April 11, 1995
"On the Verge of a Long-term Economic Boom?"
San Jose Mercury News
By Timothy Taylor
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ECONOMIC optimists are coming out of the woodwork. They believe that the U.S.
economy is experiencing not just a short-term recovery, but entering into a long-term
boom. They might even prove to be correct.
Two recent sightings of the optimists occurred in a March 29 story on the front
page of the Wall Street Journal, and in the April 3 issue of Fortune magazine.
Here's their argument in a nutshell.
Business has been investing in new capital equipment with ferocious enthusiasm.
Since the economy bottomed out in March 1991, investment has risen at an average
annual rate of 13 percent. Fortune calls this capital-spending boom "arguably
the most important economic event of the decade."
This wave of investment is making heavy use of information technology; investment
in computers and related equipment has been rising at an incredible 33 percent
annual rate these last three years. As this technology percolates through the
workforce, it is helping U.S. companies to gain an edge in global markets. As
a result, writes the Wall Street Journal, "there is good reason to believe
that despite people's jitters, living standards will get better for middle class
families over the next two decades."
Since the start of the capital spending boom in 1991, productivity growth has
been about 2 percent per year. Although this doesn't measure up to the 3 percent
rates of annual productivity growth that were regularly achieved in the 1950s
and 1960s, it is twice as high as the 1 percent growth rates that prevailed during
the late 1970s and through the 1980s.
To the uninitiated, raising productivity growth from 1 percent to 2 percent
may not sound like much reason to throw confetti. But remember that this increase
is annual and sustained, so it compounds with time.
For example, the median income for a U.S. family in 1994 was about $38,400.
If the median income grew at 1 percent per year, it would reach $46,900 in 20
years. At 2 percent annually, it would reach $57,100 in 20 years. At 3 percent
annually, median income would hit $69,300 in 20 years.
Of course, inflation over time would make these numbers look even larger. But
these illustrative calculations represent a real increase in buying power for
the typical household.
Over the long run, absolutely nothing matters more for an economy than raising
incomes through sustained productivity growth. The faster growth during these
last few years is extraordinarily welcome news.
But will it continue? The fact that the temperature rises from January to July
doesn't prove that it will keep rising the rest of the year. Similarly, the rise
in productivity during since the economy bottomed out in 1991 doesn't prove that
the productivity will keep rising when the economy eventually slows down again.
Both capital investment and productivity tend to move in a cycle with the overall
economy. Businesses often delay and defer investment in tough times, and then
splurge on investment when times are good.
Similarly, when the economy falls into recession, the amount produced declines
quickly, but businesses don't usually fire or lay off workers immediately, until
they are sure a recession has truly arrived. With lower output and much the same
workforce, productivity falls. Early in the recent recession, for example, productivity
actually fell 0.9 percent in 1989, and rose a measly 0.4 percent in 1990.
When the economy recovers, production picks up quickly but businesses are slow
to hire new workers, until they are sure the upswing will last. Thus, productivity
growth actually topped out at 4.5 percent during the second half of 1993, before
cooling off more recently.
The optimists recognize that part of the surge in growth reflects only a cyclical
pattern in the economy. However, they believe that half a percent or more of the
growth will prove permanent and lasting.
I hope they're right. But a more mainstream and pessimistic viewpoint was recently
provided by President Clinton's Council of Economic Advisers, in their most recent
Economic Report of the President.
The CEA offers provisional evidence for a slight improvement in the long- term
rate of productivity growth, perhaps 0.2 percent per year. But in the words of
the CEA, the productivity figures "are dominated by the cyclical recovery
and so may create a false impression of an improvement in the trend.... The experience
of the next few years will be quite telling for this issue."
Remember, the Clinton economic team has good political reasons to announce
that the recent productivity spurt will be long-lasting. As only one example,
optimistic projections on productivity and growth would make it easier to project
a declining budget deficit. The Clinton economists deserve credit for resisting
that old temptress, Rosy Scenario.
The most likely story is that the extraordinary private sector investment and
restructuring of the last few years, along with all the public sector belt-tightening
and deficit-fighting, is barely the beginning of a sustained resurgence in productivity.
It's still a long way to that promised land of a permanently higher rate of economic
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