The report by the Labor Department earlier this month that U.S. worker productivity declined in this year's first quarter should come as no surprise. Productivity, or output for each hour worked, usually declines at this point in the business cycle.
When the economy slows, as it has been doing for more than a year, productivity tends to fall because output slows while hours worked may not.
Sometimes, employers will hold onto labor, figuring that the drop in output is temporary. Skilled workers are hard to get at the peak of the cycle, and to lay them off is to risk losing them to the competition.
In addition, there may be union restrictions that prevent employers from cutting their work forces as fast as they would like. Then there is the moral obligation many employers feel to their employees' families.
Whatever the case, when the U.S. economy slows, workers are retained much longer than they are actually needed, and that is why productivity tends to decline. Clearly, this is the stage at which we find ourselves now, given the plethora of statistics flashing the caution signal.
The big question is, can we do anything about it? For, as my fellow Board of Economists member Laura Tyson pointed out in this space three weeks ago, "Sluggish productivity growth is a cause of some of the nation's most pressing economic problems."
The answer is, yes, productivity can be improved. Tyson's suggestion that workers be allowed to participate more in the decision-making process and be compensated in part by profit sharing seems logical. So are the efforts under way in a number of companies to step up job training and restructure responsibilities.
But to really get a handle on productivity, we should step back to examine its chief determinants. As I see it, there are three--two of which are beyond control, for all intents and purposes. The third can be influenced, however, by the correct policy mix.
The first determinant is long run in nature. It deals with how the economy is divided between those industries in which productivity gains are technologically and economically feasible and those for which such gains are few and far between.
In the former category, I would put manufacturing and agriculture; in the latter, the service sector, white-collar jobs, etc.
Manufacturing is doing OK. Factory productivity in the first quarter grew at an annual rate of 2.1%. It's the service sector that dragged productivity down. And in recent years, the service sector has grown much faster than manufacturing; four-fifths of U.S. workers are employed in service jobs.
Plainly, in the long run, there's very little that can be done at the macro, or policy, level to influence productivity, although individual company efforts certainly are worthwhile.
On the other extreme, in the very short run, productivity is equally uncontrollable. This is because it is determined by the phase of the business cycle that the economy happens to be in. And, as observed above, we are now in the slowdown phase of the cycle when efficiency tends to decline.
Obviously, if we could control the business cycle, we could influence a lot more than just productivity.
Between the long run and the short run lies a time frame during which productivity can be influenced by economic policy. Spanning one to five years, this is the time during which productivity is largely determined by the amount of money that business invests in new plant and equipment.
The degree to which labor gets new tools with which to do its job is a major factor in determining worker efficiency. And capital spending is the one determinant over which policy-makers can exert a great deal of control.
Let me illustrate the importance of capital spending. The Japanese set aside about one-third of their gross national product for investment in new plant and equipment. Productivity there has grown by about 11% each of the past 20 years.
In West Germany, over the same period, approximately 20% of GNP has been allocated for capital spending, resulting in an average rise of more than 5% per year in worker productivity.
Contrast these trends with those in the United States. Here, we have set aside barely 10% for investment in new capital goods. As a result, productivity growth has amounted to only 3% a year throughout the past 20 years.
The remedy, it would seem, is to find ways to stimulate capital spending. One way would be to bring the cost of capital down. It's difficult for business to raise money by borrowing because of interest rates that are high in both nominal and real terms. The Federal Reserve can lower rates by expanding the money supply, but the better alternative is to reduce the federal budget deficit so that demand pressures could be reduced, thereby minimizing the risk of inflation.
Raising money by selling stock is difficult because dividends are doubly taxed and because many companies' stock prices are still below book value. The capital gains tax is no longer below other rates--which means that long-term investors are penalized because they pay taxes on the increased value of assets due to inflation. What's more, the investment tax credit and accelerated depreciation adopted in 1981 have been trimmed.
We need a more reasonable tax policy to encourage individuals to save and businesses to invest. For these actions are the best ways to boost productivity. And only through greater productivity can we expect to pull ahead of other countries in the race for better quality goods, increased sales and higher living standards.