Hard times, lean firms

How much longer can America keep increasing productivity?

Dec 31st 2011 | NEW YORK

The Economist

… it was a productivity boost that has continued in defiance of expert predictions that workers can only be squeezed so hard for a short while…

…. Unless the economy picks up, he predicts that productivity growth will slow in 2012…

… workers are terrified of losing their jobs…

… tough times are forcing firms to strain every brain cell to become more efficient…

… there are signs that leading industrial firms are starting to increase their capital spending…

… all such advantages are temporary…

EVERYONE complains that corporate America is reluctant to hire additional workers. Far less attention has been paid to the flip side of the jobless recovery: the remarkable improvement in American productivity. How long can this continue? “I see no limit,” says William Hickey, the boss of Sealed Air, a packaging-maker. Is he right to be so optimistic?

American firms were slow to react to the downturn at the beginning of the century, and paid the price. They learned their lesson. When the economy slumped in 2008, they were much quicker to adjust. There was little of the fall in labour productivity that normally accompanies a recession, and this was not just a one-off “batting average” effect (in which average productivity rises because the worst performers are fired). Rather, it was a productivity boost that has continued in defiance of expert predictions that workers can only be squeezed so hard for a short while. After falling in the first half of the year, American labour productivity (output per hour) was 2.3% higher in the third quarter of 2011 than in the same period a year earlier. This was the fastest quarterly rise in 18 months. Manufacturing productivity in that quarter rose by 2.9% compared with a year earlier. America’s productivity growth has been more robust than most other rich countries’—a feat many ascribe to its flexible labour market and a culture of enterprise.

Yet some analysts expect productivity growth to stall soon. Hard-pressed workers are feeling grouchy: workforce surveys report record levels of job dissatisfaction. Many firms have been “starving the organisation to see how it can do with a lower cost structure,” says Carsten Stendevad of Citigroup, a bank. Unless the economy picks up, he predicts that productivity growth will slow in 2012. (He admits, however, that he wrongly predicted the same thing would happen in 2011.)

Two things could keep productivity rising. First, workers are terrified of losing their jobs. This makes it easier to persuade them to put in extra hours or shoulder new tasks. Even in unionised firms, there have been reports of greater flexibility. Workers have been staying on the job longer rather than “featherbedding” their hours by, for example, queuing up early to clock off as soon as the shift ends.

Second, tough times are forcing firms to strain every brain cell to become more efficient. Sealed Air, for example, has made numerous incremental tweaks, such as upgrading a machine that makes absorbent pads for supermarket meat trays so that its output increased from 400 units per hour three years ago to 550—with the same number of workers.

The willingness of firms to invest in such enhancements has varied enormously. Some would rather hoard cash or buy back their own shares than spend it on more efficient machinery or information technology. Yet there are signs that leading industrial firms are starting to increase their capital spending, says Jeff Sprague of Vertical Research Partners, a research outfit. In particular, he has noticed firms investing in “debottlenecking” which, as its name suggests, means removing hold-ups in production processes, sometimes with an additional production line.

There are hefty gains to be made from using more automation, says Mr Hickey, adding that although he worries about diminishing returns, “we haven’t hit the wall yet.” Service businesses, too, are wringing efficiency improvements from new technology. Hertz allows customers to rent cars at automated kiosks, just as airlines have for some time allowed passengers to check in without talking to anyone. Fast-food firms, such as McDonald’s and Starbucks, are continuously innovating with their products and service.

In short, the recession has forced American firms to become more muscular. This should help them thrive when the good times return. It should also give them an edge over foreign rivals. But all such advantages are temporary. As Mr Hickey points out, a factory that Sealed Air opened in Mexico was expected to be far less productive than one in America, but within four years had caught up.