Productivity is Down — Is this Finally the End of the New Economy?

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Dell Computer chairman Michael Dell talks about job cuts at his company

Worker productivity, the hallmark of the New Economy, fell at a 0.1 percent annual rate in the quarter, the Labor Department reported Tuesday morning, shocking forecasters, who were expecting a 1.1-percent growth rate. It was the measure's first drop since 1995.

Is this a temporary symptom of the bust, or the end of the rising productivity that not only made the boom work but those gargantuan ten-year surpluses too? In a Q&A, TIME senior economics reporter Bernie Baumohl takes a look at the first-quarter shocker — and the big picture. Unemployment is steadily rising. Layoff announcements are daily news, the 4,000 cuts at Dell being just Tuesday's installment. How can productivity — essentially, a measure of output per worker per hour — be going down?

Bernie Baumohl: Because companies are cutting back even faster on output than they are on workers. It's much easier to stop the assembly line for a day than to not pay your workers not to come in. When it comes to cutting labor costs, you run up against contractual obligations and labor unions — a lot of the layoffs we've been hearing about haven't kicked in yet.

Remember, unemployment is still only at 4.5 percent. That indicates that a lot of people are still working. And in an environment when companies are still struggling to sell off old inventories, new output has dropped off so quickly that companies still have more workers than they need right now.

That said, this is one of the most important numbers the government puts out, and it's very disappointing. Lowered productivity does eventually add to the cost of doing business, and companies have to try to pass along that increased cost to customers. If they succeed, we could see inflationary pressures. If they can't, because, demand is so slow, it's going to put a squeeze on their profits — which will hurt Wall Street.

What does the Fed do?

The Fed will be very worried about this — productivity is what's allowed the U.S. economy to grow without inflation, and that payoff is really at the heart of the whole theory of the New Economy. But for now, my guess is Greenspan will fight the slowdown first, and continue to cut interest rates, and worry about inflation later. Although the Fed is nominally an inflation-fighting institution, the political pressure is on him to keep this economy going. Another 50-point cut is probably the way to do that.

So is this the end of the New Economy?

It's more likely that this is cyclical. A drop in productivity, as output falls faster than payrolls, is typical at the end of a slowdown. When the labor cutbacks catch up with the production cuts, productivity should come back a little. Of course, unemployment will continue to rise until companies are able to return to profitability. When demand in the economy starts to pick up again, productivity will surge — and then level off a little as workers are rehired. It's a temporary phenomenon — part of the slowdown portion of the business cycle.

The economy has changed so fundamentally in the past five years that it would really be incomprehensible that all the technological investments — the computer systems and servers that was the fuel for the supercharged productivity that was the real key to the New Economy — have stopped for good. As technology advances, these investments will continue to pay off, and companies will start making them again.

But not for a while. It'll be the last thing to recover — maybe not until early next year. Because companies will be waiting until they're absolutely sure that the economy has recovered before they make those technological investments again.

Capital investment works sort of like traffic. When the economy is moving at 90 miles an hour like it was in the second half of the decade, everybody's driving fast and making big investments. At that speed, a lot of mistakes get made, and they're very costly ones. And when you have a big crash like we did on the NASDAQ, suddenly everyone's moving at 20 miles an hour, and they've got plenty of time to think.

There's a herd mentality to capital investment. Everybody's looking at what the competition is doing, and until the economy starts to speed up again, nobody's going to make any big new outlays that will get overall productivity going again. But it'll happen eventually — computers and software have short lifespans, and in a competitive, global economy like ours, companies can't hold off forever or they'll be at a disadvantage.

So the 10-year picture — and those budget surpluses — are still safe?

Most likely, this is merely cyclical. But anything can happen. If productivity stays down, a lot of people — from Greenspan to Congress — are going to be very, very worried.