Explaining The Productivity Paradox

Nobel Prize-winning economist Robert Solow has said that we see computers everywhere except in the productivity statistics. That productivity measures do not seem to show any impact from new computer and information technologies has been labeled the "productivity paradox." Productivity growth has slowed every decade since the 1960s while investments in information technology have grown dramatically. Some take this as proof that information technology doesn't affect productivity.

Yet the real reason for the productivity paradox may lie in the fact that the U.S. economy is neither fully in the old mechanized economy nor yet in the new digital economy. The animating force in the old economy was the desire to mechanize goods production and handling-to automate the assembly line and the farm. And this effort has paid off handsomely, with 3 percent to 4 percent productivity growth per year in manufacturing and agriculture for the last 100 years. But now, with over 80 percent of jobs in the service sector, where productivity is growing at less than 1 percent per year, mechanization has run its course as the predominant driver of productivity. Until recently, it has proven difficult to introduce the kinds of productivity-enhancing technologies in many service industries that are used in manufacturing. But the next big motor force of productivity improvement, digitization, is only in its early stages and hasn't yet reached the critical mass necessary to significantly affect macro-economic productivity statistics.

Make no mistake, application of information technology does improve productivity. Since the 1970s, productivity has grown about 1.1 percent per year for sectors that have invested heavily in computers and approximately 0.35 percent for sectors that have invested less heavily.²⁶ Research by MIT economists shows that in the 1990s computers contribute significantly to firm-level output and productivity.²⁷ But the effects have been concentrated in a limited number of firms and industries.

As we make the transition to a more digital economy, the effects are likely to be felt economy-wide. It wasn't until the early 1990s that microprocessors were fast and cheap enough to really work well in a wide range of applications. Pentium computer chips weren't introduced until 1993. The Internet didn't begin to become a mass medium until 1994. Emerging new technologies such as smart cards, voice-based computing, video telephony, "expert system" software, and the "Next Generation Internet" are just now beginning to arrive. When these and others are widely used, and when a majority of the economy and society are linked through digital networks, it will be possible to speak of a nearly complete digitization of the economy. When this happens, a large share of economic functions will be conducted through digital information technology, while paper (e.g., cash, forms, files) and routine face-to-face (e.g, clerks, order takers) transactions will become less important, leading to significantly increased efficiencies. For example, while the cost of a teller transaction at a bank is $1.07, the cost of a similar online banking transaction is one cent.

As a result, the animating force for productivity and wage growth in the New Economy will be the pervasive use of digital electronic technologies to increase efficiency and productivity, particularly in the heretofore low-technology service sector. The digitization of the economy in the 21st century promises to bring the kinds of economic benefits to Americans that mechanization brought in the 20th. And this will be spurred by the "network effect"-the more Americans use these technologies (e.g., Internet, smart cards, broadband telecommunications), the more applications will be developed, and the more value they will provide for users. Once this occurs, the productivity paradox could very likely give way to a productivity and wage boom. Government can play an important role in facilitating the transition to a digital economy by adopting laws and regulations that explicitly support and advance electronic commerce.

 
Index Home | Introduction
SECTION I | SECTION II | SECTION III
Productivity Paradox | Knowledge Economy
Nine Myths | Data Sources | Endnotes | The Authors
 
 
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