FRBSF Economic Letter
2001-14; May 11, 2001
The Future of the New Economy
The increase in productivity growth rates beginning in the mid-1990s
has helped boost economic growth and speed the rate at which living standards
rise in the United States. Between 1995 and 2000, productivity growth
averaged 2.8%—almost double the rate during the preceding 22 years! This
increase in productivity growth is thought by many observers to be associated
with the increased importance of information technology (IT), a hypothesis
often referred to as the "New Economy" view.
Whether rapid productivity growth will continue has been the subject
of much debate. And the debate has intensified in the last six months,
with the sharp decline in the tech-heavy NASDAQ index and the relatively
slow growth of the economy. In this Economic Letter, I will document
the sources of the increased productivity growth in the second half of
the 1990s and the evidence for the New Economy and then provide a discussion
of the prospects for growth over the next decade.
The New Economy
Economists are by no means agreed on the sources of the increase in productivity
growth in the late 1990s. For example, Cornwell and Trehan (2000) discuss
the arguments by one of the New Economy skeptics, Robert Gordon (2000).
In this Letter, I begin by presenting the evidence from Oliner
and Sichel (2000), whose study is more favorable to the New Economy view.
Oliner and Sichel find that labor productivity growth was 1.04 percentage
points faster in the late 1990s than in the early 1990s. They decompose
the increase into four parts (see Table 1).
First, the increased use of IT capital throughout the economy—computer
hardware, software, and communications equipment—raised labor productivity
growth by just under half a percentage point. Second, the rate of improvement
in the efficiency with which the economy produces IT capital increased
substantially during the late 1990s. The rise in this growth rate, sometimes
called multifactor productivity growth, contributed 0.37 percentage points
to the increase in labor productivity growth. The remaining two components—increased
efficiency outside the IT-producing sector and "Other"—together account
for the remaining 0.2 percentage points.
The remarkable conclusion from this analysis is that the widespread adoption
of IT in the United States, together with the increased efficiency in
its production, accounts for about three-quarters of the rise in labor
productivity growth, a quantity of about 0.8 percentage points.
The future of the New Economy
Whether or not the rapid productivity growth observed at the end of the
1990s will continue is an important and open question. Economic research
suggests several insights into the answer.
The first relates to the business cycle. When the economy comes out of
a recession and moves into a boom, productivity growth rates tend to rise.
On the one hand, this works in favor of the view that the New Economy
will continue: If productivity growth were mainly a cyclical phenomenon,
one would expect it to have been strong during 1991-1995, as the economy
came out of recession, and weak at the end of the 1990s, as the longest
expansion in U.S. history matured; instead, of course, it surged at the
end of the 1990s. On the other hand, Gordon (2000) provides an analysis
in which business cycle effects account for as much as half a percentage
point of growth at the end of the 1990s—and therefore about half of the
total rise in labor productivity growth.
The flip side of this business cycle logic is that to the extent that
the current expansion is coming to an end, one might expect productivity
growth to be low in the near term. We may have to wait until the current
cycle has run its course in order to measure the sustained impact of the
New Economy.
Second, Jorgenson (2001) identifies one of the key elements of the rise
in productivity growth as the acceleration in the rate of decline of semiconductor
prices, which began in 1994 as the industry shifted from a three-year
product cycle to a two-year cycle. This view is supported by the pattern
of multifactor productivity growth in the semiconductor sector. According
to Oliner and Sichel (2000), this growth rate was an astounding 30.7%
per year between 1974 and 1990, 22.3% between 1990 and 1995, and then
rose to an even more incredible 45.0% between 1996 and 1999. Jorgenson
suggests that, based on industry projections, this faster decline in prices
may continue for at least a decade.
Third, as has been noted by many commentators on the New Economy, including
Paul David (1990), Brad DeLong (2001), and Robert Gordon (2000), the IT
revolution is just the most recent in a series of revolutions. As the
19th century waned, a revolution based on the widespread adoption of electricity
was already underway. Shortly thereafter, the internal combustion engine
revolutionized transportation, on land as well as through the air. More
generally, revolutions have been occurring throughout the 20th century
in many other areas, including medicine, communications (radio and television),
and so on. From this perspective, looking for the IT revolution to raise
the trend growth rate may be misplaced. Rather, it may well be that the
IT revolution is simply the most recent in a series of revolutions that
allow the U.S. economy to sustain long-run economic growth.
Fourth, even if the IT revolution is somehow different from previous
revolutions, it is not obvious that the New Economy should be characterized
by a permanently higher growth rate. Theoretical models of endogenous
growth based on the discovery of new knowledge (including, for example,
work by Paul Romer (1990)), do not necessarily lead to this prediction.
Rather, a permanent increase in labor productivity growth requires increasing
the growth rate of the stock of knowledge. To the extent that the IT revolution
is simply one or even several extraordinarily productive ideas, it still
will increase only the level of income in the long-run, leaving
the long-run growth rate unaffected. Of course, a very large increase
in the level of income is itself a fantastic accomplishment, and, to the
extent that this occurs over several years or even decades, the growth
rate may be temporarily higher. However, this is different in a fundamental
way from a permanent increase in the productivity growth rate, and this
difference can be important for policy (for example, for projecting future
budgetary problems associated with Social Security or Medicare).
Unfortunately, economists cannot say, at this point, what it takes to
generate knowledge at a permanently faster rate and thereby raise the
productivity growth rate permanently. For example, while the productivity
of the economy in terms of goods and services generally increases over
time (because of the discovery of new methods of production and higher-quality
products), there is no reason to think this is the case for the productivity
of the economy in creating new knowledge. It is certainly possible that
the economy becomes increasingly better at producing new ideas—as Sir
Isaac Newton said, "If I have seen further...it is by standing upon the
shoulders of Giants." As just one example, it could be that some key ideas,
perhaps including IT, give rise to a large number of subsequent discoveries.
However, it is also possible that it becomes increasingly difficult to
discover new ideas, as the most obvious ideas are discovered first. Furthermore,
it could be that after these discoveries are exhausted, an idea "famine"
sets in, in which new discoveries are rare until the next Great Idea.
Viewed from the start of the 21st century, with so many technical advances
apparently on the horizon, this seems like an extremely remote possibility,
but it nicely illustrates a fundamental ignorance about the nature of
generating knowledge that should surely be kept in mind.
Summary
In the last half of the 1990s, labor productivity growth returned to
rates not sustained since the 1960s. The evidence suggests that a substantial
portion of this increase is associated with the increased adoption of
IT throughout the economy and with the increased efficiency with which
IT is itself produced. Whether or not these higher growth rates can be
sustained is an open question that will likely remain unanswered at least
until the completion of another business cycle.
Charles I. Jones
Assistant Professor, Stanford University,
and Visiting Scholar, FRBSF
References
Cornwell, Casey, and Bharat Trehan. 2000. "Information
Technology and Productivity." FRBSF Economic Letter
2000-34 (November 10). .
David, Paul A. 1990. "The Dynamo and the Computer: An Historical Perspective
on the Modern Productivity Paradox." American Economic Review 80
(May), pp. 355-361.
DeLong, J. Bradford. 2001. "Do
We Have a 'New' Macroeconomy?" U.C. Berkeley (March). (accessed April
30, 2001).
Gordon, Robert J. 2000. "Does the 'New Economy' Measure Up to the Great
Inventions of the Past?" Journal of Economic Perspectives 14(4),
pp. 49-74.
Jorgenson, Dale W. 2001. "Information Technology and the U.S. Economy."
American Economic Review 91, pp. 1-32.
Oliner, Stephen D., and Daniel E. Sichel. 2000. "The Resurgence of Growth
in the Late 1990s: Is Information Technology the Story?" Journal of
Economic Perspectives 14(4), pp. 3-22.
Romer, Paul M. 1990. "Endogenous Technological Change." Journal of
Political Economy 98 (October), pp. S71-S102.
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
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