FRBSF Economic Letter
2007-09; April 6, 2007
Will Fast Productivity Growth Persist?
Strong productivity growth is essential for improving
living standards and can have an important impact on economic
policy, yet economists are far from being experts at predicting
when the trend of productivity growth might shift. In the
1960s, productivity growth boomed, growing at an average
annual rate of 2-1/2%. It weakened in the early 1970s,
and for the next two decades or so averaged an annual growth
rate of only about 1-1/4%. Then, in the mid-1990s, productivity
growth boomed again, averaging about a 3% annual rate from
the last quarter of 1995 through the middle of 2004. These
shifts were not predicted and were generally not widely
recognized until years after they occurred. Considering
that, since the middle of 2004, productivity growth has
averaged only about 1-1/2% per year, it may be time to
ask whether this is just a "pause" in the boom
that started in the mid-1990s or a shift back to the growth
rates seen in the 1970s and 1980s. This Economic Letter begins to answer this question by focusing on the factors
that underlay the most recent productivity boom and what
they may portend for the future.
Information and communications technology and the productivity
surge
Technological innovation is often associated with productivity
booms. The most obvious such innovations in recent
decades have been in the production of information and
communications
technology (ICT), such as computers, software, communications
equipment, and the like. But the channels for ICT to
affect the overall economy are complex.
Economists identify three proximate or direct sources
of higher labor productivity. First, workers have more
and
better capital to work with, also known as "capital
deepening." Second, the workforce gains more education
and skill. Third is total factor productivity, or TFP,
a comprehensive term for everything not otherwise explained;
the main reason TFP rises over time is innovation in
products and processes.
Oliner and Sichel (2006) decompose labor productivity
growth using annual aggregate data through 2005. They
find that
in the 1995-2000 period, both faster TFP growth and
an increased contribution of capital-deepening raised
labor
productivity growth relative to the 1973-1995 period.
Thereafter, however, investment was relatively weak,
and the pace of
capital deepening--especially of ICT capital--fell
substantially. Yet labor productivity growth remained
strong in the
early 2000s because TFP growth accelerated even further.
Economists generally agree that a TFP acceleration
in ICT production was a significant contributor to
the acceleration
in overall TFP during the 1990s, and the causes of
the former are reasonably well understood. New product
development,
resulting especially from research and development,
led to rapid improvements in computer technology; for
example,
competition between Intel and AMD led to a faster introduction
of new semiconductor chips in the post-1995 period.
This faster pace of technological rollout appears to
explain
a large share of the ICT productivity acceleration.
Many earlier studies argued that the acceleration in
overall TFP was largely, if not entirely, due to innovations
in
sectors producing ICT goods. These innovations, in
turn, raised labor productivity in the sectors that
used ICT
because of capital deepening; in particular, falling
ICT prices reduced the effective cost to a user of
purchasing high-tech capital, leading firms to increase
their desired
capital stock. From this perspective, there is no reason
to expect an increased pace of innovation outside of
ICT
production.
Basu, Fernald, and Shapiro (2001), however, argue that
the overall TFP acceleration was broad-based--not narrowly
located in ICT production--and more recent studies
(including Bosworth and Triplett 2003) have emphasized
the TFP acceleration
in the services sector. Over time, major official data
revisions have affected the apparent size and timing
of the acceleration in different sectors but haven't
changed
the general picture. Oliner and Sichel (2006) find
that, in the 2000-2005 period, TFP in ICT production
slowed
and estimate that the acceleration in overall TFP is
completely
explained by non-ICT-producing sectors. A number of
other studies have found similar results.
To explain how ICT can affect measured production and
productivity in other sectors, a number of papers highlight
the notion
of ICT as a "general purpose technology" (GPT),
much like electricity or steam power, in that it has pervasive
and wide-ranging effects on how firms do business or even
how people live. They also note that adopting new GPTs
is neither easy nor instantaneous. First, firm-level studies
suggest that benefiting from ICT investments requires substantial,
costly investments in intangible capital, such as reorganization;
for example, faster information processing might lead firms
to think of new ways of communicating with suppliers or
arranging distribution systems. These investments may include
resources diverted to learning or purposeful innovation
arising from research and development (R&D).
Second, the GPT literature suggests the likelihood
of sizeable spillovers from ICT. For example, successful
new managerial
ideas--such as using ICT to build a new business information
system--seem likely to diffuse to other firms. Imitation
is often easier and less costly than invention, because
you learn by watching and analyzing others' experimentation,
successes and, importantly, mistakes. Indeed, firms
that
don't use computers intensively may also benefit from
spillovers of intangible capital created by firms that
use computers
more intensively. For example, if R&D has sizeable
spillovers, and if R&D is more productive with
better computers, then even firms that don't use computers
intensively
may benefit from the knowledge created by computers.
Brynjolfsson et al. (1997) study the experience of
a large medical products company following its decision
to deploy
computer-based flexible machinery. Management recognized
that the project would involve not only the purchase
of new machines but also a substantial amount of learning
and a reorganization of the production process. While
ultimately
successful (so much so that the company painted factory
windows black to prevent competitors from imitating
its
organizational and technical innovations), various
hurdles led to an extended and costly period of experimentation
and false starts; for example, production workers continued
to use the new machinery as they had used the old,
resulting
in large inventories of work in process and finished
goods. Ultimately, the firm physically isolated one
section of
its plant to experiment with different methods of reorganizing
the production line.
Another study of about 500 large U.S. firms found that
it took at least five to seven years for the full benefits
of computers to be realized. At the industry level,
Basu and Fernald (2007) find that the data are reasonably
consistent with the predictions that in sectors that
use ICT, ICT
capital growth should, with long lags, be positively
associated with TFP growth. In particular, they find
evidence that
ICT capital investments in the late 1980s and 1990s
are
positively correlated with the TFP acceleration in
the 2000s. They conclude that these results are reasonably
consistent with the firm-level evidence.
Is the era of rapid productivity growth over?
To begin to answer this question, it is useful to look
first at whether the pace of innovation in the ICT
sector has slowed. Though this is not easy to measure,
some
have argued that the relative price of ICT sector
output provides
a (rough and ready) indicator of technical progress
in this sector (see Doms (2005), for instance). Other
things
remaining the same, the faster the rate of technical
progress in the ICT sector, the faster the rate at
which the price
of ICT goods falls against other prices in the economy.
It turns out that the price of information processing
equipment and software (relative to the GDP deflator)
fell at close
to a 6-1/2% rate over the 1973:Q1-1995:Q3 period;
the rate of decline accelerated to 8-3/4% over the
1995:Q4-2000:Q4
period but has fallen back to 6% since. Based on
this evidence,
as well as the studies mentioned earlier, one could
argue that the pace of technical progress in the
ICT sector
has slowed, but there is no way to tell whether this
slowdown
is temporary or permanent.
If the productivity slowdown in ICT production is
permanent, should we then expect productivity growth
in the ICT-using
sectors to fall back to the rates seen before the
boom? The GPT literature suggests that the answer
is no.
DeLong (2002) points out that, even though the period
of double-digit
annual productivity increases in steam-power and
textile-spinning machinery ended in the early 1820s,
these technologies
made their major contribution to economic growth
in Great Britain in the subsequent 50 years. Similarly,
David
(1991) emphasizes that the benefits of the electric
motor took
nearly half a century to spread, as firms learned
how
to make more efficient use of the technology.
Is ICT likely to have the same impact that earlier
GPTs did? At least one metric suggests that it could.
It has
been pointed out that ICT prices have fallen far
more dramatically than prices of GPTs like electricity
and
the internal combustion
engine, and the resulting decline in the price of
capital goods is unprecedented. This suggests that
we might
expect productivity growth to remain elevated for
a while yet.
 Furthermore, recent data for nonfinancial corporations
suggest that productivity growth might not have slowed
quite as much as the nonfarm business sector data
indicate. It has been argued that data for nonfinancial
corporations
(whose output amounts to about 70% of nonfinancial
business sector output) is better measured than for
the noncorporate
and financial sectors of the economy. As Figure 1
shows, productivity growth in nonfinancial corporations
has
tended to track that in the overall nonfarm sector
reasonably well, but the former has not slowed as
much over the
past
year. (At press time, we have data for nonfinancial
corporations through 2006:Q3 and for nonfarm business
through 2006:Q4.)
The reasons for the divergence are not clear. The
underlying source data are different, since nonfinancial
corporate
output is measured from data on income, whereas nonfarm
output is measured from data on expenditure. While
the national accounts are designed so that, in principle,
income and expenditure necessarily grow at the same
rate,
the
two measures rely on different surveys, so there
can be a "statistical discrepancy" between
them.
Conclusion
At the peak of the "New Economy" hype of the
late 1990s, many claimed, "The Internet changes everything," and,
by implication, that it happened overnight. But
the history lessons from GPTs, like electricity
and steam power, as
well as recent theoretical and empirical work,
suggest that the necessary complementary investments
and innovations
that drive change unfold only slowly over time.
Thus, it could be that the promise of recent technological
advances
will continue to be realized. To the extent that
ICT is, indeed, a GPT on a par with the electric
dynamo, the returns
to innovation (whether managerial innovations or
the development of new products and processes)
might remain high for some
time to come. The strength of productivity growth
in nonfinancial corporations provides another reason
for hope that underlying
productivity trends remain strong.
None of this is meant to argue that trend productivity
growth will revert to the 3% rate seen around
the turn of this century; we are arguing instead that--in
the
near term--trend productivity growth is unlikely
to revert to
the rates seen during the 1970s or 1980s. But
these
are not statements that can be made with a high
degree of
certainty. As we confessed at the outset, economists,
including us,
do not have a winning record in predicting the
path of productivity growth.
John Fernald
Vice President
David Thipphavong
Research Associate
Bharat Trehan
Research Adviso
References
Basu, Susanto, and John Fernald. 2007. "Information
and Communications Technology as a General Purpose Technology:
Evidence from U.S. Industry Data." Forthcoming, German
Economic Review.
Basu, Susanto, John Fernald, and Matt Shapiro. 2001. "Productivity
Growth in the 1990s: Technology, Utilization or Adjustment?" Carnegie
Rochester Series on Public Policy, December.
Bosworth, Barry, and Jack Triplett. 2003. "Services
Productivity in the United States: Griliches Services
Volume Revisited." Brookings Institution.
Brynjolfsson,
Erik, Amy Austin Renshaw, and Marshall van Alstyne. 1997. "The
Matrix of Change." MIT
Sloan Management Review 38(2) pp. 37-54. DeLong, J. Bradford. 2002. "Productivity Growth in
the 2000s." NBER Macro Annual, pp. 113-145.
David, Paul. 1991. "Computer and Dynamo: The Modern
Productivity Paradox in a Not-Too-Distant Mirror." Technology
and Productivity: The Challenge for Economic Policy. Paris: OECD.
Doms, Mark. 2005. "IT
Investment: Will the Glory Days Ever Return?" FRBSF Economic Letter 2005-13
(June 17).
Oliner, Stephen, and Daniel Sichel. 2006. Unpublished
update to "The Resurgence of Growth in the Late 1990s: Is
Information Technology the Story?" Journal
of Economic Perspectives 14 (2000) pp. 3-22.
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
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