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PRODUCTIVITY
THE ESSENCE OF WEALTH-CREATION AND
COMPETITIVE ADVANTAGE
ABSTRACT
Productivity in its many forms has always been the primary driver of wealth generation,
of increased quality of life, of competitive advantage and of corporate survival. However,
Peter Drucker long ago (1) pointed out that currently-used metrics for productivity are
200 years out of date and often have resulted in “non-productive” interventions by the
Federal Reserve into the economy.
Current metrics were first developed during the Industrial Revolution for manufacturing,
when increased productivity came mostly from capital investments for incremental improvements and for economies of scale, not from innovation. Robert Solow has pointed
out that 80% of consumer wealth comes from innovation and only 20% from capital investments. (2) Continuing advances in “real” productivity are now driven by the fact that
90% of all scientific knowledge has been generated over just the last two decades. (3)
The remarkable Bell Labs invention during WWII of the transistor (forreplacing vacuum tubes) and of digital trans-mission of data, has since
changed the world. It has enabled creation of an Internet, satellites, billions of computers and of some 7 billion cell phones that now pervade all
world economies. Capital and information now flow with the speed of light
to all the dark corners of the planet, by-passing bureaucratic, regulatory,
language and cultural barriers, while tying the world together in real time.
Instant-connectivity is also rapidly eroding the financial and economic sovereignty of the Nation State System
Digital education is a revolutionary phenomenon, allowing realization of
the “fantasy” of world literacy and of access to personalized education on
any world doorstep for the first time in 5,000 years. Net increases in global
wealth and an increased quality of life (productivity) are perhaps beyond
comprehension.
Current inflation metrics cannot begin to measure the increased productivity that marks
this unique era. The Federal Reserve still measures inflation by price rises in a basket of
commodity goods. Inflation results when the economy surges causing rises in commodity
prices. In response, the Federal Reserve has repetitively raised interest rates and shut
down the money supply forcing the vast productive engine of the U.S. economy into
recession. (Serious global repercussions follow for all world economies). In recessions,
unemployment rises, corporate bankruptcies increase and recovery is delayed, even after
follow-on stimuli are created. This syndrome has resulted in a destructive four-year boom
and bust cycles over many decades. (See Figure II,page 4). Most importantly, it interrupts
the powerful forces generated by the digital revolution.
-2THE DRIVING FORCE OF PRODUCTIVITY
Product and process life cycles have collapsed from decades to a just a few years in most
industries, driven by an explosion of next-generation technologies. Corporate-survival
now requires continuous innovative renewal far beyond incremental improvements of
existing systems. But periodic downturns and recessions interrupt the innovative process
of renewal and some 87% of the Fortune 500 famous corporate names listed only two
decades ago, have already disappeared, mostly in those downturns. (See Figure I, page 3)
Big businesses have since lost about a net 30 million jobs through downsizing and
restructuring, a million a year on average. (4)
These downturns are no longer necessary. They resulted from tariffs
designed to protect indigenous businesses from less expensive imports.
A surging economy then caused commodity shortages and rising prices
(inflation). However, instant-connectivity has now allowed emerging
countries to reverse engineer almost any existing technology for export
at much reduced costs. U.S outsourcing from these multiple sources has
essentially eliminated cyclic shortages when the economy surges. This
pattern never needs to be repeated. Federal Reserve interventions are
destructive.
REACTIVATING THE AMERICAN MIRACLE
A Federal Reserve intervention caused the deepest (1980-3) recession since the Great
Depression Era. Unemployment and inflation rose over 10% and interest rates were over
20%. The 1981 Economic Recovery Tax then reactivated the economy, unexpectedly
causing an exponential in-crease in productivity, enabled by reduction of the capital gains
tax from 35% to 20%.
This tax unexpectedly (overnight), transformed $trillions of dormant capital in tax shelters to a virtual new” goldmine” source of risk-advantaged investment capital,
This “goldmine,” became instantly accessible to any entrepreneur, bypassing all other sources of capital from bureaucratic, risk-averse banks
and Government Agency tax dollars, a phenomenon unique in history.
It jump-started Solow’s 80% wealth-creating innovation process.
The tax reduction created powerful incentives for millions of latent entrepreneurs to pull
their “own capital” (not tax money) out of tax shelters for investment in new businesses
opportunities. Latent investment opportunities known only to millions of individual entrepreneurs have always existed in all corners of the vast U.S. economy. This tax inadvertently ferreted them out. Much higher rate of commercial success also resulted from
such personal investments, multiplying the “Solow”- new-wealth phenomenon.. No set
-3of Government Agencies or Venture Capital operations can even begin to access or
responsibly-fund the breadth of investment opportunity involved.
(This is a critical “Distribution Factor” never before enabled.
Since 1981, an explosion of some 30 million new businesses has since resulted (up from
4.6 million). About 98% of these new incorporated businesses are small businesses and
about 80% are micro businesses with less than 20 employees. Micro businesses have
since generated 90 million new jobs (3 million a year) while big businesses concurrently
lost (a net) 30 million jobs in downsizing and restructuring, (5) (Figure I) Also see
Appendices A and B). Small businesses also have since generated about 87% of all
household wealth (now over $80 trillion in 2014, up from about $10 trillion on 1981)
FIGURE I
KAUFFMAN FOUNDATION JOB DATA
The above chart illustrates the net job changes resulting from generation of about 30
million small business incorporations since 1981. Each year, about 5% (25,000 ) micro
businesses grow to be big businesses, replacing those being lost. Small businesses are not
publicly traded and therefore are essentially invisible. Their critical importance has been
little understood.
“Micro” businesses have now become the primary job and
wealth creating engine of the U.S. economy.
The historic “American Miracle has occurred in spite of intermittent recessions and
downturns orchestrated by the Federal Reserve The Federal Reserve has operated
through a three-stage sequence of interventions:
-4FEDERAL RESERVE INTEVNTIONS
(1) When the Fed perceives inflation to be rising, it decreases the money supply (M2)
and increases interest rates (the Federal Funds Rate, (FFR) This M2/FFR ratio is
useful as a monetary index. When this ratio increases, the economy goes into recession, but it takes about 12 months to reach bottom and for inflation to subside.
(2) When near the bottom, the Federal Reserve reverses the Index and about 12
months later, the economy recovers and continues to surge under stimulus by
decreased interest rates and increased money supply..
(3) The economy then “overheats causing shortages again and rising commodity
prices, which then require the next intervention. This has been a four year boom
and bust cycle. Down-turns usually occur at mid-term “election times.” ((Figure II)
FIGURE II
Shortages with rising prices resulting from surges in the U.S. economy have
now been essentially eliminated by outsourced-access to low-cost systems
from diverse sources.
Diversified sources of low cost production are redundantly available in many developing
countries and Federal Reserve interventions have since lengthened to about 10 years.
The last rise in commodity prices that caused Federal Reserve intervention, produced the
very short 1989 “Black Friday” recession. The following 1999-2003 intervention instead
was only intended to abort the “Dot-Com Bubble” (which already had independently
begun to self-implode). Finally, the mid- 2008-12 intervention by the Federal Reserve
-5also did not involve inflation, but was designed to interrupt the housing bubble, which
had resulted from elimination of a requirement for a 20% mortgage down payments.
The resulting Federal Reserve downturn, starting in 2008 then triggered the devastating “subprime-derivative” collapse.
The basis of the subprime collapse was (a) the 1999 repeal of the Glass-Steagall Act
which allowed banks to invest in speculative derivatives for the first time, combined with
(b) elimination of mortgage down-payments that resulted in the dot com bubble. The
most recent Federal Reserve interventions have involved Keynesian-type massive
injections of a $trillion a year of cash (Quantitative Easing), which stabilized the banks,
but failed (again) to restart the economy and added another $trillion each year to the
National Debt.
ALTERNATIVE MEASUREMENTS OF PRODUCTIVIVITY\
The U.S. annually spends about $550 billion a year for R&D, including $80 billion for
basic research (both more than all other countries combined). As a result, the U.S. receives about 70% of the Nobel prizes and makes most of the seminal (disruptive)
discoveries. These innovations in different disciplines also interact in unexpected ways
to produce innovations not at all anticipated in the original work. This results in a
multiplier factor of unmeasured productivity affecting all aspects of the U.S. economy.
The exponential nature of this phenomenon is partially reflected
in the 90% rise of consumer net worth since 1980. (Figure IV)
FIGURE IV
CONSUMER NET WORTH
-6Each interruption of this curve marks a Federal Reserve orchestrated downturn or recession. The 2008-10 great recession and “subprime collapse” stalled-out this historic rise in
quality of life and temporarily reduced consumer net worth to $49 trillion in 2009 (back
up to $80 trillion in 2014.) Consumer wealth is a generalized-metric, for productivity
It integrates thousands of value-added variables in all their diverse forms. Unfortunately,
even temporary interventions in U.S. growth are of great concern for the political stability
of all world economies. Other metrics only partially reflect the exponential nature of
increased productivity in recent years.
S&P INFLATION ADJUSTED COMPOSITE AND Q RATIO.
The concurrent rise in the S&P and Q ratios (6) are also concurrent with the rise and fall
of Joseph Schumpeter’s Kondratieff Long Waves (7). The Q ratio, charted since 1900, is
calculated from the total value of the market, divided by the replacement value of all
publicly registered companies (the Solow 20% capital investment factor)The 1970
decline of the Q ratio also marks the collapse of the Fortune 500 companies that had
surged following WW II. Fortunately, the 1981 Economic Recovery tax Act then initiated
its unexpected explosion of new small businesses
FIGURE V
S&P INDEX AND Q-RATIOS
-7SUMMARY.
Increased productivity is the primary driver of jobs, of wealth-generation, of quality of life, of competitive-advantage and of corporate survival.
About 80% of all per-capita wealth stems from technology-driven innovation, Basic Research discoveries are the “seed corn” of innovation.
Unfortunately, capital-intensive big businesses don’t innovate and 87% of the famous
corporate names listed in the 1980 Fortune 500 are no longer there. Since passage of the
1981 Economic Recovery Tax Act, large businesses have lost some 30 million jobs in
downsizing and restructuring. Most of these businesses collapsed during Federal Reserve
recessions.
Innovation is critically dependent on an environment conducive to innovation. The1981
Economic Recovery tax Act was combined with legislation that removed barriers to
formation and operation of new businesses. Unexpectedly, the combination has created a
unique economic environment that unleashed a torrent of latent entrepreneurial creativity,
new tax-paying jobs and household wealth.
In retrospect, this environment for risk-investments could have been put
in place decades earlier. (The entrepreneurs have always been there). Most
importantly, this process also can be widely replicated in many developing
countries (wherever political stability can be sustained).
Unfortunately, as Peter Drucker has pointed out, currently-used accounting metrics,
designed some 200 years ago for manufacturing, cannot begin to measure the explosive
technology-driven increases in total value relative to costs that have recently resulted.
Consequently, Federal Reserve periodic interruptions of the U.S. economy have led to
destructive downturns and recessions, with global consequences.
It has become increasingly important that the small business engine of the U.S economy,
which generated the American Miracle, both be restarted now through (a) elimination of
the capital gains tax for small businesses and (b) by further elimination of bureaucratic
and regulatory barriers to their formation and operation.
____________________________________________________
Hon. D. Bruce Merrifield, PhD
Former V.P. Technology Occidental Petroleum Co; Former
Undersecretary U.S. Department of Commerce, Technology and Economic Affairs, Reagan Administration; Chaired Professor of Management, Entrepreneurship, Wharton
School of Business, University of Pennsylvania.
-8RFERENCES
Fortune 500 Data Base (1905-2006); Job Creation on America” The Free Press,
Collier, McMillan. London (1887); Cyclic Indicators, The Conference Board 1982-90.
1. Peter Deucker, “Managing in the Next Century,” Truman-Talley Books, N.Y.
(2002) pp52-3.
2. Robert Solow
3. National Science Foundation Report (2006)
4. Kauffman Foundation Data; “Job D Report data in the U.S. Entirely Driven by
New Start-ups.”; [email protected]; D. Bruce Merrifield, “The American
Miracle” Pridco.net; Industrial Research Institute Annual Report (2006); Cyclic
Indicators Conference Board (1982-90).
5. The U.S. Department of Commerce, Bureau of Economic Analysis; Federal
Reserve Productivity Data.
6. National Science Foundation Report. (2006)
7. Historic Rise in S&P and Q Factors; Investopedia Charts
8. Kondratieff Long Wave; Wikipedia chart.
9. Robert Solow. Expedia, “Drivers of Economic growth.
APPENDICES
APPENDIX A
Following are Treasury Data illustrating the destructive effects on tax revenues and on
economic growth of manipulation of tax rates by the Federal Reserve.
CAPITAL GAIN TAX REVENUES
In 1981, the capital gains tax was reduced to 20% (it had been 49% in 1979). Tax
revenues were $12 billion and Keynesians were sure that those tax revenues would be
lost. Instead, they surged 450% to $56 billion, as new start-ups created new tax paying
jobs. In 1986, the OMB unbelievably raised the tax to 28% and tax revenues collapsed in
half to about $25 billion. Finally when again reduced to 28%, tax revenues surged over
$130 billion and over $160 billion when further reduced in 2003 to 15% .Reduction to
zero for new start-ups would lose no tax revenues (from non-existent businesses), but
would jump-start the latent entrepreneurial process again..
_____________________________________________________________
APPENDIX B
CORPORATE TAX RATES AND REVENUES
Corporate tax rates had been steadily raised from 35% in 1960 to 47% by 1980, cannibbalizing almost half of all the corporate profits which needed for investment. But tax
revenues did not increase with increased tax rates; they decreased! In 1981 when reduced
to 35% tax revenues surged about 20% The 35% rate is unlikely to achieve the optimumu m tax generation rate. If the tax rate is set where tax revenues are maximized, that
rate may be in the 15% to 20% range.
The top payroll tax was 70% in 1981 and was reduced to 28%. U.S Treasury data show
that the percent of total taxes paid by the top 10% of earners increased from 49% in 1980
to 70% in 2009.
CORPORATE TAX REVENEUS