Information Technology Spending and Economic = Productivity

From: Subject: Information Technology Spending and Economic Productivity Date: Fri, 26 Sep 2008 11:15:47 -0400 MIME-Version: 1.0 Content-Type: text/html; charset="utf-8" Content-Transfer-Encoding: quoted-printable Content-Location: http://pages.stern.nyu.edu/~bakos/sichel_review.htm X-MimeOLE: Produced By Microsoft MimeOLE V6.00.2900.5579 =EF=BB=BF Information Technology Spending and Economic = Productivity

The Productivity Payoff of=20 Computers:
A review of The Computer = Revolution: An=20 Economic Perspective by Daniel E. Sichel

Yannis Bakos

Stern School of Business, New York = University

Science, July 3, 1998

In the last decade, American firms have made = unprecedented=20 investments in information technology, which, according to some = estimates, now=20 accounts for 30% of new capital investment. Anecdotal evidence for the = benefits=20 of information technology is easy to come by in our Internet age, as = companies=20 are transforming their operations, their marketing, and their = relationships with=20 customers and suppliers. Amidst the phenomenal IT revolution, several = economists=20 have been puzzled to find only modest growth in productivity reflected = in the=20 official statistics of the United States economy. The recognition of = this=20 "productivity paradox" is often attributed to Nobel-winning economist = Robert=20 Solow, who famously quipped in 1987 that computers can be seen = "everywhere=20 except in the productivity statistics."

To address issues raised by this paradox, researchers = have=20 studied the productivity of information technology at the level of = individual=20 firms. The coefficients of a "production function" are estimated from = data about=20 inputs (typically computer and non-computer capital stock, information = systems=20 labor, other labor, and R&D) and outputs (typically sales or = value-added);=20 this estimates the contributions of the included input factors. = Brynjolfsson and=20 Hitt (1995, 1996) analyzed data from 367 firms over the period 1988-1992 = with=20 1,248 total data points, and found no evidence of productivity = shortfall, and if=20 anything, evidence of excess returns to IT capital and IS labor. = Their=20 results were robust to different specifications of their production = function,=20 and have been replicated by Lichtenberg (1995) and others with data from = different sources.

Although these studies indicate that there is no = "productivity=20 paradox" at the firm level, macro-level data still show that = measured=20 economy-wide productivity gains have not substantially accelerated since = 1960,=20 despite rapidly increasing investments in computers and other types of=20 information technology (e.g., see Roach 1992). Four prominent hypotheses = have=20 been proposed to explain this fact: mismeasurement, = mismanagement,=20 diffusion delay, and the capital stock theory. = Mismeasurement=20 suggests that a large proportion of the benefits from information = technology=20 will not show up in productivity statistics because they take the form = of=20 greater convenience, product variety, quality or = timeliness=E2=80=94contributions that=20 are largely missed in traditional GDP accounting (Baily and Gordon 1988, = Griliches 1994). Mismanagement might lead to wasteful or unproductive=20 information technology investments. The diffusion hypothesis suggests = that many=20 years may pass before the productive potential of an innovation is fully = realized. Paul David (1990) offers the example of the electric dynamo, = where the=20 productivity benefits followed the required technical developments = (largely=20 complete by 1880) by several decades.

In his book, Daniel Sichel, a senior economist at the = Federal=20 Reserve Board, makes the case for the fourth explanation of the=20 "productivity paradox," the capital stock theory he developed in = collaboration=20 with Stephen Oliner (Oliner and Sichel 1994). Providing a rigorous = discussion of=20 growth accounting for the U.S. economy that is accessible to the = non-economist,=20 Sichel describes how economists derive the output and contribution to = economic=20 growth for the hardware and software sectors. He then shows that despite = the=20 large current spending in information technology, computers are still = only a=20 small fraction of the existing capital stock. One reason for this is = that only=20 recently firms have been making substantial investments in computers, = while they=20 have accumulated large amounts of other productive capital from many = decades of=20 investment. Another reason is that computers rapidly become obsolete, = and as a=20 result large spending does not imply a large accumulation of capital = stock.

In 1993, broadly defined "information processing equipment" was = estimated to=20 be 11.7 percent of the stock of nonresidential equipment and structures, = and=20 computers themselves accounted for a mere 2% of this capital stock (in = nominal=20 dollars). Sichel argues that since computers represent such a small = fraction of=20 capital stock, their contribution to economic growth should be = correspondingly=20 small. For example, he estimates that for the period 1980-1992, computer = hardware contributed only 0.20% out of the total 2.3% average annual = growth in=20 gross nonfarm output. Sichel estimates the contribution of computers to = economic=20 growth through 2003 under different assumptions, projecting a = contribution to=20 net growth (i.e., after depreciation) ranging from 0.11 to 0.38% at the = end of=20 that period.

Sichel=E2=80=99s analysis is important, because we must set realistic = expectations=20 for the ability of IT to foster productivity and economic growth. It is = equally=20 important, however, to remember that even if Sichel=E2=80=99s estimates = are accurate,=20 the glass is not empty. With recent GDP growth in the U.S. around 2% and = total=20 productivity growth currently just above 1%, a 0.2% contribution of IT = to=20 economic growth would be nothing to sneeze at. The continuing = improvement in the=20 cost/performance ratio of IT is unprecedented, and as a result it is = hard to=20 point at any other single technology that has a comparable impact on=20 productivity growth.

The real picture, however, is likely to be brighter than that painted = in the=20 book. For example, Sichel does not measure directly the contribution of = IT to=20 growth, but he infers it by assuming that the net return of computers is = similar=20 to that for other capital, around 12% annually. Econometric studies at = the firm=20 level suggest that marginal net returns to IT capital investments = may be=20 twice as high as this, and, since the ability of firms to deploy IT is = limited=20 by the availability of complementary factors such as IS labor, their = average=20 returns may be even higher.

Most important, Sichel=E2=80=99s approach may be too narrow. What is = exciting about=20 information technology is not its ability to substitute for other = capital, but=20 its ability to restructure every aspect of business, in the process = creating new=20 types of markets and organizations. Unfortunately Sichel=E2=80=99s = analysis is not=20 capable of capturing these higher-order impacts. Nevertheless, as long = as his=20 findings are kept in perspective, Sichel deserves credit for = contributing an=20 interesting argument and a rigorous methodology to our understanding of = how=20 information technology affects productivity and economic growth.

REFERENCES

Baily, M. and R. Gordon, "The Productivity Slowdown, = Measurement=20 Issues, and the Explosion of Computer Power," Brookings Papers on = Economic=20 Activity, 2, 1988, pp. 347-431.

Brynjolfsson, E. and L. Hitt, "Information Technology = as a=20 Factor of Production", Economics of Innovation and New = Technology, 3,=20 185-200, (1995).

Brynjolfsson, E. and L. Hitt, "Paradox Lost? = Firm-level Evidence=20 on the Returns to Information Systems Spending", Management = Science,=20 April, 42, (1996) p.541.

David, P. A. "The Dynamo and the Computer: An = Historical=20 Perspective on the Modern Productivity Paradox," The American = Economic Review=20 Papers and Proceedings, May 1990, pp. 355-61.

Griliches, Zvi. "Productivity, R&D, and the Data=20 Constraint," The American Economic Review, March 1994, pp.=20 1-23.

Lichtenberg, F. R., "The Output Contributions of = Computer=20 Equipment and Personal: A Firm-Level Analysis", Economics of = Innovation and=20 New Technology, 3 201-217, (1995).

Oliner, S. D., and D. E. Sichel, "Computers and Output = Growth=20 Revisited: How Big Is the Puzzle?" Brookings Papers on Economic = Activity,=20 2, 1994, pp. 273-334.

Roach, S. S. Technology Imperatives. Morgan = Stanley, New=20 York, 1992