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1 the Productivity Paradox: Information Technology THE PRODUCTIVITY PARADOX: INFORMATION TECHNOLOGY AND PRODUCTIVITY by JAN VILJOEN DUVENAGE submitted in fulfilment of the requirements for the degree of MASTER OF COMMERCE in the subject ECONOMICS at the UNIVERSITY OF SOUTH AFRICA SUPERVISOR: DR JLW DE JAGER JOINT SUPERVISOR: PROF D HODGE NOVEMBER 2008 1 TABLE OF CONTENTS ACKNOWLEDGEMENTS 7 ABBREVIATIONS 8 SYMBOLS 9 1. CHAPTER 1: PRODUCTIVITY, THE PRODUCTIVITY SLOWDOWN AND THE PRODUCTIVITY PARADOX 10 1.1. Overview 10 1.2. Notes on some of the conventions used in the dissertation 11 1.3. A note on productivity and other statistics 11 1.4. A note on productivity growth rates and productivity levels 12 1.5. The importance of productivity 12 1.6. The 1973 productivity growth slowdown 17 1.7. Solow and the productivity paradox 19 1.8. The productivity paradox and computerisation 22 1.9. The 1995 productivity growth recovery and Solow’s ostensible retraction 23 1.10. Concluding remarks 25 2. CHAPTER 2: PRODUCTIVITY AND TECHNICAL CHANGE 27 2.1. Overview 27 2.2. Productivity measurement in the neoclassical framework 27 2.3. Growth accounting and the aggregate production function 29 2.4. Primal and dual approaches to productivity measurement 31 2.5. The production function and productivity 31 2.6. The basic growth accounting formula 31 2.7. Measurement of output and input 32 2.8. The Cobb-Douglas production function and productivity 33 2.9. Returns to scale 34 2.10. Elasticity of substitution 35 2.11. Factor income shares and the distribution of the product 35 2.12. Labour productivity, capital deepening and multifactor productivity 37 2.13. The translog production function 39 2.14. Forms of technical change 40 2.15. Disembodied technical change 40 2.16. Embodied technical change: technical change embodied in new investment 41 2 2.17. Neutrality of disembodied technical change 42 2.18. Harrod-neutral technical progress 43 2.19. Solow-neutral technical progress 43 2.20. Hicks-neutral technical progress 44 2.21. Conclusion 44 3. CHAPTER 3: INDEX NUMBERS AND PRODUCTIVITY 46 3.1. Overview 46 3.2. The economic theory of index numbers 46 3.3. Index numbers: a special kind of average 47 3.4. The index number problem 48 3.5. Index number bias 48 3.6. Overview of index numbers 50 3.6.1. The Laspeyres index 50 3.6.2. The Paasche index 51 3.6.3. The Fisher ideal index 51 3.6.4. The Törnqvist index 51 3.6.5. Fixed-weight indexes 52 3.6.6. Ideal, exact and superlative indexes 52 3.6.7. Chain indexes 53 3.6.8. The Divisia index 54 3.6.9. Malmquist index 54 3.7. Hedonic indexes 54 3.8. Indexes and quality change 57 3.9. Indexes and the introduction of new products 58 3.10. Hedonic indexes and ICT 58 3.11. Software, quality changes and measurement 60 3.12. Conclusion 61 4. CHAPTER 4: PRODUCTIVITY AND COMPUTERISATION IN THE NATIONAL INCOME AND PRODUCT ACCOUNTS 62 4.1. Overview 62 4.2. Revisions of the NIPAs and productivity measures 62 4.3. Productivity definitions in the US and other OECD national accounts 63 4.4. The Cobb-Douglas function and the NIPAs 63 4.5. Labour productivity 65 4.6. Multifactor productivity 66 4.7. Unit labour costs 66 4.8. LP and MFP: general issues 67 4.9. Factor income shares in the NIPAs 67 4.10. Sectors and subsectors in productivity measurement 68 3 4.11. Data sources and procedures used in the US productivity measurements 70 4.11.1. The statistical agencies: BLS and the BEA 70 4.11.2. The BLS and labour productivity 71 4.11.3. The BLS and multifactor productivity 72 4.11.4. The BLS and KLEMS 72 4.12. Computers in the NIPAs 72 4.13. ICT and capital flow tables 73 4.14. Productivity growth trends in the USA from 1948 to 2002 76 4.15. Conclusion 80 5. CHAPTER 5: ECONOMICS OF INFORMATION TECHNOLOGY 81 5.1. Overview 81 5.2. Highlights of computing history 81 5.3. Moore’s law and semiconductor prices 83 5.4. “Three faces of IT value” 84 5.5. Computers and economic growth 86 5.6. Accounting for the contribution of computing services to output 87 5.7. Computer-using and computer-producing industries 91 5.8. Spillover effects 91 5.9. Aggregate, industry and firm level studies 92 5.10. Computers and the services sector 93 5.11. Productivity, technical change and the “residual” 99 5.12. Diminishing returns 100 5.13. Declining prices and rising investment 101 5.14. Software reclassified 105 5.15. The internet and the “new economy” 106 5.16. Conclusion 109 6. CHAPTER 6: MAJOR EXPLANATIONS OF THE PRODUCTIVITY PARADOX 110 6.1. Overview 110 6.2. Principal explanations of the productivity paradox 110 6.3. The philosophical hypothesis 112 6.4. The Cambridge Controversy 113 6.5. The Cobb-Douglas production function 115 6.6. What does total factor productivity measure? 116 6.7. The mismeasurement hypothesis 116 6.8. Measurement of quality change 117 6.9. Quality change and hedonic methods 119 6.10. Intangible capital 121 4 6.11. Problems with index numbers 123 6.12. Factor income shares 124 6.13. ICT and the services sector 125 6.14. Mismeasurement of output 126 6.15. Neoclassical framework 127 6.16. Intermediate products 128 6.17. Gross versus net measures of output 129 6.18. Mismeasurement of input 133 6.19. Primal versus dual measures 133 6.20. Inflation and the understatement of productivity 134 6.21. Conclusion 136 7. CHAPTER 7: OTHER EXPLANATIONS OF THE PRODUCTIVITY PARADOX 138 7.1. Overview 138 7.2. The general purpose technology hypothesis 138 7.3. The mismanagement hypothesis 142 7.4. Computerisation and input substitution 143 7.5. The sceptical hypothesis 144 7.6. Explanations of the productivity slowdown 146 7.7. Solow’s later responses to the computer productivity paradox 147 7.8. Counterfactual research: the world without computers 148 7.9. Conclusion 149 7.10. Appendix - “If General Motors were like Microsoft” (2004) 150 8. CHAPTER 8: CONCLUSION 152 8.1. Overview 152 8.2. Productivity trends before 1973 and after 1995 152 8.3. The study of the Solow computer paradox 154 8.4. Productivity and technical change 156 8.5. Productivity measurement 156 8.6. Official data 157 8.7. Economic aspects of ICT 157 8.8. Explanations of the paradox 159 8.9. Final remarks 161 BIBLIOGRAPHY 163 5 LIST OF TABLES AND FIGURES Table 1.1: Per capita GDP growth (%) 18 Table 1.2: Productivity growth trends: 1870 to 2003 25 Table 3.1: A fictitious economy: the national accounts 49 Table 3.2: A fictitious economy (contd.): real growth rates 50 Table 3.3: Hedonic inventory: NIPA prices that reflect hedonic techniques 56 Table 4.1. Main productivity measures 65 Table 4.2: National income by type of income: labour and profit shares in 2001 68 Table 4.3: Derivation of the private business sector 69 Table 4.4: Availability of productivity measures of major sectors and subsectors 71 Figure 4.1: Final sales of computers: nominal and chained dollars 73 Figure 4.2: Private fixed investment in computers, software and communication 74 Table 4.5: I-O commodity composition for computers 75 Table 4.6: Top 10 ICT-intensive industries ranked by 1997 ICT share in total equipment and software investment 76 Figure 4.3: Labour productivity growth trends, private nonfarm business sector (1948 to 2002) (% change) 77 Figure 4.4: Multifactor productivity growth trends, private nonfarm business sector (1948 to 2002) (% change) 78 Table 4.7: Productivity growth trends, private nonfarm business (1948 to 2002) 79 Figure 5.1: Falling prices of memory chips and microprocessors 84 Table 5.1: “Three faces of IT value” 85 Table 5.2: Sources of GDP growth (annual average percentage growth rates) 90 Table 5.3: “Dividing output”: nonresidential business GNP (1982) 96 Figure 5.2: Asymptotically stagnant activities: a simulation 98 Table 5.4: Business purchases of computers (inflation adjusted) 101 Figure 5.3: Declining computer hardware and software prices 103 Figure 5.4: Supply and demand for computers: a conceptual view 104 Table 5.5: Estimates of the internet economy (1998) 108 Table 6.1: Classification of measurement error candidates 111 Table 6.2: GDP and NDP growth and depreciation in 16 OECD countries 131 Table 6.3: US productivity growth 132 Table 6.4: Boskin Commission estimates of biases in CPI 135 Table 7.1: Accounting for growth during the British Industrial Revolution 140 Figure 8.1: Long-run MFP trends: Gordon’s “one big wave” 153 Figure 8.2: Productivity growth trends and IT investment from 1959 to 2002 and the Solow computer paradox 155 Figure 8.3: ICT stock as a percentage of equipment stock 159 6 ACKNOWLEDGEMENTS I wish to acknowledge the support and encouragement I received from my supervisors, family, colleagues and friends. Jan Duvenage November 2008 7 ABBREVIATIONS BEA US Bureau of Economic Analysis BLS US Bureau of Labor Statistics CFT Capital flow tables CPI Consumer price index DOC US Department of Commerce GDP Gross Domestic Product GNP Gross National Product IP Information processing - as in “IP equipment and software” IT Information technology; also ITC ICT Information and communication technology; also IT JEL Journal of Economic Literature K Quantity of capital KLEMS Capital (K), labour (L), energy (E), intermediate inputs (M) L Quantity of labour LP Labour productivity MFP Multifactor productivity; see TFP NIPA National income and product accounts NDP Net domestic product NNP Net national product NRC National Research Council (US) OECD Organisation for Economic Cooperation and Development PC Personal computer Q Output; see Y R&D Research and development SNA System of National Accounts 8 SCB Survey of Current Business, DOC TCP/IP Transmission control protocol/internet protocol TFP Total factor productivity; see MFP Y Output (Y rather than Q is used when output is the same as Income) Y2K Year 2000 computer bug; or the Millennium bug USA United States of America WWW World wide web SYMBOLS α share of capital in total output β share of labour in total output 9 1.
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