• Productivity is the key to the outstanding performance of the US
economy. As a result of the tremendous revival in productivity in
recent years, inflation has remained dormant and corporate earnings
have advanced at a double-digit pace. Even now, as economic
growth has begun to moderate, productivity gains remain strong.
If they stay that way, inflation will probably continue to be
absent and earnings gains will be reasonable.
• The traditional definition of productivity is output per hour
worked. Federal Reserve chairman Alan Greenspan has said that
he believes that the productivity pickup is permanent, not cyclical.
Productivity rose at a 5.3% rate in the second quarter,
stronger than our estimate and 5 .1 % above its year-earlier level.
• The only other periods during which productivity gains were
strong occurred in the early stages of economic recoveries, not ten
years into an expansion. Unlike the current performance, rapid
gains during earlier periods mainly reflected a cyclical pickup as
the economy revived after recession. Indeed, during the past five
years, productivity has risen at the fastest rate since the mid-1960s.
• An equally important point to note is that productivity gains have
finally become widespread throughout the economy. Manufacturing
productivity rose at a 5.1 % rate in the second quarter and
was up by 6.9% year-to-year. That means that productivity in the
broad service sector also rose at a rate of more than 5% in the second
quarter and at about the same pace during the past year. Until
recent years, service sector productivity had been virtually
unchanged for two decades.
• The technology boom has arguably been the single-mostimportant
cause of the productivity revival. Our work shows that
productivity gains lag tech spending by roughly two-and-a-half
years. Tech spending has risen at a 25% rate during the past two
years, suggesting that productivity gains will remain robust.
Moreover, new orders for tech equipment are currently 42%
above their year-ago level, indicating that tech spending itself
should remain strong.
• The growth in productivity is likely to slow somewhat as the
pace of economic activity moderates, but we think that it will
still be impressive. We expect productivity to rise at a pace of
about 3.5% or more during the second half of 2000, and at a rate
of 3% to 3.5% for 2001. If so, we think that inflation will not
be a problem and that earnings will hold up.
• Robust productivity gains keep unit labor costs in check. Unit
labor costs fell at a 0.1 % rate in the second quarter and were down 0.4% during the past year. Manufacturing unit labor
costs have declined by 1.9% during the past year and are at their
lowest level since 1988. We expect overall unit labor costs to be
unchanged for 2000 and to rise by only l % or so next year. Inflation
simply doesn’t occur under those conditions.
• That’s borne out by the latest inflation report. The headline July
PPI was unchanged, and the core figure was up by only 0.1 %.
The PPI for crude materials other than food and energy fell by
l.8% for July, indicating that commodity price pressures are
unwinding. The core crude PPI for July was up by 7.5% year-toyear
because of commodity-price increases in late 1999 and early
2000, but it is likely to go negative before the end of 2000.
• The direction of the core crude PPI is a leading indicator of
the direction of earnings momentum. That means that the
deceleration on industrial commodity prices points to a deceleration
in earnings momentum. We expect S&P 500 operating
EPS to be up by 16% for 2000 as a whol.e, but the rate of
increase will probably be in the low double-digit area by the
fourth quarter. Next year, earnings growth of about l0%
seems likely as long as productivity growth holds up.
• Despite the surge in productivity in recent years, there is reason
to believe that productivity gains remain understated. Recent
releases of government data have made it possible to look at productivity
on and industrywide basis from 1987 through 1998. Many
industries posted huge productivity gains during that period, but
some important ones showed little or no productivity growth.
• That doesn’t mean, however, that the “laggard” industries have
missed the productivity revolution; the fault may lie with the data.
It shows that from 1992 to 1998 productivity in the construction
industry fell at a 0.9% annual rate, but that construction spending
rose by 7 .3% a year. During the same period, productivity in the
trucking industry rose by only I% annually, despite the sector’s
heavy investments in satellite and freight-management technology.
While medical costs decelerated and life spans grew longer,
productivity in the health care industry declined at a 0.6% rate.
• As we see, more reasonable assessments would raise productivity
growth for a numberofindustries, which, in tum, would boost the
productivity gain for the economy as a whole. Our best guess is
that overall productivity growth is still being underestimated by
a full percentage point. That’s another way of saying that economic
growth has been underestimated by a percentage point.
Bruce Steinberg, chief economist
