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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 growth.

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