Wednesday, February 18, 2009

Contribution of Computers and Internet to Economic growth


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How come we see the computer revolution everywhere except in the [aggregate] productivity statistics?

- Robert M. Solow, Winner, 1987 Nobel Prize for Economics (Sveriges Riksbank Prize)

imageComputers, Internet and mobile phones have fundamentally changed our life the last 2 decades. We could do more efficient shopping, connect to a lot more people and be more productive at work. As an engineer who have been a part in developing an Operating system, a search engine and a social networking tool  - the three main products of this revolution, I feel they are great things to both build and to use. They make individuals much more productive looking at the micro level. However, looking from an economic point of view and see the Macro picture I’m bogged down with “Show me the money”. Economists of the 1980s and 90s have debated a lot about this and suggested that they may not have caused a lot of economic growth.  As this review shows, the economists of late 80s successfully argued that this paradox is due to “mismeasurement, lags, redistribution and mismanagement”.

However, over a long period of time you should see the effect in economic growth, as the indirect effect of the productivity increases reflect in the macro economy. And things have changed since the original “productivity paradox” came, as PCs came into the living room and internet connected the ordinary people to do their mundane stuff in networks originally designed to survive nuclear attacks.So in this decade, have the powerful PCs, Smartphones, Search engines, Facebook led an explosive economic growth? In reopening the debate and looking at the recent data, there still seems to be dismal evidence for the productivity growth from the modern revolution. It is possible that the economy might have reached a saturation as a $10 trillion economy cannot continue to be sprinting like a $1 trillion economy, but still 1.7% annual growth in per-capita income since WWW came seems less. There might be other small causes too. The article concludes with what might be a possible cause for this.


GDP growth in the last decade

Here is the annual GDP growth since the War. We see some big spikes in the 1950s, 60s and the 70s, but the growth since the 1990s has been pretty muted, inspite of all the hype of the late 1990s.


Let me take two sample years 1995-2007 to compute the range. 1995 is year of the Windows 95 (that brought PCs to common people), Yahoo (the first search engine), Java (the language that will become the foundation of the web for the next few years) and of Netscape that brought the world of Internet to a lot of people. The next year Hotmail came in and brought email access to everybody. So, 1995 is the pretty much the start of the revolution. And, 1995 was in the start of a massive boom and 2007 was at the peak of another boom – so we should be seeing some real super growth in the period.

According to BEA statistics the GDP (chained 2000 dollars) has grown from $8.03b to about $11.6b a 45% growth in 12 years from 1995. Well that might sound great till we see the Census stats that says the population has grown from 261 million to about  303 million now.  So, the GDP per-capita has effectively grown only 24% in this time -  growth rate about 1.7%/year. Not bad, but definitely not close to an explosion.

Contribution to GDP:

Now, how much of the growth is really caused from the real productivity growth. There were four other parallel forces that contributed to the growth.

1. Globalization – with the rise of China, India and other countries, US had access to cheap capital, labor and goods. They consumed a lot of American goods and services and gave in return a lot of cheap goods that US retailers used to sell the customers and generate jobs. Thus, there was a lot of growth from personal consumption.

2. Financial “Innovation” – Wall street created a phantom growth over the last decade as it played with ever more greater financial tools. This produced rich profits for the financial companies, cheaper credit for corporations and individuals, and increased the leverage.  All these directly fed into the GDP. Well, this doesn’t last long but still contributed to the growth over that period. OECD research shows that this growth contribution could be more than 1%/year.

3. Government expenditure – US government had embarked on a substantial spending program since the start of this decade (duh) with the war in Afghanistan and Pakistan, leading to a spurt in the government component of GDP growth. The spending on homeland security has given a lot of work to defense manufacturers, and the tax cuts introduced by Bush had contributed to economic growth. All these came at the back of heavy national debt notwithstanding, for the temporary period we saw some growth.

And last but not the least:

4. Housing markets – Well, Americans spent a lot on housing between 1995-2007 will be the world’s biggest understatement. Because that is a kind of spending that has put the world in this peril. They built ever greater McMansions [Massive homes that become kind of commodity at the hands of common people], decorated it with expensive toys and spent on all the related stuff, giving jobs to millions of people. People also used their homes like ATM machines and drew money to buy all sorts of stuff. BEA statistics show that over 1% of growth per year in this period could be attributed to increasing housing spending.


Now, out of a 1.7% annual growth in the economy, we have financial sector, globalization, increased government spending and housing growth all could have contributed to growth upwards of 1% each per year, that must be subtracted from the overall growth. So where do we see the explosive growth from Computer and the Internet? As the snippet below shows, the effect of computers and information systems might have even contributed a small negative growth to the economy since 1995.


That sounds incredible to me, but that is what I see from the facts, and fits in the picture given the growth contributors above. Thus, I have to conclude that the computers, internet and social revolution might cause a long term productivity growth, but we have not seen that yet.

Where did all the time go?

Well, computers really save us the time and that cannot be denied. So, if it doesn’t go to economic growth, where does it really go? One possible explanation is people are spending more leisure time. In fact, according to this research from the Federal Reserve of Boston Americans spend 6-8 hours more than they did in the 1960s and according to this research from TNS Market Research more than a third of it is spent online.




Charts courtesy of: Measuring Trends in Leisure, written by Mark Aguiar and Erik Hurst


Chart from the “The Productivity of Information Technology”

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