Global: Productivity Convergence?
[OK Zonder, MrP, Rien or someone explain this article to me. I do not get it. Roach talks about "productivity" improvements in Europe but points to increased work hours, lessoned union rules, and more part-time workers. Exactly what does any of that have to do with productivity? Not that reforms were not overdue but how does moving the work week to 40 hours from 35 hours increase productivity? I think I would define productivity as more goods being produced with fewer hours, not more goods being produced at more hours. If more hours are worked but the same pay is given then more goods will be produced adding to inventory problems unless demand picks up. Exactly why would demand pick up when people have much less free time, and no increase in wages? If union power is being trashed, this all seems to me to be part of the global disinflation problem of attempting to keep up with China. What's next? Slashing of benefits, 60 hour work weeks, what what what? And what does any of this have to do with productivity? Mish]
Stephen Roach (New York)
It feels different in Europe. The pain of stagnation has evoked a powerful backlash that is finally driving meaningful structural reforms. Europe has nowhere to go but up, and that long and arduous journey now appears to be under way. America, by contrast, is at the top of its game -- coming off eight fat years the likes of which most leading economies have rarely seen. But now burdened with an unprecedented shortfall of national saving, a record current-account deficit, and a massive overhang of debt, it will be exceedingly difficult for the US to keep the magic alive. At work over the next several years could well be the beginning of a stunning productivity convergence between the US and Europe -- a shift that could have profound implications for the global economy, financial markets, and currencies.
The transformation in European sentiment regarding its economy has been classic -- from denial to capitulation to despair and now to anger. Over the past year, in my travels to Europe, I have detected increasingly visible signs of this latter stage -- a palpable sense of anger and frustration. I was back in Europe this week only to have these observations confirmed yet again. But now there is an important twist: Europe is in the process of converting its angst into action -- ushering in a long-awaited structural transformation that promises to alter the efficiency, competitiveness, and, yes, productivity of this vast and heterogeneous region. Like all such transformations, the changes are hard to see in the beginning. Over time, however, they build on one another. Europe is now making meaningful progress in putting several of these key building blocks in place.
Two such developments strike me as most important -- the first being an improvement in labor market flexibility. This has been concentrated in the core of Old Europe -- Germany and France -- where workers and businesses are now coming together to challenge the mandated rigidities of shortened work schedules. Germany is the leading case in point -- offering the tantalizing possibility that the nation that is hurting the most is now “getting it” the most. As Elga Bartsch of our Euro-zone team has noted, the average employee in Germany has a work schedule that is about 15% shorter than that of US workers. German industry is now challenging this key entitlement. Six months ago, agreement was reached at two Siemens plants to raise the work week from 35 to 40 hours. Adding in agreement to abrogate guaranteed holiday bonuses, Elga estimates that labor costs will be reduced by about 30% at these plants (see her 7 July 2004 essay, “Reforms Reach the Grass Roots”).
At the same time, German labor unions are losing their bargaining power. Membership is down and bargaining has become more fragmented. In 2000, only 63% of employees in the West German manufacturing sector were covered by industry-wide wage agreements -- down sharply from the 72% share in 1995. In addition, Germany has come to grips with the rigidities of worker attachment. Currently, “flexi-workers” -- part time and temporary employees -- make up about 30% of the German work force; as recently as 1990, that share was about 20%. Recent announced headcount reductions -- especially at GM’s Opel subsidiary and by the retailer, Karstadt -- are only the latest in a series of measures that will continue to put pressure on already weakened unions and still rigid and high German wages. Germany still has a long way to go in the realm of labor market flexibility, but meaningful progress is now under way.
Eric Chaney speaks of similar trends emerging in France, where the sacred institution of the 35-hour workweek has become a cornerstone of the European social contract. Yet several major French companies have recently moved to challenge this arrangement -- including Michelin, Peugeot, Cattinair, Alcan-Pechiney, and a French subsidiary of Bosch. Moreover, earlier this summer, French finance minister Nicholas Sarkozy launched an aggressive attack on the very concept of the mandated 35-hour work week. Eric argues that if Germany and France stay this course, there is tremendous scope for getting more out of their existing workforces (see his 12 July 2004 dispatch, “Putting Europe to Work”). He calculates that annual hours worked per employee in France in 2003 were down 13.9% from work schedules prevailing over the 1980-85 period. In Germany, work time was down 17.4% over the same interval. In the US, by contrast, the drop was a mere 1.3%. Europe has a long way to go closing the work-time gap. But visible signs of progress are finally apparent, as Europe now begins the painful process of dismantling deeply entrenched labor market rigidities.
There is a second and equally important piece to the euro-puzzle that is also falling into place -- the long-awaited IT catch-up. While the US invested aggressively in information technology during the late 1990s, Europe did the opposite. Sure, there was the notorious euro telecom bubble in the latter half of the 1990s, but Euroland businesses were generally slow to put IT-enabled production platforms in place. Pan-regional IT platforms lacked standardization and facile connectivity, and back-office automation lagged. That now appears to be changing, as the IT-intensity of European capital spending is on the rise. By Eric Chaney’s estimates, the stock of IT capital has risen from 15% of Euroland GDP in 1990 to about 22% today. The spread between the US and the euro-zone ratio has narrowed from four percentage points in 1990 to less than one percentage point today. Convergence, in Eric’s view, is likely by 2006.
For Europe, all this spells revival on the productivity front. Improved labor market flexibility and the IT catch-up is a powerful combination for the arithmetic of productivity growth. European productivity growth was terribly disappointing in the latter half of the 1990s -- barely inching ahead at a 1% annual rate. Eric Chaney believes that it may well be in the process of accelerating to a 2% pace -- a doubling of the anemic gains of the late 1990s (see his 18 August 2004 essay, “Productivity Revival”). In the realm of productivity analysis -- especially for Europe -- that would be a truly stunning accomplishment.
In America, the pendulum could well be swinging the other way (see my 17 September dispatch, “Productivity Endgame?”). Productivity growth has slowed in the past two quarters and more slowing may lie ahead. This may not be a statistical accident. Two powerful trends have led the US productivity resurgence of the past eight years -- the transition to IT-enabled production platforms and aggressive cost cutting. It is unlikely that these trends can continue at the same pace in the years ahead. First of all, every company in America is now IT-enabled in one form or another. This is borne out by a stunning shift in the IT content of US capital spending: IT hardware and software has risen from 35% of total outlays on capital equipment in 1995 to 58% today -- a surge that pushed the investment share of US GDP to a record 12.6% in 2000. For such capital deepening to keep driving the US productivity dynamic in the years ahead, this share would have to rise sharply higher -- highly unlikely, in my view, for an IT-saturated Corporate America.
At the same time, there is increasing evidence that the cost cutting of US businesses has now reached the “slash-and-burn” state. The lack of hiring, unprecedented reductions in unit labor costs, and the collapse of the net (capacity-enhancing) component of business fixed investment -- down fully 60% in real terms since 2000 -- all point in that direction. If Corporate America stays that course, the result will be increasingly “hollow” companies that will be unable to maintain market share in an ever expanding global economy. As US businesses refocus on growth strategies, the pendulum of cost-cutting is likely to swing the other way -- undermining the easy math of the productivity calculus.
These possibilities point to a rather shocking possibility on the US productivity front. Since the mid-1990s, business productivity gains have averaged a little over 3% -- a dramatic improvement from the anemic pace of the preceding 25 years, which averaged closer to 1%. I am not arguing that America will revert to the productivity stagnation of yesteryear. But an increasingly saving-short US economy could well have an exceedingly difficult time funding the investment requirements of ongoing productivity vigor. And the two transitional factors -- capital deepening and slash-and-burn cost-cutting -- may well be about to fade. It is perfectly conceivable, in my view, that US productivity growth could slow to the midpoint between the 3% vigor of the past eight years and the anemic 1% pace of the preceding 25 years. That would find the US on the same 2% productivity growth trend that Eric Chaney believes is now emerging in Europe. In a nutshell, that is the case for what could be a rather remarkable productivity convergence.
If US and European productivity growth were, in fact, to converge over the next few years, this would have very important implications for financial markets. Global investors have become convinced that America is the world’s best productivity story. This, together with outstanding earning performance, has had a profound impact on the perpetual overweight of US equities in global asset allocation portfolios. The US-centric productivity story has also been key to America’s seemingly effortless ability to finance an ever-widening current account deficit. Most believe that there is a “natural” demand for dollar-denominated assets since they represent a claim on the world’s greatest productivity story. The productivity convergence play could certainly challenge that presumption as well -- undermining dollar support and providing a boost to the euro at just the time when America’s current account deficit is veering out of control.
Productivity growth is where the rubber meets the road for economic and financial market performance. One of the key assumptions embodied in the collective mindset of investors, businesspeople, and policy makers is that the United States has established permanent leadership in the global productivity sweepstakes. A corollary to that belief is that Europe will never get to the Promised Land of productivity revival. In the realm of economics, it’s change at the margin that always matters most. For a congenital euro-skeptic like me, it is very hard to admit it -- the coming productivity convergence could force us to rethink the long-standing contrast between America and Europe. |
