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Before the 2000 Global Economic and Investment Outlook Conference, Carnegie Bosch
Institute, Pittsburgh, Pennsylvania
September 21, 1999

Is Information Technology the Key to Higher Productivity Growth in the United
States and Abroad?
The last few years have seen an explosion in the uses of information technology throughout
the American economy. At the same time, trend U.S. productivity growth appears to have
risen to its highest rate since the 1970s. Casual empiricism would suggest a connection-- that
the enormous investment in computer technology that has been going on for at least twenty
years has finally started to bear fruit. But although information technology is available, at
least in theory, to the whole world, the recent surge in productivity growth appears to have
been stronger in the United States than elsewhere, including the other industrialized
countries. This raises the interesting questions of what else besides simple availability is
needed to translate the promise of information technology into real productivity gains, and
whether--whatever it is--the United States has more of it?
These questions are impossible to answer with precision, so the purpose of my talk this
afternoon is to identify particular features of the American economy that might contribute to
an especially hospitable climate for translating the potential gains from information
technology into actual productivity growth.
I also want to be careful not to suggest that gains from the use of information technology can
safely be assumed to go on indefinitely at their recent pace. The recent technical advances
represent a continuation of a long string of fundamental leaps in technology that have
worked their way through the economic system over many years, boosting productivity
growth in the process, but how long a particular innovation has a beneficial effect on
productivity growth is difficult to say. That depends on the rate of investment in the
equipment that embodies the new technology, the rate at which the labor force is able to
acquire needed skills, and, of course, on the fundamental potential of the technology itself.
History demonstrates that the boost to productivity growth from a particular technological
advance is not unlimited and eventually will be fully exploited. Just as "trees do not grow to
the sky," so, too, increases in the rate of productivity growth from any given advance are not
without limits. One should be cautious in extrapolating from past trends.
What We Do Know
What we do know is that the use of information technology, at least in the United States, has
been growing by leaps and bounds. For example, personal and business Internet sites have
proliferated at an astounding rate, and a wide variety of tasks that used to require personto-person contact, such as making airline and other travel reservations and choosing and
ordering merchandise, can now be done via the Web. Search engines have cut the time

needed to track down a person or an item to a fraction of amount previously required,
clearly raising productivity. Improved communication and information flow are only part of
the story; increases in computing power also allow workers to complete a variety of tasks
more quickly.
Although it sometimes feels as if these changes are taking place at lightning speed, most of
us know that this is partly an illusion. Much of the basic technology has been around for
decades. In fact, as productivity growth slowed in the 1970s and continued to languish in the
1980s, many observers wondered whether the supposed benefits of cheaper and more
powerful computers would ever be realized. This highlights an important facet of the
innovation process: The benefits of a new technology are in no sense automatically
conferred on the economy but will show up only after the technology is widely adopted,
capital facilities are refitted and adapted to it, and workers learn to use it. For instance, Paul
David, a Stanford University economist, notes that electric motors did not boost productivity
growth appreciably until more than forty years after Edison installed the first dynamo in
Though a new technology typically will not be fully incorporated overnight, the speed of its
adoption can be faster or slower depending on the institutional and other features of the
economy. For information technology, the process of incorporation appears to be taking
place at a considerably faster rate in the United States than in other parts of the
industrialized world. For example, there are more than 23 million Internet hosts in the United
States--roughly one for every 11 people. Canada is second among the major industrial
economies with 1.6 million, one for every 19 people. In contrast, the ratios are about 1 to
128 people in France, and 1 to 174 people in Italy.
These statistics suggest that technology is being used more widely in the United States, but is
its use paying off? The answer appears to be "Yes." One pertinent piece of evidence is a
recent study of costs of managing cash flow in American versus European firms. The study
showed European costs to be roughly 30 percent above those of U.S. firms, largely because
of the slow adoption of information and other computer-based technologies. This is pertinent
because finance operations of this type are an essential activity in every firm.
If it is the case that the United States, at least at this juncture, is somewhat ahead of the rest
of the world in realizing the benefits of information technology, does this indicate that our
economy or society possess certain characteristics that are particularly conducive to rapid
diffusion of technical change? A recent study of innovation by the Agamus Consulting firm
provides some interesting insights. The United States placed second to the Netherlands out
of thirteen countries in a survey that asked companies to rate the "innovation climate" in
their home countries. A second and possibly more objective ranking, based on a measure of
innovative success developed by Agamus, placed the United States first. The most important
factor cited as conducive to innovation was the overall educational standard. Given various
cross-country comparisons of educational systems, I assume that this finding must be based
on our broad-based attainment of higher education.
Additional Possible Relevant Factors
I would like to suggest several other factors that might also make some difference. This is
not meant to be either a comprehensive or a definitive list. Instead, it is an attempt to
advance some hypotheses that might help to explain the recent dynamism of the American
economy compared with some of its major trading partners--in particular its link to
technological change--and to see to what extent the evidence supports them. The particular

features that I would like to discuss (not necessarily in order of importance) are corporate
governance and, especially, a focus on maximization of shareholder value as opposed to
other objectives; flexibility of labor markets and the willingness to accept high rates of labor
turnover; willingness on the part of labor to continue to invest in human capital over a
lifetime; the regulatory environment; and the friendliness of the institutional environment to
Corporate Governance
Clearly, the effectiveness of the system of corporate governance is important in overall
corporate performance. Adoption of new technology may require considerable effort and
short-term expense, and it is important that managers have the appropriate incentives to
search for improvements that reduce costs over the longer-term. In recent years, aggressive
cost-cutting in the United States has been linked to greater emphasis on maximization of
shareholder value and less on growth and diversification, which was more prominent in the
1970s and 1980s. This shift in perspective appears to have been driven, at least in part, by
the increasing dominance of large institutional investors in U.S. financial markets.
In the past, maximizing shareholder value had not been as widely embraced abroad,
although there are indications that views are changing. For instance, members of corporate
boards in Japanese companies often have been promoted from within, fostering control by
allied industrial concerns, family interests, banks and holding companies, which may be
more motivated by concerns other than maximizing shareholder value. In Europe, a reason
sometimes cited for the delay in the adoption of shareholder value as a motivating factor for
corporations is the greater involvement by the public sector in the economy, with a strong
emphasis on job preservation. Another important incentive for managers to maximize
shareholder value is pay-for-performance through avenues such as stock options. Although
now commonplace in the United States, such instruments were not legal in Germany and
Finland until 1998.
However, pressure for change clearly has started to emerge. Financial market liberalization
has increased the importance of equity and publicly traded debt as sources of finance.
Anecdotal reports suggest that the concept of maximization of shareholder value has been
gaining greater acceptance as firms turn more to stock and bond markets for financing and
as governments, particularly in Asia, have increased disclosure requirements. If the trend
continues and other countries move further toward the U.S. model, it will be interesting to
see whether improvements in productivity growth follow.
Labor Market Flexibility
Another factor that is often cited as a major element in the dynamism of the U.S. economy is
the extraordinary flexibility of our labor markets, especially in contrast to those of
continental European countries. Although much European regulation has been directed at
saving jobs, it can be argued, in fact, to have had the opposite effect in the aggregate, as
evidenced by the marked upward drift in continental European unemployment rates over the
past two to three decades. These jobless rates are now much higher than those in the United
States and the United Kingdom, which has also undergone a period of substantial labor
market deregulation. It is also noteworthy that the unemployment rate differential is
particularly large in younger age groups; youth unemployment rates were around 30 percent
in 1997 in France and Italy, for example. To the extent that younger people are likely to
have had more exposure to information technology in the educational process, this bias by
itself could potentially be an important obstacle to the incorporation of technology into

business processes. In addition, workers who are unemployed for long periods of time are
likely to see their technology skills deteriorate.
But why might regulations designed to protect jobs have such a perverse effect? The
evidence suggests that new technology often results in more growth in employment in
innovating industries. However, it also tends to shift demand from unskilled to more highly
skilled workers, potentially displacing unskilled workers in the process. Job protection
regulations that affect a firm's flexibility to recruit and dismiss workers can interfere with
this process, making it difficult both for newcomers to find jobs and for firms to adopt new
technologies. The inability to adjust hours flexibly through the use of overtime, part-time,
and temporary work may also stifle innovation. According to the European Car Assembly
Association, similar research projects take much longer to complete in Germany than in the
United States because of shorter working hours and less-flexible working conditions. As a
result, they argue that German automobile manufacturers are less able to exploit the shorter
product life cycles associated with more fashionable and high-tech cars.
It is axiomatic that in a truly flexible labor market everyone who wants a job can find
one--at some price. As technical change increases demand for skilled relative to unskilled
labor, the unskilled workers must acquire new skills, find new jobs at lower relative wages,
or become unemployed. OECD data suggest that the United States and Canada have been
more successful than the other industrialized countries in achieving these adjustments and,
therefore, in maintaining aggregate employment growth on a par with labor force growth in
the face of differential rates of job growth by occupations. White-collar, high-skilled
employment increased at a much faster rate than employment in the other categories in
nearly all cases in the G-7 countries over 1979-95. In the United States and Canada, whitecollar, low-skilled employment also rose at healthy rates, while blue-collar employment was
little changed. In contrast, blue-collar employment fell sharply in most of the other countries.
Human Capital
Of the three choices facing an unskilled worker in a fast-changing economy, acquiring new
skills--that is, increasing one's human capital--would seem, in general, to be preferable to
either taking a pay cut or becoming unemployed. To what extent do American workers take
advantage of such opportunities relative to the rest of world? Here the evidence is somewhat
mixed. The U.S. adult population has the highest rates of completion of upper secondary or
higher education of any of the major industrialized countries. However, educational
attainment rates are only part of the story, as skills need to be continually upgraded in a
world of rapid technical change. This does not suggest that educational attainment is
unimportant; in fact, there is a clear interaction between educational attainment and
continuing education, as more-highly-educated people are also more likely to participate in
continuing education.
Nevertheless, it is hard to make the case that the United States is ahead of other countries in
terms of participation in continuing education. In an OECD study of the role of continuing
education and employability, the rate of participation in these programs in the United States
was about average for the six countries in the sample. However, one noteworthy result was
that rates of participation in training programs were below average among the young but
above average among older workers in the United States. This suggests that American
workers tend to keep improving existing skills or acquiring new ones as they age to a greater
extent than do their counterparts in other countries.
Other Business Regulations

In addition to job protection legislation, other forms of business regulation may also have an
impact on the climate for innovation. A 1994 survey of more than 2000 European
companies by the Union of Industrial and Employers' Confederations of Europe found that
regulations made it more difficult to minimize costs, organize production in a flexible way,
reduce time to market, and reduce uncertainty. The incidence of product market regulation
is lower in the United States than in continental Europe. A cross-country comparison of
macroeconomic performance in terms of productivity growth and utilization of resources
with the OECD's index of the overall regulatory environment suggests that a country's
performance does improve as the regulatory environment becomes less restrictive. On a
micro level, differences in the regulatory regimes of the biotechnology industry in Europe
and the United States have been cited as playing an important role in explaining why U.S.
firms are ahead of European firms in important measures of innovation such as R&D
expenditures and patents. Surveys of the European biotechnology industry suggest that
regulatory restrictions tend to push product development toward existing technologies and
force firms to conduct research abroad, although I should note that it is also claimed that
American pharmaceutical companies are conducting an increasing amount of research
abroad as well because of regulatory obstacles at home.
In addition, regulatory regimes that promote competition foster innovation and diffusion of
technologies. According to an OECD study, the United States has policies that are effective
in preventing anti-competitive behavior, but Germany is not far behind. Why does a
more-competitive environment foster innovation? One hypothesis is that competition forces
firms to innovate and adopt new technologies and, therefore, it increases the speed of
diffusion of technology. In contrast, monopolists may have little incentive to innovate
because they already control most of the market. Competition will also tend to result in the
failure of unproductive businesses and facilitate the entry and success of more-innovative
ones. In addition, more heavily-regulated firms may be less motivated to choose an efficient
In recent years, industries such as telecommunications, transportation, electricity, and
banking have undergone privatization, deregulation, and increased competition in a number
of countries. In many cases, these reforms were in fact prompted by technological change,
which reduced large fixed costs and thus the scope for natural monopolies. Furthermore, in
some of these industries, there is evidence that the move toward a more liberalized
regulatory regime induced further innovation.
A good example is the telecommunications industry. Evidence on patents (one measure of
innovation) and measures of productivity suggests that those countries that have extensively
liberalized (such as Japan, the United Kingdom, Finland, and the United States) have
experienced greater innovation and larger gains in efficiency. Evidence from the
telecommunications industry also suggests that the technological diffusion rate is faster
under a more competitive regulatory regime. For instance, both growth in cellular phone
usage and the penetration rate for Internet hosts is much higher in more-competitive market
This is not to suggest that regulation is necessarily a bad thing. Regulations that protect
intellectual property rights reward those with creative ideas and therefore can act to
stimulate cost-reducing innovations. From a broader perspective, productivity growth is
obviously not society's only priority--worker health and safety, pollution control, and other
societal values are important as well. Although it has been argued that regulations requiring

mandated approaches to pollution reduction or worker safety tend to divert managerial
energies from pursuing cost-reducing innovations, studies have shown that some regulatory
changes can in fact enhance productivity by forcing a firm to develop new and
more-efficient production techniques. For example, the cotton dust standard mandated by
OSHA is claimed to have led to the adoption of new and more cost-effective technologies
utilized by the textile industry.
What I think this suggests is the need, as with so much in economics, to recognize trade-offs.
We should recognize the broad range of society's interests and continue to seek balance by
striving for regulation that serves well-defined purposes with minimal burden.
Other Institutional Features
Other institutional features are also important to the climate for innovation. For instance,
entrepreneurship is fostered by access of small firms to capital markets. A lack of breadth
and depth of financial institutions and markets can inhibit the financing of innovative
projects by small firms. Again, the United States appears to have an advantage in this regard
relative to Europe and Japan. In particular, venture capital markets here are both more
developed and more geared to financing higher-risk projects, mainly in technology-based
sectors by start-ups with prospects of rapid growth. Furthermore, the range of investors is
wide and includes pension funds, insurance companies, and even private individuals. In
contrast, in Europe, venture capital is geared toward more mainstream projects, and banks
dominate lending. In Japan, a venture capitalist is typically a subsidiary of a large financial
institution and invests mainly in established firms.
Obviously, the United States does not have a monopoly on technological advance. We
should not be smug nor complacent because certainly the U.S. experience will be adopted
and adapted by other countries. Although the United States arguably has led the way into the
information technology revolution, there is evidence that others are following. Scandinavia
in particular appears to be embracing computer-based technology; Sweden has begun to
market itself as Europe's "Silicon Valley."
Adoption of new technologies in the United States may also have been spurred in recent
years by the cyclical strength of the economy in combination with strong domestic and
international competitive pressures. With new workers increasingly difficult to hire in a tight
labor market, firms have an increased incentive to find new and more-efficient ways to use
existing labor resources. I might add that the current low inflation environment also helps
this process. In the presence of subdued inflation expectations, the first inclination of firms
in the face of rising demand for their output, thus far at least, appears not to have been to
raise prices but rather to find ways to expand output via more-efficient means of production.
It is clear that other countries, many of which are less far along in reaping the benefits
associated with the revolution in information technology, have the potential to gain more
over the period ahead. The extent to which they do realize these gains will depend on how
successful they are in adapting to their unique circumstances policies that foster efficiency
and competition in labor and product markets. I wish them well.

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