DEPARTMENTS:
Blessings of Liberty

By John Hood

Productivity's boost to living standards

During last year's election campaign, voters endured much hand-wringing about the plight of the American worker. Remember these often-repeated themes?

International trade harms average Americans by pitting them against low-paid workers in other countries.

In an era of corporate downsizing, workers no longer have the opportunity to find good jobs at good wages.

America's living standards are stagnating or declining, making the American Dream seem more like a nightmare.

Politicians of all ideological stripes sounded these themes, and their complaints were echoed in the nation's media. But all these ideas are espoused by people who either misunderstand economics or favor government intervention over the workings of free enterprise. They all fundamentally ignore the most important economic factor in a modern, competitive economy.

If we want a better standard of living for ourselves and our families, the most critical goal is to increase productivity-the value of goods and services that each worker produces. Here's why: Americans have come to expect ever-increasing incomes to raise their living standards. But a company that consistently pays workers more than their output is worth is likely to go under-and destroy its jobs along with it.

Labor costs are the largest component of the price for most goods and services. So when the work force as a whole consistently gets pay raises that exceed growth in its productivity, inflation results. Conversely, if firms try to suppress wage growth while productivity stagnates, the prospect of rising living standards disappears. Doing what you're already doing, only better and cheaper, may not be that exciting, but it is the crux of the American Dream.

The Good News

The good news is that American workers continue to be the most productive in the world. America retains an important advantage over most other societies: We are more friendly to free enterprise. Competitive markets force businesses to seek higher productivity. There are only a certain number of hours in the workday, and a relatively limited number of workers available at any one time to produce goods and services. You can try to lure people away from competitors and have them work overtime, but this is a costly solution. It is far better to get more output from each worker.

As long as the U.S. work force keeps improving its productivity, employees will enjoy rising incomes. For years, statisticians have computed "real" (inflation-adjusted) wages using the Consumer Price Index, which we know now exaggerates changes in the cost of living. If you recalculate inflation according the recommendations of the recent presidential commission of eminent economists, the decline in real worker wages since 1973 proves to be a healthy increase.

For all the fretting about America's losing ground to trade competitors, international data show that U.S. workers remain extremely productive. Harvard economist Dale Jorgenson estimates that U.S. productivity is 10 to 15 percent higher than Japan's and is growing just as fast. In manufacturing in particular, America has no equal; since 1982, the average cost per unit of factory output fell in the United States but rose in France, Japan, and Germany.

There is a reason why Haiti and Bangladesh are not manufacturing powerhouses, despite their low wages. It is the output per worker, not the cost per worker, that matters. Paying a worker 25 percent less to make 50 percent less product is no savings. That's why the name of the game in economic development is improving productivity, not creating jobs as such-or protecting them through trade barriers.

For example, while apparel manufacturing has, indeed, migrated overseas in recent years, textile plants largely have not. The thread used to make the socks is still made in America, because we are much more cost-effective. Using new technologies, we can make better textiles at lower cost while paying textile-plant workers well.

So what's the outlook for the U.S. worker? There has been much fluctuation in U.S. productivity recently, leading analysts to disagree over the prospects of significant progress in the near future. I think there is plenty of reason to be optimistic, particularly as the computer and information revolutions continue to shape the economy.

Technology Trendsetters

Consider the experience of Timken Steel in Canton, Ohio. Using new software to predict production needs more accurately, Timken was able to streamline its procurement and manufacturing process, increasing output by 15 percent without investing in new plant and equipment. Installing the new software cost a couple of million dollars; getting the same benefit by expanding plant and equipment would have cost $20 million to $30 million.

With the aid of computers, Herman Miller, a furniture maker in Zeeland, Michigan, reduced by 20 percent the time it takes to deliver a product from the moment the company receives the order. Speeding up delivery times means that the company is able to fill more orders during the same period, thus increasing output per hour.

Computers also allow managers to devise new ways of organizing workers. Business Week reports that in 1994 and 1995, auto-glass installer Safelite Glass Corp. of Columbus, Ohio, used a computer system to monitor inventory and installation times. The study convinced the firm that it was compensating workers inefficiently. Managers offered glass installers a choice between earning their current wage (a minimum of $11 an hour) or earning $20 per unit installed. When workers had the chance to earn more by working faster, output per worker rose by 20 percent. Workers reaped half of this gain immediately in the form of an average 10 percent pay raise, while strengthening their employer's competitive position.

GTE, a telephone company, increased productivity significantly when it gave repair crews laptop computers. They planned their daily schedules more efficiently and gave customers more accurate service appointments. Ultimately the firm reduced administrative its costs and served growing populations with the same or fewer service people.

Investment in technology isn't the only way to boost productivity. Many firms find that training workers to be better at what they do is money well spent. One study by the U.S. Labor Department found that increasing the average educational level of manufacturing working by one grade level typically increased productivity by 8 percent.

Motorola, a leading manufacturer of cellular and paging equipment, has long tied its fortunes to an intensive training effort for its workers and suppliers. So has Pitney Bowes, the world's largest maker of postage meters and mailing equipment. At its Stamford, Connecticut, plant, the company collaborated with a local community college to design a curriculum that gave workers basic literacy and math skills and showed them how to order materials, monitor product quality, and work better in teams. The result: higher output and fewer mistakes.

Increasing output per worker may mean that a business needs fewer workers. But it's important to remember that businesses have not only a right but a social duty to adjust their work force to their current needs, as long as the changes result from true productivity gains, rather than hysteria, and are handled with compassion. Economists with the Federal Reserve Bank of Dallas recently examined the records of the 10 corporations with the most layoffs from 1990 to 1995. They found that, while employment fell by nearly 30 percent in these companies, their output declined by only 10 percent. In other words, these firms on average increased their output per worker by 28 percent, compared with a productivity gain of only 7.5 percent over that period for the economy as a whole. McDonnell-Douglas and Digital Equipment each halved its work force and increased output per worker by 43 percent and 82 percent, respectively.

The Productivity Payoff

For average workers and families, are these reports of corporate downsizing good news or bad news? Those who were laid off have, by and large, found new jobs. According to the Bureau of Labor Statistics, most of these jobs pay at least what the workers were previously earning, or will pay such a wage after a few years of retraining. For consumers and employees as a whole, the effects are less ambiguous. Productivity gains of 20 percent or more since 1990 at such firms as K-Mart, IBM, and General Motors mean better clothes, computers, and cars at lower prices. Our standard of living rises when the goods we buy are better and more affordable.

Growth in productivity makes possible wage increases without high inflation. And there's something to be said for the higher profits brought by productivity gains, now that many working Americans invest in stocks to save for retirement or for their children's education. Profits represent the seed corn of future investments to boost productivity.

All this doesn't mean the productivity picture is uniformly rosy. Since 1973, living standards have continued to rise, but not as quickly as in the years after World War II, when the U.S. enjoyed competitive advantages over nations ravaged by war. Today, two things threaten future productivity growth: poor education and excessive taxation. Innovations in technologies and management strategies depend on a work force that is sufficiently educated to take advantage of them. But declining proficiency in reading and math suggest that the promise of a higher standard of living is in peril. And the punitive U.S. tax system taxes investment two, three, or four times, thus stunting the development of new and better technologies that make companies more productive.

Luckily, it doesn't take huge annual productivity gains to enrich society. Even modest improvements in educational preparation and the tax treatment of productive investment would yield tremendous benefits. The key is time. A boost in productivity growth of just 0.5 percent a year would add up to about $300 billion in increased economic value over a decade.

At the dawn of the Industrial Revolution in the late 1700s, the nation raised its productivity at an annual rate of 0.5 percent. At that rate, it took six generations to double a person's income. But during the first three-quarters of this century, when productivity rose 2.25 percent a year, it only took one generation. Clearly the best thing the American enterprise system can do for its workers is to continue to demand the innovations, investments, and training that make them the most productive in the world.