FRBSF Economic Letter
Number 2000-34; November 10, 2000
 Economic
Letter Index
Information Technology and Productivity
Productivity growth in the U.S. has picked up noticeably in recent years.
From 1996 to 1999, average labor productivity, or ALP, in the private,
nonfarm U.S. economy grew at a 2.8% annual rate, more than twice the rate
that prevailed between 1980 and 1995. Many observers have linked this
acceleration in productivity to the explosive growth of computers and
information technology (IT), claiming that we now have a "New Economy"--that
is, they believe that the widespread adoption of the new technologies
has led to fundamental improvements in the way business is done throughout
the economy.
Yet some well-known economists challenge such an interpretation, arguing
that there is little evidence of the New Economy outside the sectors that
manufacture computers and IT equipment. In this Letter we examine
these arguments, discuss U.S. data in light of them, and then look at
some data from abroad.
An old economy interpretation
Gordon (2000) argues that despite the growing use of computers and other
information technology, the trend (or long-term) growth rate of ALP outside
the durable goods manufacturing sector has not accelerated significantly
in recent years. He begins by calculating the difference in the growth
rate of ALP in the nonfarm private economy between two periods--1972-1995
and 1995-1999--and finds that it equals 1.35%. He then decomposes this
difference into its main components. He calculates that a little more
0.5 percentage point of the increase represents an acceleration in productivity
growth that usually occurs when an economy is in a business cycle upswing.
Of the remaining 0.8 percentage point, approximately 0.2 is attributable
to changes in labor quality and changes in the measurement of prices.
About 0.3 percentage point of the increase is the result of "capital
deepening," that is, of an increase in capital per worker (which
reflects the increased investment in computers).
The remaining 0.3 percentage point of the increase in the trend is attributable
to multi-factor productivity (MFP), which basically means improvements
in the way all inputs work together. According to Gordon, the increased
MFP is localized in the durables manufacturing sector, which includes
computers. In the rest of the economy, which accounts for 88% of total
output, MFP growth over this period has been negative and large enough
to offset the effects of capital deepening on ALP, so that the trend growth
of ALP (outside of durable manufacturing) has increased by less than 0.1
percent.
Gordon's result is troubling for the New Economy hypothesis, according
to which business investment in computers should boost ALP not only through
capital deepening (the "direct" effect), but also through increases
in MFP (the "spillover" effect). These numbers are especially
surprising because the sectors producing nondurable goods have invested
most heavily in information technology. According to one estimate, nearly
80% of the computer investment in the early 1990s was concentrated in
three industries: trade, FIRE (finance, insurance and real estate), and
services.
Gordon argues that these findings should not be surprising, since the
IT "revolution" is simply not as important as it has been made
out to be. He enumerates several "great inventions" from about
a hundred years ago--the electric lightbulb, the internal combustion engine,
the telegraph, and indoor plumbing--that fundamentally transformed the
economy and ushered in a period of robust, economy-wide MFP growth from
1913 to 1972. He argues that advanced software and the Internet do not
have the same potential to engender such an extended period of prosperity
because they primarily substitute for and duplicate other activities,
while the "great inventions" truly broke new ground.
It is not hard to disagree with some of Gordon's claims. For instance,
his adjustment for the state of the business cycle is based on the assumption
that this expansion is just like every other one. If one believed that
information technology played a larger role in the boom during the late
1990s than it did during the average expansion, then Gordon's cyclical
adjustment would amount to throwing the baby out with the bath water.
Oliner and Sichel (2000) make no such adjustment and find that over the
1996-1999 period, the average rate of MFP growth in the nonfarm business
sector excluding computers and semiconductors exceeded the rate
achieved over 1974-1995 by 0.4%. In another study, Jorgenson and Stiroh
(2000) reach mixed conclusions about productivity growth outside the IT
sector. While they do find an acceleration in MFP outside the IT sector
during the late 1990s, the extent of this increase depends upon price
indexes that are not necessarily reliable right now.
Some evidence from abroad
The debate in the U.S., then, revolves around the contribution that increased
use of computers might have made to the observed acceleration in productivity.
Since this debate appears difficult to settle on the basis of U.S. data
alone, it is useful to look at the experience of a group of developed
countries to see what light can be shed on the issue. Because of data
limitations, we confine ourselves to the G-7 countries--Canada, France,
Germany, Italy, Japan, the U.K., and the U.S. The small size of the sample
means that our conclusions will be tentative.
Figure 1 (pdf 2.5 KB) shows ALP growth in these
countries during 1980-1995 and 1995-1998. (To allow for consistent comparisons
across countries, we use an OECD data set; the cost of doing so is that
some key data series are not available beyond 1998.) The U.S. is the only
country that has experienced an increase in the growth rate of productivity
between these periods. Averaged over the remaining six countries, productivity
fell at an annual rate of just over 1% between these periods.
Clearly, the "New Economy" has not led to a productivity surge
in these countries. One can think of several explanations for this. For
example, it may be that IT has not penetrated these countries as deeply
as it has penetrated the U.S. In fact, OECD data show that while the U.S.
had 0.33 computers per capita in 1995, Italy had only 0.08, while the
values for the remaining members of the G-7 were between 0.13 and 0.19.
Alternatively, cyclical factors may have been at play; as mentioned above,
the behavior of productivity varies over the cycle. In fact, however,
an examination of output data shows that--with the exception of Japan--none
of these countries were in or near recessions in the later period; instead
they had suffered recessions in the early 1990s.
More generally, it is difficult to build a complete model that controls
for all the factors that may be responsible for the differences in productivity
growth across countries. A simpler, though necessarily less complete,
way to assess the contribution made by computers is to focus just on the
two variables that are of interest: changes in productivity growth and
computer use.
Figure 2 (pdf 2.5 KB) plots the change in productivity
growth between the two periods shown in Figure 1 against the number of
computers per capita in the G-7 countries in 1995. The figure shows that
greater computer use in 1995 was associated with a greater acceleration
in productivity in the subsequent period. A somewhat more formal way to
measure the strength of the relationship between these variables is to
look at the correlation coefficient, which has an absolute value between
0 and 1. It is useful to keep in mind, however, that a finding that two
variables are correlated does not prove causality. The correlation coefficient
for the G-7 countries turns out to be 0.92. When the U.S. is excluded,
the correlation coefficient is 0.68.
Why employ lagging data for computer use, instead of data that cover
the same period as the change in productivity growth that we are trying
to explain? We do this to avoid simultaneity. Specifically, if we were
to find a positive correlation using contemporaneous data on computers,
we would be unable to tell if this was because the New Economy hypothesis
was true--that is, greater computer use had caused faster productivity
growth--or because the causation was, in fact, the reverse--that is, fast
productivity growth had led to higher profits and incomes allowing firms
and households to buy and use more computers.
Another issue has to do with the best measure of computer use. Since
it is hard to determine what the most appropriate measure may be, we tried
a number of alternatives. As one proxy for business use, we looked at
data on business spending on information and communications technology
(ICT). The correlation coefficient between the change in productivity
growth and the share of ICT expenditures in total investment during 1996
for the G-7 countries was 0.76 (0.59 excluding the U.S.). Thus, countries
that invested more in ICT equipment relative to total investment in 1996
tended to have a larger acceleration in productivity growth subsequently.
As another alternative, we used data from a survey that measured Internet
use by businesses in 1999. The correlation coefficient this time was 0.62
(0.58 excluding the U.S.). Note that this last result suffers from the
simultaneity problem discussed above.
Another question, important in view of the U.S. debate, is whether the
correlation between computer use and productivity merely reflects the
correlation between computer production and productivity. To answer this
question we would have liked to decompose the acceleration in productivity
over this period into the contribution made by the contemporaneous production
of computers as well as other factors. Unfortunately, we do not have the
contemporaneous data that we need. To get some sense of the kind of relationship
that may exist, we did look at some results using data on IT production
through 1996. The correlations between IT production and productivity
tended to be rather small.
Summing up
With the rapid growth in U.S. productivity in recent years, the debate
about the contribution of information technology to productivity growth
has shifted. There is no dispute about the efficiency gains in the production
of computers and related equipment; instead, the debate between the believers
in the New Economy and the skeptics centers on the benefits of using IT
outside the IT production sector.
We have looked at some international evidence which suggests that there
is some room for optimism about the benefits associated with the use of
IT in the rest of the economy. While this conclusion must be regarded
as tentative (for various reasons discussed earlier), this Letter
illustrates the potential of using data outside the U.S. to analyze the
contribution that recent technological changes may have made to productivity
growth.
Casey Cornwell
Research Associate
Bharat Trehan
Research Officer
References
Gordon, Robert J. 2000. "Does the 'New Economy' Measure Up to the
Great Inventions of the Past?" Forthcoming, Journal of Economic
Perspectives.
Jorgenson, Dale W., and Kevin J. Stiroh. 2000. "Raising the Speed
Limit: U.S. Economic Growth in the Information Age." Mimeo. Harvard
University.
Oliner, Stephen D., and Daniel E. Sichel. 2000. "The Resurgence
of Growth in the Late 1990s: Is Information Technology the Story?"
Forthcoming, Journal of Economic Perspectives.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
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