August 7, 2001 Productivity Revisions Tarnish New Economy By Dean Baker __________________________________________________ ___________ The lower productivity numbers should raise serious questions about stock prices. __________________________________________________ ___________ The second quarter productivity release included large downward revisions to previously released productivity numbers. These revisions raise serious questions about the extent to which the United States really has a "new economy" with a qualitatively different productivity growth path. The reported annual rate of productivity growth in the non- farm business sector from the fourth quarter of 1997 to the fourth quarter of 2000 (the period for which data was revised), was lowered from 3.24 percent to 2.69 percent. This is still a significant upturn from the 1.35 percent annual rate of growth from 1973 to 1995, but much less impressive than the numbers originally reported. The data for the second quarter of 2001 showed a strong rebound from the first quarter, with productivity rising at a 2.5 percent annual rate in the second quarter compared with an increase of just 0.1 percent in the first quarter. However, this turnaround was entirely attributable to a sharp drop in the number of working hours reported in the second quarter. According to Labor Department's data, hours worked fell at a 2.4 percent annual rate in the quarter. The numbers reported for hours worked in this data is poorly measured. It is more likely that the falloff in hours reported in the second quarter, and therefore the rise in productivity growth, was attributable to errors in measurement. Productivity has probably been advancing at an annual rate close to the average reported for the first two quarters, or 1.3 percent, so far this year. The main reason for the downward revisions in the productivity data was a downward revision in the rate of output growth reported for 1999 and 2000. The increase in output in the non- farm business sector had originally been reported as 5.7 and 3.6 percent, respectively. In the new report the growth rate of output for 1999 was revised down to 4.9 percent, and to 2.8 percent for 2000. The downward revision to output was in turn primarily attributable to a significant reduction in the output of software reported by the Commerce Department in its GDP revisions last month. With this report, the new economy years from 1996 to 2000 look somewhat less impressive. The average rate of productivity growth over this period was 2.5 percent, compared to the 2.9 percent previously reported. It is also worth noting that this 2.5 percent figure somewhat overstates the increase per hour in usable output. Productivity is a measure of gross output per hour. The output that is actually usable, by consumers or firms, is determined by the growth in net output. The difference in the measures is the amount of output that is used to replace warn out or obsolete equipment. Wages and profits must be generated out of net output, no one can eat worn out equipment. Typically, the increase in gross and net output is virtually the same. In fact, in the sixties and seventies net output actually increased slightly faster than gross output. However, in the last five years, there has been a large gap between the growth of gross and net output, with gross output rising at a rate that is approximately 0.35 percentage points faster than net output, on average. This difference is due to the increasing use of computers, which have very short lives. This means that a productivity measure that examined the growth in net output over the period from 1996 to 2000 would show an annual rate of growth of less than 2.2 percent. This is still an upturn from the productivity growth rates of the mid seventies and eighties, but its far below the 3.0 percent productivity growth rates of the sixties. The productivity revisions in this report should raise questions among new economy optimists. It is unlikely that we will see the sort of rapid GDP and profit growth that many had anticipated. This should raise some questions on Wall Street, where stocks are still priced as though the economy will maintain high rates of growth for the indefinite future. The downward revisions may also affect budget projections. The Congressional Budget Office assumed that productivity growth will average 2.7 percent over the next decade. With the revised data, the rate assumed by CBO is now higher than the growth rate achieved even at the peak of the boom. Based on this new data, CBO is likely to revise down its growth projections, and its surplus projections as well.
