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IT and Economic Growth

by Matti Pohjola

The popular view is that information technology will change the world by boosting productivity and income. But while IT has many visible effects on the modern economy—the growth in electronic commerce for example—its impact on productivity and economic growth has been surprisingly difficult to detect.

Although there is increasing evidence that IT investment is associated with an improvement in company performance in industrial countries, studies that look at the bigger macroeconomic picture find little correlation between IT investment and overall productivity—and some studies even find a negative correlation.

Explaining the Productivity Paradox

How can we explain this discrepancy between the micro and macro pictures? The table on page 2 sheds new light on this paradox by displaying results from a UNU/WIDER study for three countries—Finland, Singapore and South Korea—and comparing them with findings for the United States economy by Daniel Sichel (see the references at the end of this article). All these countries have invested large amounts in IT over the past two decades; computer capital (hardware etc.) has grown at annual rates ranging from 25 per cent in Finland to 40 per cent in South Korea.

Economists measure the contribution of computers to GDP growth by first multiplying the growth rate of computer capital by the share in national income of the return on computer investment. In doing so we find that computers have accounted for the greatest share of GDP growth (32 per cent) in South Korea, and the smallest share (8 per cent) in the United States. These estimates measure the impact of computers and peripherals as a factor of production, and do not measure the effect on GDP of their manufacture.

The last two rows in the table show that the growth contribution of computers in the United States has doubled in recent years. At the same time the growth rate of GNP in the United States has also doubled, so the relative share of IT in growth has been virtually unchanged. It does seem, however, that IT investment has become more profitable.

The increased productivity of IT investment may be a result of networking—the fact that all of the world’s computers can be linked to each other via the Internet. In this way enterprises and households that use IT benefit from the investments made by others. Moreover, enterprises may have learnt to modify their organizations and practices so that the return on these investments has risen.

The table (below) also suggests that the ‘productivity paradox’ has been largely an American phenomenon. IT’s growth contribution has been much greater in other countries for which data is available. In Finland the stock of computers has grown at practically the same rate as in the United States. Computers have had a bigger impact on GDP growth in Finland (16 per cent) because they account for a larger share of national income in Finland than in the United States. This does not, however, imply that IT investment is more productive in Finland. Rather, Finland has a more capital-intensive economy than the United States—partly because of greater intervention in the labour market—so that capital produces a greater proportion of Finland’s national income.​

IT in Developing Countries

According to UNU/WIDER’s crosscountry comparison of a larger sample of 23 OECD countries in 1980-95, investment in computers and software is strongly correlated with economic growth. The effect of IT investment has been almost as great as the effects of all other fixed investment combined. On the other hand there has been no corresponding growth effect in our sample of developing countries. It would therefore seem that developing countries have not yet invested sufficiently in physical infrastructure and human capital to make IT investment worthwhile. Consequently, from a historical perspective, IT does not yet seem to offer the developing countries a shortcut to prosperity.

The figure above illustrates the basic difference between developed and developing countries. The investment share in GDP is very high in such fast growing economies as China, South Korea, and Thailand. But the IT content of investment is low. However, in develped countries such as Finland and the United States, the investment ratio is low but the share of IT investment in total investment is high.

Policy Priorities​

Investment in infrastructure, physical capital, and education is still the key to economic development. This is, of course, a long-standing recommendation. But it needs to be updated for a world economy in which the use of IT is spreading fast, so that no country—rich or poor—can ignore the need to invest in IT. Thus, the UNU/WIDER study concludes that the IT content of investments in infrastructure, physical capital, and education must be raised. The old policy recommendation is therefore given a new twist.

Besides providing IT education and training for their citizens, governments can themselves become sophisticated users of information technology. By developing advanced applications of IT—and by becoming a model for the private sector—governments can change the attitudes of workers, firms and consumers and lower their costs of adopting IT. It is the use of information technology, not necessarily its production, which matters for economic development in this new century.

References:

Pohjola, M. (ed.) Information Technology, Productivity and Economic Growth: International Evidence and Implications for Economic Development, Forthcoming Oxford University Press publication.

Sichel, D.E. ‘Computers and Aggregate Economic Growth: An Update’. Business Economics 34, April 1999.

The author is the Principal Academic Officer and Acting Director of UNU/WIDER and director of research on the economics of IT. Further information at www.wider.unu.edu.​