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Markets: Is America Still as Productive?
New York: February 14, 2005
By John R. Stephenson

One of the great things about the American economy has been the productivity miracle that has helped North America remain competitive in the face of stiff competition from overseas. So significant has the productivity miracle been that it is almost taken for granted by investors as a permanent feature of the investing landscape. Without doubt, the productivity gains of the past have been significant with America's productivity gains over the last thirteen quarters averaging some 4.4% on an annualized basis. The question for investors is - is this productivity growth sustainable?

The latest numbers out of Washington cast some doubt about the American productivity miracle. The recent fourth quarter productivity report made one thing clear - U.S. productivity growth is slowing. Output-per-hour in the nonfarm business economy rose at just a 0.8% annual rate which is one-fifth the productivity recorded in the previous quarters. While it is certainly conceivable that this latest statistic is an anomaly, I believe there are many reasons to think that it isn't.

For starters, much of our productivity increases have occurred because of gains from information technology. That is, the use of technology to enhance productivity. The economic gains occurring from increased productivity through the use of technology have been impressive but may well be showing signs of rolling over. Between 1995 and 2004, the information technology share of total capital equipment expenditures grew from 36% to 58% in inflation adjusted terms. But in the last three quarters of 2004, the spending on information technology started to slow. With no new technological breakthroughs on the horizon, it is likely that future spending on technology will be driven more by replacement of existing equipment than by acquiring new technology platforms. In fact, it appears that information technology saturation is at hand. A sobering thought for an economy in the midst of an information revolution. It seems unlikely that the spending on information technology in the next ten years will approach the twenty-percentage point increase of the past decade.

Cost cutting has not been limited to the manufacturing sector -the service sector of the economy has also seen costs cuts in the form of employee's layoffs or longer working hours. This trend is clearly evident in the weakest ever job creation numbers that this recovery has logged. It would appear that the slash-and-burn mentality may have run its course as labor costs rose some 2.3% in the fourth quarter of 2004. This bump up in wages may signal that corporations are no longer able to force workers to bear an increasing share of the corporate cost cutting. If indeed the pendulum has started to swing the other way, this could be bad news for the nation's productivity figures as the remaining workers are stretched to capacity.

Another reason to suspect that productivity gains may be on the run is the basis for the government's productivity figures may well be faulty. By understating the true hours worked they are able to overstate the productivity of American workers. According to the U.S. government, the official number that they use to calculate the productivity figures assumes an estimated work-week of just 33.7 hours (according to the establishment survey). In areas such as financial services, the official estimate of hours worked seems woefully inadequate clocking in at just 35.8 hours - a figure that dates back to the 1981 survey. This seems hard to believe particularly in an era when products such as the Internet, cell phones, laptop computers and wireless email devices allow workers to continue to toil at all hours of the day and night. With productivity gains potentially the result of increased working hours it seems hard to rationalize how the gains in productivity can continue with a physical limit to the number of hours an overtaxed workforce can continue to work.

The economic consequences of declining American productivity would be enormous. If the U.S. economy is indeed experiencing weaker productivity, corporate earnings and the stock market would come under pressure. Productivity is also a key input into the trend growth assumptions for the country's GDP and tax revenue projections with any fall in productivity likely to make the country's deficits look even worse. As well, a reduction in productivity would introduce inflationary pressures into the system as economic growth would be hard to sustain without the increase in profitability coming from productivity gains.

The gains from productivity have been at the heart of America's economic resurgence over the last several decades. This productivity miracle driven by technological innovation, cost cutting and extended working hours appears to be running out of steam. Investors would be well advised to avoid heavy exposures to equities, particularly those stocks strongly levered to a growth orientation.


StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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