[OPE-L:6816] a workers' boom?

From: Rakesh Bhandari (rakeshb@stanford.edu)
Date: Mon Mar 25 2002 - 13:11:22 EST

APRIL 1, 2002/BusinessWeek

Restating the '90s

By Michael Mandel.

We now have enough perspective to look back at the last decade and assess
what was real--and what wasn't. Conjure up the economic gains of the 1990s,
and what comes to mind? Perhaps it was how the stock market ruled: All those
initial public offerings that raked in unprecedented billions for venture
capitalists. Or the dramatic rise in 401(k)s and mutual funds. Or the
growing ranks of the Investor Class who cashed in big-time as the Standard &
Poor's 500-stock index quadrupled.

And wasn't it a great time to be a top manager, with productivity gains
boosting the bottom line and igniting executive pay? While it was going on,
venture capitalist L. John Doerr called the boom the "largest single legal
creation of wealth in history." For both investors and managers, it seemed
like nirvana.

Well, yes and no. With the recession apparently over, it's now possible to
make a more realistic assessment of the entire business cycle of the 1990s:
The sluggish recovery that started in March, 1991, the extraordinary boom,
the tech bust, and the downturn of 2001. And guess what? A lot of things
happened that defy the conventional beliefs about the decade.

For starters, over this 10-year period, productivity rose at a 2.2% annual
rate, roughly half a percentage point faster than in the 1980s--a
significant gain. But the real stunner is this: The biggest winners from the
faster productivity growth of the 1990s were workers, not investors. In the
end, workers reaped most of the gains from the added output generated by the
New Economy productivity speedup. This revelation helps explain why consumer
spending stayed so strong in the recession--and why businesses may struggle
in the months ahead.

The key is that wage growth accelerated dramatically for most American
workers in the 1990s business cycle. Real wage gains for private-sector
workers averaged 1.3% a year, from the beginning of the expansion in March,
1991, to the apparent end of the recession in December, 2001. That's far
better than the 0.2% annual wage gain in the 1980s business cycle, from
November, 1982, to March, 1991. The gains were also better distributed than
in the previous decade. Falling unemployment put many more people to work
and swelled salaries across the board: Everyone from top managers to factory
workers to hairdressers benefited. Indeed, the past few years have been "the
best period of wage growth at the bottom in the last 30 years," says
Lawrence F. Katz, a labor economist at Harvard University.

By contrast, the return on the stock market in the 1990s business cycle was
actually lower than it was in the business cycle of the '80s. Adjusted for
inflation and including dividends, average annual returns on the S&P-500
index from March, 1991, to the end of 2001 were 11.1%, compared with 12.8%
in the previous business cycle. Bondholders and small savers saw their
returns drop even more in the '90s. The real return on six-month
certificates of deposit, for example, was only 3.1% over the past decade,
compared with 4.7% in the '80s.

Overall, BusinessWeek calculates that workers received 99% of the gains from
faster productivity growth in the 1990s at nonfinancial corporations.
Corporate profits did rise sharply, but much of that gain was fueled by
lower interest rates rather than increased productivity.

Why did workers fare so well in the 1990s? The education level of many
Americans made an impressive leap in the '90s, putting them in a better
position to qualify for the sorts of jobs that the New Economy created. Low
unemployment rates drove up wages. And a torrent of foreign money coming
into the U.S. created new jobs and financed productivity-enhancing equipment

Meanwhile, U.S. corporations were hit by a one-two punch: an economic
slowdown overseas following the 1997 Asia financial crisis and the tech bust
at home in 2000. To the dismay of tech investors, the hundreds of billions
poured into Internet ventures and new telecom equipment ended up lowering
prices for users, not raising profits for corporations. "We convinced
ourselves we had discovered some magic elixir of productivity that would
elevate corporate profits far above historical standards," says Gary Hamel,
head of consulting firm Strategos and author of the 1994 best-seller
Competing for the Future. "But most of the productivity gains that are made
possible by e-business will never go to the bottom line. They will all go to

The fact that workers reaped the bulk of the benefits of New Economy
productivity gains helps explain why consumer spending and the housing
market stayed strong during the 2001 recession. Heftier wages have
"sustained consumption at levels higher than we would have expected," says
Barry Bluestone, an economist at Northeastern University.

Moreover, it is now easier to understand why corporate executives remain
relatively bleak about the future despite the apparent recovery. Labor costs
now absorb almost 87% of the output of nonfinancial corporations, the
highest level ever, and way above what companies were paying out at the end
of the last recession. When the economy improves, companies are likely to
face a lethal combination of rising interest rates and rising wages. "If the
recovery is taking hold, workers will be in a position to bargain for wage
gains," says George Magnus, chief economist at UBS Warburg. "The benefits of
productivity growth are being drained away by labor."

There are two possible outcomes for this kind of profit squeeze. In the
positive scenario, companies can increase productivity fast enough to fund
both higher wages and decent profits for shareholders. The darker
possibility is a double-dip recession, with rising wages depressing
corporate profits even as the economy recovers. That would mean lower levels
of business investment and slower growth rates. Eventually, companies would
resort to wholesale layoffs to try to eke out profits--leading to another

Whatever the outcome, there's little doubt that the productivity gains of
the 1990s are real and sustainable. They have been tested during this
recession and have remained strong, breaking the historic pattern of sagging
during downturns. "You can look at Enron and the dot-com bust and wring your
hands," says Martin N. Baily, who served as chairman of the Council of
Economic Advisers under President Bill Clinton. "But I wouldn't be surprised
to see 2.5%" annual productivity growth in the coming years.

The real issue is determining who benefits most. When the productivity
revolution started in 1995, it seemed that corporations, not workers, were
going to be the big winners. As late as mid-1997, real wages were still
growing slowly, while profits soared.

But historically, wage gains have trailed productivity increases by a year
or two, and that's exactly what happened this time. As productivity
continued to stay strong and unemployment fell below 5%, wage gains took
off. From mid-1997 to 2001, real wages accelerated at a 2.1% clip. Real
compensation per hour--which includes benefits--in the nonfarm business
sector rose at an incredible 3.1% rate. The last time compensation rose that
fast for a four-year stretch was in the 1950s.

The wage gains in the past few years were so momentous that they made up for
the slow growth in the early part of the 1990s. All told, real wages for the
average private-sector worker rose by about 14% in the 1990s business cycle,
measured by the Labor Dept.'s employment cost index. That's compared with a
slim 1.4% gain in the previous decade.

What's more, workers with a wide range of skills and occupations thrived
over the past decade. In the '80s business cycle, real wages of blue-collar
and service workers fell substantially. Blue-collar wages, for example,
declined by 3.5% from 1982 to 1991. But in the '90s, real wages for these
less-skilled jobs rose by 12%. Full-time cashiers saw their median weekly
earnings jump by 11% (adjusted for inflation), while auto mechanics' pay
went up by 14%, after falling sharply in the 1980s. Hairdressers got an
almost 18% boost. That's despite Clinton-era welfare reform and a huge
influx of immigrants, both of which were expected to hold down wages at the

That said, the income gap between rich and poor did continue to widen, but
not as fast as it did in the 1980s. One reason: The 20% increase in the
minimum wage in the mid-1990s, which immediately benefited people at the
bottom. Equally important, low unemployment rates forced employers to reach
deeper into the pool of low-skill workers, hiring and training people who
would otherwise have been left out in the cold. "Tight labor markets for a
long-lasting period do more good at the bottom than we would have
predicted," says Katz.

In many ways, the most tangible sign of worker gains in the 1990s was the
home-buying boom. Homeownership has always been a critical part of the
American dream. During the 1980s, that dream seemed elusive, as the
percentage of households owning their homes fell slightly from 1982 to 1991.
By contrast, homeownership rates over the past decade rose from 64% in 1991
to 68% in 2001, the highest level ever.

Even the economic slowdown of 2001 and the events of September 11 have
failed to put much of a dent in wage growth. When William M. Mercer Co., a
human-resources consulting firm, surveyed corporations in January, projected
pay increases in 2002 had come down a bit since last summer. Nevertheless,
expected wage increases are still running well ahead of inflation. The
reason? Fear of being caught without enough workers in the recovery, says
Steven Gross, principal at Mercer. "Corporations worry [that] if they
disenfranchise core workers too much, they'll leave."

A key reason many Americans could take advantage of the New Economy is that
they absorbed the big lesson of the 1980s: Education pays, especially in an
information-based economy. The latest numbers show that 51% of the adult
population now has at least some college education, up sharply from 40% in
1991 and 33% in 1982. Among the critical 25- to 34-year-old age group, the
percentage with some college education has risen from 45% in 1991 to 58% in

Particularly encouraging was the rising participation of minorities in
higher education, especially among blacks and hispanics in their 20s, groups
that traditionally had lagged behind. For blacks age 22 to 24, the
percentage enrolled in school rose from 19.7% in 1990 to 24% in 2000,
nearing the 24.9% level for non-Hispanic whites. The improvement among
Hispanics age 22 to 24 was even more dramatic, almost doubling from only 10%
school enrollment in 1990 to 18% by 2000.

And contrary to the conventional wisdom, U.S. workers were the big
beneficiaries of globalization. Many expected that globalization meant U.S.
corporations would shift their capital spending abroad, building factories
and back-office operations in low-wage countries and shifting jobs overseas.
Competition from low-wage foreign workers would then drive down U.S.
pay--what economists call factor-price equalization.

Guess what? The jobs went the other way. True, U.S. companies did boost
their direct foreign investment abroad in the 1990s, with $1.2 trillion
flowing out of the country between 1991 and the end of 2001. But foreign
companies invested even more--$1.3 trillion--in U.S. factories and
businesses, creating new jobs and raising demand for labor.

More important, the foreign money that flooded the U.S. stock and bond
markets during the 1990s financed a big chunk of the New Economy
productivity gains. From 1991 to 2001, total foreign investment in U.S.
financial markets reached $2.3 trillion more than U.S. investment abroad.
This inflow provided the resources for much of the $3.4 trillion spent by
businesses on information-technology equipment and software over the decade.
Without that foreign money, it would have been a lot more expensive for
companies to make the investments that boosted productivity--and wages--in
the 1990s.

Despite fears that U.S. incomes would be dragged down by foreign
competition, the wage gap between U.S. manufacturing jobs and those in the
rest of the world actually widened in the 1990s, according to government
data. In 1991, the hourly compensation for U.S. factory workers was 17%
higher than the average for foreign workers, measured in U.S. dollars. By
2000, the difference had increased to 31%, as high-tech, high-wage
manufacturing industries expanded and low-wage industries shrank.
"Factor-price equalization is out the window," says Donald R. Davis, a trade
expert who is chairman of the Columbia University economics department. "It
isn't happening, in any form."

It's not just the impact of trade that needs to be restated. Technology,
too, had a very different effect on wages than most people anticipated. The
common belief was that technology eliminated many low-skill jobs and
depressed wages for the rest. That's certainly what happened in the 1980s.
But new research suggests that technology has a much more selective impact.
Jobs that can be boiled down to a set routine--such as making a loan,
assembling an engine, or processing a bill--are prime targets for
computerization, whether they are done by low-education or high-education
workers. Computers are good at "rules-based" tasks, argues Frank Levy, an
economist at Massachusetts Institute of Technology. Indeed, the amount of
work using routine skills, both manual and cognitive, plunged in the 1990s,
according to a new paper by Levy and two other economists, David H. Autor of
MIT and Richard J. Murnane of Harvard.

But there are plenty of nonroutine tasks that cannot be easily replaced by
technology--and those were the ones that boomed in the 1990s. They span a
wide range of skill and education levels and include such jobs as sales,
truck driving, and network installation.

But this litany of good news raises a question: If workers prospered in the
1990s, why didn't investors get their fair share of the gains? After all,
corporate profits did rise substantially in the 1990s. Over the entire
business cycle, inflation-adjusted earnings per share for S&P 500 companies
averaged $36, measured in 2001 dollars. That's 40% above the '80s average.
And this gain is not the result of squirrely accounting: An even bigger
increase shows up in the government's numbers for operating profits, which,
unlike S&P earnings, deduct the cost of exercised stock options.

The bad news for investors is that much of these corporate gains were a
result of companies paying lower interest rates for debt. At several points
in the 1990s, long-term corporate interest rates plunged below 7%, enabling
companies to borrow at low cost, helping the bottom line. At Gillette, for
example, interest expenses have gone up less than 25% since 1991, even
though debt has more than tripled. Indeed, adjusted for inflation, interest
expenses have been roughly flat.

And remember that the average investor has a portfolio not only of stocks
but also of bonds and money-market funds. These funds invest in corporate
bonds and commercial paper. So when companies cut their interest costs, it
shows up as lower interest payments to investors. Building up profits by
cutting interest costs is like robbing Peter to pay Paul: It all comes out
of the same investor pocket in the end.

It's important to step back and quantify how the productivity gains of the
1990s were distributed. Consider nonfinancial corporations, where annual
productivity growth accelerated from less than 1.8% in the 1980s to 2.2% in
the 1990s. Over the course of the 1990s business cycle, this increase in
added productivity translated into $812 billion in additional output,
measured in 2001 dollars. Out of that sum, an astounding $806 billion--or
99%--went to workers in the form of more jobs and higher compensation,
including exercised stock options. In effect, not only did the economy speed
up in the 1990s but the workers got a bigger share of the pie.

At the same time, faster productivity was not propelling corporate profits
with the same intensity. Corporate profits went up by an extra $559 billion,
a truly striking performance. But that was mainly because because companies
paid lower interest rates on debt.

Look beyond nonfinancial corporations to the economy as a whole, and the
results are similar. Faster productivity growth created $1.9 trillion in
additional output in the 1990s business cycle, measured in 2001 dollars, and
almost all of that gain went to workers and small-business owners. The
combined gains for corporate profits, interest, and returns on real estate
amounted to only about $50 billion.

To understand why investors failed to cash in from the productivity gains,
it's important to recall the devastating impact of the tech bust. Enormous
sums of money were thrown away in the dot-com mania and the telecom
meltdown. Furthermore, globalization compounded investors' headaches.
Increased trade and higher levels of investment abroad were supposed to pay
off by getting U.S. companies access to fast-growing foreign markets. The
result was expected to be a big shot of profits from abroad.

But that didn't materialize. Export growth over the decade fell short of
expectations, and net profits from overseas actually grew only slightly
faster than domestic profits. The reason: Foreign markets did not boom as
expected, especially after the 1997 Asian financial crisis. Many countries,
both industrialized and developing, actually posted slower growth in the
1990s business cycle than they did in the '80s. The one big exception was
China--but even with that country included, global growth slowed from 3.6%
in the 1980s to 3.3% in the 1990s business cycle.

Of course, there's no reason why the factors that depressed profits in the
1990s should be repeated in the coming decade. It's possible that as the
U.S. moves into a new expansion, profits could bounce back quickly. Germany
and France show signs of escaping the doldrums, while key exporters like
Korea and Taiwan are picking up speed. Certainly a synchronized global
recovery could help profits, just as the worldwide slowdown of the late '90s
hurt them.

Moreover, technology investments by companies could produce even bigger
productivity payoffs than in the 1990s. Productivity surged in the fourth
quarter of 2001 at an amazing 5.2% rate. That level of productivity growth
is not sustainable. Still, big enough productivity gains could enable
companies to boost profits while paying high wages. That could start a new
virtuous cycle, as it did in the 1990s when high levels of investment
produced faster productivity gains, fueling growth and investment.

But it won't be as easy as the 1990s, because workers are starting with a
bigger share of output and faster wage growth. To satisfy workers and build
profits at the same time, companies are going to have to do better than the
2.2% productivity growth of the 1990s. And that will likely take place in an
environment of rising interest rates, putting more pressure on profits.

As it turns out, our original perceptions of who benefited most from the
productivity gains of the 1990s was flipped on its head. Looking ahead, the
economic pie is growing bigger all the time, but it's still up for grabs who
will get the largest piece in the future. "At a national level we may get
substantial productivity gains, but the real question is how are they
shared," says management consultant Hamel. And in the end, that's the real
lesson of the 1990s.

By Michael J. Mandel

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