Greenspan's Labor Comments
Highlight Productivity Dilemma

By JACOB M. SCHLESINGER and BOB DAVIS
Staff Reporters of THE WALL STREET JOURNAL

WASHINGTON -- Six years of inflation-free growth are finally taking their toll on some American businesses.

Wages, at last, are rising in many markets. But prices, by and large, aren't. And that applies a vise to profits. If the clamp tightens over the next year, the much-vaunted "new" American economy will face its toughest test yet.

In recent weeks, several blue-chip companies have said earnings won't meet analyst expectations. Some, like Coca-Cola Co. and Gillette Co., attribute this in part to lower revenues from overseas, pushed down by a strong dollar. Others, like Aetna Inc. and Cigna Corp., face problems specific to their industry, such as rising medical costs. Most large companies haven't yet predicted slower profit growth because of rising wage costs.

Yet lower down the business food chain, the laws of supply and demand clearly are being felt. Consider:

A shortage of welders, electricians and engineers recently forced Universal Dynamics Inc., a small Woodbridge, Va., maker of machinery for the plastics industry, to raise annual salaries by as much as 10% this year, after long holding wage gains down to the inflation rate. This comes even as customers such as the auto industry still demand the same deep price cuts they have enjoyed for some time. Earnings will still grow, the company says, but far more slowly than in prior years.

Roger Bullivant of Texas Inc., which repairs building foundations in Grand Prairie near Dallas, has kicked up its starting wage to $6 per hour from $5.50. But it can't raise prices to offset the wage increases because it faces competition from 117 other local firms in its market.

Morrison Restaurants Inc. in Atlanta has raised wages by 6% to 8% during the past year, more than double the increases of the prior year. But when the company added a dime to the price of its $4.29 "bundle" meal (one entree, two vegetables and bread), customers complained and some took their business elsewhere. The restaurant chain had a $1.6 million operating loss for the latest quarter, compared with a $1.2 million operating profit a year earlier.

The financial markets have in recent weeks dismissed these anecdotes as isolated. They justify lofty share prices by assuming the economy has undergone a fundamental improvement in efficiency that will allow continued fat profit growth for years to come.

Greenspan's Bombshell

But Wednesday, Federal Reserve Chairman Alan Greenspan shook that confidence. In congressional testimony, he said "the performance of labor markets this year suggests that the economy has been on an unsustainable track."

There simply aren't enough idle workers to keep the economy -- and profits -- growing as rapidly as they have been unless productivity growth, currently running at about 1% a year by official measures, doubles. "While not inconceivable, such a rapid change is rare in the annals of business history, especially for a mature industrial society of our breadth and scope," Mr. Greenspan wryly noted. The comments caused the stock market to plummet more than 100 points instantly, though it recovered slightly later in the day to close down 83.25 at 8095.06.

It is only a matter of time before the wage pressures affecting small firms are felt at larger companies, says David Wyss, research director at Standard & Poor's DRI in Lexington, Mass. "With tight labor markets, companies are going to have to give more to workers," Mr. Wyss says. "Profits cannot rise relative to GDP forever."

Changing the Balance

In the short term, an earnings squeeze isn't altogether a bad thing. Financial markets might be rattled, but workers would get a larger piece of the pie. At the moment, the share of total gross domestic product that businesses keep is at a three-decade high of about 10%, while the portion going to workers has slipped somewhat in recent years to 58%. Changing that balance could be healthy for the economy, putting more money in the hands of consumers and damping the possibility of social unrest.

But unless the productivity patterns of the past two decades change, a profit squeeze could eventually force companies to either raise prices, if they can get away with it, or cut workers.

Some of that is already happening. Information Management Resources Ltd. a Clearwater, Fla., software services company, has covered wage increases by boosting prices by as much as 20%. Meanwhile, earnings pressures forced Whirlpool Corp. last month to announce a 10% reduction of its 46,000-employee global work force, including cutting 800 jobs in North America. Mr. Greenspan has suggested that shrinking profit margins, which could prompt companies to raise prices, could signal that inflation lies ahead and persuade the Fed to raise interest rates.

To manage such pressures successfully, U.S. businesses will need improved productivity during the next few years at a much faster rate. If they succeed, then a new American economy could well be at hand. If they fail, either inflation or an economic slump could result.

At the core are labor costs, which make up about two-thirds of all business expenses. An unusual trait of the 1990s expansion has been surprisingly mild wage growth. Overall, worker compensation for the year ended June 30 rose by 2.8%, or half a percentage point over the consumer price index. That is hardly a windfall for workers. But it is far larger than the 0.1% inflation-adjusted gain of the year-earlier period.

Moreover, official data and anecdotal evidence suggest that increases aren't yet taking hold across the board. Wages and benefits are growing fastest for executives, and for the best-trained and hardest-to-find workers. Among blue-collar workers, compensation is growing slowest for the highest-paying jobs and fastest for those that pay less. For example, pay for unionized workers is growing only 1.6% annually, while pay for nonunionized workers is growing twice as fast.

Highly Prized Professions

Regions and industries with low unemployment rates are seeing the biggest gains. Highly prized software designers are getting 20% annual raises, and even routine customer-support technicians are commanding 15% pay boosts, according to the Information Technology Association of America, an Arlington, Va., trade group.

In particular, U.S. companies face an estimated shortfall of 190,000 software professionals needed to build computer networks and fix old mainframes so they don't go haywire by misfiling data in the year 2000. So TRW Inc. pays recruitment bonuses of $5,000 to $10,000 to new programmers and is "desperately offering big raises" to keep others from jumping ship, says Raymond Godman, vice president of TRW's division that designs computer systems for the government.

The trucking industry faces a similar squeeze, with drivers deserting big rigs for jobs that let them spend more time at home. Faced with job turnover above 100% annually, several trucking firms have offered double-digit raises. J.B. Hunt Transport Service Inc., Lowell, Ark., raised pay for many drivers by 30% in February -- and saw earnings in the quarter ended June 30 plunge by more than 70%. Ed Cimochowski of Rolling Meadows, Ill., has been collecting another 10% a week since August, about $80 extra, hauling huge paper rolls for Schneider National Corp., Green Bay, Wis., the nation's largest trucker. "Before, I was worrying whether there was enough money for the kids' soccer," says the father of three young children.

Breakfast Wars

In the 1970s and '80s, executives such as Joseph Casper, who runs 40 McDonald's franchises in Florida's Tampa Bay area, didn't worry much about wage increases. "I was generally able to raise prices to offset them." But the rules have changed. Despite the minimum-wage increase and tight labor markets that have led Mr. Casper to pay $7 an hour in some outlets, nearly $2 above the legal minimum, he is locked in 99-cent breakfast wars. "Because of the competitiveness of the market, we've had to absorb the higher wages," he says, adding that margins at his McDonald's outlets are "the lowest they've ever been."

In prior expansions, inflation accelerated as growth persisted. But in this, the seventh boom year, inflation is actually decelerating. A big reason is an intriguing and perhaps unprecedented disparity: While labor markets have become quite tight, product markets (as measured by the percentage of capacity being used) remain fairly slack, making it hard for companies to raise prices without getting undercut. In the service sector, a surfeit of retail stores and restaurants has created a similar situation.

Greater globalization is one reason for this trend. Citing a renewed Japanese assault on the American auto market, Chrysler Corp. has cut 1998 model-year prices by 0.6% from 1997 prices, its first broad decrease ever. Eastman Kodak Co. is locked in a similar price war with Japan's Fuji Photo Film Co.

Technology's Part

Technology also plays a role. New manufacturing techniques have cut production costs per ton of steel by as much as two-thirds during the past decade, making it possible for four new mills to open this year. With the industry facing a glut in the U.S. despite strong demand, "our competitors are undercutting us," says John Correnti, chief executive of Nucor Corp. Last month, the Charlotte, N.C., pioneer of the minimill fought back by announcing a 7% price cut on some products.

Executives also cite a spreading anti-inflationary mentality among individual and corporate consumers, best illustrated by the spread of major discounters. South Dakota's tight labor market has forced Larson Manufacturing Co. of Brookings, S.D., to raise wages as much as 4% a year. But its chief customer for storm doors, the national megadiscounter Home Depot Inc., has played manufacturers against each other to keep prices flat for 2 1/2 years.

Larson has used every trick in the book to offset wage increases. It is reorganizing its 1,200 assembly workers in South Dakota and Iowa into "manufacturing cells." It is phasing out long assembly lines, where workers can waste time as components are hauled to assembly areas, and has supervisors prowling the lines looking for slip-ups. Its workers are being organized into teams of 20 to 30 people, and given far more responsibility to order parts, assemble them and deliver finished goods. "We're producing a door in less than four hours," says Ben Remer, Larson's controller. "It used to take us 24 hours." Even so, Mr. Remer says, "margins have slipped."

A Productivity Boost

To handle higher wages and lower prices, companies need to boost their productivity more. To date, the government's official numbers don't show any sign of an economywide surge. Productivity is rising at roughly the same lethargic pace of the past two decades: about one-third of the nearly 3% annual rate of the 1950s and '60s.

Still, there are plenty of firms creatively managing both rising wages and falling prices with productivity improvements. Take Diamond Casting & Machine Co., which during the past year has raised pay an average of 6%, kept price increases below the inflation rate and still increased profit margins, according to President Jerry Letendre.

"We've installed a lot more automation. In our casting area, we previously had one man per machine; now we're operating there without an operator," he says. As a result, the small New Hampshire supplier of aluminum components has seen labor drop to 25% of total costs from 30% a year ago, despite the raises, Mr. Letendre says.

Even many companies that have seen profits fall during the past year because of wage increases insist they ultimately will find new efficiencies. J.B. Hunt's pay boost lets the company attract and keep more experienced and productive drivers. As a result, it says both turnover and accidents have been cut by about half. "Before, we had training costs that would make you sick," says Stephen Palmer, executive vice president for human resources.

At J.B. Hunt, according to Mr. Palmer, the new American economy is alive and well. Already, he says, the company has made up 75 cents of every dollar of additional pay and "we may get the full payback in the first year."