Perils of the Productivity Sag

During most of the 1960s, the U.S. enjoyed rapid economic growth combined with both low unemployment and low inflation. But in the 1970s the economy has been plagued by inadequate expansion, persistently high unemployment and galloping inflation; indeed last week the Labor Department set the rise in consumer prices for all of 1978 at a full 9%, making it the second most inflationary year in the past three decades.* Why the enormous difference between the fat Sixties and the souring Seventies? Though no single factor can be assigned all the blame, one trend is now being recognized as supremely important: the growth of productivity has slowed sharply in this decade, and since 1976 it has almost stopped.

Through the 1960s, output per man-hour worked--the conventional, though not entirely adequate, way by which productivity is measured--rose on average about 3% a year, a healthy pace that had been maintained since shortly after World War II. In the '70s, productivity growth has averaged only about half that. Some economists long hoped that the slowdown was a cyclical fluke, caused mainly by the recessions of 1970 and 1973-75 (recessions always hurt productivity because companies run high-powered machinery at a slow pace and keep on the payroll workers who do not have much to do). But the annual report of the Council of Economic Advisers, submitted to Jimmy Carter last week and sent by the President to Congress with a covering letter, pretty well blew away that theory. Productivity, the CEA pointed out in the report, has not recovered during the past two years of expansion. In fact, productivity throughout the private economy rose only 1.6% in 1977 and a miserable .4% last year. Indeed, the report pessimistically suggests that the U.S. may be entering a new era in which productivity growth for many years will average no more than 1.5%.

If that should happen, the implications would be nearly disastrous. Productivity is the key both to raising living standards and to controlling inflation. If each worker produces more, then total output will grow rapidly and employers can raise wages without jacking up prices; the rise in output per employee will offset the higher costs. If productivity is flat, almost every dollar of wage gains is translated into price boosts. Over the decades, price rises have closely followed increases in employers' unit labor costs--that is, wage gains minus productivity.

In the short run, low productivity can create jobs as more workers are needed to supply rising demand. That happened in early 1978, when joblessness dropped much faster than production rose. But in the long run, low productivity hurts employment too. In the 1960s, it was thought that the economy could grow 4% each year without setting off a burst of demand-pull inflation. Mostly because of the collapse in productivity, the Administration now reckons the safe-growth ceiling to be 3%. An economy growing that slowly cannot create enough jobs for all the people who are looking for work.

Why has productivity been so sluggish? Groping for explanations, economists cite a variety of possible factors, from drug abuse to the doctrines of John Maynard Keynes--which, some contend, led policymakers to pay too much attention to manipulation of total demand in the economy and too little to productivity.

But there is wide agreement on at least some of the major causes, which have very little to do with worker attitudes. In the complex U.S. economy, how much an employee produces depends far less on his zeal than on his education and training, and even more on the efficiency of the machinery that he works with. The most important reasons for productivity lag:

> Excessive regulation. Companies have had to pour more and more money into costly antipollution equipment and devote increasing attention to complying with health and safety rules, rather than buying productive machinery and figuring out more efficient operating methods. Though lives undoubtedly have been saved and the air and water cleansed, the price has been high. The CEA estimates that regulation may be cutting annual nonfarm productivity growth by four-tenths of a percentage point.

> Inadequate investment. Between 1948 and 1973, business spending on new plant and equipment added 3% a year to the capital investment supporting each man-hour of work. Since then this capital-labor ratio has increased only 1.75% annually. Economists argue fiercely whether the chief reason has been tax policies that favor consumption over investment or business fear that recession and/or inflation will wipe out the profit on new investment. In either case, the result has been to slow the introduction of cost-cutting, labor-saving machinery and, says the CEA, to slash the growth of productivity by half a percentage point each year.

> Reduced R. and D. In 1964, research and development spending accounted for 3% of the gross national product; last year the share was down to 2.2%. Some reasons: the Government has cut its support of R. and D. programs sharply with the end of the Viet Nam War and the de-emphasis of the space program; private universities have been in a financial squeeze; industry in an inflationary era has judged the payoff from R. and D. spending to be too long term and uncertain. The toll on productivity is hard to calculate, since it would have to be measured in inventions not made and labor-saving processes not developed, but it surely has been high.

> Change in the work force. Since the mid-'60s, women and youths born during the postwar baby boom have flooded into the job market. Many lacked the training and experience to become highly productive workers in their first few years. By the CEA's estimate, industry's reliance on them to fill jobs has lowered productivity more than a third of a point per year.

As the new workers mature and acquire job savvy in the '80s, they should cease to be a drag on productivity. It is also faintly reassuring that the productivity slowdown has not been uniformly severe throughout the economy but at its worst in a few industries: mining and utilities, which have been most deeply affected by new antipollution and safety rules; construction, where outmoded building codes have held back the use of new technology; and retail sales. Stores have been staying open nights and Sundays to satisfy shoppers' demands for more convenience; the longer hours force them to hire more workers but do not add proportionately to weekly sales. Other areas of the economy have had difficulty too, but manufacturing in general had a good productivity rebound last year.

Whether it will last, no one can tell. The forces working to slow productivity further are dauntingly powerful. The rise in energy costs pinches productivity hard by increasing the expense of using labor-saving machinery. So does the inexorable switch to a service economy: it is much harder for doctors, credit counselors, teachers and policemen to raise or even measure their productivity than for steelworkers. The investment lag is especially perilous: as productivity slows and costs inflate, businessmen become even more hesitant to spend on new machinery, which in turn cuts productivity and speeds inflation still further.

But there are some obvious avenues of attack. Government should loosen regulation, as President Carter has promised. One method would be to set pollution standards and impose stiff fines for violations, but leave it to industry to devise the least costly methods of cleaning up; this would be more sensible than specifying in great detail what equipment should be installed and how plants should be modified, as regulators often do now. Tax policies could be revised to spur investment. Economists quarrel about whether further cuts in taxes on capital gains and corporate profits, more generous investment tax credits or faster depreciation write-offs would be most effective. Probably some combination of all these approaches will be needed.

Tax credits for R. and D. spending are another possibility. In addition, even those economists who insist on the importance of reducing federal spending make an exception for R. and D. outlays; their potential benefits far outweigh the costs. Several economists suggest that the Government put up matching funds to spur university research programs into ways to improve productivity of service industries--dry cleaners and restaurants, for example--in which most companies are too small to undertake any significant R. and D. That approach has enormously increased the productivity of farming.

Even if all these strategies were adopted overnight, speeding up productivity might well take a discouragingly long time. The '70s lag in investment and R. and D., in particular, will go on harming productivity well into the '80s. But the effort must be started. A long period of sluggish productivity would mean an era of slow growth, little or no rise in living standards, persistent unemployment and high inflation--just like the '70s, only worse.

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