Added Security Will Trim Productivity

The added costs of vigilance will hit some companies harder than others.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

October 12, 2001

Extra guards, extra paperwork, new employee ID systems, longer waits at airports, biohazard drills, more employee counseling, package checking and other hidden time eaters—all are new costs that businesses face in the wake of the Sept. 11 terrorist attacks on the World Trade Center and the Pentagon. These costs sap the bottom line, eating away at profits and productivity.

While some companies will get hit with sharply higher costs, the overall effect will be to shave just a sliver off productivity growth—about 0.1% a year for the next few years. As a drag on the economy, the "security tax" won't be as dramatic, for example, as the '70s' oil price increase, which forced the entire economy to retool.

But the small overall hit to productivity is important because changes in output per hour ripple through the entire economy, and accumulating gains played a major role in the U.S. economy's recent remarkable 10-year expansion. "With productivity, every tenth makes a difference," says Martin Baily, a productivity expert and former Clinton administration chief economic adviser now at the Institute for International Economics.

After the Organization of Petroleum Exporting Countries quadrupled the price of oil in '73-'74, productivity suffered as businesses were forced to change procedures and revamp schedules to reduce consumption, workers lost countless hours waiting in line to buy gasoline, and a multitude of other changes cut productivity. From '74 to '95, productivity gained an average of just 1.4% annually, and that period was marked by rampant inflation, high interest rates, four recessions, and huge budget deficits.

But since '96, productivity has averaged a 2.5% annual gain, allowing the Federal Reserve to hold interest rates low even as unemployment dipped below 4%—almost unimaginable a few years earlier. The profound changes made possible by the technological revolution, new management techniques and the rising education level have made workers so much more efficient that profits and the economy can continue growing along with overall employment and workers' pay.

The economy's current downturn will temporarily reduce productivity because output falls faster than employment. In fact, output per hour worked slipped to a 2.1% annual growth rate in the second quarter. But when this brief recession has run its course by next spring, productivity will come back to a 2.5% annual pace, slowed just a bit from what it would have been otherwise. That's because the technological revolution has a long way to run yet—many more efficiencies yet to be realized and implemented. "Ultimately, I see productivity rebounding sharply. Spending on technology is what's driven productivity higher, and that will resume. Businesses will continue to look for ways to lower costs," says Robert Allsbrook, chief economist with AmSouth Bank in Birmingham, Ala.

Although the overall productivity picture remains good, companies will be coping with new security demands, and for some the costs will be hefty. On the front lines are transportation businesses such as RUAN Transportation Management Systems, a trucking firm in Des Moines, which has hired extra guards for its 36-story headquarters building. Richard Mikes, the company's executive vice president, says that his firm is seeing other new costs too. Drivers have to fill out added paperwork requested by federal officials about the kinds of materials they're carrying. "Trucks are being detained, either loading, unloading, or en route. At some point, these costs start totaling up," Mikes says.

Some of those extra costs will hurt RUAN's profits, while some—maybe most—will be passed along to other companies. Morgan Stanley Dean Witter & Co. estimates that U.S. businesses will pay up to $4 billion in added transportation costs over the next year due to increased inspections at border crossings, more X-rays and other screening at airports, tighter security at seaports and related delays. Jeremy Leonard, an economic consultant for the Manufacturers Alliance/MAPI, estimates a higher price tag, from $5.6 billion to $16.8 billion a year. But even that is only a dot in the nation's $10-trillion economy.

Energy companies, including oil, gas, nuclear power and electric utilities, are another group facing higher expenses from stepped-up security. "Access to nuclear plants has been strict, and that will extend to all power generating plants," notes Dennis Delay, senior economist with Public Service Co. of New Hampshire. More guards will be hired, and companies will devote time to revising delivery procedures and controlling access by outsiders.

In some instances, an industry may be able to get someone else to pick up the tab. Airlines, for example, pay about 2% of their revenues for security measures, which is much less than Israel's El Al, which pays about 4% of its revenues for safety, according to Baily. The cost will rise in the U.S., but it appears that Congress will pass that cost on to fliers, slapping a tax of $2.50 to $3.00 on the price of a plane ticket.

Of course, many companies will make changes that won't cost very much. Monnie Peterson, executive vice president of Industrial Label Corp. in Omaha, says that his company "took a real hard look at our backup systems" and increased duplication of accounting and other data. "From a cost standpoint, it's minimal," he adds.

There's also a limit to how far companies will be willing to add spending, even if it seems desirable at first. Every company will weigh higher costs against expected sales and profits. "At the end of the day, economics takes over and you can only afford to do what the customer will pay for," notes Michael Kays, president of Walker Equipment Companies, a Wisconsin-based manufacturer of equipment for the food and pharmaceutical industries.