(FORTUNE Magazine) – WHEN YOU come down to it, the purpose of work and investment is to live well today and better tomorrow. That depends on each worker and machine yielding a growing output of ever more valuable goods and services -- in other words, rising productivity. For America to retain the world's highest standard of living, its factories, stores, and offices must be the most productive in the world. Says General Electric CEO Jack Welch: ''For a company and for a nation, productivity is a matter of survival.'' The U.S. is surviving pretty well, thank you. According to Organization for Economic Cooperation and Development data, the average American worker produced $45,100 of goods and services in 1990, vs. $37,850 for the average German worker and $34,500 in Japan, where workers toil more hours per year. The figures are particularly useful because they're adjusted for purchasing- power parity, eliminating distortions caused by exchange-rate fluctuations. Labor flexibility is the biggest reason for the U.S. advantage, says Bill Lewis, a partner at McKinsey & Co. who has been studying international productivity. American business is much freer than most competitors -- which are often restrained by unions, social policies, and regulation -- to hire and fire, reorganize, and deploy resources where they will be most productive. Being king of the hill is great, but the good news disguises three disquieting facts. First, U.S. productivity is improving more slowly than before and slower than its rivals'. Second, American business does a terrific job of increasing productivity by cutting inputs like labor but needs to work on the output side by investing in people and innovation. Third, productivity growth has been a sluggard in the service sector -- the economy's largest. Unless these trends change, Americans' standard of living is at risk. Productivity is output divided by input. That's simple; getting accurate numbers is not. Outputs of goods and services that can't be quantified in market-determined dollars -- as they often can't be within companies -- have to be adjusted for quality and other indices of the value added; inputs can be measured as labor, or labor plus capital. After you measure them, do the arithmetic. If your company increases output while holding input steady, productivity goes up; if it cuts input without losing output, productivity goes up. If it does both -- raises output while cutting input -- buy the stock. Take the math a step further to find the standard of living. When a company lays off an employee who labored mostly as a greeter at the water cooler, national productivity rises: same output, less input. But until he finds new, useful work, the standard of living -- GDP per capita -- hasn't changed: same output, same population. Living standards won't improve until investment, innovation, entrepreneurship, and other engines of growth put people to work creating outputs that weren't put out before. America's lead is good news, both for its competitiveness and its standard of living, only if productivity is rising. Rising it is, but slowly. As measured by the U.S. government, output per hour, which grew 3% a year from 1937 through 1973, has risen sluggishly since, just 0.9% a year. Improvement slowed in other big economies too, but not as much. The OECD (which measures output per employee) says U.S. business sector productivity rose 0.5% a year from 1979 through 1990, while West Germany's increased 1.6% and Japan's 3%. In the long run, that's trouble. No one knows why America's productivity growth stagnated. Economists used to blame the oil shocks of the Seventies, but productivity growth didn't perk up when petroleum prices fell. Better candidates are insufficient private and public investment combined with tens of millions of new workers -- women, baby-boomers, and immigrants -- whose need for jobs held wages down and lessened the pressure on management to increase each worker's efficiency. Adds Martin Baily, an economist at the Brookings Institution: ''In the Fifties and Sixties there were opportunities that just don't exist now. Utilities and chemicals got big gains by building huge plants and refineries. With smaller plants and specialty chemicals, productivity growth has to come from skills, not scale.'' + The second worry: U.S. manufacturing investment is low, jeopardizing future gains. It's true that manufacturing is America's productivity star. Superb new data developed by a team at the University of Groningen in Holland show U.S. manufacturing at the head of the class in every industry category but one (see chart). After stumbling badly in the Seventies, output per hour danced ahead 36.6% from 1982 to 1990, according to the Bureau of Labor Statistics. That handily beats Germany's 26.2% and nearly matches the 38% gain in Japan. All in all, says Baily, manufacturing productivity growth in the Eighties ''was about as good as in the glory years of the Fifties and Sixties.'' Through takeovers, lopping off non-core businesses, scouring away bureaucracy, process redesign, and plain old downsizing, manufacturing cured itself of the dropsy that afflicted it the decade before. That's cold comfort to the millions who lost jobs, but American manufacturing is more productive as a result. Trouble is, smokestack America isn't cranking up output as much as its increased efficiency would permit. From 1980 through 1990, U.S. industrial output rose only three-quarters as fast as manufacturing productivity. In Japan, by contrast, industrial output and productivity grew in lock step. As U.S. manufacturers cut payrolls, they also put the brakes on capital spending and research. As a percentage of GDP, U.S. private nonresidential fixed investment has been the lowest among the Group of Seven nations for the past five years; at 10.7% last year, it was just half Japan's. The average age of capital stock at nonfinancial U.S. corporations is now 8.52 years, the highest since 1965. One result: The typical machine tool in an American factory is seven years older than in Japan, and two-thirds of all metal-forming machine tools in use in America are more than ten years old -- this amid a revolution in machine- tool technology. New computer-controlled tools are so much better than their predecessors that Brian Papke, president of the American branch of Japanese toolmaker Yamazaki Mazak, tells customers that the surest path to success is to rip out old equipment and give it away to rivals. Productivity rocket ship Rubbermaid (five-year average annual growth in output per hour: 21.4%) is an outfit that doesn't stint on new machines. In 1990, certain that recession had taken hold, the company upped its 1991 capital budget 30% rather than cut, as most U.S. corporations did to protect ( short-term profits. While Rubbermaid doesn't give away its hand-me-downs, it turns them over to brokers to sell, and competitors are welcome to them. Says President Wolf Schmitt: ''Our goal is to reinvent ourselves. That's how you achieve productivity.'' But Rubbermaid is an exception. Also worrisome is the need to tweak up corporate research and development. Using Census Bureau data on 20,000 factories, professor Frank Lichtenberg of Columbia University's business school found that a dollar invested by business in R&D yields productivity gains approximately eight times greater than a dollar invested in plant and equipment. But too often in the U.S. those dollars have gone to the wrong products or industries, and the growth in private R&D spending -- which is much more efficacious than government R&D -- has fallen off dramatically since the mid-Eighties (see ''What the U.S. Can Do About R&D''). THE THIRD unwelcome trend is in services, which employ four-fifths of the work force. Measuring services' output is so difficult, mostly because it is often intangible, that data don't exist for about 70% of service output -- including insurance, government, health care, and the professions. Yet U.S. services must be comparatively productive. Explains McKinsey's Lewis: ''The U.S. lead over Japan and Germany in manufacturing productivity is not large enough to explain the gap at the GDP-per-employee level. Therefore we must have a lead in services.'' Considering aggregate GDP figures, and taking into account the size of the service sector in the U.S. compared with those of other advanced nations, Lewis estimates that the U.S. has a 15% to 25% edge in service productivity. However strong it is, this Achilles has a heel. Most evidence suggests that service productivity growth has been dismal. Economist Stephen Roach of Morgan Stanley calculates that private-sector service output per hour grew 0.7% a year in the 1980s (vs. 3.8% in manufacturing). Says James Trice, a vice president of Gemini Consulting who is an expert in insurance: ''Most executives are still in the denial stage. They won't face up to the fact that they're not competitive.'' Plenty of data back him up. In the Eighties, according to the BLS, output per hour in U.S. auto factories went up 43%; dealers and repair shops, however, improved just 18% and 7.5% respectively. Productivity growth in petroleum refining, 37%, more than doubled the 18% gain for petroleum pipelines, a service business. The most stark evidence is what's happening to employment in services. The grim list of recently announced, permanent staff cuts at service companies -- 1,900 at Nynex, 4,800 at Aetna, 3,500 at the Travelers, 48,000 at Sears -- is proof that the service sector had plenty of fat to trim. In the Nineties, the knives are out. The reason: competition. Big chunks of the service economy -- telecommunications, transportation, banking, insurance -- have seen government regulation lifted or loosened, destroying cushy markets. Often the competition is global. For example, foreign banks' share of commercial and industrial loans to U.S.-based business jumped from 18% in 1983 to 45% by the end of 1991. Responding to this tough new world, smart companies aren't just trimming, they're rethinking the way they work. As a result, they are at last beginning to benefit from their gargantuan investments -- $862 billion in ten years -- in information technology. A lot of this equipment did nothing for productivity because it was bought without thought for whether the newly automated processes were required at all. Says William Wheeler, a consultant at Coopers & Lybrand: ''That's putting whipped cream on garbage.'' Garbage -- or something like it -- was what the Bank of Boston found when it looked at its securities-processing business late in 1989. The business handles stock transfers, dividend and interest payments, pension plan administration, and related tasks -- about 25 million transactions a year. It had six separate operations, each with its own mainframe, scattered over 11 locations. Work for one customer could shuffle through several systems -- one for dividends, another for stock sales, a third for bond interest -- costing time, labor, and money at each point. Working with Coopers & Lybrand, the bank put everyone in securities processing at one location with two computer systems and set up the work around its core process, moving money. Computer cables run across the ceiling like track lighting, allowing the bank to change the layout overnight. The idea was to mimic a just-in-time, flexible factory. Says senior vice president John Towers: ''We created a utility that could service all the product lines.'' Productivity soared: After 2 1/2 years, with 17% fewer employees, the division does 80% more securities-processing business. Thousands of service companies are starting to see such results. If gains in the first half of 1992 continue, nonmanufacturing productivity will leap 2.5% * this year. But beside the river of opportunity sits the Lorelei that seduced manufacturers: restructuring without investing in growth. Says Gemini's Trice: ''We're going to see productivity increases -- and it's about time, it was ridiculous -- but if we're not careful we'll just downsize and spin off lines of business.'' Such a ''slash-and-burn approach,'' Morgan Stanley's Roach warned Congress earlier this year, could cost the economy four million new jobs by 1997 -- ''a steep price to pay for faster productivity growth.'' HOW TO QUICKEN productivity's rise? Through work-redesign concepts like lean production, total quality management, and process reengineering, business knows more about how to cut inputs than ever before. Process reengineering, for example, usually eliminates many low-added-value jobs, replacing them with a few high-skill jobs. Consultants who do this work boast of quantum leaps in productivity. Privately, some worry. Says one: ''How high does structural unemployment have to get before the social cost is too great?'' Fixing America's productivity problem means raising output faster, not just cutting inputs. The place to start is the federal deficit, which is the biggest source of disinvestment, soaking up savings faster than a Bounty towel does coffee. Government must also do more to enhance domestic private investment through policies that encourage capital formation, research, training, education, and entrepreneurship. The aim, besides boosting output, should be to ease the burden on those who are hurt by cuts in input while maintaining the flexibility that is America's great asset. A long list of laws, incentives, habits, and regulations discourages investing for the long term. Among them: capital gains taxes that aren't indexed to inflation; state incorporation laws that require companies to pursue shareholder value but don't protect companies against lawsuits if they go for long-term growth rather than quick stock-price gains; the Glass- Steagall Act barring commercial banks, which might take the long view, from holding equity stakes in corporations; mutual funds that compete for new investors on the basis of quarter-to-quarter results; accounting rules that keep intangible investments like R&D off the balance sheet while docking it for potential liabilities like retiree health costs. There are good reasons for most of these, and some are more important than others. But, as Harvard business school professor Michael Porter argues in a new report for the Council on Competitiveness, a private Washington, D.C., group, together they and other laws and customs encourage American business to live for today rather than build for tomorrow. Changing corporate grasshoppers into ants is delicate work. But a number of steps can be taken immediately, such as enacting tax credits for new plant and equipment -- preferably aimed at new or small business -- and, especially, a permanent tax credit for R&D. America must also build its intellectual capital stock. A study by James Rauch of the University of California at San Diego ranked several American cities by the average level of education of their work forces, then compared their productivity. For every additional year of schooling, Rauch found 2.8% greater productivity. That's not only because educated workers do any old task better; good workers also beget better jobs. Highly skilled people attract investment in high-tech, high-productivity industries and could enable other industries, like textiles, to return to these shores by substituting smart labor for cheap. Training has similar benefits. In Boynton Beach, Florida, Motorola can make 200% more pagers than it could four years ago with just 22% more manufacturing employees. Says general manager Hector Ruiz: ''The factory doesn't look much different. The improvement came about through training. Our return on training is on the order of 30 to 1.'' AMERICA NEEDS more incentives for skill building (see following story). A laid-off worker who goes to school to learn new skills has to lie about it or lose her unemployment check -- an easy-to-fix disincentive. State and local governments might want to increase support for community colleges, which as employee training institutions can be a powerful attraction to business. The feds should consider industrial extension programs modeled on those of the Department of Agriculture. To encourage training, companies should be required to disclose what they spend on it in their published accounts. Here's how one business titan put the productivity imperative: ''Cutting wages does not reduce costs -- it increases them. The only way to get a low- cost product is to pay a high price for a high grade of human service and to see to it through management that you get that service.'' The man who said it? Henry Ford. As much as anyone, he helped create a mass consumer market of well-paid workers. But how many executives in the U.S. today remember Ford's point?

BOX: INSIGHTS

-- U.S. manufacturing and services rank first in productivity. -- But productivity improvement has slowed. Japan, Germany, and other competitors are gaining. -- U.S. business raises productivity well by cutting inputs, but only investing more in people and innovation to increase outputs will raise living standards.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: OECD, MCKINSEY & CO. CAPTION: PRODUCTIVITY

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: DIRK PILAT AND BART VAN ARK, UNIVERSITY OF GRONINGEN (NETHERLANDS) CAPTION: U.S. PRODUCTIVITY STACKS UP STRONG