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The New Economy's New Austerity


It was practically an article of faith during the go-go years of the New Economy boom: The path to increased productivity and higher profits lay in stepped-up corporate capital spending, especially on computers and other information technology.

Well, a funny thing happened on the way from boom to bust. Corporate capital outlays collapsed as demand headed south and the economy fell into a recession. Even now, with the recovery more than three quarters old, capital spending remains stuck in the doldrums.

But productivity gains are anything but dull. Over the last year, productivity has soared by 4.8%, a stellar performance even by the standards of the boom years. The rapid rise has Alan Greenspan, Federal Reserve chairman and productivity guru, scratching his head. "We at the Federal Reserve are struggling to account for so strong a surge," he said in a speech on Oct. 23.

Part of the answer, undoubtedly, is good old-fashioned cost-cutting: paring workforces and eliminating corporate fat. During the roaring '90s, companies padded payrolls and added layers of management. With those halcyon days over, they have cut back sharply. Just look at General Motors Corp (GM): It has cut salaried staff by 10% in each of the past two years to 40,000, boosting efficiency.

But something else is at work as well. Stung by a steep fall in profits over the last two years, corporate honchos are taking a much more hard-headed approach to investment outlays, even as demand has picked up and profits have improved. With capital-spending budgets tight, they're concentrating on squeezing ever more out of the investments they have already made. "The world has changed," says John A. McKinley Jr., chief technology officer at Merrill Lynch & Co. (MER) "We're in an era of austerity."

Call it spending better, rather than spending more. Company chiefs are demanding quick payouts from their investments. And they're pressing underlings to make do with what they have by learning to work their existing plants and factories more efficiently. "It's a more-with-less approach," says H. John Riley Jr., chief executive of Cooper Industries Ltd. (CBE), the Houston-based maker of electrical products, tools, and hardware.

Of course, no executive worth a paycheck is about to stop investing in business or cease spending on IT equipment. Even now, during a capital-expenditure bust, companies are shelling out some $1 trillion a year in investment. And once the uncertainties about Iraq and corporate scandals clear and the economy picks up, there's no doubt they'll step up spending. Moreover, with companies able to use the equipment they have to boost productivity, they should be willing to buy plenty more once the replacement cycle plays out.

But the new, more sober approach of corporate execs to capital investment could mean that the upturn will be more muted than many of the more optimistic economists expect. "It will pick up," says Martin N. Baily, a productivity expert who headed up the White House's Council Economic Advisors under Bill Clinton. "But budgets are going to be much more closely supervised than they were in the '90s."

The reason is simple: Today's belt-tightening has taught execs that they can get a lot more out of their equipment than they had been getting, so spending splurges are unlikely until they see the end of such gains. At Priceline.com Inc. (PCLN), improved software is allowing the Norwalk (Conn.)-based online reservations site to push its computer networks harder. Its computers now run some tasks as much as 500% faster than before. As a result, the company has deferred some capital spending and redeployed some servers for other uses. "We've got more out of the existing machines and infrastructure we already have," says Chief Information Officer Ronald V. Rose.

Not only New Economy companies are learning new tricks. In the last three years, Avery Dennison Corp. (AVY), a $4 billion maker of labels and bar-code tags based in Pasadena, Calif., generated 50% greater production of some of its lines through better set-up and scheduling. "We've added capacity without having to spend capital," says Chief Financial Officer Daniel R. O'Bryant.

In the post-bubble world, companies are finding that bite-sized bits of IT spending on upgrades and other enhancements are more efficient than massive tech buys of the past. Research by Chicago Fed economist John G. Fernald and Susanto Basu and the University of Michigan's Matthew D. Shapiro suggests the disruptions caused by the frenetic pace of capital investment reduced annual productivity growth by about a half percentage point during the latter half of the '90s, as bosses and workers raced to keep up. With the spending spree slowed, there are fewer costly disruptions. That alone, the research suggests, may have boosted productivity growth by about a quarter percentage point over the past year.

Smaller-is-better is clearly the strategy at specialty-materials producer Engelhard Corp. (EC) "The big programs always take a huge amount of capital and resources in a short period of time--and every one I've looked at delivers less than anticipated," says CEO Barry W. Perry. Instead, Engelhard began what Perry calls a three- to five-year "just-in-time IT enhancement program," a series of piecemeal, plant-by-plant upgrades.

The tough-minded approach isn't good news for high-tech companies looking for a return to glory days. And, short term, it means the hoped-for return of robust capital spending isn't yet on the horizon. Still, in the long run, such pragmatism can't be anything but good for America's productivity and prosperity. By Rich Miller in Washington, with Faith Keenan in Boston, Christopher Palmeri in Los Angeles, Ira Sager in New York and bureau reports


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