The recently reported revised second quarter productivity figures add to the accumulating evidence that the U.S. economy is benefiting from a sustained period of reasonably strong productivity increases.
A number of important factors have converged in recent years to generate these improvements. Among them are capital spending, the high technology revolution and the reallocation of resources from public sector spending, especially for defense, to private sector investment.
Often overlooked, but nevertheless important, has been the resurgence of entrepreneurship in the United States. Although that is difficult to measure, it nevertheless is an inherent component of the current prolonged, profitable expansion.
Over the course of this expansion - beginning with the second quarter 1991 and continuing through the second quarter of 1995, 17 quarters and counting - productivity has risen at an average annualized rate of 2.4%. This is the longest continuous and most rapid increase in productivity in over 30 years and the second longest for any business cycle since the end of World War II.
Meanwhile, independent of productivity, compensation rates have grown slowly.
As a result, unit labor costs have slowed considerably. For example, the latest year-over-year figure for unit labor costs for the entire business sector shows no change in the second quarter. For all of 1993, unit labor costs rose 2%. For 1994, they rose 0.7. In other words, productivity improvements have offset incremental costs arising out of compensation to hold unit labor costs to very small increases.
The result is improved profitability and well-contained inflation, leading to rising profits, additional capital spending, further enhancements in productivity and contained inflation - a virtuous cycle. That will contribute, in large measure, to the sustainability of the expansion.
The reasons for this improvement in productivity are obvious and not so obvious. Among the obvious reasons are the rapid increases in capital spending over the past three and one half years and the introduction and enhancement of high technology throughout the mainstream of America.
One of the less obvious contributors to productivity has been the transfer of resources from government spending, especially for defense, to the private sector. The end product of defense spending is not productive in an economic sense. Furthermore, since most defense spending is based on cost-plus pricing, the incentive for price competitiveness and productivity is diminished.
In contrast, production for private sector purposes constantly faces market tests of utility, price competitiveness, and quality. Moreover, in cases of capital spending, the end product has a continuing useful economic life that sustains the chain of economic output.
Still another less obvious contributor to productivity has been the resurgence of entrepreneurship in America. The restructuring of American business that began in the 1980s is now showing dramatic results.
Layoffs and containment of labor costs is only a part of the story. At least as important has been the introduction of innovative technologies, reengineering, and adoption of new management techniques.
Competitive pressures have also forced American business managers to give greater emphasis to profitability and stockholder returns than to size. Another element in the improvement in entrepreneurship has been the trend to reward workers with incentive compensation. These incentives are usually based on company profitability and worker performance. This has sharpened worker focus and improved effort up and down the echelons for a much larger percentage of workers than was the case prior to 1991. Finally, aggressive deregulation has enhanced competitiveness within the United States and, to that extent, has also contributed to improved productivity. This is an exciting picture.
A productive and competitive America generates prosperity, a part of which is good profits. Those profits induce further capital spending, improved technology, more productivity, enhanced competitiveness and so on. In the process, inflation remains contained.
With the economy well balanced, barring policy mistakes, the expansion can continue indefinitely. Mr. Sherman is director of research with M.A. Schapiro & Co.
