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Productivity, IT, and the New Economy

by Kevin J Stiroh

The strength of the U.S. economy in the second half of the 1990s has led many observers to assert that something fundamental had changed, that this expansion was intrinsically different, that there was a "new economy". These claims were largely motivated by the surge in output and productivity growth, relatively subdued inflation, and rising stock market seen in the U.S. from to 1995 to 2000. To explain these events, these observers pointed to the growing role of information technology, as well as the beneficial effects from globalization and deregulation. While opinions varied in the details, these are the essential components of the "new economy" position that was so widely discussed in recent years.

More recent events in the U.S., of course, have taken some of the luster off of this view. The U.S. stock market, particularly high-tech issues, plummeted from their highs in March 2000 and the U.S. economy entered recession in March 2001 with unemployment rising to 6 percent in 2002. Not all aspects of the economy have deteriorated so badly, however. Most prominently, labor productivity (output per hour) has held up remarkably well and information technology is still seen as a key driver of these gains.

My presentation at the WIDER Conference on "The New Economy in Development" focused on the recent performance of U.S. productivity growth and the role of information technology (IT) in the post-1995 resurgence. In particular, I addressed three questions: Was the U.S. productivity revival real?   Did IT play a key role in the productivity revival?  Can strong productivity growth continue?  As discussed below, the answer to all three questions appears to be yes.

Was the U.S. Productivity Revival Real?

The resurgence of U.S. productivity growth in the mid-1990s is one of the most important recent developments in macroeconomics. After growing only 1.4 percent per year from 1973 to 1995, nonfarm business productivity g rowth jumped markedly to 2.5 percent per year from the end of 1995 to the middle of 2002, according to the most recent estimates by the U.S. Bureau of Labor Statistics. (1) Due to downward revisions in U.S. GDP growth rates in recent years, these estimates are somewhat below those originally reported, but they remain quite impressive nonetheless: a 1 percentage point increase in trend productivity growth can have enormous macroeconomic consequences in terms of a higher standard of living and reduced inflationary pressures.

It is important to emphasize that this strong 2.5 percent average annual growth covers a period of 6 and a half years that includes a recession. This is significant because productivity growth is very procyclical and moves with the economy as a whole. Had robust productivity growth been confined only to a booming economy, one could more plausibly argue that the majority of the gains were cyclical in nature and not reflective of an improvement in the underlying trend. Over the four quarters ending June 2002, which include the 2001 recession, however, U.S. produc- tivity grew a very strong 4.7 percent. This impressive performance in the midst of overall economic weakness provides compelling evidence that we have indeed seen an improvement in trend productivity and that the U.S. productivity revival was real.

Did IT Play a Key Role in the Productivity Revival? 

The emerging consensus is that both the production and the use of IT made substantial contributions to the U.S. productivity gains. Recent studies have extended the standard growth accounting approach, which quantifies the growth contribution from capital, labor, and the technology residual, to isolate the impact of IT-production and IT-use. The contribution from IT-production is measured as the part of aggregate total factor productivity originating in the production of IT equipment and software, while the contribution from IT-use is measured as the capital deepening effects related to IT investment.​

As shown in the accompanying table, U.S. private labor productivity increased from 1.44 for 1973-1995 to 2.36 percent for 1995-2000, an increase of 0.92 percent. The growth accounting methodology attributes about 0.3 percent of this to IT-production, i.e., the enormous technological progress in the relatively small part of the economy that produces computers, semiconductors, and other high-tech gear. The relentless technological progress in these sectors has also driven the price of IT equipment down at unprecedented rates, and provided powerful incentives for firms to invest in IT. This IT-use effect can be seen in the 0.4 percent contribution to the U.S. productivity revival from IT capital deepening. Thus, IT-production and IT-use account for a sizable portion of the U.S. productivity gains.

Disaggregated studies provide an alternative perspective on this question. The industries that use IT most intensively, for example, have shown the strongest productivity gains in the post-1995 period, which is consistent with the notion that the use of IT has real productivity benefits. Similarly, firm and plant- level studies have typically found large gains associated with IT investment and capital accumulation. Of course, IT is not a panacea and complementary investments in human capital, changes in organizational structure, and improved workplace practices are all needed to maximize the productive impact of IT, but the evidence from the macro and micro studies clearly points to an important role for IT.

Can Strong Productivity Growth Continue? 

The third, and most challenging, question centers on the outlook for future productivity growth. This is obviously an important policy topic and a number of productivity analysts have recently presented projections of future productivity growth. Despite different methodologies, these studies seem to be converging around an estimate of sustainable productivity growth of about 2.2 percent per year over the next decade or so. This is somewhat below the recent experience and acknowledges the possibility of both slower investment in IT goods and slower growth in labor quality.​

Economic projections are always difficult, however, and productivity projections are no exception. Most importantly, technological progress, which is the key driver behind productivity growth, is subject to considerable uncertainty. As a result, the majority of recent studies present a range of possible outcomes that varies based on the underlying assumptions about factors like the rate of technological progress in high-tech industries and the responsiveness of business investment. As a concrete example, a recent paper by Jorgenson, Ho, and Stiroh (2002) reports a base-case projection of productivity growth of 2.2 percent per year, with a plausible range of 1.3 to 2.9 percent. (2) Despite considerable uncertainty, most analysts expect relatively strong productivity for the medium term.

Conclusions

The "new economy" has clearly not lived up to all of the hype - recent events have proven that the U.S. economy is not immune to recession and that stock market values can decline. Nonetheless, one of the cornerstones of the new economy - strong productivity growth - has held up remarkably well in recent years. The latest data show the growth rate in the post-1995 period was 2.5 percent per year and various projection exercises report only slightly slower growth for the fore- seeable future. Moreover, informa- tion technology, another cornerstone of the new economy discussions, is seen as a critical driver of this success. Through both the direct technological gains in the production of high-tech assets and through the benefits accruing to the most intensive users, information technology has made an important contribution to the resurgence of U.S. productivity growth.

Kevin J. Stiroh is a Research Officer at the Federal Reserve Bank of New York. The views expressed in this paper are those of the author only and do not represent those of the Federal Reserve Bank of New York or the Federal Reserve System.

(1) Note that these revised estimates, released in August 2002, differ from these reported at the WIDER conference on the New Economy in Development, Helsinki 10-11 May 2002.

(2) Jorgenson, Dale W., Mun S. Ho, and Kevin J. Stiroh. "Projecting Productivity Growth: Lessons from the U.S. Growth Resurgence". Economic Review, Federal Reserve Bank of Atlanta, forthcoming 2002.