Economic Truth and Economic Fallacy in The United States

We currently have an economy that suffers from a famous fallacy in economics: The Fallacy of Aggregation.

Durable goods prices fell by 2.8% last quarter compared to the same quarter last year. Companies are cost cutting their way out of the economic slowdown.

That strategy may work for one individual company. But when EVERY Company does it, it doesn't.

Cost cutting does not only reduce the cost of supply. It also reduces demand. What is cost to a company, is income to somebody else. When cost is cut, so is income. When people have less money to spend, they buy less. Thus the hoped for increase in demand evaporates, and cost cutting becomes self-defeating.

During the Internet bubble, the wealth effect allowed people to increase demand because of their personal balance sheets had improved. Now the reverse situation of a negative wealth effect causes demand to drop. The major consumer wealth that still remains, is housing. Lowering interest rates have caused housing prices to increase, and refinancing has allowed people to free up some of the resources tied up in real estate. This is what is currently keeping the economy going. That, and one other factor.

The other factor is productivity. In every previous recession, productivity has fallen, as companies try to hold on to their work forces even though production is cut back. This time, productivity is staying positive. And that is why this slowdown has been relatively mild.

More than two centuries ago Jean Baptiste Say noted how a country could get out of a recession. It had to be something that lowered prices, increased wages, and boosted profits--all at the same time. He knew of only one strategy that could accomplish that extraordinary feat: Improving productivity!

Productivity improvement does not suffer from the Fallacy of Aggregation. When everyone does it, prices do go down, but income and profits both rise. A productivity driven deflation is about as good as economic life can get. It is what we have seen in Silicon Valley the last three decades. It is not what we have seen in the most admired companies in America lately. There is where the cost cutting is being done. And with the help of six sigma, productivity improvement is driven towards zero in those fabled companies.

If you reach 3.4 errors per million in the production process, the definition of six sigma, you don't want to change. No change means no productivity improvement. No productivity improvement means lower profits, lower wages, and no price reductions.

There is a way out. Productivity improvement will always work its magic wherever and whenever it is introduced. Companies, who do so, will gain market share even in a shrinking market. And if others join, everyone will be better off.

One more thing: 2/3 of all negative stress and dissatisfaction is linked to non-productive behavior. For that reason, productivity improvement always increases job satisfaction, and decreases negative stress.

It is for this and other reasons that we think the US is ready for the Productivity Revolution. This revolution has already started in some companies, and in some countries. And the results are remarkable.

The Productivity Revolution is not about incremental change. That was the case during the Quality Revolution, which lasted for 30 years. Everyone had time to fold Deming's principles into their production processes. But it simply is not possible to sit on the sidelines when a competitor suddenly becomes 30% more productive.

So--Welcome to the Productivity Revolution!

It will make everyone better off.

Everyone.

Except those who choose not to join……