2003 dallas federal reserve annual report

8/2/2019 2003 Dallas Federal Reserve Annual Report

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Productivity and Reorganizationin the American Economy

2003 ANNUAL REPORT FEDERAL RESERVE BANK OF DALLAS


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Contents

From the President . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

A Better Way . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Senior Management . . . . . . . . . . . . . . . . . . . . . . . . . 25

Boards of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Officers and Advisory Councils . . . . . . . . . . . . . . . . . 28

Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . 29

Notes to Financial Statements . . . . . . . . . . . . . . . . . 35

Volume of Operations . . . . . . . . . . . . . . . . . . . . . . . . 47


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Federal Reserve Chairman Alan Greenspan was moder-ating a session at a conference a few years ago when theparticipants were slow returning from a coffee break. Thatprompted him to offer a little lesson in process improvementand productivity. If you pour the coffee, add cream andthen stir, its a three-step process, he said. If you put thecream in first and then pour, its a two-step process.

Adam Smith, in Wealth of Nations , emphasizes the divisionand specialization of labor. By specializing, we gain skill

and productivity. We do what we do best and trade for therest. Productivity gains are limited only by the extent of the market. Bigger markets bring bigger gains.

Productivity is a hot topic these days. Its also the subjectof this years annual report essay.

Increasing productivity is what raises our standard of living. We have to produce more to consume more. Someproductivity gains come from improved worker knowledge,skills and experience. Probably more come from workershaving better technology and more capital to work with.

And, yes, process improvements.Ive mentioned before my (thankfully) brief experience

as a 10-year-old picking cotton on Billy Joe Hoppers farmin North Georgia. My goal was to pick 100 pounds in aday. The adults alongside me could easily pick 300 pounds.

With size and experience going for them, they weremainly responsible for their greater productivity. Today,one person driving a mechanical cotton picker can pickseveral acres a day.

Such quantum leaps in productivity have more to dowith capital than with labor and have been common inagriculture. Indeed, the cotton gin was instrumental inushering in the Industrial Revolution. Productivity growthon the farm now enables about 2 percent of U.S. workersto produce more food than 90 percent did in an earlier era.The same has been occurring in manufacturing for decades. Productivity gains enable fewer workers to man-ufacture more each year. Progress is measured by how fewworkers it takes to produce a given output, not by howmany. We sometimes lose sight of this simple fact, especiallyduring slack periods, such as weve had recently.

The Essay Economists have traditionally discussed productivity in

terms of inventions, new technology, laborcapital ratiosand the like. Our essay, A Better Way, focuses on broader,macroeconomic factors such as trade and competition.

Think about your productivity level today as you workand spend the resulting income on the output of others.Now imagine how productive you would be if you weretransported back to the United States of 100 years ago or 200 years ago or to an underdeveloped country of today.

You might work harder and longer, but without our moderninfrastructure of capital and technology you are unlikely tobe as productive and well-off. You could work harder, butnot smarter.

Think about how productive and well-off you would be

if trade barriers isolated you from the workers and outputof other countries. You might produce as much, physically,but your output would buy less and your standard of livingwould be lower. How would it affect your standard of livingif the government prevented all job losses resulting fromnew technology, trade or competition?

Our productivity is as much about our economic envi-ronment, infrastructure and interaction with others as it isabout us personally. Thats just one more reason to celebrateliving in the USA.

The Economy Recovery from the last recession began in November

2001, over two years ago. It was erratic initially and lostmomentum, but it picked up in the second half of 2003when GDP growth averaged over 6 percent. Unfortunately,new job creation did not match the recovery in output andincome during the year. Job growth resumed in late 2003,but not vigorously. Productivity a godsend in the long

2003 ANNUAL REPORT FEDERAL RESERVE BANK OF DALLAS

A Letter from the President A Letter from the President

Having communicationstechnology at our finger-tips is raising productivity.

Having communicationstechnology at our finger-tips is raising productivity.


4/51FEDERAL RESERVE BANK OF DALLAS2003 ANNUAL REPORT

On a Personal Note

2003 was a good year for me in severalrespects. I saw China up close and personal andmet many of its officials. Just as I had suspected,China is really big with lots of people. The

supply of workers to the cities will likely beunlimited for a long time. Chinas rapid growthand growing market orientation are good notonly for its citizens but for ours as well. Webenefit when our trading partners prosper.

Last years Friedman conference was thehighlight of my conference career. Sharing aplatform with them was a personal privilegeand honor I shall always remember.

A more frivolous 2003 highlight was myvirtual resurrection of Buddy Holly on NPRsMorning Edition. Host Bob Edwards recalledmy pilgrimage to Buddys grave in Lubbockand asked me about his contribution to eco-nomics. I told him Rave On would make agreat anthem for the New Economy. Whenthe interview aired two days later, it closed inthat special NPR way with Buddy singingRave On. Was that cool or what?

Speaking of the New Economy, note thatmy new-paradigm frog is emerging from hislengthy hibernation with a distinctlyWestern look. It may just be a phase; heprobably doesnt have many cattle.

2003 endedliterallyon a highnote for me. On New Years Eve I readmy first drugstore cowboy poem withAllen Damron at Ms. Tracys Cafenear Terlingua, Texas. Ms. Tracys ispretty hard to get to but a mightygood place to be. If youre curious,see Rhymes with No Reason in mysection of our web site. For moreserious fare, see the other sections ofwww.dallasfed.org. Its the best littleweb site in Texas.

Bob McTeer

run temporarily slowed job growth as businesses continuedto find ways to produce more with fewer workers.

Until full employment is restored, we should do what wecan to promote the dynamic growth needed to create new

jobs, but avoid shortsighted actions that preserve the old jobs at the expense of new ones.

The Dallas FedThe Dallas Fed had a good year in 2003 despite thechallenges brought on by a declining volume of paper checks. Like other businesses, weve had to adapt byreducing costs and staff, but the transition from paper toelectronic payments is part of the productivity revolutionthat raises living standards.

We held several major conferences in 2003, the mostnotable of which marked the 25th anniversary of Milton andRose Friedmans Free to Choose . The Friedmans participatedin the conference, as did a long list of distinguished speakerswho paid tribute to them and assessed their contributionsto economic prosperity over the past quarter century.The Friedmans are national treasures make that worldtreasures and show no signs of slowing down in their 90s.

Robert D. McTeer, Jr.President and CEO

Sharing the platform with the Friedmans.Sharing the platform with the Friedmans.


5/512003 ANNUAL REPORT FEDERAL RESERVE BANK OF DALLAS

Compare America today with earlier times or other nations, and one factstands out: We live better.

Give most of the credit to produc-tivity. Through it, we get more goodsand services from each bit of workeffort. Through it, we secure economicprogress and earn bigger paychecks.The power of productivity has made theUnited States the worlds richest nation.

America has prospered by doingthings a better way.

Weve become more productive bybuilding our capital stock addingmore machinery, factories, offices andresearch facilities.

Weve become more productive byupgrading workers skills, whether through formal schooling, on-the-jobexperience or retraining.

Weve become more productive byintroducing new technologies thatincrease output, improve efficiencyand lower costs.

Weve become more productivethrough trade, too. Open marketsforce companies to strive harder tocompete. Through trade, companiesgain access to cheaper inputs, a deeper pool of investment funds and tech-

nology from around the world. Tradeenlarges markets so companies canexploit economies of scale.

Most Americans readily recognize and celebrate the forces that raise pro-ductivity in the workplace, but theresmore to this engine of economicprogress. As companies and workersachieve greater efficiency at the micro-

economic level, they unleash a power that reorganizes the whole economy,spurring further productivity gains at themacro economic level. (See Exhibit 1.)

Resources from streamlined opera-tions arent just cast out into idleness.

With less labor needed to produce theexisting output level, workers talents andenergy become available for other tasks,either at companies already in business or at new enterprises. Reorganizationexpands production throughout theeconomy, fulfilling wants that hadbeen unmet or maybe even unknown.

Reorganization from trade providesanother source of macroeconomicproductivity. As competition forcesproducers to seek comparative advan-tage in the marketplace, resources shiftto their best uses, creating a more effi-cient economywide deployment of labor.

History shows us the power of macroeconomic productivity in action.

At its founding America was primarilyagrarian, with more than 90 percent of the population toiling on farms. As trac-tors, threshers, irrigation and high-yieldseeds made individual farmers moreproductive over the past century or so,the United States could feed itself

and expand its export markets withfar fewer agricultural workers.

Displaced farmhands flocked to cities,where they found work assembling cars,building houses, generating electricityand making an abundance of consumer goods. Over time, factories grew moreautomated and saw great leaps of pro-ductivity. Workers moved from assembly

Productivity and Reorganizationin the American Economy



Exhibit 1. The Path to Progress

MICROECONOMICSOURCES OF PRODUCTIVITY GROWTH

Economies boost their productivityin two waysmicro and macro.Microeconomic gains take placewithin an enterprise as it invests,trains workers, innovates and com-petes. Macroeconomic gains occurwhen the overall economy reorganizes,shifting resources so they producemore than before. Both types of pro-ductivity make us better off. Statisticscapture productivitys capacity toincrease consumption and leisure,but they ignore other gains, such asbetter working conditions, new andbetter products, and greater variety.

INVESTMENT

Increasing the capital goods with which labor works raises output. In rece

years, America has been putting more than 10 percent of its GDP intadding to its stock of machinery, factories, offices and research facilities

INNOVATION

New technology has always played a leading role in raising productivityby boosting output, improving quality, and saving time and other resource

EDUCATION AND TRAINING

Workers become more productive when they upgrade their skills and talenBuilding human capital starts in the classroom, but modern economies rewaworkers for a wide range of abilities.

TRADE

Open markets intensify competition, giving companies greater incentivelower costs and improve quality. Trade also provides access to technologyinputs and capital that might not be readily available at home.

Americas history has been one continual upheaval in jobsfirst off the farms and into factories, then on to serThe economys relentless reorganization raises productivity.

How America Works



lines to jobs in retailing, medical care,

finance, management and services.Over the grand sweep of history, the

cumulative effects of productivity onliving standards have been astounding.Per capita output has grown 25-foldsince 1776. In just the past two genera-tions, average real income in the UnitedStates has more than doubled, thankslargely to increased output per hour.

Productivity has also allowed

Americans to reduce the average work-week from 76 hours in 1830 to 60 in1890, 39 in 1950 and just 34 today. Alltold, productivity provides somethingclose to economic alchemy: more for less. We get more of the goods andservices we want for less time at work.

Human beings possess some innateinstinct to innovate and improve, but

productivity advanced at a snails pace

for much of history. American farmersin the early 1800s worked the soil thesame way their European forebears hadfor centuries. Not surprisingly, their livingstandards were about the same, too.

The advent of industrial capitalismin the 19th century quickened thepace of progress by providing a pow-erful, even ruthless impetus for pro-ductivity. The competitive hothouse

of capitalism pits producers againstone another in a contest for resourcesand customers. Market disciplinerewards those who produce and pun-ishes those who plunder. Winners in theproductivity race reap increased profitsand gain market share, while losers seetheir capacity to compete shrink untilthey eventually go out of business.

The efficiency gains that make

firms leaner and the economywidereshuffling of jobs require painfuladjustments. Some see only thehardships. Fearful of job loss andupheaval in their lives, such peoplehave a single message: Preserve thestatus quo. What they fail to see isthat society must endure the turmoilto get the payoff from productivity.

Taken together, micro- and macro-

productivity are a potent brew for economic progress. Through a succes-sion of technology revolutions andindustrial reorganizations, the nationadvanced from the horse-and-buggyage to one of jet travel, satellite com-munications, robotics, genetic engi-neering and the Internet all gener-ated by waves of productivity.

MACROECONOMICSOURCES OF PRODUCTIVITY GROWTH

THE PAYOFF FROMPRODUCTIVITY GROWTH

TRADE

A powerful force for reorganization, trademakes economies more productive, even if enter-prises dont become more efficient.

REORGANIZATION

As companies and workers become more efficient,the economy reallocates resources to more pro-ductive uses, either in existing companies ornew ones. As the market recycles workers andother resources, the economy grows.

MEASURED

Higher GDP

More leisure time

UNMEASURED

Better working conditionsNew and improved productsMore varietyGreater safety and securityCleaner environment



Because productivity determineshow well we live, Americans want toknow how theyre doing.

In an economy as large and diverseas ours, its a Herculean task to calculatea productivity number that sums up theefforts of 130 million workers, employedin millions of establishments that pro-duce more than $11 trillion in output.The Bureau of Labor Statistics doesthe best it can in producing quarterlyestimates of output per hour, derivedlargely from surveys of businesses.

BLS data show that U.S. productivityhas grown steadily over the longhaul, with output per hour rising anaverage 2.3 percent annually since1870. A few percentage points a year

might not sound like much, but thishistorical rate doubles per capitaincome every three decades or so.(See Exhibit 2.)

The productivity path has beenchoppy due to business-cycle upturnsand slowdowns as well as longer-term economic trends. From 1950 to1973, for example, output per hour rose a healthy 2.7 percent annually.Over the next 22 years, productivitysank below its long-term trend, rising

just 1.5 percent a year. The slowdownremains something of a mystery,although some economists suggestthat early investments in computersand information technology didntprovide a big enough payoff.

Productivity broke out of its two-decade doldrums in the mid-1990s ascomputers, scanners, the Internet andother innovations finally reachedcritical mass in Americas workplaces.

Average annual productivity gainshave surged at 3.2 percent since 1995.

The revival shows every sign of continuing. The economy emergedfrom the 2001 recession with produc-tivity growth well above the averageof the seven significant business cyclessince 1960. In the first 11 quartersafter employment peaked, productivity

jumped 13 percent, compared withthe historical norm of 8 percent. Inanother break with the past, the gainsspread beyond manufacturing, the

Riding a Surge of Technology

The Internet and other innovations have helped ignite a surge in U.S. productivity since the mid-1990s. In the cueconomic recovery, companies are continuing to see gains from investments in new technologies.The Internet and other innovations have helped ignite a surge in U.S. productivity since the mid-1990s. In the cueconomic recovery, companies are continuing to see gains from investments in new technologies.



traditional productivity leader, andinto the whole economy, includingretailing and services.

Productivitys postrecession surgehas been strong enough to spark con-troversy. The labor market has lan-guished, with no net job creation two

years into the recovery. Some see pro-ductivity as a millstone that allowscompanies to expand without hiringmore workers. But viewing productivityas a drag on employment is myopic.

Americans dont face a choice betweenhaving work and working a better way.Higher productivity raises incomes andprofits, which fuels demand, boostsinvestment and puts more people towork, usually at new jobs.

We could dismantle our factoryrobots and farm equipment with theidea of hiring lots of busy hands tobuild cars and till the soil. We could

junk our backhoes and dig ditches withshovels. Doing so would be absurd.

Wed immediately see that renouncingproductivity would do us great harm.Prices would be higher, wages lower and the economy smaller. Work would

be harder. Living standards would bedragged backward in time, sacrificed tothe false god of more jobs.

Rather than shunning productivity,we should embrace it and move for-ward. As the economic recovery con-tinues, the United States may not beable to sustain the same pace of pro-ductivity growth it has the past two

years. Even with a slowdown, the

nation will likely build on recent yearsstrong productivity growth, rather than relapse into the post-1973 slump.

The bullish case for future produc-tivity centers on the technologies thathave made U.S. workplaces more effi-cient in recent years. The microchiprevolution still has plenty of kick leftin it. And as world markets integrate,

we should add to our productivitygains from trade.

Further out, new generations of

world-shaking technologies will impactthe way we work. Take nanotechnology,the science of rearranging atoms andmolecules. It promises to create newmaterials that are stronger, lighter andmore flexible and substances with perfectinsulating, lubricating and conductingproperties. Biotechnology will emerge,too, as a potent force for progress.

When combined with Americasentrepreneurial bent and open markets,the inventory of cutting-edge tech-

nologies should deliver rapid produc-tivity growth for years. Healthy gainsin output per hour may restore theluster of the New Economy, a concepttarnished by the dot-com implosion.The New Economy carries a powerfulpolicy implication: With stronger pro-ductivity, the economy can grow faster without fueling inflation.

Future productivity gains are likely to come from breakthroughs in biotenology, a field just now tapping the possibilities opened by decoding thhuman genome.

Future productivity gains are likely to come from breakthroughs in biotenology, a field just now tapping the possibilities opened by decoding thhuman genome.



Exhibit 2. Productivity by the Numbers

Better machinery, fertilizers, irrigation and high-yield seedshave made farms more productive. Corn output rose from 38bushels per acre in 1950 to 142 in 2003, rice from 2,371 to6,645 pounds, and potatoes from 15,300 to 36,700 pounds.

Technology makes electric power plants more efficienKilowatt-hours per ton of coal rose from 1,682 in 1950 to1,955 in 2002; per barrel of oil, from 447 to 573; andper 1,000 cubic feet of natural gas, from 71 to 113.

30

40

50

60

70

80

90

100

110

120

130

140

0095908580757065605550

Index, 1992 = 100

98

100

102

104

106

108

110

112

114

1211109876543210

Average of previous 7 major business cycles

200103

Quarters since peak quarter of employment

Productivity index, peak quarter of employment = 100

Range of previous 7 major business cycles

After Picking Up in Recent Years . . .The U.S. economy has achieved

steady increases in productivity over thepast five decades (right). A surge since1995 has not only reversed a 22-year

slowdown but also eclipsed the historicaltrend of 2.3 percent a year.

. . . Productivity Really Takes OffProductivity growth has been espe-

cially strong in the most recent businesscycle (below). In the 11 quarters sincethe high point for employment, outputper hour has increased faster than inany of the seven major recessions andrecoveries that preceded it.

Years Change18702003 2.3%19501973 2.7%19731995 1.5%19952003 3.2%

Better machinery, fertilizers, irrigation and high-yield seedshave made farms more productive. Corn output rose from 38bushels per acre in 1950 to 142 in 2003, rice from 2,371 to6,645 pounds, and potatoes from 15,300 to 36,700 pounds.

Technology makes electric power plants more efficienKilowatt-hours per ton of coal rose from 1,682 in 1950 to1,955 in 2002; per barrel of oil, from 447 to 573; andper 1,000 cubic feet of natural gas, from 71 to 113.

Productivity Trends



Jobs, Productivity Go TogetherThe causes of job losses include greater efficiency, rising import competition and other factors that spur reorganiz

in the economy. The number of workers filing initial claims for unemployment insurance shows layoffs are a routiof economic life, whether employment is rising or falling (shaded).

This reorganization, combined with efficiency gains in the workplace, forges a more productive economy withjobs. Output per hour rose 67 percent in the past quarter century. At the same time, the United States added almosmillion workers to the employment rolls.

Except for brief recessions and their aftermath, the economy creates enough new opportunities for both those wlost jobs and new entrants to the labor force, increasing total employment and lowering the unemployment rate.

At auto assembly plants, computers and robots now handle welding and many other tasks once done by hand. Although todaycars are vastly more complex, annual production per employee increased from 9.8 vehicles in 1950 to 13.5 in 2002.

With ATMs, electronic fund transfersand the Internet, banks can handlemore transactions using fewer tellersand support staff. Output per hour incommercial banking has nearly dou-bled since 1970.

Electronic telephone switches havetaken over much of the nations long-distance and toll-call traffic. Callsper operator rose from 17 a day in1950 to 2,072 in 2002.

Monthly Average Net Job Gain 94,000 91,000 212,000 71,000 224,000 67,000End-of-Period Employment 90,936,000 88,756,000 109,118,000 108,261,000 132,441,000 130,043,000Annual Average Unemployment Rate 6.6% 9.7% 6.5% 7.3% 5.3% 5.8%

End-of-Period Productivity* 100 102 119 123 148 167

197980 198182 198390 1991 19922000 200103

Monthly Average Initial Claims 436,000 519,000 366,000 448,000 338,000 404,000

More efficient blast furnaces, computerized controls and shorter down-times are helping Americas steelmills compete. Tons per U.S. steeworker increased from 97.8 in 1950to 314.8 in 2002.

At auto assembly plants, computers and robots now handle welding and many other tasks once done by hand. Although todaycars are vastly more complex, annual production per employee increased from 9.8 vehicles in 1950 to 13.5 in 2002.

With ATMs, electronic fund transfersand the Internet, banks can handlemore transactions using fewer tellersand support staff. Output per hour incommercial banking has nearly dou-bled since 1970.

Electronic telephone switches havetaken over much of the nations long-distance and toll-call traffic. Callsper operator rose from 17 a day in1950 to 2,072 in 2002.

More efficient blast furnaces, computerized controls and shorter down-times are helping Americas steelmills compete. Tons per U.S. steeworker increased from 97.8 in 1950to 314.8 in 2002.

*Index, Fourth quarter 1979 = 100


12/51FEDERAL RESERVE BANK OF DALLAS2003 ANNUAL REPORT0

Exhibit 2. Productivity by the Numbers (continued)

0

10

20

30

40

02999693908784817875726966636057545148

Percent

Productivity Powers ProgressIncreasing productivity holds the key to higher living standards. The U.S. economy hasnt seen big changes

unemployment rate (1 ), labor force participation rate (2 ) or consumption as a share of income (3 ). Productivity (4stands out as the prime force behind economic progress. Most of the productivity gains taken as time off thoccurred before 1980 (5 ). Today, were taking most of the benefits of productivity in higher consumption (6 ) andunmeasured gains in living standards.

Unemployment Rate

40

50

60

70

80

02999693908784817875726966636057545148

Percent of GDP

40

50

60

70

80

02999693908784817875726966636057545148

Percent

14

46

42

38

34

30

26

22

18

02999693908784817875726966636057545148

2003 dollars per hour worked

34

41

40

39

38

37

36

35

02999693908784817875726966636057545148

Hours worked

10

35

30

25

20

15

02999693908784817875726966636057545148

2003 dollars per person (in thousands)

Labor Force Participation Rate

Consumption as a Share of Income Productivity

Average Workweek Consumption per Person

1 2

4

65

3



Day in and day out, markets encouragecompanies to push for greater outputper hour. Do the job faster. Reduceinputs. Improve quality. Trim a fewcents off the cost of production. Therelentless march of productivity comesin myriad ways, limited only by tech-nology and human ingenuity.

Burlington Northern and Santa FeRailway Co. raised freight-haulingproductivity with a computerizedcommand center in Fort Worth. At

Wal-Mart Stores Inc., the next leapforward in productivity will featureminiature tracking devices that simplifykeeping tabs on inventory. Continental

Airlines Inc. increased productivitywith hundreds of airport kiosks thatallow passengers to get boarding passeswithout going to ticket agents. Dr Pepper/Seven Up Bottling Group Inc.grew more productive with hugemachines that fill and package 800bottles or 1,500 cans a minute.

Working Smarter, Not Harder

For Burlington Northern and Santa Fe Railway Co., productivity means hauling more freight per worThousand gross ton milesthe tons of grain, coal and other cargo transported 1,000 milesreached 24,875 in2003, up 9 percent in just three years.

The productivity increases come from a range of initiatives, many of them applying new technologies to the oldbusiness of running a railroad. The Internet-based iPower tool, for example, saves countless hours of paperworkputting scheduling, tracking, billing and other services at customers fingertips.

For BNSF, it all comes together at the Network Operations Center in Fort Worth, a cavernous control room fwhich the railroads dispatchers direct traffic, maintenance and staffing on the 32,500-mile, 36,500-worker systeCentralizing operations reduces delays, improves safety and saves fuel.

For Burlington Northern and Santa Fe Railway Co., productivity means hauling more freight per worThousand gross ton milesthe tons of grain, coal and other cargo transported 1,000 milesreached 24,875 in2003, up 9 percent in just three years.

The productivity increases come from a range of initiatives, many of them applying new technologies to the oldbusiness of running a railroad. The Internet-based iPower tool, for example, saves countless hours of paperworkputting scheduling, tracking, billing and other services at customers fingertips.

For BNSF, it all comes together at the Network Operations Center in Fort Worth, a cavernous control room fwhich the railroads dispatchers direct traffic, maintenance and staffing on the 32,500-mile, 36,500-worker systeCentralizing operations reduces delays, improves safety and saves fuel.



ment has greater weight because of new technologies. Handheld devices,wireless communications, faster Internetconnections, satellite tracking, virtualreality software and other innovationsare becoming more common.

Although strong investment spendingcoincided with the productivity surgein recent years, more output per hour isnt just a matter of money. Firmsbolster productivity through business

10 percent of GDP every year since1996, reaching 13 percent in 2000before slipping to 11 percent in 2003.Between 1980 and 1995, nonresiden-tial investment exceeded 9 percentof GDP only twice.

Companies are getting more bangfor their investment buck. Someproductivity-enhancing tools mostnotably, computing power keepgetting cheaper. Each dollar of invest-

Over the past few decades, Americas farms, steel mills, automo-bile factories, power plants, banksand telecommunications firms haveall shown strong gains in productivity.These industries and countless othersare getting the payoff from a will-ingness to invest in new plant andequipment that embodies the latesttechnology. In real terms, nonresi-dential fixed investment has topped

Wal-Mart Stores Inc., the nations largest retailer, sees the next round of productivity gains in radio-frequeidentification tagssilicon chips that emit signals for electronic readers to receive and decode.

RFID tags can store information on a products origin, location, expiration date and cost. New-generation RFIDare small enough to embed in products and packaging and use frequencies that allow readers to identify individuitems assembled in no particular order.

Wal-Mart will require RFID tags on shipments from its top 100 vendors in 2005 and all suppliers by year-end 20As a step up from bar codes, RFID technology will make Wal-Marts inventory management more efficient. With incopallets and cases carrying the tags, the retailer will be able to track the exact location and condition of every item in sto

Wal-Mart Stores Inc., the nations largest retailer, sees the next round of productivity gains in radio-frequeidentification tagssilicon chips that emit signals for electronic readers to receive and decode.

RFID tags can store information on a products origin, location, expiration date and cost. New-generation RFIDare small enough to embed in products and packaging and use frequencies that allow readers to identify individuitems assembled in no particular order.

Wal-Mart will require RFID tags on shipments from its top 100 vendors in 2005 and all suppliers by year-end 200As a step up from bar codes, RFID technology will make Wal-Marts inventory management more efficient. With incopallets and cases carrying the tags, the retailer will be able to track the exact location and condition of every item in sto



strategies, both simple and sophisti-cated, to improve operations and takea bite out of costs.

Mergers eliminate duplication andcapture economies of scale. Outsourcingsaves money by transferring peripheralfunctions to more efficient suppliers,allowing companies to focus on whatthey do best their core business. Bytightening supply chains, companiesimprove the process of getting inputs

from suppliers, tracking inventories anddelivering products to customers.

One emerging industry centers onselling productivity solutions. TeleportecInc. has developed a technology thatprojects a three-dimensional image,making teleconferencing more attrac-tive as an alternative to business trips.

Adrenaline Inc. simplifies outsourcingthrough its 00Voice service, whichallows busy professionals to input data,

make notes and arrange schedules viacell phone calls to transcribers.

In the end, productivity depends onpeople. Americas economy benefitsfrom a highly skilled labor force well-educated at the top, experiencedthroughout and highly motivatedeven at the bottom. Workers withmore education and experience areusually more productive, and it showsup in the higher pay they receive.

Following the September 11 terrorist attacks, U.S. airlines scrambled to find ways to reduce costs and make flymore convenient for passengers facing tighter security.

For Continental Airlines Inc. and other carriers, one answer was check-in kiosks that allow passengers with electrtickets to bypass lines at the counters. Continental installed the industrys first kiosk in 1995 and greatly expanits program in the past two years. With an industry-leading 779 kiosks in 130 U.S. airports, Continental saw usadouble in 2002 and set a record of 650,000 kiosk check-ins that December.

Kiosks mean airlines need fewer ticket agents to load their planes. Forrester Research Inc., which tracks technoindustries, found that self-service check-ins cost airlines 16 cents a passenger, compared with $3.68 for ticket counter ag

Following the September 11 terrorist attacks, U.S. airlines scrambled to find ways to reduce costs and make flymore convenient for passengers facing tighter security.

For Continental Airlines Inc. and other carriers, one answer was check-in kiosks that allow passengers with electrtickets to bypass lines at the counters. Continental installed the industrys first kiosk in 1995 and greatly expanits program in the past two years. With an industry-leading 779 kiosks in 130 U.S. airports, Continental saw usadouble in 2002 and set a record of 650,000 kiosk check-ins that December.

Kiosks mean airlines need fewer ticket agents to load their planes. Forrester Research Inc., which tracks technoindustries, found that self-service check-ins cost airlines 16 cents a passenger, compared with $3.68 for ticket counter ag



High wages mean companies needto get the most out of their humancapital by improving skills and incen-tives. Soviet-style central planningused fear and propaganda to pushworkers to produce more. Earlyindustrialists employed time andmotion experts in their quest to raiseoutput per hour. The tyranny of stateand stopwatch both proved unsuc-cessful. Todays managers stress

motivation and communication toencourage productivity in an increas-ingly adaptable and educated work-force. They engage employees inimproving quality and productionprocesses. New and better ideas oftenmove from the bottom up.

Beyond improvements in basiceducation, the United States facesthe challenge of retraining workersfor new employment opportunities.

Rapid productivity growth puts apremium on retraining becauseprogress entails job losses. The faster workers recycle into new employ-ment, the better.

In our highly competitive economy,companies cant afford to relent intheir quest to find a better way. Moreoften than not, productivity gainsresult from working smarter rather than simply working harder.

Sometimes it takes big machines to deliver big productivity. To meet the growing demand for its Deja Blue wDr Pepper/Seven Up Inc. invested $7 million two years ago in a mammoth, state-of-the-art bottling line at its IrTexas, facility.

Computer-controlled, the line automates the entire processfeeding empty bottles, filling, capping, packaginto cases and loading on pallets. Three or four workers, operating a U-shaped line that stretches nearly two foball fields in length, oversee a process that turns out 800 12-ounce bottles a minute, about double the previous geeration of machinery.

The key to faster bottling lies in increasing the number of spouts that inject water or soft drinks into contaiThe Deja Blue line contains 96 of them on a rotating drum, up from 60 on less advanced machines.

Sometimes it takes big machines to deliver big productivity. To meet the growing demand for its Deja Blue wDr Pepper/Seven Up Inc. invested $7 million two years ago in a mammoth, state-of-the-art bottling line at its IrTexas, facility.

Computer-controlled, the line automates the entire processfeeding empty bottles, filling, capping, packaginto cases and loading on pallets. Three or four workers, operating a U-shaped line that stretches nearly two foball fields in length, oversee a process that turns out 800 12-ounce bottles a minute, about double the previous geeration of machinery.

The key to faster bottling lies in increasing the number of spouts that inject water or soft drinks into contaiThe Deja Blue line contains 96 of them on a rotating drum, up from 60 on less advanced machines.



The Star Trek TV series futuristicwonders included the transporter, amarvelous device that could zap peopleand objects from one place to another.

What a boon to productivity!Commutes and business trips wouldtake no time at all. Work would speedup as companies moved raw materials,inventories and finished products inthe blink of an eye.

The transporter, if it ever came tobe, would trigger an economic revo-lution, as unsettling as it would bemiraculous. Instant transport wouldrender obsolete our entire transporta-tion infrastructure cars, trucks,boats, airplanes, railroads, warehousesand more. Most workers in theseindustries would lose their jobs.

Teleportation provides a fancifulillustration of the paradox of produc-tivity. It makes us better off, but notwithout a gut-wrenching reorganiza-tion that changes both where andhow we work.

Manufacturing provides an ongoing

case study of productivity in action.Since the Industrial Revolution, thesector has endured wave upon waveof reorganization, largely because of new technology that increased averageworker output per hour. The number of factory workers peaked in 1979 at20 million and slipped to a low of 14million in 2003. Manufacturing hasalso been falling as a percentage of

total employment since World War II,hitting a low of 11 percent in 2003.

The job losses didnt mean con-sumers lacked manufactured goods.Bolstered by greater productivity,domestic factory output has held itsown, ranging between 15 percentand 17 percent of an expanding GDPsince 1977. At the same time, weve

been able to trade our farm output,services and other products for foreignmanufactured goods.

While U.S. manufacturing employ-ment shrank, the overall labor marketkept moving forward ( Exhibit 2 ). From1979 to 2003, Americans filed morethan 114 million initial claims for unemployment benefits, a figure thatcaptures just a fraction of the number of job losses. Yet during this sameperiod, America created enough workfor a growing labor force, with totalemployment rising from 91 million to130 million. For the most part, theadditional workers produced newgoods and services, expanding thesize of the economic pie.

Despite the job losses during therecent recession, the U.S. unemploy-ment rate has been relatively low inrecent years. And out of all the shufflingand reshuffling, productivity marchedever upward, posting an increase of 67 percent from 1979 to 2003.

Strong productivity and job growth

go hand in hand because the UnitedStates hasnt tried to thwart the reor-ganization of the labor market withexcessive regulation. In 2003, Forbesmagazine concluded that the UnitedStates had the worlds freest labor market by a wide margin.

Countries that impede economicchange become laggards, not just inthe race for productivity but in living

standards as well. Laws making ithard to fire workers and mandates for excessive severance pay hinder thechanges that are the lifeblood of pro-ductivity. The cost of good intentionscontinues to be high in Latin America,for example. Most nations in theregion thwart reorganization byfavoring entrenched economic interests.

The Wringer of Reorganization

Trade increases productivity in bothexporting and importing nations.Trade increases productivity in bothexporting and importing nations.



Exhibit 3. Trading Up: How Simple Exchange Boosts Productivity

Two Nations, Two GoodsTrade seems to create productivity out of thin air. To illustrate how, simplify the world into China and the United

each endowed with a hypothetical labor force, money supply and production capacity. As the more advanced natthe United States maintains an absolute advantage in producing both products.

Trade Expands the PieWithout trade, each country meets its own needs. Both China and the United States allocate labor to produce soyb

and shoes. Given their labor supply and productivity, the nations turn out a combined 800 pairs of shoes and 7,0bushels of soybeans. With free trade, China exploits its comparative advantage in producing shoes. The U.S. edgein growing soybeans. Trade increases total output: Shoes rise to 2,000 pairs, while soybeans increase to 10,0bushels. With increased output, both China and the United States consume more shoes and more soybeans.

Prices Down, Productivity UpImports lower prices. U.S. soybeans cost Chinese consumers 80 percent less than those grown at home. Chi

shoes cost Americans 50 percent less than domestic ones. Neither country became more efficient in producing sor soybeans, but an hour of work now buys more than it did before. Simply through trade, productivity grows 122 perin China and 47 percent in the United States.

CHINA UNITED STATESLabor Force 500 100Money Supply 4,000 $10,000

Output per WorkerShoes (pairs) 4 5Soybeans (bushels) 8 100

CHINA UNITED STATESEmployment No Trade Free Trade No Trade Free Trad

Shoes 125 500 60 0Soybeans 375 0 40 100

ProductionShoes 500 2,000 300 0Soybeans 3,000 0 4,000 10,000

ConsumptionShoes 500 1,500 300 500Soybeans 3,000 5,000 4,000 5,000

CHINA UNITED STATESPrices No Trade Free Trade No Trade Free Trad

Shoes 2 2 $20 $10Soybeans 1 0.2 $1 $1Overall Index 100 45 100 68

ProductivityOverall Index 100 222 100 147



By doing so, theyve cheated them-selves out of economic progress.

Labor mobility, of course, isnt theonly driver of macroeconomic pro-ductivity. As the economy reorganizesto produce more, it also lowers pricesrelative to wages, so that our pay-checks buy more. The price effect isparticularly visible with the produc-tivity gains from trade, where cheaper imports make consumers budgets gofurther. To illustrate how exchangegenerates greater productivity, letssimplify the world to just two countriesand two goods the United States andChina, producing soybeans and shoes.

In a world without trade, eachcountry makes both products. Their

combined output totals 800 pairs of shoes and 7,000 bushels of soybeans.Introducing trade into this stylizedworld allows the United States to spe-cialize in soybeans while Chinamakes shoes a reflection of compar-ative advantage. (See Exhibit 3.)

What happens? The total output of shoes increases to 2,000 pairs, allmade in China. At the same time,production of soybeans rises to10,000 bushels, all grown in theUnited States. Both countries con-sume more of both products and payless for the one they import.Calculating productivity, we findincreases of 122 percent for Chinaand 47 percent for the United States.

The added productivity representsa bonus from trade and trade alone.Labor forces and money suppliesstayed the same in both the UnitedStates and China. Neither countryraised output per hour in either shoesor soybeans. Trade made both of them more productive, even thoughfirms and workers didnt get anymore efficient on their own.

Trade can be every bit as powerfulas technology in making us productive.To achieve the same results withouttrade, the United States would requirenew technology good enough to doubleits productivity in shoes. China wouldneed to become four times more effi-cient in soybean farming.

With computers, tiny cameras and robotic arms, doctors can now operate by manipulating delicate instruments remote control. Surgeons in the emerging field of telemedicine have already performed procedures on distpatients, creating potential savings in travel time while using facilities more efficiently.

With computers, tiny cameras and robotic arms, doctors can now operate by manipulating delicate instruments remote control. Surgeons in the emerging field of telemedicine have already performed procedures on distpatients, creating potential savings in travel time while using facilities more efficiently.



The example highlights what occurswith a wide range of goods and servicesin the real world. Like technology and

other sources of productivity, trademakes a powerful contribution to theeconomys overall efficiency. Tradesproductivity gains provide a strong jus-tification for open markets. Enormousbenefits are lost when countries bow totheir producers narrow interests andenact protectionist measures that blockimports or raise their price.

Productivity gains from trade oftenentail overseas outsourcing, a contro-

versial trend because of its impact on

U.S. jobs. Moving employment offshoreis not new in manufacturing, but theInternet and other networking tech-nologies have made it possible to shiftsome service jobs to lower-wage coun-tries. Computer programmers are writingcode from distant lands. Call centersin India, not Indiana, are handlinginquiries from American customers.

Technology and open markets dic-tate that production will continue toshift overseas. Outsourcing does

mean some job losses at home, but wecant ignore the corresponding gains:Companies reduce costs. Consumerssee lower prices. The economybecomes more productive, fuelinggrowth and new jobs. A more effi-cient global division of labor will givethe U.S. economy a big productivityboost for years to come.

Using radio scanners to collect tolls makes transportation more efficient, saving motorists time. Open-road toll can handle about 2,000 cars an hour, compared with 750 for automated coin boxes and 360 for human toll-takers.Using radio scanners to collect tolls makes transportation more efficient, saving motorists time. Open-road toll can handle about 2,000 cars an hour, compared with 750 for automated coin boxes and 360 for human toll-takers.



Nature endowed human beingswith numerous characteristics thatcan create economic value. Our arms,legs and backs can perform physicallabor. Our hands and fingers canmold and manipulate objects. Our brains can reason, imagine and inno-

vate. Our human spirit can entertain,comfort and inspire.

As productivity reorganizes theeconomy, it changes how we use our innate skills and talents in the work-place. The progression flows mainlyfrom technology and trade. Eachgeneration of inventions and innova-tions produces tools to take on moreof the tasks once done by humanbeings. Each expansion of tradeopens the possibility of doing tasksmore economically in countries payinglower wages.

Americans adjust by taking jobsthat put our other talents to work.Over time, our work moves up a hier-archy of human talents, focusing onnew tasks that require higher-order skills, ones that machinery or out-sourcing cant do as well. By redefiningthe way we work, the economy cre-ates a new and more productive mixof technology and human talents.

At the most primitive level of eco-nomic development, work involvedsheer muscle power digging, lifting,hauling and the like. Our forebearshunted, gathered and carved furrowsfor crops eventually harvested byhand. Armies of workers, haulinghuge stones with only simple tools,built Egypts pyramids. Some workersearned their living exploiting other talents, but muscle power dominated

economic life until the IndustrialRevolution. (See Exhibit 4.)

The new age brought machinesstronger and more durable thanmuscle power, and they took on moreof the physical work. Peoples nichebecame manual dexterity, the abilityto control tools with motor skills.Human hands were needed to operatemachinery. We worked with power drills and forklifts rather than picksand shovels. Millions of Americanstook jobs on the nations assemblylines, becoming cogs in the vastmachinery that churned out steel, cars,processed food and much more.

New technology led to automationsophisticated enough to run themachines, reducing the number of workers on the factory floor. Manymodern factories employ just a few

The Evolution of Work

Workers once used muscle power to dig with picks and shovels. Over timeever-larger digging and loading machines have allowed a single operator todo what once required legions of laborers.

Workers once used muscle power to dig with picks and shovels. Over timeever-larger digging and loading machines have allowed a single operator todo what once required legions of laborers.



The work we do has evolved in response to economic progress. Advances in technology create tools capabldoing tasks better or cheaper than human beings. As machines make some talents obsolete, people move on to jthat use others. In this way, workers move upward over time to jobs demanding more sophisticated talents. In thedecade, the United States saw employment declines in jobs requiring muscle power, manual dexterity and formintelligence. The nation has added jobs that use analytic reasoning, imagination and creativity, and people skills.

Exhibit 4. Hierarchy of Human Talents

PercentChange

Employment Gains(9202)

PEOPLE SKILLS/EMOTIONAL INTELLIGENCERegistered nurses +512,000 +28Financial-services sales +248,000 +78Lawyers +182,000 +24Educational and vocational counselors +48,000 +21Recreation workers +35,000 +37IMAGINATION/CREATIVITYDesigners +230,000 +43Hairstylists and cosmetologists +146,000 +19Architects +60,000 +44Actors and directors +59,000 +61Photographers +49,000 +38ANALYTIC REASONINGLegal assistants +159,000 +66Electronic engineers +147,000 +28Medical scientists +22,000 +33Metallurgical engineers 2,000 8Computer operators 367,000 55FORMULAIC INTELLIGENCECost and rate clerks 16,000 24Health records technicians 36,000 63Telephone operators 98,000 45Bookkeepers 247,000 13Secretaries and typists 1,305,000 30MANUAL DEXTERITYTool and die makers 30,000 23Lathe operators 30,000 49Typesetters 34,000 62Butchers 67,000 23Sewing machine operators 347,000 50MUSCLE POWERGarbage collectors 2,000 4Stevedores 3,000 17Fishing workers 14,000 27Timber cutters 25,000 32Farmworkers 182,000 20



highly trained technicians to main-tain the computers that run nearly allphases of production.

People who once operated machineryfound work that relied more on usingtheir minds. At first, many jobs calledfor formulaic intelligence, applying rotestandards in keeping ledgers, countingand other duties. The next stepupward involved jobs that requiredanalytical reasoning, the ability tosolve problems. We took jobs as engi-neers, managers and programmers.

In our time, computers are takingon many of the mental tasks that notlong ago only humans could do. Atfirst, the machines could handle onlythe relatively simple tasks of formulaicintelligence, proving faster and moreaccurate in calculating than thehuman brain. Increasingly powerfulcomputers, capable of running hugeprograms, now perform more of our analytical tasks. Advances in artificialintelligence enable computers to flyplanes, answer phone calls and trackbuying patterns. An IBM computer even beat world chess champion

Garry Kasparov in 1997.In todays world, companies and

workers face the challenge of ascendingthe hierarchy of human talents.

Workers are increasingly using thosetraits that make us truly human.Some jobs require imagination andcreativity, including the ability todesign, innovate and entertain. Other

jobs rely on such social skills as con-

flict resolution, cooperation and evenhumor. Work is more likely to put apremium on the ability to inspireand motivate, a capacity social sci-entists call emotional intelligence.

Many jobs requiring muscle power,manual dexterity and formulaic intelli-gence are increasingly performed byworkers in other countries. As the

Internet speeds communications, com-panies are hiring more foreigners withanalytical skills. Not all old-line jobs haveleft the United States, but more of us areearning our paychecks at the upper

echelon of the hierarchy of human talents.Over the past decade, an era of rapid

technological change and globaliza-tion, big employment gains came inoccupations that rely on people skillsand emotional intelligence. We added512,000 registered nurses and 248,000people in financial-services sales.Others in growing occupations includelawyers, educational and vocational

counselors, and recreation workers.The past decade also saw gains in

jobs that involve imagination andcreativity designers, architects, pho-tographers, actors and directors. Thehairstylists and cosmetologists cate-gory rose by 146,000 jobs. Manyoccupations that use analytic reasoninghave continued to grow, too, but

computer operators and others arebeginning to see their numbers fall.

The occupations in eclipse are gen-erally those that involve muscle power,manual dexterity and formulaic intel-

ligence. The number of secretaries andtypists, for example, has fallen by 1.3million since 1992, as more computers,printers, voice mail and other officemachines have entered the workplace.The ranks of sewing machine opera-tors have declined by 347,000, those of farmers by 182,000.

The United States will continue tomove up the hierarchy of human talents

as it becomes more productive. Fewer jobs at relatively lower pay will beavailable for those who offer employersonly muscle power, manual dexterity or formulaic intelligence. Americans whowant to prepare for the better jobs of thefuture will concentrate on developingtheir creativity, imagination, peopleskills and emotional intelligence.

People skills and emotional intelligence will become increasingly importto work in the 21st century. Employment opportunities are growing fteachers as well as nurses, sales representatives, lawyers, counselors andrecreation workers.

People skills and emotional intelligence will become increasingly importto work in the 21st century. Employment opportunities are growing fteachers as well as nurses, sales representatives, lawyers, counselors andrecreation workers.



No matter how much we focus onwork and jobs, an economys truetest lies in how well it provides for the vast majority of consumers.Even the most spectacular advancesin productivity would be hollow if they didnt translate into better living standards.

As they get richer, most societiesmove down a list of priorities. Wefirst take care of the basics of food,clothing and shelter. We then move tofurniture, transportation, health care,and a long list of other goods andservices. At some point, most of usbegin to prefer nonmaterial benefits,ranging from leisure time to a cleaner environment. The richer the society,the more likely it will take productivitygains as something other than moreconsumer goods.

As output per hour has increasedsteadily over the years, weve takenplenty of our added productivity asmaterial gains more cars, bigger and better-equipped houses, an abun-

dance of goods and services. We con-sume more than any other nation, butweve sacrificed some potential con-sumption to take at least part of our productivity gains in other ways.

For example, we work less. Over the past few generations, the typicalworker has gone from a six-dayworkweek with little vacation to anaverage of 34 hours plus three weeks

off. Anecdotal reports suggest that Americans have begun workinglonger hours in recent years, but thetrend doesnt show up in the system-atic studies of how we use our time.Neither Department of Labor surveysof work hours nor University of Maryland time diaries find lengtheningaverage workweeks.

Statistics measuring productivitycapture added output and the shorter workweek. Still other ways of capi-talizing on greater productivitydont show up in the numbers,largely because they arent fullyaccounted for in gross domesticproduct. Unmeasured payoffs of productivity include better workingconditions, new products andgreater variety. All improve livingstandards, and all ultimately derivefrom increased productivity: 1

Commerce Department statisticsshow the U.S. economy has beendoing very well in becoming moreproductive. In reality, its even better.The numbers capture productivityscontribution to greater consumptionand leisure, but they miss the gainsweve achieved in other areas.

Compared with what previousgenerations experienced, modern

workplaces are safer, cleaner, quieter and less crowded. Employers, awarethat happy workers are more pro-ductive, offer relaxed dress codes,flexible work schedules and other extras not included in GDP.

Todays Americans pack cellphones in their pockets, pull in tele-

vision signals from outer space andshop the world over the Internet.

Our daily lives are filled with newand better products, improving lifeby more than the GDP numbersindicate.

Were also enjoying a dazzlingdiversity of goods and services inthe marketplace, an array of sizes,colors and flavors yet the explo-sion of consumer choice barelyshows up in GDP.

Reaping Productivitys Payoff

Cell phones can save time andmoney by keeping us in touch.Cell phones can save time andmoney by keeping us in touch.



Productivity matters because it deter-mines how well we live. Go around theglobe. Go back in time. Poorer countriesarent nearly as productive as richer ones. Societies that have risen frompoverty to affluence have done it byfinding ways to get more from their labor and other resources.

Looking back, its clear that produc-tivity has made the United States a richnation. Looking ahead, it should be

just as clear that productivity remains Americas best hope for improving livingstandards in the future. Other possiblepaths to a better life dont hold muchpromise. We cant consume a larger portion of our national output. Familyobligations and lifestyle choices suggestwe wont increase the proportion of thepopulation at work. The unemploymentrate rose during the recession and its

aftermath, so it could come down butonly a percentage point or so.

Productivity differs from these lim-ited sources of progress. Productivitypromises a better way because itsboundless. It draws on the vast poten-tial of modern technology. It flowsfrom the infinite promise of humaningenuity. It taps into the endlesscapacity to organize the economymore efficiently. Productivity willtake us as far as we let it.

History tells us that economicprogress can be a messy, often chaoticprocess. There are lags as well as costsfor worker retraining and relocation.Turmoil in the job market causeshardships for displaced workers andtheir families. Some workers end upworse off. But the harsh realities of economic life cant be short-circuited.

Some of the troubling aspects of economic life the job losses, the out-sourcing are good for productivity, thewellspring of progress. Understandingthat, we can face economic changewith less fear.

Human nature clings to the statusquo: Most people are in favor of progress; its change they dont like.

We cant fall into that trap. We wontachieve greater productivity withoutshifting resources from existing tonew uses. When labor moves fromwhere its no longer needed, we profitby whatever the recycled workersproduce elsewhere.

Letting the economy reorganize tobecome more productive has workedwonders for the United States. Our future, no less, depends on doingthings a better way.

W. Michael Cox and Richard Alm

The Best Hope for a Better Future

Bar codes and scanners are making the service sector more productive. Supermarkets and other retailers ainstalling $25,000 self-service checkout stations, reaping an average cost savings of about 40 percent.Bar codes and scanners are making the service sector more productive. Supermarkets and other retailers ainstalling $25,000 self-service checkout stations, reaping an average cost savings of about 40 percent.



AcknowledgmentsA Better Way was written by W.

Michael Cox and Richard Alm. Theessay is based on research conducted byCox, senior vice president and chiefeconomist, Federal Reserve Bank ofDallas. Alm is an economics writer in theBanks Research Department. Julia

Kedrova provided important researchassistance on the project. CharleneHowell assisted with photo research.

NoteFor more information, see the Dallas

Feds Annual Report essays for 2000,Have a Nice Day!; 1993, These Arethe Good Old Days; and 1998, TheRight Stuff.

Exhibit Notes and DataSourcesExhibit 2. Productivity by theNumbersThe 1980 business cycle is not includedamong major business cycles becauseit was only six months long.

Bureau of Labor Statistics (BLS);Bureau of Economic Analysis (BEA),national income and product accounts.Historical productivity trends for

18701973 were calculated usingAngus Maddison,Monitoring the World Economy: 18201992 (table J-5); for19732003, BLS.

Agriculture: U.S. Department ofAgriculture, Economics and StatisticsSystem, http://jan.mannlib.cornell.edu;National Agricultural Statistics Service,Crop Production, Jan. 12, 2004.

Energy: Energy Information Admin-istration, Annual Energy Review , 2002(tables 8.2a and 8.3c).

Banking: Statistical Abstract of the United States 1987 (table 673), 1996(table 655) and 2002 (table 604); BLS.

Telephone operators:Statistical Abstract 1955 (tables 241 and 605); FederalCommunications Commission,Statisticsof Communications Common Carriers,200203; BLS.

Steel: U.S. Geological Survey:http://minerals.usgs.gov/minerals/

pubs/of01-006/ironandsteel.html andMineral Commodity Summaries 2004,http://minerals.usgs.gov/minerals/pubs/mcs/2004/mcs2004.pdf; BLS.

Auto manufacturing:Ward's Motor Vehicle Facts & Figures 2003; BLS.

Exhibit 3. Trading UpAuthors' calculations.

Exhibit 4. Hierarchy of HumanTalents

BLS.

Page 18Toll lane productivity: International

Bridge, Tunnel and Turnpike Associationestimates, www.ibtta.org.

Photo CreditsCover (from left)

Bottom row: David Bray Photographer/Port of Houston Authority; U.S. Departmentof Agriculture.

Second row: Library of Congress, Prints& Photographs Division, FSA-OWI Collection[LC-USW33-031077-C DLC]; Deere andCompany Archives; 1957ford.com.

Third row: Library of Congress, Prints& Photographs Division, FSA-OWICollection [LC-USE6-D-006951 DLC],[LC-USF33-011801-M4 DLC]; NebraskaState Historical Society; Library ofCongress, Prints & Photographs Division,FSA-OWI Collection [LC-USE6-D-001290DLC]; Library of Congress, Prints & Photo-graphs Division, Theodor HorydczakCollection [LC-H814-T01-1007 DLC].

Fourth row: Chicago HistoricalSociety, Chicago Daily News NegativesCollection, DN-0082996; Library ofCongress, Prints & Photographs Division,FSA-OWI Collection [LC-USF34-034565-D DLC], [LC-USF34-026059-D DLC];Library of Congress, Prints & Photo-

graphs Division, Detroit PublishingCompany Collection, D34403; Libraryof Congress, Prints & PhotographsDivision, Theodor Horydczak Collection[LC-H824-T01-2873-003-x DLC].

Page 4Agriculture: Northwest Museum of Arts

& Culture/Eastern Washington State His-torical Society, Spokane, left.

1

Industry (from left): Chicago HistorSociety, Chicago Daily News NegativCollection, DN-0001064; Library of Cogress, Prints & Photographs Division, FOWI Collection [LC-USE6-D-004076 D CCLRC Rutherford Appleton Labora

Services: Fred Hultstrand HistoryPictures Collection, NDIRS-NDSU, FaN.D., left; Chicago Historical Socie

Chicago Daily News Negatives CollectioDN-0084883, middle.

Page 8U.S. Department of Agriculture, l

Roberts & Schaeffer Company.

Page 9United States Steel Corporatio

upper right.

Page 12Wal-Mart Stores, Inc.

Page 13Continental Airlines, Inc.

Page 15David Bray Photographer/Port

Houston Authority.

Page 17 2004 Intuitive Surgical, Inc.

Page 18North Texas Tollway Authority.

Page 19U.S. Department of Agriculture, upp

left; American Environmental PhotograCollection [AEP-INN52], DepartmenSpecial Collections, University of ChicaLibrary, lower left; Bucyrus InternatioInc., right.

Page 20Agricultural Research Service, USD

Scott Bauer, third down; Carousel DesigLtd., fifth down.

Page 23Robert Harbison/2001The Christia

Science Monitor .



Senior Management

Robert D. McTeer, Jr.President and CEO

Helen E. HolcombFirst Vice President and COO

Meredith N. BlackSenior Vice President

W. Michael CoxSenior Vice President andChief Economist

J. Tyrone GholsonSenior Vice President

Robert D. HankinsSenior Vice President

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Larry J. ReckSenior Vice President

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Boards of Directors

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Ray L. Hunt

(Chairman)Chairman, President andCEO, Hunt Consolidated Inc.

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DallasRobert D. McTeer, Jr.President and CEO

Helen E. HolcombFirst Vice President and COO

Meredith N. BlackSenior Vice President

W. Michael CoxSenior Vice President andChief Economist

J. Tyrone GholsonSenior Vice President

Robert D. HankinsSenior Vice President

Joanna O. KolsonSenior Vice President

Larry J. ReckSenior Vice President

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Millard E. SweattSenior Vice President,General Counsel,Ethics Officer and Secretary

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Bob W. WilliamsAssistant Vice President

E. Ann WorthyAssistant Vice President

Mark A. WynneAssistant Vice President

Stephan D. BookerAccounting Officer

Jeffery W. Gunther

Research OfficerLawrence E. HallDirector of Security Operations

Lawrence G. RexAudit Officer

Sherry M. KiddInformation Technology Officer

El PasoRobert W. GilmerActing Vice President in Charge

Javier R. JimenezAssistant Vice President

HoustonRobert Smith IIISenior Vice President in Charge

Ren G. GonzalesVice President

Luther E. RichardsVice President

Richard J. BurdaAssistant Vice President

Daron D. PeschelAssistant Vice President

Donald N. Bowers IIOperations Officer

San Antonio James L. StullSenior Vice President in Charge

Taylor H. BarbeeAssistant Vice President

D. Karen DiazAssistant Vice President

Richard A. GutierrezAssistant Vice President

As of December 31, 2003

Small Businessand Agriculture

Advisory Council

Frank M. Aldridge IIIPresident and CEOCirca Capital Corp.Dallas

Johnny N. CavazosOwnerCavazos Insurance AgencyBrownsville, Texas

Franois ChandouOwnerLa Cave WarehouseDallas

Hattie HillChief Executive Officer

Hattie Hill Enterprises Inc.Dallas

Ray Joe RileyChairman and PresidentEstacado Industries Inc.Hart, Texas

Gregory J. RohanPresidentHeritage Capital Corp.Dallas

Steven R. VandegriftGeneral PartnerTechxas VenturesAustin

Federal AdvisoryCouncil Member

Gayle M. EarlsPresident and CEOTIBThe Independent BankersIrving, Texas

As of December 31, 2003

Officers Federal Reserve Bank of Dallas



MANAGEMENTS ASSERTION

February 12, 2004

To the Board of Directors of the

Federal Reserve Bank of Dallas:

The management of the Federal Reserve Bank of Dallas (FRBD) is responsible for the preparation and

fair presentation of the Statement of Financial Condition, Statement of Income, and Statement of

Changes in Capital as of December 31, 2003 (the Financial Statements). The Financial Statements

have been prepared in conformity with the accounting principles, policies, and practices established

by the Board of Governors of the Federal Reserve System and as set forth in the Financial Accounting

Manual for the Federal Reserve Banks (Manual), and as such, include amounts, some of which are

based on judgments and estimates of management. To our knowledge, the Financial Statements are,

in all material respects, fairly presented in conformity with the accounting principles, policies, and prac-

tices documented in the Manual and include all disclosures necessary for such fair presentation.

The management of the FRBD is responsible for maintaining an effective process of internal controls

over financial reporting including the safeguarding of assets as they relate to the Financial Statements.

Such internal controls are designed to provide reasonable assurance to management and to the Board

of Directors regarding the preparation of reliable Financial Statements. This process of internal controls

contains self-monitoring mechanisms, including, but not limited to, divisions of responsibility and a

code of conduct. Once identified, any material deficiencies in the process of internal controls are report-

ed to management, and appropriate corrective measures are implemented.

Even an effective process of internal controls, no matter how well designed, has inherent limitations,

including the possibility of human error, and therefore can provide only reasonable assurance withrespect to the preparation of reliable financial statements.

The management of the FRBD assessed its process of internal controls over financial reporting includ-

ing the safeguarding of assets reflected in the Financial Statements, based upon the criteria established

in the Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations

of the Treadway Commission (COSO). Based on this assessment, we believe that the FRBD maintained

an effective process of internal controls over financial reporting including the safeguarding of assets as

they relate to the Financial Statements.

President First Vice President

Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas

Chief Financial Officer

Federal Reserve Bank of Dallas


32/51FEDERAL RESERVE BANK OF DALLAS 2003 ANNUAL REPORT0

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors of the

Federal Reserve Bank of Dallas:

We have examined managements assertion, included in the accompanying Management assertion,

that the Federal Reserve Bank of Dallas (FRB Dallas) maintained effective internal control over finan-

cial reporting and the safeguarding of assets as they relate to the financial statements as of December

31, 2003, based on criteria established in Internal ControlIntegrated Framework issued by the

Committee of Sponsoring Organizations of the Treadway Commission. FRB Dallas management is

responsible for maintaining effective internal control over financial reporting and safeguarding of assets

as they relate to the financial statements. Our responsibility is to express an opinion on managements

assertion based on our examination.

Our examination was conducted in accordance with attestation standards established by the AmericanInstitute of Certified Public Accountants and, accordingly, included obtaining an understanding of the

internal control over financial reporting, testing and evaluating the design and operating effectiveness

of the internal control, and performing such other procedures as we considered necessary in the cir-

cumstances. We believe that our examination provides a reasonable basis for our opinion.

Because of inherent limitations in any internal control, misstatements due to error or fraud may occur

and not be detected. Also, projections of any evaluation of the internal control over financial report-

ing to future periods are subject to the risk that the internal control may become inadequate because

of changes in conditions, or that the degree of compliance with the policies or procedures may dete-

riorate.

In our opinion, managements assertion that FRB Dallas maintained effective internal control over

financial reporting and over the safeguarding of assets as they relate to the financial statements as of

December 31, 2003, is fairly stated, in all material respects, based on criteria established in Internal

ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the

Treadway Commission.

This report is intended solely for the information and use of management and the Board of Directors

and Audit Committee of FRB Dallas, and any organization with legally defined oversight responsibilities

and is not intended to be and should not be used by anyone other than these specified parties.

March 1, 2004

Dallas, Texas



REPORT OF INDEPENDENT AUDITORS

To the Board of Governors of The Federal Reserve System

and the Board of Directors of The Federal Reserve Bank of Dallas:

We have audited the accompanying statements of condition of The Federal Reserve Bank of Dallas

(the Bank) as of December 31, 2003 and 2002, and the related statements of income and changes

in capital for the years then ended, which have been prepared in conformity with the accounting

principles, policies, and practices established by the Board of Governors of The Federal Reserve

System. These financial statements are the responsibility of the Banks management. Our respon-

sibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States

of America. Those standards require that we plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material misstatement. An audit includes examin-ing, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An

audit also includes assessing the accounting principles used and significant estimates made by man-

agement, as well as evaluating the overall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

As discussed in Note 3, the financial statements were prepared in conformity with the accounting prin-

ciples, policies, and practices established by the Board of Governors of The Federal Reserve System.

These principles, policies, and practices, which were designed to meet the specialized accounting and

reporting needs of The Federal Reserve System, are set forth in the Financial Accounting Manual for

Federal Reserve Banks and constitute a comprehensive basis of accounting other than accounting prin-

ciples generally accepted in the United States of America.

In our opinion, the financial statements referred to above present fairly, in all material respects, the

financial position of the Bank as of December 31, 2003 and 2002, and results of its operations for the

years then ended, on the basis of accounting described in Note 3.

March 1, 2004

Dallas, Texas


34/51FEDERAL RESERVE BANK OF DALLAS 2003 ANNUAL REPORT2

Statements of Condition (in millions)

December 31, 2003 December 31, 2002

ASSETS

Gold certificates $ 507 $ 485

Special drawing rights certificates 98 98

Coin 141 163

Items in process of collection 383 624

U.S. government and federal agency securities, net 26,475 14,184

Investments denominated in foreign currencies 442 378

Accrued interest receivable 198 121

Interdistrict settlement account 6,997 14,306

Bank premises and equipment, net 211 166

Other assets 32 50___________ ___________

Total assets $ 35,484 $ 30,575___________ ______________________ ___________

LIABILITIES AND CAPITAL

Liabilities

Federal Reserve notes outstanding, net $ 32,657 $ 28,416

Securities sold under agreements to repurchase 1,005 468

Deposits:

Depository institutions 952 727

Other deposits 2 4

Deferred credit items 487 505

Interest on Federal Reserve notes due U.S. Treasury 84 21

Accrued benefit costs 60 56

Other liabilities 15 6___________ ___________

Total liabilities 35,262 30,203___________ ___________

Capital

Capital paid-in 111 186

Surplus 111 186___________ ___________

Total capital 222 372___________ ___________

Total liabilities and capital $ 35,484 $ 30,575___________ ______________________ ___________

The accompanying notes are an integral partof these financial statements.



Statements of Income (in millions)

FOR THE YEARS ENDEDDecember 31, 2003 December 31, 2002

INTEREST INCOME

Interest on U.S. government and federal agency securities $ 768 $ 530

Interest on investments denominated in foreign currencies 6 6___________ ___________

Total interest income 774 536

INTEREST EXPENSE

Interest expense on securities sold under agreements to repurchase 7 ___________ ___________

Net interest income 767 536___________ ___________

OTHER OPERATING INCOME

Income from services 51 63

Reimbursable services to government agencies 11 12Foreign currency gains, net 60 45

U.S. government securities gains, net 1

Other income 1 2___________ ___________

Total other operating income 123 123

OPERATING EXPENSES

Salaries and other benefits 102 98

Occupancy expense 16 15

Equipment expense 12 12

Assessments by Board of Governors 48 14Other expenses 39 30___________ ___________

Total operating expenses 217 169___________ ___________

Net income prior to distribution $ 673 $ 490___________ ______________________ ___________

DISTRIBUTION OF NET INCOME

Dividends paid to member banks $ 11 $ 10

Transferred to (from) surplus (75) 22

Payments to U.S. Treasury as interest on Federal Reserve notes 737 458___________ ___________Total distribution $ 673 $ 490

___________ ______________________ ___________



36/51

Statements of Changes in Capitalfor the Years Ended December 31, 2003,and December 31, 2002 (in millions)

Capital Paid-In Surplus Total Capital

BALANCE AT JANUARY 1, 2002(3.3 million shares) $ 164 $ 164 $ 328

Net income transferred to surplus 22 22

Net change in capital stock issued(0.4 million shares) 22 22

________ ________ ________

BALANCE AT DECEMBER 31, 2002

(3.7 million shares) $ 186 $ 186 $ 372

Net income transferred from surplus (75) (75)

Net change in capital stock redeemed( (1.5) million shares) (75) (75)

________ ________ ________

BALANCE AT DECEMBER 31, 2003

(2.2 million shares) $ 111 $ 111 $ 222________ ________ ________________ ________ ________


FEDERAL RESERVE BANK OF DALLAS 2003 ANNUAL REPORT4



Notes to Financial Statements

1. STRUCTUREThe Federal Reserve Bank of Dallas (Bank) is part of the Federal Reserve System (System) cre-ated by Congress under the Federal Reserve Act of 1913 (Federal Reserve Act) which establishedthe central bank of the United States. The System consists of the Board of Governors of the FederalReserve System (Board of Governors) and twelve Federal Reserve Banks (Reserve Banks). The

Reserve Banks are chartered by the federal government and possess a unique set of governmental,corporate, and central bank characteristics. The Bank and its branches in El Paso, Houston, and SanAntonio serve the Eleventh Federal Reser

2003 dallas federal reserve annual report

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