, interest rates, Fed policy and more in the years ahead. The implications for corporate decision-makers are pervasive. So, in August, Financial Executive contacted three notable market and economic authorities for in-depth discussions of the productivity question: Ed Yardeni, chief investment strategist at Deutsche Banc Alex. Brown; Ethan Harris, co-chief U.S. economist at Lehman Brothers Holdings Inc.; and Susanto Basu, who has been studying productivity for over a decade as associate professor at the University of Michigan and research associate at the National Bureau of Economic Research.

Ed Yardeni

Chief Investment Strategist

Deutsche Banc Alex. Brown

What is this productivity debate all about?

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