consultado dic.8 de 2000

Untangling e-conomics

Sep 21st 2000

From The Economist print edition

Will the economic benefits of information technology match those of earlier technological revolutions? Quite probably, says Pam Woodall, our economics editor; but the laws of economics will still apply

"EVERYTHING that can be invented has been invented." With these sweeping words, the Commissioner of the United States Office of Patents recommended in 1899 that his office be abolished, so spectacular had been the wave of innovation in the late 19th century. History is littered with such foolish predictions about technology. The lesson is that any analysis of the economic consequences of the current burst of innovation in information technology (IT—computers, software, telecoms and the Internet) should proceed with care. At one end, the Internet’s boosters have boldly proclaimed it as the greatest invention since the wheel, transforming the world so radically that the old economics textbooks need ripping up. At the other extreme, sceptics say that computers and the Internet are not remotely as important as steam power, the telegraph or electricity. In their view, IT stands for "insignificant toys", and when the technology bubble bursts, its economic benefit will turn out to be no greater than that of the 17th-century tulip bubble.

The first programmable electronic computer, with a memory of 20 words, was built in 1946, but the IT revolution did not really start until the spread of mainframe computers in the late 1960s and the invention of the microprocessor in 1971. The pace of technological advance since then has been popularly summed up by Moore’s Law. Gordon Moore, the co-founder of Intel, forecast in 1965 that the processing power of a silicon chip would double every 18 months. And so it has, resulting in an enormous increase in computer processing capacity and a sharp decline in costs (see chart 1). Scientists reckon that Moore’s Law still has at least another decade to run. By 2010 a typical computer is likely to have 10m times the processing power of a computer in 1975, at a lower real cost.

Over the past 40 years global computing power has increased a billionfold. Number-crunching tasks that once took a week can now be done in seconds. Today a Ford Taurus car contains more computing power than the multimillion-dollar mainframe computers used in the Apollo space programme. Cheaper processing power allows computers to be used for more and more purposes. In 1985, it cost Ford $60,000 each time it crashed a car into a wall to find out what would happen in an accident. Now a collision can be simulated by computer for around $100. BP Amoco uses 3D seismic-exploration technology to prospect for oil, cutting the cost of finding oil from nearly $10 a barrel in 1991 to only $1 today.

The capacity and speed of communications networks has also increased massively. In 1970 it would have cost $187 to transmit "Encyclopaedia Britannica" as an electronic data file coast to coast in America, because transmission speeds were slow and long-distance calls expensive. Today the entire content of the Library of Congress could be sent across America for just $40. As bandwidth expands, costs will fall further. Within ten years, international phone calls could, in effect, be free, with telecoms firms charging a monthly fee for unlimited calls.

As communications costs plunge, more and more computers are being linked together. The benefit of being online increases exponentially with the number of connections. According to Metcalfe’s Law, attributed to Robert Metcalfe, a pioneer of computer networking, the value of a network grows roughly in line with the square of the number of users. The Internet got going properly only with the invention of the World Wide Web in 1990 and the browser in 1993, but the number of users worldwide has already climbed to more than 350m, and may reach 1 billion within four years.

Between the extremes

IT is revolutionising the way we communicate, work, shop and play. But is it really changing the economy? The ultra-optimists argue that IT helps economies to grow much faster, and that it has also eliminated both inflation and the business cycle. As a result, the old rules of economics and traditional ways of valuing shares no longer apply. Cybersceptics retort that sending e-mail, downloading photos of friends or booking holidays online may be fun, yet the Internet does not begin to compare with innovations such as the printing press, the steam engine or electricity. Some even say that America’s current prosperity is little more than a bubble.

Whom to believe? The trouble is that IT commentators go over the top at both extremes. Either they deny that anything has changed, or they insist that everything has changed. This survey will argue that both are wrong, and that the truth—as so often—lies somewhere in the middle. The economic benefits of the IT revolution could well be big, perhaps as big as those from electricity. But the gains will be nowhere near enough to justify current share prices on Wall Street. America is experiencing a speculative bubble—as it has done during most technological revolutions in the past two centuries.

The Internet is far from unique in human history. It has much in common with the telegraph, invented in the 1830s, as Tom Standage, a journalist on this newspaper, explains in his book "The Victorian Internet". The telegraph, too, brought a big fall in communications costs and increased the flow of information through the economy. But it hardly turned conventional economic wisdom on its head.

Extra brain-power

The value of IT and the Internet lies in their capacity to store, analyse and communicate information instantly, anywhere, at negligible cost. As Brad DeLong, an economist at the University of California at Berkeley, puts it: "IT and the Internet amplify brain power in the same way that the technologies of the industrial revolution amplified muscle power." But is IT really in the same league as previous technological revolutions? There are several tests.

First, how radically does it change day-to-day life? Arguably, the railways, the telegraph and electricity brought about much more dramatic changes than the Internet. For instance, electric light extended the working day, and railways allowed goods and people to be moved much more quickly and easily across the country. Yet the inventions that have the biggest scientific or social impact do not necessarily yield the biggest economic gains. The printing press, seen by some as the most important invention of the past millennium, had little measurable effect on growth in output per head. In scientific terms, the Internet may not be as significant as the printing press, the telegraph or electricity, but it may yet turn out to have a bigger economic impact. One reason is that the cost of communications has plummeted far more steeply than that of any previous technology, allowing it to be used more widely and deeply throughout the economy. An invention that remains expensive, as the electric telegraph did, is bound to have a lesser effect.

A second test of a new technology is how far it allows businesses to reorganise their production processes, and so become more efficient. The steam age moved production from the household to the factory; the railways allowed the development of mass markets; and with electricity, the assembly line became possible. Now computers and the Internet are offering the means for a sweeping reorganisation of business, from online procurement of inputs to more decentralisation and outsourcing.

The ultimate test, however, is the impact of a new technology on productivity across the economy as a whole, either by allowing existing products to be made more efficiently or by creating entirely new products. Faster productivity growth is the key to higher living standards. After years when people puzzled over the apparent failure of computers to boost productivity, there are signs at last that productivity growth in America is accelerating. The question is whether that faster growth is sustainable. Undeniably, though, America’s economy has had a fabulous decade in which it achieved both faster growth and lower inflation, and some part of that is due to IT.

And whatever the impact of IT so far, there is more to come. Paul Saffo, who heads the Institute for the Future, in California, believes that the IT revolution has only just begun, both in terms of innovation and the adoption of new technologies. Corporate America’s R&D has increased by an annual average of 11% over the past five years, which suggests that innovation will go on. As yet, only 6% of the world’s population is online; even in the rich world, the figure is only 35%. Only a third of American manufacturing firms are using the Internet for procurement or sales. All technologies follow an S-shaped path (see chart 2). They are slow to get going, but once they reach critical mass the technology spreads fast. The world may already be half-way up the curve for computers, but for the Internet it is only at the bottom of the steep part, from where it is likely to take off rapidly. Moreover, IT is only one of three technological revolutions currently under way. Together with fuel-cell technology, and genetics and biotechnology, it could create a much more powerful "long wave" than some of its predecessors.

Even so, predictions about future growth must be kept in perspective. Those who claim that technology has created a new growth paradigm that will allow America’s GDP to keep expanding at well over 4% a year do not realise just how bold their forecasts are. That sort of annual rate implies growth in GDP per head of more than 3%. For that to materialise, computers and the Internet would need to be a far more important engine of growth than steam, railways or electricity. Through most of the 19th century America’s GDP per head grew by less than 1.5% a year, and in the 20th century by an average of just under 2%. In truth, many current expectations for American growth are probably unrealistic.

On the other hand, global growth may well turn out to be faster than in the past. America has been the first to embrace the IT revolution and the new economy, which is why so much of the evidence in this survey is concentrated in that country. But it is no longer alone. A later section of the survey will argue that if the rewards from IT are significant in America, the gains in Europe, Japan and many emerging economies could be even bigger. If so, this could yet prove to be the biggest technological revolution ever for the world as a whole.

So is it true that the "new economy" is making a nonsense of the laws of economics? It is argued that rules for, say, monetary and antitrust policy that worked in the age of steel and cars no longer apply now that computers and networks hold sway. But as Carl Shapiro and Hal Varian neatly put it in their book "Information Rules": "Technology changes, economic laws do not." The business cycle has not really been eliminated; if economies grow too fast, inflation will still rise; share prices still depend on profits; and governments still need to remain on their guard against the abuse of monopoly power.

Don’t burn the textbooks

But perhaps the most important economic rule of all is that new technology is not a panacea that cures every economic ill. To reap the full benefits from IT, governments still need to pursue sound policies. America’s recent economic success is not due to new technology alone, but also to more stable fiscal and monetary policies, deregulation and free trade. A period of pervasive structural change lies ahead. Economies will enjoy big gains overall, but these will not be evenly spread. Many existing jobs and firms will disappear. In this environment, the risks of policy errors are high.

To see how governments can choke the economic benefits of innovation, look back 600 years to China, which at that time was the most technologically advanced country in the world. Centuries before the West, it had invented moveable-type printing, the blast furnace and the water-powered spinning machine. By 1400 it had in place many of the innovations that triggered the industrial revolution in Britain in the 18th century. But then its technological progress went into reverse, because its rulers kept such tight control on the new technology that it could not spread. It is a warning that the fruits of the IT revolution should not be taken for granted.

Copyright 1995-2000 The Economist Newspaper Group Ltd. All rights reserved.

consultado dic.8 de 2000

Elementary, my dear Watson

Sep 21st 2000

From The Economist print edition

How information technology can boost economic growth

IN THE 1940s Thomas Watson, then chairman of IBM, predicted that the world market for computers would add up to five; he simply could not foresee any commercial possibilities. Today there are around 300m active computers in the world, so the economic impact of IT will turn out to be somewhat bigger than Mr Watson might have guessed. But how big?

People nowadays take it for granted that they will grow richer year by year. Yet for most of human history, growth in world output per head averaged little more than 0.1% a year. It was not until the late 18th century that growth accelerated, to an average of 1.2% a year over the past 200 years (see chart 3), thanks to a spurt in technological innovation. Since then, the world has seen four main waves of innovation. The first, from the 1780s to the 1840s, was the industrial revolution in Britain, fuelled by steam power; the second, from the 1840s to the 1890s, was the railway age; the third, from the 1890s to the 1950s, was driven by electric power and the car. Now we are in the information age.

People are often frightened of technological change. Yet the world would be much more frightening without innovation. Economies have limited resources of capital and labour. So without better ways to use these resources, growth would soon run out of steam.

Traditional models of growth developed in the 1950s concentrated largely on inputs of capital and labour, and had nothing to say about technological change. It was seen as exogenous, something that rained down from heaven. But a new theory, developed in the 1980s by Paul Romer and others, put technological change at centre stage. This "new growth theory" regards knowledge creation as endogenous, responding to market incentives such as improved profit opportunities or better education. Rather than raining down at a steady rate, the pace of technological change depends partly on governments and firms. Mr Romer argues that the economic incentives for innovation have strengthened in recent years. Raising finance for innovation has become easier, and a bigger global market has increased the likely return. Global R&D as a share of GDP has increased. It is claimed, strikingly, that about 90% of all the scientists who have ever lived are alive today. The pace of innovation does not just seem to be faster: it really has increased.

Taking the plunge

A good gauge of the pace of technological change is the rate of decline in the cost of a new technology. Over the past three decades, the real price of computer processing power has fallen by 99.999%, an average decline of 35% a year. The cost of telephone calls has declined more slowly, but over a longer period. In 1930, a three-minute call from New York to London cost more than $300 in today’s prices; the same call now costs less than 20 cents—an annual decline of around 10%.

These price plunges are much bigger than those in previous technological revolutions. The first steam engines were little cheaper than water power. By 1850 the real cost of steam power had fallen by only 50% from its level in 1790. The building of the railways reduced freight rates across America by 40% in real terms between 1870 and 1913, an annual decline of only 3%. The introduction of the telegraph hugely reduced the time it took to send information over long distances, but the service remained expensive. In the 1860s, a transatlantic telegram cost $70 a word in today’s prices. Over the next decade the cost fell, but a 20-word message still cost the equivalent of around $200 to send. Today a 20-page document can be e-mailed for a mere cent. Electricity prices fell more steeply, but still by an average of only 6% a year in real terms between 1890 and 1920.

Thanks to rapidly falling prices, computers and the Internet are being adopted more quickly than previous general-purpose technologies, such as steam and electricity. It took more than a century after its invention before steam became the dominant source of power in Britain. Electricity achieved a 50% share of the power used by America’s manufacturing industry 90 years after the discovery of electromagnetic induction, and 40 years after the first power station was built. By contrast, half of all Americans already use a personal computer, 50 years after the invention of computers and only 30 years after the microprocessor was invented. The Internet is approaching 50% penetration in America 30 years after it was invented and only seven years since it was launched commercially in 1993.

In addition to plunging prices, computers and the Internet have four other noteworthy features:

• IT is pervasive: it can boost efficiency in almost everything a firm does, from design to marketing to accounting, and in every sector of the economy. The productivity gains of steam, electricity and railways were mainly concentrated in the manufacture and distribution of goods. This could be the first technological revolution to boost productivity in services, from health care and education to finance and government. That would be no small matter: services account for nearly three-fifths of America’s GDP.

•By increasing access to information, IT helps to make markets work more efficiently. Economists at UBS Warburg suggest that the "new economy" should really be called the "nude economy" because the Internet makes it more exposed and transparent. The Internet allows consumers to seek the lowest price, and firms to get quotes from more suppliers; it also reduces transaction costs and barriers to entry. In other words, it moves the economy closer to the textbook model of perfect competition, which assumes abundant information, many buyers and sellers, zero transaction costs and no barriers to entry. IT makes these assumptions a bit less far-fetched. (However, it also seems to increase monopoly power in some industries, which will be discussed in a later section of this survey.)

Better-informed markets should ensure that resources are allocated to their most productive use. Farmers can get instant information on weather, prices and crop conditions in other regions. Manufacturers can track changes in demand more closely via direct links to electronic scanners in shops.

•IT is truly global. More and more knowledge can be stored as a string of zeros and ones and sent anywhere in the world at negligible cost. Information technology and globalisation are intimately linked. By reducing the cost of communications, IT has helped to globalise production and capital markets. In turn, globalisation spurs competition and hence innovation, and speeds up the diffusion of new technology through trade and investment.

•IT speeds up innovation itself, by making it easier and cheaper to process large amounts of data and reducing the time it takes to design new products. Thanks to ever more powerful computers, the mapping of the human genome, completed earlier this year, took much less time than first expected.

Net gains

Many economists believe that although computers are undoubtedly useful on their own, it will take the Internet to unlock their full economic potential. E-commerce still accounts for only 1% of total sales in America, but it is growing rapidly. firms, such as Amazon and eBay, have become household names, but far more important from an economic point of view will be business-to-business (B2B) e-commerce, linking buyers and sellers electronically along the supply chain. The Gartner Group, a consultancy, forecasts that global B2B e-commerce will reach $4 trillion by 2003, compared with less than $400 billion of online sales to consumers.

The best way to analyse the impact of the Internet on the economy is as a fall in the cost of an input, in this case information. Expressed diagrammatically, this pushes the aggregate supply curve (an economy’s productive potential) out to the right (see chart 4), in exactly the same way as the invention of the wheel or electricity did in the past. Assuming no change in aggregate demand (D1), the equilibrium level of production rises from Q1 to Q2, and the price level falls from P1 to P2.

B2B e-commerce can cut firms’ costs in several ways. First, it reduces procurement costs, both by making it easier to find the cheapest supplier and through efficiency gains. It is much cheaper to place an order online, and there are likely to be fewer errors in orders and invoicing. That may seem trivial, but Cisco reports that a quarter of its orders used to have to be reworked because of errors in its phone and fax ordering system. When it switched to online ordering, the error rate fell to 2%, saving the company $500m. British Telecom claims that buying goods and services online reduces the cost of processing a transaction by 90% and cuts the direct costs of goods and services it buys by 11%.

A second possible saving is from much lower distribution costs for goods and services that can be delivered electronically, such as financial services, software and music. The marginal cost to a bank of a transaction over the Internet is a mere cent, compared with 27 cents via a cash machine, 52 cents by telephone and $1.14 by bank teller. Online commerce also allows more efficient supply-chain management, cutting out layers of middlemen. And lastly, better information reduces the need for firms to keep large stocks. Dell Computer’s build-to-order model completely eliminates inventories, and is being widely copied.

The B2B exchanges being set up by car, steel, construction and aerospace firms will provide a more efficient marketplace for buyers and sellers to exchange products. Such exchanges are likely to spring up in most industries. GM, Ford, Daimler-Chrysler and Renault-Nissan plan to move all their business to a joint electronic exchange with a turnover of $250 billion and 60,000 suppliers. According to one estimate, dealing with suppliers online could reduce the cost of making a car by 14%.

The biggest savings are likely to come in procurement. A report by Goldman Sachs, an investment bank, estimates that online purchasing could save firms anything from 2% in the coal industry to perhaps 40% in electronic components. As a result of such cost savings, Goldman Sachs reckons, B2B e-commerce could boost the level of output in the rich economies by an average of 5% over time. More than half of that would come through within ten years, an increase of 0.25% a year in the rate of growth over the next decade. Add in the potential indirect cost savings from the Internet as firms reorganise the way they do business, and the total gains could be considerably bigger.

The popular distinction between the old and the new economy completely misses the point. The most important aspect of the new economy is not the shift to high-tech industries, but the way that IT will improve the efficiency of all parts of the economy, especially old-economy firms. This distinction will be examined further in a later section of this survey. But first those productivity gains have to materialise—and economists find it impossible to agree on how far IT has already started to lift America’s productivity growth.

Copyright 1995-2000 The Economist Newspaper Group Ltd. All rights reserved.

consultado dic.8 de 2000

Solving the paradox

Sep 21st 2000

From The Economist print edition

IT is making America’s productivity grow faster at last, but for how long?

EIGHTEEN years ago Time magazine declared the computer "person of the year". But as for so many people and firms feted on the front cover of magazines, this proved to be a curse: computers failed to live up their billing. In 1987, Robert Solow, a Nobel laureate in economics, famously said: "You can see the computer age everywhere but in the productivity statistics." The failure of massive investment in information technology to boost productivity growth became known as the productivity paradox. In fact, productivity growth slowed sharply in most countries in the 1970s and 1980s. The surge in America’s productivity growth since the mid-1990s has therefore been seized upon with relish. Has the productivity paradox now been solved?

This is no trivial question, for productivity growth is the single most important economic indicator. It determines how fast living standards can grow. The reason why the average American today is seven times better off than his counterpart at the turn of the century is that he is seven times as productive. And faster growth not only lifts living standards, it also boosts tax revenues and makes it easier to pay for tomorrow’s pensions.

Spending on IT equipment and software now accounts for about half of all investment by American firms. So why has it taken so long for that investment to show up in faster productivity growth? History suggests that there were also long lags before both steam power and electricity boosted productivity. Work by Paul David, an economist at Oxford University, shows that productivity growth did not accelerate until 40 years after the introduction of electric power in the early 1880s. This was partly because it took until 1920 for at least half of American industrial machinery to be powered by electricity. But firms also needed time to figure out how to reorganise their factories around electric power to reap the efficiency gains.

Mr David suggests that a technology will start having a significant effect on productivity only when it has reached a 50% penetration rate. American computer use has reached the 50% mark only recently, and other rich economies still lag behind (see chart 5). That puts IT at roughly the same stage now that electricity had reached in 1920. Almost exactly on cue, growth in labour productivity in America’s business sector has increased to an annual average of 2.9% since 1996, from an average of 1.4% in 1975-95 (see chart 6). In the year to the second quarter of this year, productivity surged by 5.2%.

But economists disagree on whether this increase in productivity growth is sustainable. To complicate things, there are two different measures on offer: labour productivity (output per man-hour), and total factor productivity (TFP, which takes account of the efficiency with which both capital and labour inputs are used). To most people, it is labour productivity that matters, because this is what ultimately determines living standards. Economists, though, get more excited about TFP growth, which they see as a costless way of boosting growth without increasing scarce inputs. Faster TFP growth automatically increases labour-productivity growth.

IT can boost growth in labour productivity in three ways: by increasing the amount of capital deployed per worker (ie, capital deepening), as firms invest in IT; by speeding up TFP growth in IT-producing industries, thanks to technical advances; and by increasing TFP growth in sectors that use IT. Nobody can deny that productivity in the sector that produces IT goods has surged, with growth in the 1990s averaging 24% a year. The disagreement is about the effect of IT on the rest of the economy.

Of the flurry of studies on the spurt in American productivity that have appeared over the past year, one of the most optimistic is by Stephen Oliner and Daniel Sichel at the Federal Reserve in Washington. It probably also comes closest to the current thinking of the Fed’s chairman, Alan Greenspan. The two economists conclude that IT has been the key factor behind America’s improved productivity growth, and they expect a substantial portion of it to persist. They estimate that nearly half of the acceleration in productivity growth between the first and second halves of the 1990s was due to capital deepening as firms invested in IT. The other half was due to faster TFP growth, of which two-fifths came from efficiency gains in computer production. The authors conclude that roughly two-thirds of the increase in labour productivity was due directly to the production of or investment in computers.

Another study, by Dale Jorgenson, at Harvard University, and Kevin Stiroh, at the New York Fed, reaches similar conclusions: heavy investment in computers and faster productivity growth in the computer industry have substantially boosted labour-productivity growth. However, the authors worry that although TFP growth outside the computer sector has increased, there is little evidence that this is linked to IT. Indeed, the sectors which have invested most in IT have generally seen smaller productivity gains. This could be due to measurement problems, but for the moment it casts some doubt on the argument that IT is boosting TFP growth throughout the economy.

Nevertheless, Messrs Jorgenson and Stiroh conclude that labour-productivity growth of around 2.3% a year could be sustained over the next decade. That would allow America’s GDP to grow at an average rate of almost 3.5% a year without pushing up inflation, compared with an average growth rate of around 3% in the two decades to 1995.

Tools or toys?

However, Robert Gordon, an economist at Northwestern University and one of the most outspoken new-economy sceptics (a stance that requires considerable courage in America today), is less impressed by America’s productivity "miracle" than other economists. He reckons that the entire increase in total factor productivity outside the computer sector is due to the economic cycle. At times of rapid growth, firms work employees harder, so productivity rises; but then it falls again in the next downturn. Moreover, he finds that after excluding the manufacture of all durable goods as well as of computers, there has been absolutely no increase in labour productivity in the remaining 88% of the economy, after adjusting for the cycle. Yet this is where most of the investment in computers has taken place. He concludes that the productivity paradox is alive and well.

Mr Gordon is not surprised that IT has failed to lift TFP growth throughout the economy. Computers and the Internet, he says, do not rate as an "industrial revolution", as did electricity and the car. Much Internet activity, he argues, is merely a substitute for things that are already being done. For example, downloading music simply replaces buying a CD; it does not create new products, in the way that electricity prompted the invention of the vacuum cleaner and the fridge. Indeed, the Internet can even reduce productivity in the workplace. The traffic on many consumer-oriented websites, he notes, peaks in the middle of the working day, not in the evening.

The main reason why Mr Gordon’s conclusions differ from those of other researchers is that he adjusts productivity growth for the effects of the economic cycle. This is a reasonable thing to try to do, because falling unemployment shows that output has been growing faster than trend. But many economists are unhappy about the way he has done it. They are convinced that at least part of the increase in productivity growth is structural, if only because it is highly unusual for productivity to accelerate so late in an economic boom. The usual pattern is for it to slow down at that point.

Mr Greenspan recently dismissed the notion that the increase in productivity growth is largely cyclical. He also argued that the underlying rate of productivity growth was still accelerating. A study by economists at the OECD seems to give his view some support. After adjusting for the economic cycle, it concludes that labour-productivity growth and TFP growth both increased significantly in America in the 1990s.

A second point of difference is that Mr Gordon’s test of the economic importance of IT—whether it has boosted TFP growth in sectors that use IT—is tougher than that of the other studies, which merely ask whether IT has lifted labour-productivity growth in the economy as a whole.

Why does the composition of the increase in labour-productivity growth matter? If faster labour-productivity growth is largely due to capital deepening, growth will remain high only if the price of IT equipment continues to fall. If technological progress in the IT sector were to slow, then overall productivity growth would be hit by a double whammy: the rate of TFP growth in the IT industries would fall, and the pace of investment in IT in the rest of the economy would slow.

However, scientists are confident that the rapid rate of innovation, and hence the fall in prices, will continue for at least another decade. If so, capital deepening will persist for some time. In any case, the split between capital deepening and TFP growth is very sensitive to the method of calculation. Using a wider measure of TFP, the OECD estimates that cyclically adjusted TFP growth has been growing faster in recent years than Mr Gordon suggests.

Mr Gordon’s wider dismissal of IT is also somewhat unfair. He concentrates mainly on consumer use of the Internet, yet the biggest economic effect is likely to flow from B2B e-commerce. This has only just got going, so any productivity gains would not be expected to show up yet. And although IT may not yet have created many new products, it has opened up many new opportunities. Genetics and biotechnology, mobile phones, online auctions and financial derivatives would all be impossible without low-cost computer processing power.

The evidence from aggregate economic data may be mixed, but studies that look at individual firms suggest that computers have yielded substantial gains. In an analysis of 600 big American firms between 1987 and 1994, Erik Brynjolfsson at MIT and Lorin Hitt at the University of Pennsylvania found that investment in computers appeared to boost annual TFP growth by 0.25-0.5%. The productivity gains got bigger over longer periods, confirming that it takes time for firms to reorganise their business before they reap the full benefits of IT. Their research also shows that firms that coupled IT investment with changes in their organisational structure, such as decentralisation, enjoyed the biggest productivity gains from IT.

Messrs Brynjolfsson and Hitt argue that much of the benefit of IT comes in the form of improved product quality, time savings and convenience, which rarely show up in official macroeconomic data (see article). Microeconomic studies are able to identify these gains because firms whose products offer such intangible benefits will enjoy higher revenues.

Outside America, much less research has been done on the economic effects of IT. Comparisons are difficult because different countries use different methods to measure IT and to allow for quality improvements. All things considered, it seems likely that official figures understate European productivity growth relative to America’s. IT investment rose strongly in all the G7 economies in the 1990s, but its contribution to growth is much less significant in Japan and most European economies than in America, largely because IT equipment accounts for a much smaller share of the total capital stock: only 3% in Japan and Germany against 7% in America.

By far the best international study has been done by Andrea Bassanini, Stefano Scarpetta and Ignazio Visco, at the OECD. They find that after adjusting for the economic cycle, annual TFP growth increased by at least half a percentage point in the 1990s in Australia, Canada and the Scandinavian economies as well as America, but it fell in Japan and the big European economies.

Ranking revolutions

America has invested more, and earlier, in IT than the other big economies, so the economic benefits would be expected to emerge there first. It is still too early to judge how IT lines up against previous industrial revolutions, but it is possible to compare some of the growth forecasts now being made for the next decade with actual growth rates during the eras of steam and electricity.

Suppose, optimistically, that America’s average rate of labour-productivity growth in the late 1990s were to be sustained for the next couple of decades as IT and the Internet continue to transform the way business is done. This would allow GDP per head to grow by around 3% a year, much faster than during the first industrial revolution’s peak in the mid-19th century, when GDP per head grew by an average of around 1.5%, or during the electricity age, when growth accelerated to just over 2% in the 1920s.

In fact, previous technological revolutions resulted in more modest rates of overall productivity growth than most people realise. In its prime years in the 19th century, the world’s first industrial revolution produced average labour-productivity growth in Britain of barely 1% a year. Electricity provided a bigger spark, with America’s labour-productivity growth in manufacturing jumping to more than 5% a year in the 1920s. But the productivity growth rate across the whole economy was a less impressive 2.3% (see table 8).

New-paradigmers who suggest that rates of productivity growth of 3-4% a year are sustainable for the next decade or so are really saying that IT will have a far bigger economic impact than electricity, telephones and cars. That is very ambitious. More likely, America’s long-term trend rate of labour productivity and hence per capita growth might be lifted to an annual 2.5%. That might not sound much, but it would make IT at least as significant as electricity.

Over the past 200 years, growth in GDP per head has gradually accelerated from 0.6% a year in 1800-40 to 2.3% in 1960-99 (see chart 9). A growth rate in GDP per head of around 2.5% over the next few decades would fit this trend. Paul Romer, the father of new growth theory, believes that the rate of growth has increased over time because of increasing returns to knowledge. Knowledge builds upon itself: the more that mankind discovers, the better it gets at the process of discovery. That rings true, but as Jack Triplett at the Brookings Institution points out, simply to keep productivity growth constant, the pace of introduction of new technology and new products needs to keep increasing.

The recent spurt in labour-productivity growth in America is almost certainly exaggerated by the current economic boom. But at the same time the official figures will probably understate the likely full effect of IT on the structural rate of productivity growth, for two reasons. First, official statistics significantly understate growth. Second, many economists believe that the Internet will trigger faster productivity growth by prompting firms to reorganise from top to bottom. Bigger gains may therefore lie in the future. But will they be big enough to justify the current level of share prices?

Copyright 1995-2000 The Economist Newspaper Group Ltd. All rights reserved.



Virtual guesswork

Sep 21st 2000

From The Economist print edition

IT IS ironic that in this information age there is a distinct dearth of statistics with which to measure the true economic impact of computers. This is not just a matter of a lack of data on new businesses, such as e-commerce. The main problem is that statistics designed for the industrial age are ill-equipped to measure output in the 21st century.

A breakdown of productivity growth by industry shows that in many of the sectors that use computers most intensively, notably banking and education, productivity actually declined in the 1990s (see chart 7). So is IT a waste of money? Not necessarily: more likely, the figures are flawed. The service sector has always been hardest to measure, and IT and the Internet have exacerbated the problem because much of their benefit comes in the shape not of cost savings, but of increased product quality, convenience and customer service. Such gains rarely show up in GDP figures.

When the quality of a product is changing rapidly, number-crunchers find it tricky to work out which part of an increase in nominal spending is due to higher prices and which part to gains in real output. If statisticians had their way, products would all be like Henry Ford’s model-T car, introduced in 1908 and basically unchanged for two decades; but in practice change is becoming ever more rapid, and the faster the rate of product innovation, the bigger the statistical error is likely to be. If quality improvements are ignored, productivity growth will be understated. For example, the introduction of ATMs and online banking has substantially improved the service offered to customers, yet the official statistics take little account of these benefits. One study of American banking puts the increase in output between 1977 and 1994 at 7% a year after allowing for technology-related improvements in the quality of service, whereas the official statistics recorded an annual increase of only 1.3%.

Health-care statistics look particularly fishy. According to official figures, productivity in America’s health-care industry has fallen by more than 20% over the past decade; indeed, total factor productivity is now almost 40% down on 1960. Yet there is little doubt that medical care is much better today than it was 40 years ago. Diagnosis is more accurate, patients need to spend less time in hospital, and new medical equipment allows less invasive treatment. All this implies big cost savings, as well as greater convenience for the patient. Again, however, official output figures, based on indicators such as the number of doctors and hospital beds, fail to take account of higher quality, so growth is understated.

Official statistics also fail to capture the benefit of the increasing choice consumers enjoy. In Henry Ford’s day customers could have any colour they wanted, so long as it was black. Since then choices have proliferated. In the early 1970s Americans could buy five types of running shoes; in 1999 they could pick from 285. There used to be four types of milk; now there are 19. IT also makes it easier and cheaper to offer personalised goods and services. CDs, computers and even golf clubs can be customised for an individual buyer. Michael Cox and Richard Alm, at the Federal Reserve Bank of Dallas, argue that mass production was all about producing more stuff at lower cost; mass customisation is about producing the right stuff. Consumer satisfaction has increased, but GDP fails to capture such intangible benefits.

Lost in cyberspace

There are good reasons, therefore, to suspect that official figures understate productivity growth—and by more than they may have done in the past. To be fair, America’s Department of Commerce has made big strides over the past decade in improving its numbers. It has pioneered new methods for measuring changes in the quality and price of computers, and since last year it has included software as part of IT investment. Most other countries are some way behind America in measuring the importance of IT. Morgan Stanley, a bank, reckons that if Europe used the same price deflator for IT as America to calculate its GDP, its growth rate might turn out to be half a percentage point higher.

In this statistical fog, only one thing seems certain: the productivity of official statisticians has seriously declined.

consultado dic.8 de 2000


Sep 21st 2000

From The Economist print edition

All technological revolutions carry risks as well as rewards

IF INFORMATION technology is lifting America’s rate of growth, surely that justifies the current lofty heights of share prices? Sadly, no. Wall Street still looks dangerously high relative to likely future profits. Every previous technological revolution has created a speculative bubble, and there is no reason why IT should be different.

New-economy fanatics argue that in this new world of rapid technological change, old methods of share valuation have become irrelevant. Profits are for wimps. But both economic theory and history suggest otherwise. In his book "Irrational Exuberance", Robert Shiller, an economist at Yale University, tracks the p-e ratio of America’s S&P 500 over 120 years, a period that covers huge technological change: America’s railway boom, electricity, telephones, radio and cars. With each wave of technology, share prices soared and later fell. Ominously, though, prices now are higher in relation to profits than they have ever been before (see chart 10).

The inventions of the late 19th century drove p-e ratios to a peak in 1901, the year of the first transatlantic radio transmission. By 1920 shares prices had dropped by 70% in real terms. The roaring twenties were also seen as a "new era": share prices soared as electricity boosted efficiency and car ownership spread. After peaking in 1929, real share prices tumbled by 80% over the next three years.

There are many similarities between the Internet today and Britain’s railway mania in the 1840s. Would-be rail millionaires raised vast sums of money on the stockmarket to finance proposed lines. Most railway companies never paid a penny to shareholders, and many went bust, largely because over-investment created excess capacity. The Great Western Railway was for decades the most admired railway company in Britain, yet anyone who had bought shares at its launch in 1835 (at a fraction of their peak in 1845) and held them until 1913 would have seen an annual return of only 5%. Even so, the railways brought huge economic benefits to the economy long after share prices crashed. The lesson is that although IT may be causing a bubble, it may still produce long-term economic gains. But many investors could lose their shirts.

Current valuations of shares seem to assume that they are going to grab a huge chunk of market share from existing firms. Yet history suggests that the gains from technological revolutions often go to unexpected quarters. The biggest winners from America’s railway boom were small firms and farmers who benefited from the opening up of the continent. It is a sobering thought that 99% of the 5,000 railway companies that once existed in America are no longer around. The same is true of 2,000 car firms. And according to a study by Goldman Sachs, profits and share prices of the early electricity firms were disappointing, despite the industry’s profound effect on the economy.

Goldilocks and the three myths

This time, it is said, will be different. Three popular explanations are offered to justify the high level of share prices: that profits will grow faster; that the economy and hence equities have become less risky; and that lower, more stable inflation will reduce real interest rates. True or false?

Faster productivity growth should indeed boost profits. But even if America’s future average economic growth is as steep as optimists believe, say just over 4% a year, the current level of share prices implies that profits will rise even faster. Looking back over time, the share of profits in America’s national income has been fairly stable. During the electrification of American industry, profits actually fell slightly as a share of GDP: although firms’ costs came down, strong competition ensured that savings were passed on to consumers.

Profits can outpace GDP for a period if companies build more monopoly power, but if IT reduces barriers to entry and increases competition, profit margins are more likely to shrink than widen. B2B e-commerce will cut costs, but one company’s lower costs are another’s lower prices and profits. Moreover, by increasing price transparency, the Internet shifts power from producers to consumers, and so is likely to squeeze average profit margins. Consumers, not producers, will reap the lion’s share of the rewards of IT. If the Internet increases competition, it cannot also increase the share of profits in GDP. It has to be one or the other.

What about the argument that the equity-risk premium (the premium that investors demand over risk-free assets such as government bonds) has fallen close to zero because of greater economic stability? Not only have fiscal and monetary policies become more prudent, it is said, but IT also helps to smooth the economic cycle. B2B e-commerce allows firms to hold fewer stocks and, by providing better information about changes in demand, it also reduces the risk of overstocking. But the business cycle has been declared dead many times in the past, usually just before a recession. A hard landing remains a real risk for the American economy.

Another flaw with this theory is that stockmarket volatility remains high. Valuing individual shares becomes more difficult in periods of rapid change because current revenues and profits may be poor predictors of future performance. As in all technological revolutions, some new firms will make fortunes but most will fail, which implies a greater dispersion of returns from individual shares. This surely makes equities more risky, not less.

The proposition that the real rate of interest (used to discount future profits) will be lower in future because of lower and more stable inflation is another myth. If the IT revolution increases profitable investment opportunities, then the equilibrium real interest rate must rise in order to encourage households to save more to finance the higher level of investment.

Taking account of all this, share prices seem to assume there will be an implausible rate of growth in profits. Martin Barnes of The Bank Credit Analyst, a research group based in Canada, calculates that assuming the equity-risk premium is 2% (well below its historical average of 5%), then the current level of America’s S&P 500 index implies profits growth of over 6% a year in real terms over the next three decades, well above likely GDP growth.

A crash in share prices would make a serious if temporary dent in America’s economy, even though the underlying economic benefits of IT would continue. Stockmarkets in many other economies are overvalued too, but a bursting of the bubble would claim many more victims in America than in Japan or Europe, partly because far more people own shares and partly because in recent years American households and companies have borrowed huge sums in the expectation that share prices will continue to climb. Sooner or later they are likely to discover their mistake.

Monetary matters

Technological revolutions and financial bubbles seem to go hand in hand, but has the Fed done all it could to prevent a bubble inflating? Judged by the traditional test of inflation, the Fed has done a superb job, combining relatively low inflation with rapid growth. Setting monetary policy in the new economy is no easy task, because the old relationship between growth and inflation seems to have broken down. No central banker believes the popular claim that inflation is dead. In the long run inflation is determined by monetary conditions; the Internet can affect only relative prices, not the overall rate of inflation. But if America’s productivity growth has indeed increased, it is safe for the Fed to allow the economy to grow a bit faster before touching the brakes. The snag is that nobody knows what the new rate of productivity growth is, and if the economy grows too fast, it will still overheat.

In the face of increased uncertainty about underlying productivity growth, many economists now argue that a central bank should not try to restrain an expansion until there is visible evidence that inflation is rising. A premature tightening could stifle investment and innovation. The Fed has, more or less, taken this advice. But, as a result, it has encouraged share prices to move even higher during the past couple of years.

Should central banks worry more about the surge in share prices that has accompanied the IT revolution? In theory, there is a strong case for central banks to try to prick bubbles before they get too big. Letting out some air early on can help to prevent a painful crash later on. The problem is that it is hard for a central bank to know whether it is dealing with a financial bubble or a new era of much faster growth. Jan Hatzius, an economist with Goldman Sachs in New York, argues that when share prices and investment are booming as they were in America in the late 1990s, the correct policy is to raise interest rates regardless. If it turns out to be a bubble, then the central bank needs to raise interest rates to let out some air. If it is a new era of faster growth and new investment opportunities, then the equilibrium real interest rate (the rate at which monetary policy neither boosts nor restrains the economy) would rise, so the central bank would be right to move interest rates towards that level.

Many people believe that the Internet makes a central banker’s job easier by helping to hold down prices. But initially, the IT revolution might actually increase inflationary pressures, as shown in chart 11. In the long term, IT will shift the economy’s aggregate supply curve from S1 to S2, but this will happen gradually. Meanwhile, investors will anticipate faster future growth in output and profits, pushing up share prices. This will boost households’ wealth and encourage them to spend more, even before the increase in supply has materialised. As a result, the demand curve will shift to the right, from D1 to D2, pushing up the price level to P*. The risk is that if the increase in demand outstrips the increase in supply, inflation will rise unless the central bank raises interest rates. This could describe America today, as Mr Greenspan hinted in a speech earlier this year.

Central bankers clearly have their work cut out in these uncertain times. Yet for shouldering this onerous responsibility, Mr Greenspan is paid a comparatively modest $140,000 a year. Central banking is one of the very few knowledge jobs that have not benefited from fat pay rises in recent years.

consultado dic. 8de 2000


Labour pains

Sep 21st 2000

From The Economist print edition

Wanted: more brains, less brawn

GO TO, a website set up by trade unionists to monitor bosses’ pay at all big companies, and tap in your annual pay. Suppose you are a blue-collar worker employed by General Electric, America’s biggest company, earning $25,000 a year. You will learn that if you want to equal what your ultimate boss, Jack Welch, got paid last year (including his stock options), you will have to work for 3,663 years. Today’s average chief executive earns 475 times as much as the average factory worker, up from a ratio of 42 in 1980. The new economy is rewarding some more handsomely than others.

Until a few years ago, workers’ main worry was that new technology would create mass unemployment as people were replaced by computers and robots. America’s boom during the past few years has muted such fears: unemployment has fallen to 4%, the lowest rate for 30 years. Ever since Britain’s Luddites in the early 19th century smashed the power looms and spinning jennies that threatened their livelihood, people have feared that technological change would increase unemployment. Yet during two centuries of huge technological progress, employment has risen almost continuously. Millions of jobs have been destroyed, but even larger numbers of new jobs have taken their place. For blacksmiths and coachmen, read car mechanics and airline pilots.

But that is little consolation if you are one of those whose job is destroyed by new technology. A steel worker cannot easily get a job as a computer programmer. Most of the jobs being lost as a result of IT are concentrated among the low-skilled, whereas many of the new jobs require good education and skills. As the demand for brains has risen relative to the demand for brawn, so wage differentials have widened in favour of the better-educated. Since 1979, average weekly earnings of college graduates in America have risen by more than 30% relative to those of high-school graduates (see chart 12), increasing the wage gap to its widest for at least 60 years. The wage gap between college graduates and high-school drop-outs has grown by twice as much. Since average real wages rose relatively slowly for much of this period, the real pay of the least educated has actually fallen over the past 20 years.

Why life isn’t fair

Economists have put forward four main explanations for the increase in wage inequality: technological change; increased imports from low-wage developing economies; higher immigration of low-skilled workers; and the waning power of trade unions. All four have probably played a role, but most economists reckon that new technology is by far the most important factor. Trade by itself is simply not large enough to be the major culprit, and the timing is wrong. America’s trade with developing economies grew much faster in the 1990s than in the 1980s, yet most of the rise in wage inequality dates from the 1980s.

There are two reasons why computers might increase the relative demand for better-educated and more highly skilled workers. Low-skilled, routine jobs, done by clerical and production workers, can be automated and replaced by computers more easily than professional or managerial jobs. The second reason is that computers complement skilled workers, increasing the return on the creative use of information, whether in designing a car, trading bonds or managing a company.

To shed some light on the factors behind rising wage inequality, Larry Katz, an economist at Harvard University, has examined the changes in wage differentials and skill levels over the past century. Educational standards have increased continuously over time, yet despite a larger supply of educated workers, the wage premium enjoyed by the better educated has increased in every decade since 1950. This suggests that the increase in the relative demand for skills started well before computers became widespread, but accelerated in the 1980s.

Even so, the pay gap today is still considerably narrower than at the beginning of the 20th century. Between 1900 and 1939, wage differentials by educational level were severely compressed. Factory electrification, like IT, also eliminated many unskilled manual jobs and increased the demand for skills, but this was more than offset by a huge increase in the supply of educated workers. In 1910 fewer than 10% of American youths had high-school diplomas; by the mid-1930s the figure had risen to 40%.

Skill premium

Mr Katz suggests that although the greater relative demand for skilled workers caused by IT must have played a part in the widening of wage inequality over the past two decades, slower growth in the supply of more educated workers may have been an even bigger factor. In the 1970s, the supply of educated workers surged in America as the baby-boom generation entered the workforce and college enrolment rose. But since then the education level of the workforce has improved much more slowly.

A comparison of the United States with Canada supports this argument. During the 1980s and 1990s the ratio between the earnings of university graduates and high-school graduates rose sharply in America, but fell in Canada. In both countries the demand for skills rose by similar margins, but the supply of educated workers rose much more rapidly in Canada than in the United States.

Looking at a wider range of countries, Mr Katz finds that where wage differentials between skilled and unskilled workers have widened the most, growth in the supply of better-educated workers has generally slowed down. In contrast, in France, Germany and the Netherlands, where wage differentials have not increased over the past two decades, the supply of educated workers has grown rapidly. Static wage differentials in continental Europe are usually explained by factors such as powerful trade unions and high minimum wages. But it is possible that faster expansion in the supply of well-educated workers is more important. This suggests that the real culprit behind rising inequality in America is not IT, but the government’s failure to improve education and training.

Since the mid-1990s, wage inequality in America has flattened or even narrowed slightly, and growth in the relative demand for college-educated workers seems to have slowed, despite the continuing spread of computers. Will IT continue to favour better-educated workers in future?

Some economists argue that part of the increased wage premium enjoyed by skilled workers reflects the fact that they tend to be more flexible, so all technological change increases the relative demand for skills during a transitional period. But as technologies mature, the advantage of the better-educated wanes. If this is true, the wage premium for skill or education depends on the pace of innovation. As a technology matures, the skill premium will narrow. Perhaps this is happening now. However, a more likely explanation of why inequality has stopped rising in recent years is that America’s economic boom has reduced the unemployment rate to a historic low and pushed up wages at the bottom end of the labour market.

An alternative, and more persuasive, theory about technology and jobs argues that each technological innovation favours different skills. Electricity and computers have both increased the relative demand for skilled workers, whereas the mechanisation of factories during the steam age in the 19th century increased the relative demand for unskilled workers. Highly skilled craftsmen, such as weavers, were replaced by machines and unskilled labour. So perhaps what matters is not the pace of innovation, but the type. IT, the current driver of change, favours better-educated workers, so during this particular wave of innovation the demand for such workers will go on growing.

Even so, if the government puts more effort into increasing the supply of well-educated workers, then America’s wage inequality could narrow in future years. However, that still leaves the question of the growing divide between the information haves and have-nots. Richer and better-educated people are more likely to have a computer and access to the Internet (see chart 13). In 1998, 60% of Americans with incomes above $75,000 used the Internet, compared with under 20% of those with incomes below $25,000. More than 60% of college-educated workers, but only about 15% of high-school drop-outs, used the Internet. Poorer, less educated people are therefore at a double disadvantage. They have less access to information which might help them to get a better job, and they are shut out of e-commerce and the opportunity to seek lower prices that could most benefit the less well-off.

But the Internet also has a more direct effect on the labour market: a growing number of jobs are being advertised online. About 400 of the world’s 500 biggest firms (and over 90% of American ones) use websites for recruitment, and half accept applications online. Employment websites, such as, can improve information and reduce search costs in the labour market. By better matching of vacancies and job seekers, this may reduce the level of unemployment consistent with stable inflation. But what will the Internet do to pay structures?

One view, based on standard trade theory, holds that by making it easier for workers to keep informed about job opportunities and pay rates, the Internet will help to create a uniform market for skills and reduce pay variations within occupations, just as has caused a move towards uniform book pricing across America.

A competing theory suggests that as the Internet expands the market for individuals with special talents, small differences in ability will lead to huge differences in rewards. This idea is based on the work of Sherwin Rosen, an economist at the University of Chicago. In a classic paper written in 1981, "The Economics of Superstars", he explained why in sectors such as sports and films a few top stars are paid vast sums whereas the runners-up lag far behind. This "winner-takes-all" principle already applies to an increasing number of occupations, including bond dealers, doctors, lawyers and chief executives. In these jobs, being slightly ahead of the pack is hugely important. An ambitious investment bank does not want the second-best bond dealer, so it pays well over the odds for the best. IT has expanded the market for such skills to a global scale, so the premium for superstar talent has increased.

David Autor, at MIT, suggests that the Internet could cause both effects in different parts of the labour market. In routine occupations, such as cashiers and clerks, pay is likely to become more uniform as technology reduces regional wage differentials. On the other hand, the superstar effect could spread to more occupations, such as teaching and software engineering, as the Internet increases the power of talented individuals to serve a bigger market. But if winners take all in the labour market, does the knowledge economy reward companies in the same way?

consultado dic.8 de 2000


Knowledge is power

Sep 21st 2000

From The Economist print edition

Do we need a new competition policy for the new economy?

HOW many Microsoft computer programmers does it take to change a light bulb? None. Bill Gates will simply call a press conference and announce that the new standard is darkness. Every revolution has its enemies, and this time Microsoft has been cast as the main villain of the information economy. Whatever the outcome of the battle between Microsoft and the American government, some economists worry that because of the very nature of information and knowledge, which form the building bricks of the new economy, more and more monopolies like Microsoft are likely to emerge. But how does that fit with the accepted wisdom that IT and the Internet will make markets more efficient, and will therefore boost competition?

Economies are increasingly based on knowledge. Finding better ways of doing things has always been the main source of long-term growth. What is new is that a growing chunk of production in the modern economy is in the form of intangibles, based on the exploitation of ideas rather than material things: the so-called "weightless economy". In 1900 only one-third of American workers were employed in the service sector; now more than three-quarters are (see chart 14). More and more goods, too, from Mercedes cars to Nike trainers, have an increasing amount of knowledge embedded in them, in the form of design or customer service.

Economists have a problem with knowledge because it seems to defy the basic economic law of scarcity. If a physical object—a spade, say—is sold, the seller ceases to own it. But when an idea is sold, the seller still possesses it and can sell it over and over again. However much knowledge is used, it does not get used up. Yet the market system as described by Adam Smith 200 years ago was based on the notion of scarcity, including a cost structure in which it is more expensive to produce two of anything than one.

Traditional economic theory assumes that most industries run into "diminishing returns" at some point because unit costs start to rise, so no one firm can corner the market. But an increasing number of information products (anything that can be transformed into a string of zeros and ones), such as software, books, movies, financial services and websites, have "increasing returns". Information is expensive to produce, but cheap to reproduce. High fixed costs and negligible variable costs give these industries vast potential economies of scale. A new software program might cost millions of dollars to develop, but each extra copy costs next to nothing to make, especially if it is distributed over the Internet.

There is nothing new about increasing returns. Alfred Marshall, a British economist, discussed them at length in 1890. Gas, electricity and railways were subject to increasing returns long before the information age. But increasing returns may be more prevalent in information goods because of their cost structure. Besides, economies of scale have increased. In the days of Standard Oil early in the 20th century, if a firm was twice as big as its rivals, its average unit costs might be 10% lower. Today, if a software firm is twice as big as its competitor, its average unit costs might be up to 50% lower. This makes it harder for new entrants to break into a market.

In such circumstances, the natural market structure therefore becomes a monopoly. An added complication with information goods is that economies of scale may apply not just on the supply side but on the demand side as well, thanks to network effects (which economists call "network externalities"). The value of many information goods, such as fax machines or software packages, increases as more people use them. Microsoft’s Windows is valued by customers precisely because it is so widely used. Network effects can thus create strong barriers to entry. If everybody you know uses Microsoft Word, then you will find life easier if you use it too.

Once again, network effects are not new. A century ago the Bell System, later to become AT&T, took advantage of network externalities to become dominant in the telephone business. However, Carl Shapiro of the University of California at Berkeley reckons that economies of networks have become more important relative to traditional economies of scale. The combination of demand-side and supply-side economies of scale in many information industries can be very powerful. Higher sales not only reduce production costs, but they also make the product even more valuable to other users. In such markets, one firm tends to become dominant.

A third factor can then strengthen a leader’s grip on the market: the lock-in effect. Once a customer has learned how to use a computer program, say, he is loth to switch because of the hassle of learning a new program. Users gain big benefits from common standards, so a newcomer has to show a huge advantage to persuade consumers to switch.

This suggests that the antitrust authorities will be kept busy. But some commentators suggest that the old competition rules are no longer appropriate for the information economy. In particular, they argue that the government should go easy on high-tech companies. With rapid technological change and vigorous competition, they say, current market share means little; monopolies will prove only temporary. Furthermore, breaking up a monopoly could actually hurt consumers. A traditional monopoly maximises profits by restricting supply and raising the price. But in information goods, a firm facing demand- and supply-side economies of scale will do the exact opposite: it will increase output and reduce the price. There is a risk, therefore, that if antitrust policy limits the market share of high-tech firms, prices could rise. So perhaps there is a case for greater tolerance of monopolies to allow them to reap full economies of scale, in the knowledge that rapid innovation within the industry will always keep them on their toes. If they become inefficient, they will quickly be displaced by sharper rivals.

A game of monopoly

Some economists have argued, therefore, that by clamping down on Microsoft, the Department of Justice has made a mistake. In a speech earlier this year Larry Summers, America’s Treasury secretary, seemed to sympathise with the view that natural monopolies may be good, not bad for the consumer: "The only incentive to produce anything is the possession of temporary monopoly power...without that power, the price will be bid down to marginal cost and high fixed costs cannot be recouped. So the constant pursuit of that monopoly power becomes the central driving thrust of the new economy." In other words, the economics of information requires an imperfect market, so that innovators can recoup their investment. This follows from the ideas of Joseph Schumpeter, an early-20th-century economist. His theory of "creative destruction" suggested that monopoly can actually stimulate innovation and growth, because it increases the incentive to innovate when a firm can capture more of the gains without being copied by rivals.

However, all the talk about the need for new competition rules misses the point. The government’s case against Microsoft was not that it has a monopoly, or that big is bad, but that it protected and extended its dominant position through anti-competitive behaviour. As Joel Klein, head of the antitrust division at the justice department, says, "The legitimate and illegitimate ways of acquiring and maintaining market power have not really changed in 100 years." The core principles of competition policy are still relevant. Microsoft used its monopoly in operating systems to squeeze out rival software firms, thus making it more difficult for new technologies to enter the market. The key issue for competition policy in the new economy is not market share, but the abuse of market power by a dominant firm to discourage innovation by others.

Arguing that Microsoft broke the law is one thing. Much trickier is the issue of whether splitting up the firm will make consumers any better off. If network effects exist, then consumers benefit from the biggest network. That is one reason why the government rejected the idea of splitting the Windows monopoly into three new firms. Instead, it wants to break Microsoft into two: a Windows company and an applications company which would own Internet Explorer, Word and such like. Each company would be free to compete in all lines of business, developing products that compete with each other. The applications company would have an incentive to develop office software not just for Windows, but for other operating systems, helping them to grow. In turn, Windows would have more incentive to co-operate with makers of rival applications. Other software firms would have more incentive to innovate, with less fear of being squashed. This should spur innovation and competition.

Paul Romer, a leading advocate of the importance of innovation for growth, firmly believes that competition is more likely than monopoly to encourage innovation. Mr Romer rejects the idea that because technological change today is faster, antitrust enforcement is less important. That, he says, rests on the false notion that technological change is exogenous, simply raining down from heaven. If that were true, faster technological change would indeed tend to undermine monopoly power more quickly, at a lower cost to society. Instead, he says, the pace of technological innovation is influenced by economic incentives. And since new technology would undermine the monopoly power of an incumbent, it has a huge incentive to try to stifle innovation to protect its monopoly position, and thereby discourage new firms from innovating. If Mr Romer is right, that makes competition policy more, not less important during times of rapid technological change, because there are many more opportunities for blocking innovation.

Competition authorities will therefore need to watch out, but only up to a point. Monopolies are unlikely to pop up all over the place in the new economy. High-tech industries in which network effects loom large account for only 8% of America’s GDP. Microsoft is the exception rather than the rule. There may be a tendency towards monopoly in pure information goods, but in most of the economy IT will help to increase competition.

Broadly speaking, the Internet reduces barriers to entry, because it is cheaper to set up a business online than to open a traditional shop or office. The Internet also makes it easier for consumers to compare prices. Both these factors increase competition. It does not matter if only a small fraction of goods is being sold online so far; traditional firms will still find it harder to push up prices.

Don’t do it yourself

Most previous technological breakthroughs have increased the optimal size of firms either by reducing production costs and increasing economies of scale, as with electricity and steam, or by reducing transport costs, as with railways, thus favouring concentration. By contrast, outside the digitisable sectors such as software the Internet reduces economies of scale in most of the economy by increasing the opportunities for outsourcing and by lowering fixed costs.

More than 60 years ago Ronald Coase, a Nobel-prize-winning economist, explained why firms are vertically integrated (as opposed to individuals buying and selling goods and services at every stage of production). The main reasons, he said, were imperfect information and the need to minimise transaction costs. A firm can either produce component parts or services itself or buy them from a supplier. They will probably be cheaper if bought in the marketplace, but against that the firm will have to spend time and money on finding what is available, and on ordering the products.

In the past, these transaction costs were high, so firms often preferred to do lots of things in-house, which made them bigger. Vertical integration solved the problem of imperfect information. But as the Internet increases access to information and reduces transaction costs between firms and suppliers, it makes it more attractive for firms to concentrate on what they are best at and buy in other goods and services from outside. This reduces their optimal size. A small firm can now use accounting software rather than employing an accountant, a word processor instead of a typist, and e-mail or voicemail instead of a telephone receptionist.

The Internet offers small and medium-sized firms many of the advantages of large, diversified firms. It gives them access to the same information as big firms, and makes it easier for them to get into international markets. Many big firms have been using electronic-data-interchange systems for years to communicate with their bigger suppliers. The Internet does the job much more easily and cheaply, making such things accessible to firms of all sizes.

It is true, therefore, that IT both diminishes and increases competition, but it is not really much of a paradox. In industries where network externalities are important, IT will favour giants to exploit economies of scale, both on the supply and the demand side. In the rest of the economy tiddlers will thrive.

consultado dic.8de 2000


The end of taxes?

Sep 21st 2000

From The Economist print edition

NOTHING in this world is certain, said Benjamin Franklin, except death and taxes. Even the Internet cannot prevent death, but some people predict that it will make it harder for governments to collect taxes, forcing them to take an axe to their welfare states. More likely, however, the composition of the tax burden will change.

The Internet will make the taxman’s job harder in three ways:

•It makes it easier to avoid paying sales tax. If a German buys a CD from a local shop, he automatically pays VAT at a rate of 16%. If he buys it from an American online retailer who delivers it by post, he may well escape the tax he is supposed to pay, because the taxman cannot open every package entering the country. However, the most serious problem arises over products downloaded from the net, such as music, software and videos. It is almost impossible for the taxman to track digital products.

In America Internet buyers rarely pay tax. Sales taxes are usually collected by the seller at the point of sale, but under American law mail-order firms do not have to collect taxes on sales in other states. In the past the tax loss was modest, but if B2C e-commerce really takes off, the loophole could cause serious damage. Studies show that people living in states with high sales taxes are much more likely to buy online.

•The Internet increases the mobility of firms and certain kinds of skilled workers. Businesses or individuals operating over the net can move to low-tax countries or to tax havens. For example, many British gambling firms have recently set up online operations offshore. The Internet makes it harder to pinpoint the identity and location of individuals or businesses engaged in taxable activities. A domain name may give no clue to the location of a site. And if plans to develop anonymous e-money bear fruit, potential taxpayers will become even harder to identify.

•The Internet could also make life harder for the taxman by cutting out retailers, bankers and other middlemen who currently play an important role in collecting taxes or providing useful information.

At present, e-commerce accounts for only a tiny fraction of total spending, so it is unlikely to cause a serious erosion of the tax base in the near future. The size of the potential drain on tax revenue also tends to be exaggerated: most products cannot be digitised and distributed over the net; most people do not want to move abroad to work; and where a company decides to set up in business depends on many other factors besides tax. Nevertheless, the problem is likely to grow. European governments, which raise more revenue from consumption taxes than America, are likely to be squeezed most.

The European Commission is worried about losing tax revenues through the net. It has proposed that foreign companies with annual online sales of more than euro100,000 in the EU should register for VAT in at least one EU country and then collect the tax on all services downloaded from the Internet. But this would be almost impossible to enforce.

It will be no bad thing if the Internet does lead to increased tax competition between economies, forcing governments to reduce tax rates. But do not expect overall tax burdens to decline by much. The Internet will certainly increase the pressure on governments to reduce taxes on company profits and on consumption, but their most likely response is to shift the tax burden to people and things that can be pinned down more easily—such as ordinary workers, property and energy use.

In 1831 a British member of Parliament asked Michael Faraday, a pioneer of electrical theory, what use his discovery might be. Mr Faraday replied that he did not know, but he was sure governments would one day tax it. The Internet may be rather harder to tax, but someone, somewhere will find a way.

consultado dic.8 de 2000


Catch up if you can

Sep 21st 2000

From The Economist print edition

Europe and Japan cannot afford to miss the boat

SO FAR the "new economy" has largely been an American spectacle, with little sign of an increase in productivity growth in Japan or the big European economies. Many Americans expect it to stay that way because the tired "old" economies of Europe and Japan lack the necessary innovation and entrepreneurial flair. But historically, the biggest economic gains from a new technology have come not from its invention and production, but from its exploitation. Over the coming years, as IT and B2B e-commerce spread all over the globe, America’s economic lead should narrow.

Growth in America spurted ahead of the other big rich economies during the 1990s. Since 1995 the country has enjoyed average annual GDP growth of 4.2%, compared with 1.8% in Germany and only 1.2% in Japan. At least some of this can be explained by their different positions in the economic cycle. The gap in growth rates of GDP per head is also smaller because population growth in America has been faster. But by any measure America has outperformed the others. America’s lead in IT and the Internet, it is argued, will give it a big advantage for many years to come, and present European and Japanese high-tech firms with formidable barriers to entry. After all, Europe lacks world-class technology producers like Microsoft, Cisco or Dell. Of the world’s 50 biggest IT companies by revenue, 36 are American, nine Japanese and only four European. IT production accounts for 7% of America’s GDP, 6.5% of Japan’s and 4% of Europe’s .

But this gloomy view ignores the vital point that it is the use of IT that will do most to lift productivity, not the making of IT products. Many (though not all; remember Robert Gordon) of the studies that have dissected the recent increase in America’s productivity growth suggest that IT production accounted for only about one-quarter of the increase in labour-productivity growth in the second half of the 1990s. A more important factor was investment in IT. Europe and Japan currently spend less on IT as a share of GDP than does America (see chart 15), but their investment is starting to catch up.

Europe and Japan do not need to create cutting-edge technology to close the productivity gap with America. They can make their economies more productive simply by adopting or imitating American technology and B2B e-commerce. For all the talk about first-mover advantage, there are actually several advantages to being a follower. Catching up is much cheaper than trail-blazing. A Japanese or European firm buying IT equipment today will pay much less than it would have had to a few years ago. For example, in 1993 American firms invested $143 billion in IT, but the same level of computer processing power, estimates Paul Donovan, an economist at UBS Warburg in London, could now be had for perhaps $15 billion, thanks to falling computer prices.

Second-movers are also able to wait and see what works. They can cherry-pick the best bits and avoid the mistakes of American firms. As a result, Mr Donovan predicts that over the next decade growth in GDP per head could well be faster in Europe and Japan than in America. However, this does not mean that America will lose its economic supremacy; merely that its lead will narrow.

There are plenty of archaic business practices left in Europe and Japan that keep prices high and productivity low. IT and the Internet will make inroads into these by increasing transparency and competition. Corporate America, after a decade or so of vigorous restructuring, has already cut out a lot of economic waste. Japan and Europe, by contrast, can look forward to bigger cost savings simply because they are further behind.

E-commerce could also help to transform Japan’s famously inefficient and expensive distribution system. A recent study by McKinsey, a consultancy, found that although productivity in many Japanese manufacturing sectors was higher than in America, in retailing it was only half as high. If consumers can buy much more cheaply from abroad—which the Internet will help them do—domestic producers and retailers will be forced to reduce their prices. The Internet also offers Japanese firms a way to cut out the swathes of inefficient middlemen. The longer the supply chain, the bigger the potential gains from B2B e-commerce.

An obstacle race

Yet although the potential cost savings from IT in Japan and Europe may be bigger than in America, there remain some big obstacles to realising that potential. Inflexible labour and product markets could hinder the shift of labour and capital that is needed to unlock productivity gains. For example, strict employment-protection laws block the swift reallocation of workers from old to new industries. America’s better economic performance over the past decade may owe something to its flexible, competitive markets as well as to its use of technology.

Starting a company is also harder in Europe and Japan, because venture-capital markets are less developed and new businesses get entangled in red tape. It can take ten times as long and cost four times as much to start a new business in continental Europe as in America. Recent research by the OECD has found some evidence that the benefits of IT may indeed be amplified by flexible labour and product markets. Economies with the most flexible arrangements have adopted IT more swiftly, and have also seen a better performance in TFP growth in the 1990s (see chart 16).

All this means that to close the productivity gap, it is not enough for Europe and Japan simply to invest in IT: they must also shake up their labour and product markets. On past experience, that could mean a long wait, but things are changing. European governments are embracing tax reform and greater labour-market flexibility more swiftly than anybody expected a few years ago. The venture-capital industry is growing briskly, and many European businesses are starting to adopt a management style closer to America’s. The Internet is itself a catalyst for change, by exposing restrictive rules and helping to remove barriers to trade. European and Japanese consumers need only click on their screens to see what a raw deal they are getting. Likewise, high tax rates become harder to maintain when people and firms can up sticks and move to a lighter tax regime (see article).

In the cyber-age, national restrictions on shop-opening hours or strict rules on pricing and promotion are becoming a nonsense. The German economics minister recently said he was planning to abolish some retail legislation that gets in the way of e-commerce, such as the law that forbid shops from discounting prices by more than 3% below the manufacturer’s recommended price. In Japan, the Internet will force structural change by bringing stronger competition to the supply chain. It strikes at the heart of the keiretsu system, the network of shareholding relationships that link manufacturers with their preferred suppliers and retailers.

Structural rigidities will continue to slow the rate at which the productivity gap is being closed, but at least Europe and Japan are starting to catch up in their use of IT. In 1997, 48% of American employees but only 28% of German ones used the Internet, a 20% gap. By 1999 both countries had moved on, to 65% and 58% respectively, leaving a gap of only 7%. But Internet access charges are generally still higher in Europe and Japan than in America, not least because governments have been slow to liberalise and introduce competition into the "local loop", the final link between the telephone network and homes and offices. Countries where the cost of access is low are generally heavier Internet users (see chart 17).

There is one sector, however, where Japan and many European countries lead America: in the use of mobile phones, which some think could one day become the main gateway to the Internet. Proportionally, many more Japanese than Americans have mobile phones, and one in three Japanese users already has Internet capability. America’s fragmented market of operators and operating standards has held back the use of mobiles across the country.

America also lags behind in another crucial area: education. At the very top, it has the best universities in the world. But for the bulk of the population, Japan and Europe provide a better education. This could seriously hold back America’s economy in the years ahead. Japan and Europe may have been slower to adopt IT, but once they get round to it, the economic pay-off could be bigger than in America. As Paul Saffo, at California’s Institute for the Future, puts it, "The early bird may catch the worm, but it is always the second mouse that gets the cheese."

consultado dic. 8 de 2000


Falling through the net?

Sep 21st 2000

From The Economist print edition

For the developing world, IT is more of an opportunity than a threat

WITH information technology now claimed to be the main engine of growth over the next couple of decades, many people worry that developing economies, which have far fewer computers and Internet connections than the rich world, will get left behind. The income gap between rich and poor countries will widen further. But such fears about a "digital divide" seem to be based on a misunderstanding of the nature of growth as well as of the nature of IT. If IT can boost growth in the rich economies, why should it not do the same trick in emerging economies?

Pessimists point out that the rich countries account for only 15% of the world’s population but 90% of global IT spending and 80% of Internet users. Much of the developing world is too poor to buy computers or telephones. In Bangladesh a computer costs the equivalent of eight years’ average pay. The 2 billion people living in low-income economies (with average incomes below $800 per head) have only 35 telephone lines and five personal computers for every 1,000 people, compared with 650 phone lines and 540 computers in America. One in two Americans is online, compared with only one in 250 Africans.

Not only are developing countries less wired (see chart 18), but the Internet may cause the gap between rich and poor nations to widen further, worries Avinash Persaud, an economist at State Street Bank. He has three particular concerns. The first is that the "network externalities" helping first-movers to establish a dominant position will favour American giants, so that local firms in emerging economies will be frozen out of e-commerce. The second is that the shift in power from sellers to buyers which the Internet inevitably entails—the next supplier is never more than a mouse-click away—will harm poor countries. Since emerging economies, especially commodity producers, tend to come low down in the supply chain, he fears that their profit margins will be squeezed by rich-country firms. And lastly, Mr Persaud argues that high-tech shares in rich economies have offered investors a much more attractive combination of risk and return than emerging economies, so poorer countries will enjoy less inward investment than they might otherwise have done.

Each of these arguments has a grain of truth in it, but there are good reasons for hoping that many emerging economies could nevertheless gain even more from IT than the rich world. In rich economies, the only way to sustain rapid growth is to increase productivity by devising new technologies or better management methods. Poor countries, by contrast, start off with much less capital per worker. For example, in the mid-1990s the average amount of capital deployed per worker in Thailand was only one-eighth of that in America. So developing countries have huge scope to grow rapidly by buying rich countries’ technology and copying their production methods. This allows them to grow faster than developed economies, even if they start with fewer computers. As latecomers, poorer countries do not need to reinvent the wheel or the computer, but merely to open their economies to ideas from the rich world.

The key question, therefore, is how fast technology diffuses across borders to poorer economies, and the answer is cheerful. Computers, modern telecommunications and the Internet all reduce communications costs and break down geographical borders, so they are bound to speed up the global diffusion of knowledge. Previous technologies such as railways and electricity took decades to spread to developing countries, but IT is advancing in leaps and bounds. OECD figures show that IT spending in developing economies has been growing more than twice as fast as in developed ones over the past decade (though admittedly from a low base).

IT can even allow developing economies to leapfrog old technologies, for example, by skipping intermediate stages such as copper wires and analogue telephones. New wireless technologies require less fixed investment and maintenance than traditional wire-based ones, so they are more effective in countries with sparse populations and tricky terrain. Mobile phones can extend communications to areas that copper wires might have taken decades to reach, allowing remote villages to tap into the global store of knowledge.

The Internet offers virtually free access to a huge amount of information and expert advice on subjects from engineering and plant cultivation to birth control and health care. A single Internet connection can be shared by many, giving schools access to the world’s top libraries when they previously did not even have books. Distance learning gives students the chance to be taught by better teachers. The African Virtual University, which is partly financed by the World Bank, uses satellites to broadcast televised courses to students in 15 African countries, who communicate with teachers by e-mail, fax and telephone.

Another good thing about IT, from the emerging countries’ point of view, is that it reduces the optimal size of a firm in most industries. Firms in emerging economies are typically smaller than in rich countries, and the Internet, argues Andy Xie, an economist at Morgan Stanley in Hong Kong, allows such small firms to sell direct into global markets at lower cost. The Internet makes it possible for a tailor in Shanghai to hand-make a suit for a lawyer in Boston, then FedEx it to him. A women’s weaving co-operative in a remote village in Guyana is selling hammocks over the Internet for $1,000 each. Firms in Africa can now bid online for procurement contracts tendered by America’s General Electric.

Furthermore, by bringing down the cost of communicating with someone on the other side of the world, IT makes it easier for multinational firms to move production to emerging economies to take advantage of low labour costs, but ensure close contact with head office. That should help poorer countries to attract more foreign direct investment. IT also allows some previously untradable services to be traded just like physical goods. Any activity that can be conducted via a screen and telephone can be carried out anywhere in the world. Computer programming, airline revenue accounting, insurance claims and call centres have all been outsourced to developing economies.


But before we get carried away with rosy visions of IT bringing huge prosperity to emerging economies, some big caveats need to be added. There is nothing automatic about the process of economic catch-up. IT will certainly increase the opportunities for emerging economies to narrow the income gap with rich countries, but wiring the country is only the beginning. IT is not a panacea that allows governments to avoid doing all the hard stuff, such as opening up markets to foreign trade and investment, liberalising telecommunications, protecting property rights, improving education, and ensuring an effective legal system and efficient financial markets. Indeed, IT makes it even more important for governments to do all these basic things, because it increases the rewards for doing so. For example, open markets help to speed up technology transfer, and education increases a country’s ability to absorb knowledge. There is little point in spending millions of dollars connecting villages to the Internet if most people cannot even read and write.

Many developing countries, especially in Africa, are at a huge disadvantage so long as telecommunications services remain in the hands of an inefficient, state-controlled monopoly. Because of inadequate investment, waiting lists for telephones are long and charges have not fallen as fast as in the rich economies. Developing countries pay, on average, three times more than rich-country users to access the net. According to an UNCTAD study, 20 hours of access a month costs $90 in Mexico, equivalent to 15% of average income, compared with only $25 in America, a mere 1% of average income. In Africa, average access charges top $200 a month.

This suggests that although IT may help many emerging economies to catch up with the developed world, it will also lead to a further widening in economic performance within the developing world itself. Matti Pohjola, a Finnish economist, has analysed the relationship between IT investment and growth in 39 countries over the period 1980-95. He found that whereas IT investment appears to boost growth in developed economies, the same is not true in developing countries. It would seem that to reap the economic benefits from IT investment, developing countries need to put in place other policies as well.

The way not to do it is to throw a lot of public money at developing high-tech industries sheltered by trade barriers. When Brazil tried (unsuccessfully) to develop a national computer industry behind strong protectionist walls, it imposed huge costs on the whole economy: computer prices were much higher than they otherwise would have been because of import restrictions. The money would have been much better spent on increasing numbers at secondary school, which only one-third of Brazilian children attend at present. Likewise, Malaysia’s much-hyped Multimedia Supercorridor, which the government has built at vast expense to create an Asian Silicon Valley and lure foreign high-tech firms, does not really make sense. The comparative advantage of emerging economies lies in applying new technology developed in rich economies, not trying to invent it.

Bangalore in India is a popular—and misleading—example of how IT can affect emerging economies. It has a thriving software industry, thanks to English-speaking workers with good technical skills and low labour costs. Programmers are paid a quarter of what they would earn in America. Software exports have been growing by 50% a year, reaching almost $6 billion in 1999. But this is not a quick-fix, high-tech route to development. A few sophisticated Indians are creating a lot of wealth for themselves, increasing the gap between India’s rich and poor, but there have been few positive spillovers to the rest of the economy. Thanks to over-regulation and a lack of competition in the telecoms sector, which is only now being tackled, most Indians have no access to telephones or the Internet, and capacity bottlenecks mean that phone lines are often jammed. A better example of a low-income country that is wholeheartedly embracing IT is China, which has four times as many telephone lines and Internet users per 1,000 people as India, and 18 times as many mobile phones (see table 19).

The East Asian economies are likely to benefit more from IT than Africa or Latin America. Africa lacks many of the economic and legal institutions needed for a thriving information economy, and Latin America is well behind Asia on educational standards. East Asia has not only adopted many of the right policies to enable it to gain from the use of IT, but as a big manufacturer of IT equipment it could also do very well out of the global IT investment boom. Electronics account for one-third of the region’s exports.

Bernie Eschweiler, an economist at J.P. Morgan in Singapore, argues that the biggest gains from the Internet in Asia will be in services. Asian manufacturing is famously efficient, but many service industries, being tightly regulated and closed to competition, are surprisingly flabby. The Internet can help to change this by giving consumers more power.

American firms such as Wal-Mart and J.C. Penney insist that suppliers abroad deal with them over the net, which has forced their Asian trade partners to take to e-commerce sooner rather than later. In Thailand, all importers and exporters have to be online because the government has passed a law requiring all trade documentation to be provided on the web.

South Korea has embraced the Internet more fervently than most. By next year, 20m of its 48m people are expected to be wired. South Korea has the foundations of a knowledge-based economy, with higher investment in education as a proportion of GDP than in many developed economies. But a knowledge-based economy also needs a more competitive environment that provides incentives for the efficient use of knowledge. The government is using the web as a way of forcing change within South Korea’s economy. It has ordered all state-owned firms to make 50% of their purchases online by 2001. All government procurement will be on the net by 2002. The hope is that increased transparency and open competition will help to transform the country’s traditional cosy and opaque business relations. B2B e-commerce will break the links between the chaebol (conglomerates) and their suppliers, and so help to loosen the stranglehold of the chaebol on the economy.

Sun Bae Kim, an economist at Goldman Sachs in Hong Kong, reckons that over the next decade the efficiency gains from IT and e-commerce will be bigger in emerging Asia than in the rich economies. Goldman Sachs has tried to estimate the size of these gains. In addition to the direct savings in procurement costs from B2B e-commerce, the bank has attempted, more ambitiously, to estimate the spillover benefits of IT in reducing barriers to competition and eliminating inefficiencies in the supply chain.

Mr Kim suggests that the effects of the Internet will be similar to those of an economy opening up to trade. Economic studies suggest that a one-percentage-point increase in trade as a share of GDP boosts the level of productivity by 0.5-2%. Making the brave assumption that opening up an economy to e-commerce will give a similar spur to productivity, and adding in the direct cost savings from procurement, the bank estimates that over time the Internet will boost the level of GDP by amounts ranging from 5% in Indonesia to an impressive 12% in Singapore. This gain will be spread over a couple of decades, so annual growth rates might increase by between 0.2% and 0.8% over the next ten years.

The Internet can help developing countries catch up with developed ones, so lack of access will clearly prejudice their growth prospects. But the same might have been said about any previous technology, from telephones to electricity. Developing countries may have fewer computers and Internet connections than the rich economies, but it does not automatically follow that they will grow more slowly. Fears that the "digital divide" will widen the income gap between rich and poor countries are exaggerated. Indeed, perhaps the biggest risk is that governments, businesses and aid agencies in emerging economies will get distracted by the Internet and concentrate all their efforts on getting wired, but fail to tackle deeper economic obstacles to development.

The Internet will assist development, but it is not a magic drug for growth. Opening markets, breaking up telecoms monopolies and improving education are all far more important concerns. Those economies that get left behind should blame themselves, not technology.

consultado dic.8 de 2000


The beginning of a great adventure

Sep 21st 2000

From The Economist print edition

Globalisation and information technology were made for each other

THIS survey has outlined many common fallacies about the new economy. The new-economy fanatics, who believe that the economic benefits of the Internet will be far bigger than those of any previous technological revolution, have been shown to be just as misguided as the sceptics who consider the IT revolution as nothing more than a stockmarket bubble. The economic benefits of IT are likely to be big, perhaps even as big as those from electricity, but not big enough to justify the current dizzy heights of share prices. Two other ideas—that the IT revolution is uniquely American, and that the information economy requires all the rules of economics to be rewritten—have also been knocked firmly on the head. But one more fallacy still needs to be deleted: the proposition that the information economy can thrive completely free of government interference.

It is true that IT brings the economy closer to the textbook model of perfect competition, but governments still retain an important role in ensuring that the opportunities offered by IT are fully exploited. Well-functioning markets for labour, products and capital are important, but on their own they are not enough. Investment in education, too, will be crucial, to ensure that the workforce is equipped for the information economy. America, in particular, needs to get moving on that. Governments also have a role to play in encouraging innovation. Studies suggest that the social return from R&D is at least twice as big as the private return because of spillover benefits to other firms. Companies may invest too little in research because they are unable to capture all the benefits, which suggests there is a case for government support for R&D, especially basic science research. The Internet may now be synonymous with free markets, but in the beginning it was itself the product of government funding. Yet government tax credits and research grants for R&D may not be enough.

Paul Romer argues that such subsidies increase the demand for scientists and engineers, but if the supply does not expand, the entire increase in spending may be squandered on higher pay instead of boosting innovation. In the long run higher pay should encourage more young people to study science and engineering, but the education system suffers from serious time-lags. In particular, it is notoriously bad at switching resources between university departments, because every head of department is determined to maintain the status quo.

Between the mid-1980s and mid-1990s, the number of degrees awarded in engineering, mathematics and computer sciences in America actually fell, despite the unfolding of the computer revolution. Mr Romer suggests that to increase the number of graduates in science and engineering, the government should spend some of the money it now uses to subsidise R&D on grants and fellowships that would boost the supply of scientists directly.


Keep it global

"I’m all for progress; it’s change I don’t like." Mark Twain’s words probably sum up the feelings of many of those who took to the streets of Seattle last year to protest against the meeting of the World Trade Organisation. Globalisation is an easier villain to blame than technology (the Internet, after all, helped the protesters to organise their demonstrations), but in reality IT and globalisation are closely related. By reducing the cost of information and communication, IT has helped to globalise production and capital markets. In turn, globalisation amplifies the economic gains from IT. Perhaps the most important role of governments in the information economy, therefore, is to keep markets open. A retreat from globalisation would seriously hurt the new economy, which needs the free flow of trade and capital to maximise the benefits of IT.

Today’s globalisation is not just the inevitable result of technological change; it is also driven by trade liberalisation, which could be reversed. In some ways the world economy at the start of the 20th century was just as globalised as it is now, but after the first world war governments imposed trade barriers and capital controls, so economies turned inwards.

Could globalisation be undone again? Not so easily, because it goes much deeper today than last time round. Many more economies are now part of the global market, and economies and multinationals are much more interconnected. A mobile phone might be designed in London and made in China from parts produced in Canada, America and Sweden, on the orders of a headquarters in Finland. A hundred years ago foreign investment by multinationals was much less important than it is now.

IT has itself encouraged faster growth in international trade, especially of products that are delivered over the net. Even if governments were to turn protectionist, trade in such products would be almost impossible to block. Thanks to IT, information is also much more global than it was a century ago. As consumers find out more about products on offer abroad, and discover the benefits of being part of the global economy, political pressure to open borders to trade is likely to intensify. It would therefore be far harder for globalisation to be reversed now. But it would not be out of the question.

The information-technology revolution has barely begun, but it is spreading fast. A century ago, technological innovations took decades to make their way around the world. Today, developing countries have almost immediate access to new knowledge, and the faster pace of diffusion of technology is itself boosting global growth. The economic benefits of electricity in the 1920s and 1930s were partly undermined by growing protectionism. That prompts the tantalising thought that IT, combined with the benefits of globalisation, might deliver even bigger economic gains to the world economy as a whole than electricity did all those years ago. A retreat into protectionism, on the other hand, would have bigger costs today than ever before in human history.


Sep 21st 2000
From The Economist print edition

The books and articles used are, where possible, grouped by topic, but many of them straddle several articles.


"Information Rules: A Strategic Guide to the Network Economy", by Carl Shapiro and Hal Varian, Harvard Business School Press, 1999.

"The New Paradigm", Federal Reserve Bank of Dallas, 1999 Annual Report.

"A New Economy? The Changing Role of Innovation and Information Technology in Growth", OECD 2000.

"OECD Information Technology Outlook, 2000".

"E-Commerce: Impacts and Policy Challenges", OECD Economic Outlook No. 67, June 2000.

"The Victorian Internet", by Tom Standage, Walker Publishing Company, 1998.

"Digital Economy 2000", US Department of Commerce, June 2000.

"Global Electronic Commerce: A Policy Primer" by Catherine Mann, Sue Eckert and Sarah Cleeland Knight, Institute for International Economics, 2000.

"An E-conomy?" By Stephen Cohen, Bradford DeLong and John Zysman, December 1999.

"Speculative Microeconomics for Tomorrow’s Economy", by Bradford DeLong and Michael Froomkin, 1999.

"Technology, the Internet and the New Global Economy", by Gavyn Davies, Martin Brookes and Neil Williams, Goldman Sachs Global Economics paper No. 39.

"UBS Warburg New Economic Perspectives", No. 1 and 2, by Andrew Cates and Walter Kemmsies.


"The Resurgence of Growth in the Late 1990s: Is Information Technology the Story?", by Stephen Oliner and Daniel Sichel, February 2000.

"Raising the Speed Limit: US Economic Growth in the Information Age", by Dale Jorgenson and Kevin Stiroh, May 2000.

"Does the ‘New Economy’ Measure up to the Great Inventions of the Past?", by Robert Gordon, May 2000.

"Knowledge, Technology and Economic Growth: Recent Evidence from OECDCountries", by Andrea Bassanini, Stefano Scarpetta and Ignazio Visco, OECD, May 2000.

"The Contribution of Information and Communication Technology to Output Growth: A Study of the G7 Countries", by Paul Schreyer, OECD STI working paper 2000/2.

"The Solow Productivity Paradox: What do Computers do to Productivity?", by Jack Triplett, Brookings Institution, 1998.

"Computing Productivity: Firm-Level Evidence", by Erik Brynjolfsson and Lorin Hitt, April 2000.

"Beyond Computation: Information Technology, Organizational Transformation and Business Performance", by Erik Brynjolfsson and Lorin Hitt, 2000. "Intangible Assets: How the Interaction of Computers and Organizational Structure Affects Stock Market Valuations", by Erik Brynjolfsson, Lorin Hitt and Shinkyu Yang.

"The Shocking Economic Effect of B2B", by Martin Brookes and Zaki Wahhaj, Goldman Sachs, February 2000.

"Digital Technology and the Productivity Paradox: After Ten Years, What Has Been Learned?", by Paul David, May 1999.

"Early Twentieth Century Productivity Growth Dynamics: An Inquiry into the Economic History of Our Ignorance", by Paul David and Gavin Wright, University of Oxford Discussion Papers in Economic and Social History, No.33, 1999.

"Increasing Returns and Long-Run Growth", by Paul Romer, Journal of Political Economy, 1986, vol.94, No 5.


"Productivity in the Services Sector", by Jack Triplett and Barry Bosworth, Brookings Institution, January 2000.

"The Right Stuff", by Michael Cox and Richard Alm, Adam Smith Institute, 1999.


"Irrational Exuberance", by Robert Shiller, Princeton University Press, 2000.

"Is the Internet Better than Electricity?", by Martin Brookes and Zaki Wahhaj, Goldman Sachs Global Economics Paper No. 49, July 2000.

"Technology, the New Economy and the US Long Wave Upturn", by Martin Barnes, The Bank Credit Analyst, July 2000.

"Corporate Sector Finance: a Ticking Time Bomb?", by Martin Barnes, The Bank Credit Analyst, June 2000.


"Technological Change, Computerization and the Wage Structure", by Lawrence Katz 1999.

"The Returns to Skill in the United States across the Twentieth Century", by Claudia Goldin and Lawrence Katz, NBER working paper No.7126, May 1999.

"Wages, Skills and Technology in the United States and Canada", by Kevin Murphy, Craig Riddell and Paul Romer, NBER working paper No. 6638, 1998.

"Changes in the Wage Structure and Earnings Inequality", by Lawrence Katz and David Autor, Handbook of Labour Economics, Volume 3, 1999.

"Wiring the Labour Market", by David Autor, Journal of Economic Perspectives, forthcoming.

"Should the Government Subsidise Supply or Demand in the Market for Scientists and Engineers?", by Paul Romer, NBER working paper 7723, June 2000.


"Rethinking Antitrust Policies for the New Economy", by Joel Klein, Berkeley New Economy Forum, University of California at Berkeley, May 2000.

"The New Wealth of Nations", remarks by Lawrence Summers, Hambrecht & Quist Technology conference, San Francisco, May 2000.


"Is there a "New Economy" and is it Coming to Europe?", by Jonas Eriksson and Martin Adahl, Bank of Sweden Economic Review, 1/2000.

"Challenging America’s New Economy Supremacy", by Paul Donovan, UBS Warburg New Economic Perspectives, No.3.


"Building Confidence: Electronic Commerce and Development", UNCTAD, 2000.

"Information Technology and Economic Growth: a Cross-Country Analysis", by Matti Pohjola, UNU World Institute for Development Economics Research, working paper No. 173.

"B2B Economic Impact: Latecomer’s Advantage", by Sun Bae Kim, Dominic Wilson, Dick Li and Adam Le Mesurier, Goldman Sachs Asia Pacific, 2000.

"Korea’s Transition to a Knowledge-Based Economy", World Bank-OECD Report, 2000.


"Globalisation and Growth in the Twentieth Century", by Nicholas Crafts, IMF working paper 00/44.

"Factors Driving Global Economic Integration", by Michael Mussa, Federal Reserve Bank of Kansas City symposium, August 2000.