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Benson's Economic & Market Trends

"Productivity:  The Illusion of Prosperity"

March 31, 2003

The Chairman of the Federal Reserve has used the mantra of "Increasing Productivity" to both justify the creation of the Credit and Stock Market Bubbles, and to make us "feel good" about the state of the economy as the bubbles blow out.  There is no question that over the long course, economic development and prosperity are tied to increases in productivity.  However, in the "Post Bubble" phase of the US economic cycle, the measured increase in productivity is purposely mismeasured and used as old-fashioned propaganda, or "Psychological Warfare," to help stabilize the markets.

The government has manipulated the inflation index to create knowing bias for price increases to be greatly under-reported. The number of dollars spent on computers and IT has been basically flat for the last four years, yet the government's economic statistics reflect that "real spending" increased 40% because the equipment has "improved".  Simply because a computer chip is faster, or a hard drive can store more data, doesn't necessarily mean that a user will really be any better off.  Example:  If you buy a Porsche that can go 180MPH, instead of a Ford that can go 120MPH, it doesn't help you get home any faster if the speed limit is 35MPH or you are stuck in traffic.  Sure, more for the money helps, but not 40%! This simple mismeasurement is very likely cutting inflation by about 1% a year, and boosting reported GDP and productivity by about 1%.  Without this false measure there would have been no economic growth in 2002.

Another major cause of increased productivity is the sad by-product of a negative return on capital.   Even the return on cash is negative.  The CPI was up 3% for February 2002 - February 2003, while the return on cash in a money market fund, before tax, is 0.75%.  Capacity utilization is 75%, and the only way to get a positive return on capital in the US is to take capacity off-line permanently.   Hundreds of dot.coms have closed never to return.   The telecom, cable, and wireless industries have had massive bankruptcies and are still in need of additional consolidation. Hundreds of airplanes sit idle in the desert, and many more are expected.  Pilots fortunate enough to keep their jobs will have their wages cut 30%, and their pensions cut in half, as their firms file Chapter 11.  Cutting wages and pensions make productivity soar!  Productivity goes up every time a company moves from a defined benefit plan to a defined contribution plan, or makes workers pay for a larger share of their health benefits.   A major contributing factor to rising productivity is the result of 2,000,000 US workers losing their jobs. 

We can expect these types of increases in productivity to continue this year.  American Airlines is restructuring without formal bankruptcy. Except for Southwest and JetBlue, the entire airline industry has to restructure, lay off thousands of workers, and park hundreds of more airplanes in the desert.  In the auto industry, production for the second quarter has been cut back over 12%. More cut-backs are necessary.  There are 17 domestic auto plants slated for permanent closure, probably in the fourth quarter.  The auto manufacturers  entered into insane labor contracts during the Bubble Prosperity that stipulated they would pay workers 90% of their salaries whether they worked or not. The Zero, Zero, Zero percent financing only made sense because both capital and labor became fixed costs.  When auto labor again becomes a variable cost, productivity can go up as these workers are let go. One look at used car prices, which have collapsed, tells the whole story on how many new cars Americans really need.

There are many more productivity increases to follow.  US pension funds still have an under-funded liability of $300 billion dollars.  Just think of the tremendous productivity increases that are still available as more industries restructure, and default, on these promises of a full pension.  Typically, the US Pension Guarantee Corp. picks up about half of what the old promised pensions were, and ultimately the liability is shifted to the US taxpayer!  Think of all the tremendous increases in productivity that can be had by moving more corporate obligations back to the American taxpayer.  

Finally, the biggest and most worrisome source of American Productivity is our trade deficit.  As we "gut our factory base" and import more components from China, our productivity soars! A worker in China will work for 10% of what it costs to use an American. If China makes the parts, and we use just a few workers to do a tiny amount of final assembly here in the US, we get to count all that cheap Chinese labor as Real US Productivity, because the final good was "Made in the USA".  The cost of Chinese labor is so low that the factories just south of the Mexican Border are closing and production has moved to Asia.  Now that is real productivity!

Productivity is a simple measure based on total output, divided by the number of workers.  Since we have a negative return on capital, the more factories we close to raise capacity utilization, and the more factories we move to China, the fewer workers we will need.  Therefore, by definition, productivity goes up.  So when our Fed Chairman says "everything is all right because productivity is rising and this is good for the economy and good for the "market", you should stop and think about who Chairman Greenspan is really talking about.  As in every downturn in the past 25 years, when manufacturing jobs go, they don't come back.  We are continuing to move to a modern service economy that is "post industrial".

The real bubble that remains is the Debt Bubble.  What ails corporate America is the need to pay down debt.  Moreover, there is no need to invest in new equipment until such time as there has been enough corporate restructuring to get capacity utilization back up to 85%.  If new investment is going to be undertaken it is then likely to be undertaken where the labor is hard working and cheap, like China.  Even service industries are letting workers go.  Productivity is rising, but lay-offs are at recession levels.  There are no new jobs. Wages in some industries are dropping, benefits are being slashed, and pensions are not going to be there.  We have rising productivity, falling incomes, a negative return on cash, and the destruction of financial capital that will continue until enough factories are taken off line and permanently closed.  Both physical and financial capital are in surplus and need to be "destroyed" to bring back a positive return to new investment.

The Credit Bubble created by an over-accommodating Fed, leaves a horrible hangover and massive imbalances yet to work their way out of the system. Citing productivity gains is nothing but propaganda to divert the public from the policy blunders of the past, and present, economic winter. The productivity mantra is being used to give the illusion of prosperity to an investing public that needs hope to soldier on.  Only time, bankruptcy, merger, corporate restructuring, and industry consolidation will cure the disease of "bubble induced over-investment".  Only then will we see real productivity from the next round of needed investment, and the re-employment of labor to meet society's endless needs. 

Hopefully, the next generation Fed Chairman will learn that bubbles are only fun on the way up, and the downside destroys more than the upside created.  Bubbles always end badly.