PRODUCTIVITY TO THE RESCUE

Compaq's 1992 restructuring was one of those events that, with hindsight, marked a turning point. After years of losing sales to low-cost rivals, the personal- computer maker struck back by sharply hiking productivity and cutting prices. By 1994, revenues had more than doubled, earnings had quadrupled, and Compaq Computer Corp. had leapt to the No.1 position in the PC business, with a 13% market share. Now, in a quest for even faster growth, Compaq is investing in new information systems, overhauling manufacturing techniques, and chasing overseas sales. ''For us to keep growing, we have to put in place state-of-the-art technology, make constant progress, and make constant improvements,'' says Compaq Chief Executive Eckhard Pfeiffer. ''If you stand still, you will fall behind.''

It's a catchphrase for our era, the Age of Productivity. The sense of urgency is evident all around. Managements are reengineering operations and building an information infrastructure of computers, software, and telecom equipment. Giant AT&T splits itself into three separate companies to become a nimbler, more flexible competitor. Ford Motor Co., nearly pushed into the scrap heap by the Japanese juggernaut in the early 1980s, now runs some of the car industry's most productive plants. The U.S. semiconductor industry, in a bold bid for global market share, is constructing $9 billion worth of new plant capacity in the U.S. Says Paul A. Allaire, chief executive of Xerox Corp.: ''I think inside corporations, everybody is more focused on being competitive and efficient than they ever have been.''

All this ferocious activity is part of a comeback that borders on reincarnation. For much of the past two decades, U.S. companies appeared to be no longer competitive with foreign rivals. Many feared that America would follow other imperial powers such as Austria-Hungary and Britain into economic decline. Japan was poised to become the world's hegemonic economy, eclipsing the U.S. in everything from autos to televisions. In 1986, when author James Fallows shared a beer with an English friend in Tokyo, his friend said: ''Why don't you just face the fact that you're second-raters like us?'' By 1988, Japan's stock market accounted for 44% of world-market capitalization, up from 17% in 1980, according to Morgan Stanley Capital International. Over the same period, the U.S. stock market fell from 50% of the world market to 29%.

Today, Corporate America has embarked on a capital-spending boom. Corporate profits as a percentage of national income are far higher than they were in the 1980s. Unit labor costs have been flat over the past year, compared with an average annual increase of 4.1% in the 1980s, a clear sign of improved efficiency. The U.S. has also regained its primacy as the world's leading stock market, rising by 75% since 1990, while the Japanese market has plummeted by 50%.

Underlying these gains is a powerful upsurge in productivity. In the 1990s, nonfarm productivity has been rising at a 2.2% rate, more than twice the anemic pace of the previous two decades. And in the fifth year of an economic expansion, a time when output per worker typically subsides, productivity posted a remarkable 3.5% year-over-year gain in the second quarter of 1995. ''In a truly competitive global economy, U.S. performance has been outstanding,'' says Grady E. Means, head of strategy consulting services at Coopers & Lybrand. Adds William Lewis, director of the McKinsey Global Institute: ''The U.S. has the highest productivity and the best job creation performance among the industrial countries.''

FRONTIER DAYS. Small differences in productivity add up to big changes in income over time. If the U.S. raises its productivity trend growth rate by just 0.5% a year, to 1.5%, that increment cumulates to about $300 billion over 10 years--sufficient to compensate for about three garden variety recessions, says Stephen S. Roach, economist at Morgan Stanley. If the current 2% pace remains, national output will rise about 10% more than it otherwise would over the next decade. Put somewhat differently, real per-capita gross domestic product in the U.S. increased by 1.75% a year from 1870 to 1990 to the world's highest level--from $2,224 to $18,258 (in 1985 dollars). Had the U.S. growth rate been just one percentage point less--0.75% a year--then real per-capita GDP in 1990 would have been $5,519, or around Mexico's level and about $1,000 less than Portugal's, according to calculations by Robert J. Barro, economist at Harvard University.

To be sure, the full extent of the productivity gains are muddied by some problems with the underlying statistics. The government's current 2.2% productivity number for the 1990s will be revised. Soon, government number-crunchers will introduce a new method for calculating economic growth that is likely to cut productivity growth by perhaps half a percentage point, estimates Edward McKelvey, senior economist at Goldman, Sachs & Co.

At the same time, most economists agree that the government numbers miss many of the biggest gains from higher productivity. The advantages to consumers from automated teller machines, affordable fax machines, and increased choice of mutual funds do not show up in the figures. Moreover, by understating the extensive use of software, telecom gear, and other high-tech investment, the official statistics underestimate GDP and, by inference, productivity. For example, the current capital-spending upturn is centered on information technologies, but software expenditures are not counted as investment (except for software sold with computer hardware as a package). The addition of corporate software purchases could boost information-processing investment by more than 20%, according to the Bank Credit Analyst, an investment and business forecasting firm.

The economy's productivity expansion follows a long gestation, which is hardly surprising. Whenever a major new technology such as computers is introduced into an economy or workplace, productivity falters as workers and managers struggle to master unfamiliar skills. Learning how to exploit a frontier technology takes years of experimentation and organizational reshuffling. Over time, though, both management and labor move up the ''experience curve.'' At the same time, additional innovations make technology easier to use, and falling prices speed the diffusion of the new technology. The payoff: higher productivity. Says Richard S. Belous, chief economist for the National Planning Assn.: ''I would not be surprised if we see productivity growth that rivals the agricultural revolution and the manufacturing revolution.''

MAJOR PLAYERS. The signs of resurgence are striking, especially from an international perspective. American companies are way ahead of almost all others in leading-edge high-tech industries, from software to biotech to online services. The U.S. has 63 personal computers per 100 employed workers (including PCs at school and home) to Japan's 17, according to International Data Corp. The U.S. is the low-cost producer among industrial nations, with unit labor costs rising more slowly than in either Japan or Germany. American manufacturers are 10% to 20% more productive than German or Japanese manufacturers, and the U.S. service sector is 30% to 50% more productive, estimates Nariman Behravesh, chief international economist at DRI/McGraw-Hill. U.S. companies are major players in telecommunications, finance, and other businesses in the developing world. Exports to the Pacific Rim, the world's fastest-growing region, account for 18% of total U.S. export sales, vs. 15.5% in 1990, according to DRI.

The gains in competitiveness have not prevented the U.S. merchandise trade deficit from ballooning to a record $188 billion, at an annual rate. In part, this reflects the powerful demand that Americans have for imported oil, cars, and other goods. And there's ample evidence that closed or partially closed markets abroad may dampen exports. Korea's auto industry thrives behind steep trade barriers. India is on strike against foreign capital. The mercantilist Japanese export to the world and protect their home market.

Yet the trend is toward more open markets and freer trade, as exemplified in the North American Free Trade Agreement and the broadened General Agreement on Tariffs & Trade. Out of the 16 most populous developing nations, 13 liberalized trade and foreign investment rules from 1980 to 1993, according to Henry S. Rowan, professor at Stanford University. Even to Japan, U.S. merchandise exports surged by 20.4% from a year ago, to $36 billion during the seven months of 1995.

Moreover, today's trade deficit is a different beast from the red ink of the 1980s. For one thing, an increasing share of today's imports is feeding Corporate America's powerful investment boom rather than going into consumer products, which do not add to the capital stock. And the U.S. has kept its export boom alive despite economic weakness in virtually all of its leading trading partners. The industrial world's strongest economy, the U.S. has been a magnet for imports. Still, exports are up by more than 11% compared with a year ago, after adjusting for inflation. ''Considering differences in business cycles, if we hadn't seen strong productivity growth and increased global competitiveness, the trade deficit would be much worse,'' says Mark Zandi, economist at Regional Financial Associates Inc. Over the next several years, assuming world growth rates pick up, the trade deficit could fall sharply.

Fact is, American companies are ahead of the pack because of the openness of the U.S. economy. Business here has lived longer than its overseas adversaries with red-hot competition. With the world's largest consumer market luring foreign rivals, battles for markets and profits have been relentless. With a government eager to deregulate, market forces have been unleashed in everything from telecommunications to electric utilities. With a society open to entrepreneurs, upstarts such as Bill Gates of Microsoft Corp. and Herbert D. Kelleher of Southwest Airlines Co. have shaken up industry after industry. ''The more open U.S. market has forced American companies to be very competitive, both domestically and internationally,'' says David L. Blond, director, international trade forecasting at DRI. ''American companies made the transition sometime around the mid-1980s, and they have embraced a competitiveness ethic much more than either German or Japanese companies.''

SMOTHERING. Indeed, Europe Inc. is only now starting a painful restructuring. True, many European companies overhauled their operations in preparation for a single market in 1992, and competition is keener with the collapse of communism and the rise of emerging markets. But competition in Europe is still a far cry from what it is in America, and, for the most part, managements have a long way to go to get their organizations more efficient and their production costs down. Take the chemical industry. ''American companies have lowered their unit-cost base by about 5%, while European companies have done little or nothing,'' says S.G. Warburg & Co. chemical analyst Paul Raman.

Sputtering multinational giants such as Germany's Daimler Benz, France's Alcatel Alsthom, and Belgium's Societe Generale face the unenviable task of slashing tens of thousands of jobs to improve efficiencies. Many of the Continent's players in such leading-edge businesses as computers and telecommunications are smothering under interventionist government policies. European governments are still struggling to deregulate their airline industry nearly two decades after the U.S. did.

Japan, battered by the bursting of its 1980s ''bubble economy'' and the surging yen in the 1990s, is financially fragile. Even when its banking mess is cleaned up and the economy revives, many companies face years of paring employment. Despite first-rate multinationals, such as Toyota Motor Corp. and Hitachi Ltd., a surprisingly large number of Japanese industries are lagging their global rivals, a situation that may only worsen as Japan's economy becomes more service-oriented and information-intensive. ''The Japanese are world-class in autos, consumer electronics, and a few other high-tech areas. Once you get beyond those industries, Japan is not very competitive or productive,'' says economist Behravesh.

Some economists are still skeptical that Corporate America's gains are durable. They believe the improvements mainly mirror the lower value of the dollar rather than advances in competitiveness. Worse, they say gains by U.S. companies have little to do with better living standards for the mass of Americans. Productivity is up. Corporate coffers are full. But worker paychecks haven't kept pace. After adjusting for inflation, wages have been stagnant in the 1990s.

But this widely shared outlook is much too gloomy. A stronger dollar could pinch profits at multinationals such as Gillette Co., which had 68% of its sales overseas last year. Yet adjusting for both the domestic and global business cycles, improvements in U.S. productivity have been twice as important in explaining U.S. export performance as the changes in the value of the dollar since 1991, says economist Zandi. Currency is not the story. It's productivity.

What's more, if history is any guide, sustained gains in productivity eventually translate into higher living standards (page 116). It took time for management and labor to learn how to use the new technologies. Now, the productivity gains are clearly emerging, and incomes will follow. This doesn't just mean higher wages, though that's a big part of it. Faced with a fearsome competitive environment, companies are offering higher quality goods and services at a lower cost, which also boosts living standards. ''Forget price increases,'' says Southwood J. ''Woody'' Morcott, CEO of Dana Corp., a $6.6 billion auto-parts maker. ''The only way to improve your margin today is by improving your product.''

The evidence from a wide range of industries shows that the productivity gains are real and ongoing. Whether it's manufacturing semiconductors, offering banking services, or keeping track of medical records, U.S. companies are doing more with less. GTE Corp.'s operations in Florida's Tampa-Sarasota region is more the rule than the exception. Over the past five years, the area's population and telephone system have grown by about 7% annually, yet GTE still employs the same number of service people, about 250. Laptops let repair crews plan their daily schedules efficiently and allow customers to get a more accurate time of arrival from the repair folks. The staff backing up these technicians has dropped from 45 to 11 as software-driven ''expert'' systems take customer requests and arrange them in the most efficient order. Professor Erik Brynjolfsson and Lorin Hitt of Massachusetts Institute of Technology found evidence in a survey of nearly 400 companies that the return on investment in information systems could exceed 50%.

TEAMWORK. Investment spending is remarkably robust, too. Outlays for producer durable equipment as a share of nominal GDP is 8.2%, compared with 6.5% in 1991. With prices for computers and office machinery falling by 13% a year over the past half-decade and the sustained rise of the U.S. stock market attracting billions in new capital, companies should continue to invest. ''It all basically points to a period of fairly low inflation and higher-trend productivity growth than we've had for a couple of decades,'' says William Sterling, managing director at BEA Associates, a money-management firm in New York City.

Of course, the world isn't standing still. Managements in Europe and Japan are grappling with their problems, and developing nations such as South Korea and Taiwan are coming on strong. That's why U.S. companies are now taking investment in their human capital--their workforces--more seriously. When mass production ruled, competitive advantage lay in fragmenting work, highly specializing tasks, and managing via hierarchical bureaucracy. What's different today is that productivity gains, in an era of computers and communications technology, increasingly rely on delegating authority and organizing workers into self-managing teams.

As in any dramatic conversion, a lot of companies are stumbling as they grope for a more flexible, responsive corporation. Reengineerings and restructurings have often been just management-speak for massive layoffs without any transformation of work or a shattering of bureaucracy. Surveys by consultants and academics show companies often cut too deeply into their workforces and refuse to delegate sufficient authority.

Nevertheless, the signs point toward more and more companies trying to change. Look at DuPont Co. It has gone through a wrenching two-stage restructuring since 1991. In round one, jobs were slashed in middle- and upper-management ranks, and employee morale plummeted. Round two was also distressing. Senior management split the company into some 20 semiautonomous business units aimed at flexibility and creativity. Financially, the maneuvers have paid off. Last year, earnings rose by 65%, excluding extraordinary charges, and are on track to show a 25% improvement this year. Among employees, the turnaround is palpable. Says Edward A. Trolley, a 25-year veteran and manager of corporate training and education: ''I find it liberating. You have the freedom to go out and make changes and make things happen. You don't have to ask permission.'' Adds Michael J. Fradette, director for manufacturing consulting at Deloitte & Touche: ''To make money in a disinflationary period takes real innovation and creativity at all levels of the corporation.''

Companies are also putting more effort into preparing workers for the new world of work. Formal company training increased by 45% from 1984 to 1993, according to Anthony Carnevale, director of human resource studies at the Committee for Economic Development, a think tank in Washington, D.C. For example, Dana Corp. has doubled the time and money it spends on training and education programs over the past several years. ''We're teaching people to look for ideas,'' says CEO Morcott. ''A lot of the education is on how to spot ways to improve our business.'' In general, corporate training programs tend to favor technical workers and managers, but a study by Ann Bartel and Nachum Sicherman, economists at Columbia University, found that in industries with high rates of technological change, employers do compensate for workers' lower levels of education by providing more training.

Then there's the experience of Pitney Bowes Inc., the world's largest maker of postage meters and mailing equipment. Nearly five years ago, the Stamford (Conn.) company collaborated with a local community college to devise a customized seven-stage training curriculum. In a manufacturing setting where more than 17 languages were spoken, about 40% of its 1,500 production workers were not literate to the required minimum of fourth-grade level, and 65% required some kind of math training. Today, almost everyone meets the basic literacy and math requirements, and employees spend several hours a week in training sessions developing other skills. Employees now work in teams, collaborate with engineers, order materials, and monitor product quality. Says Kevin Connolly, director of systems-products manufacturing: ''These workers have homes; they make decisions all the time. Yet in the past, we treated them as if they were incapable of making decisions when they came into the factory. No more.''

Like any market, be it oil or stocks, wages are sensitive to the ebb and flow of supply and demand. For more than a decade, those with a college education or technological skills have been well-paid while everyone else stagnated. The U.S. workforce is heeding the market's message. The percentage of high school graduates enrolling in college after graduation jumped from 49% in 1980 to 62% in 1992. The ratio of bachelor's degrees awarded to those 18 to 24 years of age rose a remarkable 29% from 1980 to 1990, according to John Bishop, economist at Cornell University. New entrants to the job market are considerably better educated than workers retiring from the labor force.

At the same time that more people are getting the education and training employers desire, information technologies are increasingly user-friendly. All of the major computer and software companies are developing programs that blur the distinction between expert and novice. ''Up until the early 1980s, the only people able to use personal computers were a very tiny elite. Now, a lot of software is for numbskulls. In some sense, the technology is democratizing rather than elitizing,'' says David Card, economist at Princeton University. Adds Sharyl Schubert, a hairdresser in Chicago who recently bought an Apple Macintosh computer for her 4 1/2-year-old daughter, Jessica: ''I don't think the emphasis on computers is going to be divisive for American society. I think they are going to be part of normal life, and right now, we're in the transition. There are computers everywhere--Marshall Field's, restaurants, even my Dad's pharmacy.''

PAINFUL UPHEAVAL. Adam Smith was right. There is a great deal of ''ruin'' in a nation. The dynamism of capitalist competition is devastatingly painful. While 18th century textile makers in Britain built the factory system, middle-class weavers in Yorkshire sank into poverty. In the 1800s, the spread of railroads devastated communities without a rail link. The 1950s and 1960s were an era of U.S. economic dominance, but many industrial laborers never recovered from losing the well-paying manufacturing jobs thousands of them held before industrial companies moved from the Northeast and Midwest to cheaper sites in the South and West.

Today, high school dropouts and less skilled workers confront troubled times. With the world economy more competitive than it has been in at least a century, everyone--the educated and the uneducated alike--faces job insecurity and earnings instability. That is why all of society's major economic institutions--from businesses to schools to government--are under increasing pressure to do more for those ill-prepared to compete in the new economy and to cushion workers against income fluctuations.

Nevertheless, the nation's economic vitality is being restored. Many U.S. industries, from telecommunications to entertainment to Wall Street, are genuine global competitors. The lesson of history is that given time, the productivity bounty that has been largely confined to corporate coffers will be shared by all Americans--improving everyone's standard of living.