Productivity: Often ignored, always important

Just what does productivity have to do with the price of a mocha latte or a basket of onion rings at the neighborhood diner?”

The answer is: “almost everything.”

Productivity is the ugly duckling of popular economics. It doesn’t get nearly as much attention as its more glamorous siblings, inflation and unemployment. The press reports it only perfunctorily. But in the long run, nothing matters as much as productivity, nothing at all.

Productivity is what was referred to as “bang for the buck” in the Pentagon during the Kennedy-Johnson years. It refers to how many goods and services our economy is able to produce with a given set of inputs, workers, machines and natural resources. When productivity goes up, it means that we are getting more physical things and more intangible services to meet our needs and wants out of the same set of available resources.

Tuesday’s Labor Department report said that for every hour someone worked last year, she produced 3 percent more than in 1998. That may not sound like much, but if it continued, it would double per-capita incomes in 24 years.

It is important to distinguish between the “monetary” economy and the “real” economy. For convenience sake, we tabulate the value of output and of incomes in dollars. But no one eats dollars, or is protected from the cold by dollars, or gets to work or the store by riding a dollar. In the long run, if a society does not produce more food, clothing, shelter and transportation, people cannot consume more. If people do not have any more goods and services to meet their needs and wants, their real income has not increased.

Lets look at this a little more closely by following an increase in the productivity of a typical American worker, whom we will call Victoria. Victoria is a manufacturing worker who makes, let’s say, aluminum cake pans.

Say that Victoria turned out 500 cake pans per eight-hour shift in 1998. In 1999, her productivity rose by the industry average in 1999 of nearly 10 percent. In other words, this past year she produced 550 pans per shift. Those extra 50 pans are something that society did not have a year earlier, and Victor did not work any more hours to produce them.

How could she do this? First, she may have learned how to do the job better. Perhaps her movements are swifter and more dexterous. Maybe she is better at noticing when the machine she operates is getting out of adjustment. Or perhaps her team changed the physical layout of machines on the shop floor to make materials flow more efficiently. Perhaps the company installed a new, more efficient machine for her to use.

Productivity increases usually come from a combination of smarter, better-trained, more motivated people and better machines. The relative importance of each varies from case to case.

Regardless, Victoria now produces more pans. Society has more pans to meet people’s needs. Who is going to benefit from this improvement?

As economists are wont to say, it depends! Victoria might get a pay increase since the company now has more products to sell for every hour that she works. Or the company might invest in even more new machines. In that case, sales will go up at the machine factory.

The company may also face competition from pans made in Asia. It may choose to lower its prices to meet this competition. They can do so because Victoria’s hourly compensation can be spread over 50 more pans than the year before. In this case, she may not get any more pay, but she may keep a job that she might otherwise have lost.

In addition, any consumers who need to buy a new pan will find that they can get one cheaper. This is like a slight increase in income; they can buy the pan and still have money left over for other things compared with the year before.

Or the company may be able to keep prices up and wages where they were.

This will increase profits. The profits will be paid out to shareholders as increased dividends. Higher earnings will cause the price of a share of stock to go up, and some household may cash in their stock and use the profits to buy a new car or take a vacation.

It is possible that the company’s managers or executives may get higher salaries. They would then be the ones buying new cars and taking vacations.

Exactly who will reap the benefit of the 50 extra pans is uncertain. It could be Victoria, the CEO, consumers, stockholders, managers, machine suppliers or even the company that supplies the aluminum sheets used in the factory. The exact outcome will depend on many factors. But more useful things, more real wealth, has been created than a year before, and someone in society is going to benefit.

Cynics may say, “Yeah, it’ll probably be the fat cats, the CEOs and the stockholders.” They may get a nip at the pie, but labor markets are as tight as they have been in 30 years. Victoria will get a good chunk, or she will get a job elsewhere.

Higher productivity is good news, very good news. Over our lifetimes it is much more important than the Dow, the Nasdaq, or the value of any mutual fund.

© 2000 Edward Lotterman
Chanarambie Consulting, Inc.