Diane Coyle: When America stops sneezing, we'll still be down with a cold

There are signs of long-term recovery in the US, but UK firms are too short-sighted to invest

Tucked away amid all the dismal news of recession in manufacturing, share price nosedives, job cuts and plummeting corporate profits was a tiny ray of sunshine last week. It was that labour productivity, the amount of output per worker hour, in the American economy had unexpectedly risen sharply in the three months to June.

Productivity is pivotal to the outlook for growth in the US, and hence the rest of the world, beyond the next six months or so. The assumption there had been a "prod-uctivity miracle" is what underpinned the dot-com share price boom, and now the boom has bust, some people have already dismissed the idea that there was anything special happening in the economy.

But it was always a mistake to think an economic transformation would mean super-high profit growth for lots of companies for ever. For in the end the fruits of productivity gains go mostly to the workers who have achieved them, and the economy-wide split between total profits and total labour earnings varies over the business cycle but rarely diverges very far from one-third/two-thirds (or, in some European countries, one-quarter/three-quarters). Conversely, that lots of companies will make very disappointing profits for a while does not necessarily imply nothing funda-mental has happened to the US economy.

Figuring out which changes are going to last and which are temporary due to the swings of the economic cycle is very hard, however. In the past, the normal pattern for labour productivity was that it would climb during a business cycle upturn, with companies increasing output faster than they added new jobs, and fall during a downturn as they cut output faster than they laid off workers. In other words, the level of output varies a lot more than that of employment.

Productivity growth has also typically been higher in the early stages of expansion than later on. However, the long expansion since 1992 and the current slowdown have not been typical. Labour productivity growth got faster and faster the longer the record-breaking expansion lasted, and this remains true even though the figures for last year have recently been revised down by the Bureau of Labor Statistics. The growth rate fell sharply in the first quarter of 2001 but has now picked up again even though (as the second two charts show) overall growth has almost halted and industrial output is slumping.

It's hard to know what to make of these aggregate figures. They are very volatile anyway, especially as US statistics tend to be reported as quarter-on-quarter changes annualised. According to the newest estimates, the weakest recent performance was actually in the first quarter of 2000, before anybody had an inkling that growth would halt so suddenly later in the year.

The judgement about long-term economic trends is complicated by the fact that the measure really needed incorporates improvements in the productivity of all factors of production, including capital. But this is much harder to calculate and not yet available for last year and this.

As a result, the data lends support to optimists and pessimists alike on the fundamental health of corporate America. On one hand, the trend productivity growth rate from 1996 to 2000 was only 2.5 per cent, not the 2.8 per cent previously estimated. That's higher than the previous sub-2 per cent trend, but not as spectacular an improvement as originally thought. On the other hand, productivity growth has not slowed down nearly as much this time as it has in previous business cycles.

These figures are not going to change many minds. Certainly both Federal Reserve chief Alan Greenspan and Paul O'Neill, the US Treasury Secretary, are sticking with their underlying optimism. Mr Greenspan said recently: "By all evidence we are not yet dealing with maturing technologies that, after having sparkled for half a decade, are now in the process of fizzling out." And Mr O'Neill said: "If the best companies continually develop productivity growth, I think it's a leading indicator for what's possible."

Of course they would say that, wouldn't they? Yet the macro-economic entrails pored over by all commentators for evidence of the long-term productivity trend is only part of the information on what's been going on in US industry. There are more and more studies looking at individual companies rather than aggregated statistics. For example, estimates based on studies covering hundreds of companies show big productivity gains from the use of new technologies. These gains are small at first but impressive after several years because the effective use of technology requires new skills, business reorganisation and different management techniques.

The available company-level evidence points to potential productivity rises of 15 or 20 per cent. If some firms in an industry achieve that kind of result, competitors will eventually have to follow suit. No wonder Mr O'Neill is a long-term optimist.

It doesn't matter if many glum econo-mists believe he will be proved wrong. But businesses ought to be thinking hard about what view they should take. If the economy is in for a long stretch of slow growth or even a recession, it's hardly the best time to be spending heavily on investment and reorganising the company. On the other hand, if there is such a big productivity reward dangling in front of those that take the technology seriously, it would be short-sighted to ignore it.

The dilemma is more severe in the UK. Across the Atlantic, many companies have invested in a lot of new technology that will be in place when the economy eventually turns up again, whereas the recent investment and productivity record here has been disappointing. There are still pockets of British manufacturing using machines installed in the 1970s, and their old-guard managers will boast about not having wasted money on unnecessary new equipment. There is a real risk that the collapse of dot-com mania and the severe US slowdown will offer another excuse for not investing and not improving productivity.

What the laggards here do not realise is that the future is not a time you can sit back and wait for, but a destination you have to shape for yourself.

diane@enlightenmenteconomics.com

Diane Coyle's book, 'Paradoxes of Prosperity', is published by Texere next month.