MEASURING AND SUSTAINING THE NEW ECONOMY

Report of a Workshop

DALE W. JORGENSON AND CHARLES W. WESSNER, EDITORS

Board on Science, Technology, and Economic Policy

Policy and Global Affairs

National Research Council

NATIONAL ACADEMY PRESS
Washington, D.C.



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Measuring and Sustaining the New Economy: Report of a Workshop MEASURING AND SUSTAINING THE NEW ECONOMY Report of a Workshop DALE W. JORGENSON AND CHARLES W. WESSNER, EDITORS Board on Science, Technology, and Economic Policy Policy and Global Affairs National Research Council NATIONAL ACADEMY PRESS Washington, D.C.

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Measuring and Sustaining the New Economy: Report of a Workshop NATIONAL ACADEMY PRESS 2101 Constitution Avenue, N.W. Washington, D.C. 20418 NOTICE: The project that is the subject of this report was approved by the Governing Board of the National Research Council, whose members are drawn from the councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The members of the committee responsible for the report were chosen for their special competences and with regard for appropriate balance. This report has been reviewed by a group other than the authors according to procedures approved by a Report Review Committee consisting of members of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the organizations or agencies that provided support for the project. International Standard Book Number: 0-309-08298-6 Limited copies are available from: Board on Science, Technology, and Economic Policy National Research Council 1055 Thomas Jefferson Street, N.W. Washington, D.C. 20007 202-334-2200 Additional copies are available for sale from: National Academy Press Box 285 2101 Constitution Ave., N.W. Washington, D.C. 20055 800-624-6242 202-334-3313 (in the Washington Metropolitan Area) Internet: http://www.nap.edu Copyright 2002 by the National Academy of Sciences. All rights reserved. Printed in the United States of America

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Measuring and Sustaining the New Economy: Report of a Workshop THE NATIONAL ACADEMIES National Academy of Sciences National Academy of Engineering Institute of Medicine National Research Council The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. Upon the authority of the charter granted to it by the Congress in 1863, the Academy has a mandate that requires it to advise the federal government on scientific and technical matters. Dr. Bruce M. Alberts is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of outstanding engineers. It is autonomous in its administration and in the selection of its members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages education and research, and recognizes the superior achievements of engineers. Dr. Wm. A. Wulf is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The Institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Kenneth I. Shine is president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad community of science and technology with the Academy’s purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the Council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the government, the public, and the scientific and engineering communities. The Council is administered jointly by both Academies and the Institute of Medicine. Dr. Bruce M. Alberts and Dr. Wm. A. Wulf are chairman and vice chairman, respectively, of the National Research Council.

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Measuring and Sustaining the New Economy: Report of a Workshop Steering Committee for Measuring and Sustaining the New Economy* Dale Jorgenson, Chair Frederic Eaton Abbe Professor of Economics Harvard University M. Kathy Behrens Managing Partner Robertson, Stephens Investment Management Vinton G. Cerf Senior Vice President WorldCom Kenneth Flamm Dean Rusk Chair in International Affairs LBJ School of Public Affairs University of Texas at Austin Bronwyn Hall Professor of Economics University of California at Berkeley James Heckman Henry Schultz Distinguished Professor of Economics University of Chicago Ralph Landau Consulting Professor of Economics Stanford University William J. Spencer, Vice Chair Chairman Emeritus SEMATECH Richard Levin President Yale University David T. Morgenthaler Founding Partner Morgenthaler Mark B. Myers Senior Vice President, retired Xerox Corporation Roger Noll Morris M. Doyle Centennial Professor of Economics Stanford University Edward E. Penhoet Dean, School of Public Health University of California at Berkeley William Raduchel Chief Technology Officer AOL Time Warner Alan Wm. Wolff Managing Partner Dewey Ballantine *   As of December 2001.

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Measuring and Sustaining the New Economy: Report of a Workshop Project Staff* Charles W. Wessner Study Director Alan H. Anderson Consultant Adam K. Korobow Consultant Sujai J. Shivakumar Program Officer McAlister T. Clabaugh Program Associate David E. Dierksheide Program Associate Christopher S. Hayter Program Associate *   As of December 2001.

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Measuring and Sustaining the New Economy: Report of a Workshop For the National Research Council (NRC), this project was overseen by the Board on Science, Technology and Economic Policy (STEP), a standing board of the NRC established by the National Academies of Sciences and Engineering and the Institute of Medicine in 1991. The mandate of the STEP Board is to integrate understanding of scientific, technological, and economic elements in the formulation of national policies to promote the economic well-being of the United States. A distinctive characteristic of STEP’s approach is its frequent interactions with public and private-sector decision makers. STEP bridges the disciplines of business management, engineering, economics, and the social sciences to bring diverse expertise to bear on pressing public policy questions. The members of the STEP Board* and the NRC staff are listed below: Dale Jorgenson, Chair Frederic Eaton Abbe Professor of Economics Harvard University M. Kathy Behrens Managing Partner Robertson, Stephens Investment Management Vinton G. Cerf Senior Vice President WorldCom Bronwyn Hall Professor of Economics University of California at Berkeley James Heckman Henry Schultz Distinguished Professor of Economics University of Chicago Ralph Landau Consulting Professor of Economics Stanford University Richard Levin President Yale University William J. Spencer, Vice Chair Chairman Emeritus SEMATECH David T. Morgenthaler Founding Partner Morgenthaler Mark B. Myers Senior Vice President, retired Xerox Corporation Roger Noll Morris M. Doyle Centennial Professor of Economics Stanford University Edward E. Penhoet Dean, School of Public Health University of California at Berkeley William Raduchel Chief Technology Officer AOL Time Warner Alan Wm. Wolff Managing Partner Dewey Ballantine *   As of December 2001.

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Measuring and Sustaining the New Economy: Report of a Workshop STEP Staff* Stephen A. Merrill Executive Director Philip Aspden Senior Program Officer McAlister T. Clabaugh Program Associate Camille M. Collett Program Associate David E. Dierksheide Program Associate Charles W. Wessner Program Director Christopher S. Hayter Program Associate Adam K. Korobow Consultant Sujai J. Shivakumar Program Officer Craig M. Schultz Research Associate *   As of December 2001.

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Measuring and Sustaining the New Economy: Report of a Workshop National Research Council Board on Science, Technology, and Economic Policy Sponsors The National Research Council gratefully acknowledges the support of the following sponsors: National Aeronautics and Space Administration Department of Energy National Institute of Standards and Technology Sandia National Laboratories Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the authors and do not necessarily reflect the views of the project sponsors.

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Measuring and Sustaining the New Economy: Report of a Workshop Contents PREFACE   xiii I. EXECUTIVE SUMMARY   3 II. INTRODUCTION   9 III. PROCEEDINGS         Introduction Bill Spencer, International SEMATECH   31     Welcome to the New Economy Vint Cerf, WorldCom   32 Panel I:   Defining and Measuring the New Economy Moderator: Robert Shapiro, U.S. Department of Commerce   44     Raising the Speed Limit: U.S. Economic Growth in the Information Age Dale Jorgenson, Harvard University   50 Panel II:   Drivers of the New Economy Moderator: Ralph Gomory, Alfred P. Sloan Foundation   60     Semiconductors: The Arrival of the New Economy Bill Spencer, International SEMATECH   62

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Measuring and Sustaining the New Economy: Report of a Workshop     Semiconductors: Economics of the New Economy David Mowery, University of California at Berkeley   69     Microprocessors and Computers: Five Trends Alan Ganek, IBM   74     Microprocessors and Computers: The Phenomenon of Price Declines Ken Flamm, University of Texas at Austin   82 Panel III:   Communications and Software Moderator: Robert Borchers, National Science Foundation   89     Communications Alfred Aho, Lucent Technologies   90     Software: The Challenge to Getting There Daniel T. Ling, Microsoft   95 Panel IV:   Applications and Policy Issues Moderator: Bill Raduchel, AOL Time Warner   100     Communications Shane Greenstein, Northwestern University   101     Economic Issues of E-Business Erik Brynjolfsson, MIT/Sloan School of Management   105     E-Business Policy Issues Elliot Maxwell, Department of Commerce   111     Investments in Information Technology Applications Tim Bresnahan, Stanford University   115     Old Business to E-Business: The Change Dynamic Sid Abrams, AT Kearney   119 Panel V:   Roundtable Discussion Moderator: Dale Jorgenson, Harvard University Bill Raduchel, AOL Time Warner Ralph Gomory, Alfred P. Sloan Foundation Lee Price, Department of Commerce   124

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Measuring and Sustaining the New Economy: Report of a Workshop IV. APPENDICES     A.   Raising the Speed Limit: U.S. Economic Growth in the Information Age Dale W. Jorgenson, Harvard University, and Kevin J. Stiroh, Federal Reserve Bank of New York   137 B.   Biographies of Speakers   223 C.   Participants List   239 D.   Bibliography   243

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Measuring and Sustaining the New Economy: Report of a Workshop Preface The decade of the 1990s witnessed rapid technological change in communications, computing, and information management. This phenomenon coincided with the sustained expansion of the U.S. economy through much of the 1990s.1 Along with other structural and policy explanations this technological change is a key element in the strong growth in labor productivity, especially after 1995. The term “New Economy” captures the role that these new technologies are thought to play in contributing to the non-inflationary growth and high employment that characterized this period. Although the New Economy is, itself, a macro phenomenon, its underlying dynamics appear to combine elements of technological innovation, structural change, and public policy. Technological innovation—more accurately, the rapid rate of technological innovation in information technology (including computers, software, and telecommunications) and the rapid growth of the Internet—are seen by some as underpinning the productivity gains that characterize the New Economy. These productivity gains derive from greater efficiencies in the production of computers from expanded use of information technologies.2 1   See Jorgenson, Dale and Kevin Stiroh. 2000. “Raising the Speed Limit: U.S. Economic Growth in the Information Age” Brookings Papers on Economic Activity; 0(1), pp. 125-211. This paper is reproduced in this volume. 2   See, for example, Stephen Oliner and Daniel Sichel. 2000. “The Resurgence of Growth in the late 1990’s: Is Information Technology the Story?” Journal of Economic Perspectives 14(4) Fall. Oliner and Sichel estimate that improvements in the computer industry’s own productive processes account for about a quarter of the overall productivity increase. They also note that the use of information technology by all sorts of companies accounts for nearly half the rise in productivity.

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Measuring and Sustaining the New Economy: Report of a Workshop Many therefore believe that the New Economy is closely linked to the unprecedented rate of technological innovation characteristic of information technology industries.3 Structural changes arise from a reconfiguration of knowledge networks and business patterns made possible by innovations in information technology. Phenomena, such as business-to-business e-commerce and Internet retailing, are altering how firms and individuals interact, enabling greater efficiency in purchases, production processes, and inventory management.4 These structural changes are still emerging as the use and applications of the Internet continue to evolve. Public policy plays a major role at several levels. This includes the government’s role in fostering rules of interaction within the Internet5 and its discretion in setting and enforcing the rules by which technology firms, among others, compete.6 More familiarly, public policy concerns particular fiscal and regulatory choices that can affect the rate and focus of investments in sectors such as telecommunications. The government also plays a critical role within the innovation system.7 It provides national research capacities,8 incentives to promote education and training in critical disciplines, and funds most of the nation’s basic research.9 The government also plays a major role in stimulating innovation, most 3   See Alan Greenspan’s remarks before the White House Conference on the New Economy, Washington, D.C., April 5, 2000. <www.federalreserve.gov/BOARDDOCS/SPEECHES/2000/20000405.HTM>. For a historical perspective, see the Proceedings below. Ken Flamm compares the economic impact of semiconductors today with the impact of railroads in the nineteenth century. 4   See, for example, Brookes Martin and Zaki Wahhaj. 2000. “The Shocking Economic Impact of B2B,” Global Economic Paper, 37, Goldman Sachs, February 3. 5   Dr. Vint Cerf notes, in the Proceedings, that the ability of individuals to interact in potentially useful ways within the infrastructure of the still expanding Internet rests on its basic rule architecture: “The reason it can function is that all the networks use the same set of protocols. An important point is these networks are run by different administrations, which must collaborate both technically and economically on a global scale.” Also in the Proceedings, see the presentation by Dr. Shane Greenstein on the evolution of the Internet from academic and government-related applications to the commercial world. 6   The relevance of competition policy to the New Economy is manifested by the intensity of interest in the antitrust case, United States versus Microsoft, and associated policy issues. 7   See Richard Nelson, ed. 1993. National Innovation Systems, New York: Oxford University Press. 8   The STEP Board has underway a major review of the role and operation of government-industry partnerships for the development of new technologies. Major recent publications include National Research Council, Charles W. Wessner, ed. 2001. The Advanced Technology Program—Assessing Outcomes, Washington, D.C.: National Academy Press, and National Research Council. 2000. SBIR— An Assessment of the Department of Defense Fast Track Initiative, Washington D.C.: National Academy Press. 9   National Research Council. 2001. Trends in Federal Support of Research in Graduate Education, Washington, D.C.: National Academy Press.

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Measuring and Sustaining the New Economy: Report of a Workshop Box A: The New Economy Enigma “How can it be that the recent surge in investment in computers, and the great efforts most companies are making to get the most out of the Internet and other new technologies, are failing to have a marked effect, or indeed any cyclically adjusted effect, on America’s service and non-durable manufacturing industries? One possibility is that the output of these industries is not being properly measured. Measuring the output of service industries is notoriously difficult; so is measuring the inputs of the high-tech capital that many such industries use intensively. Maybe investment and production of final goods and services have both been understated. If so, the performance of the American economy would be much better than the figures seem to suggest, and perhaps even as good as most people appear to think.” The Economist , “Performing Miracles,” June 15, 2000 broadly through the patent system.10 Government procurement and awards also encourage the development of new technologies to fulfill national missions in defense, health, and the environment.11 Collectively, these public policies play a central role in the development of the New Economy. Sustaining this New Economy will require public policy to remain relevant to the rapid technological and structural changes that characterize it. Data on the New Economy is a key input in the policy-making process. Yet, current statistics do not fully capture changes in productivity and growth brought about by recent applications of information technologies.12 10   In addition to government-funded research, intellectual property protection plays an essential role in the continued development of the biotechnology industry. See Wesley M. Cohen and John Walsh, “Public Research, Patents and Implications for Industrial R&D in the Drug, Biotechnology, Semiconductor and Computer Industries” in Government-Industry Partnerships in Biotechnology and Information Technologies: New Needs and New Opportunities, Washington, D.C.: National Academy Press, forthcoming. 11   For example, government support played a critical role in the early development of computers. See Flamm. 1988. Creating the Computer, Washington, D.C.: The Brookings Institution. For an overview of government-industry collaboration, see the introduction to the recent report on the Advanced Technology Program, National Research Council, The Advanced Technology Program: Assessing Outcomes. Charles W. Wessner, ed. 2001. Washington, D.C.: National Academy Press. 12   See the presentation in this volume by the then Under Secretary of Economic Affairs at the U.S. Commerce Department, Robert Shapiro, and then Deputy Under Secretary for Economic Affairs, Lee Price.

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Measuring and Sustaining the New Economy: Report of a Workshop While recent studies confirm soaring labor productivity in the computer manufacturing industry and in the durable goods manufacturing industry, the surge in investments and use of new information technologies is not captured in the statistics on the American service and non-durable manufacturing industries.13 Measurement problems continue to hamper our understanding of the impact of advances and cost reductions in areas such as telecommunications. THE ROLE OF THE STEP BOARD Since 1991 the National Research Council’s Board on Science, Technology, and Economic Policy (STEP) has undertaken a program of activities to improve policymakers’ understanding of the interconnections between science, technology, and economic policy and their importance to the American economy and its international competitive position. The Board’s interest in the New Economy and its underpinnings derive directly from its mandate. The STEP Board’s activities have corresponded with an increased recognition by policymakers of the importance of technology to economic growth.14 WORKSHOP AND DISCUSSIONS The impetus for this workshop follows from a recognition by members of the STEP Board that economic issues related to the phenomenon referred to as the New Economy are distinguished by important questions on one hand and a surprising lack of data on the other. As with other STEP Board initiatives, this study is intended to bring together the needed expertise to illuminate a complex and important area of policy research. To this end, on October 6, 2000, the STEP Board convened a workshop on Measuring and Sustaining the New Economy. The workshop included presentations and remarks from leading academics and innovators in the information technology sector (Appendix B lists these individuals). The “Proceedings” chapter of this volume contains summaries of their presentations and discussions. Given the quality and the number of presentations, summarizing the workshop proceedings has been a challenge. We have made every effort to capture the main points made during the presentations and the ensuing discussions. We apologize for any inadvertent errors or omissions in our summary of the proceedings. 13   See Jorgenson and Stiroh, op. cit. Also see: Robert Gordon. 2000. “Does the New Economy Measure up to the Great Inventions of the Past?” Journal of Economic Perspectives 14(4), Fall. 14   See Paul Romer. 1990. “Endogenous Technological Change,” Journal of Political Economy, 98(5): 71-102. See also: Gene Grossman and Elhannan Helpman. 1993. Innovation and Growth in the Global Economy, Cambridge, MA: MIT Press.

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Measuring and Sustaining the New Economy: Report of a Workshop ACKNOWLEDGEMENTS There is considerable interest in the policy community in a better understanding of the technological drivers and appropriate regulatory framework for the New Economy, as well as in a better grasp of its operation. This interest is reflected in the support on the part of agencies that have played a role in the creation and development of the New Economy. We are grateful for the participation and the contributions of the National Aeronautics and Space Administration, the Department of Energy, the National Institute of Standards and Technology, and Sandia National Laboratories. Several members of the STEP staff deserve recognition for their contributions to the preparation of this report. We are once again indebted to Alan Anderson for his preparation of the meeting summary and his contribution to the introduction. We wish to thank Sujai Shivakumar, who recently joined the STEP team, for his many contributions to the report. We are also indebted to David E. Dierksheide and McAlister Clabaugh, who have once again played an instrumental role both in preparing the conference and, with Christopher Hayter, helped prepare this report for publication. NRC REVIEW This report has been reviewed in draft form by individuals chosen for their diverse perspectives and technical expertise, in accordance with procedures approved by the NRC’s Report Review Committee. The purpose of this independent review is to provide candid and critical comments that will assist the institution in making its published report as sound as possible and to ensure that the report meets institutional standards for objectivity, evidence, and responsiveness to the study charge. The review comments and draft manuscript remain confidential to protect the integrity of the deliberative process. We wish to thank the following individuals for their review of this report: Dr. Martin N. Baily, Institute for International Economics; Dr. Kenneth Flamm; Lyndon B. Johnson School of Public Affairs, University of Texas; Dr. Barbara M. Fraumeni, Bureau of Economic Analysis; Dr. Robin Gaster, North Atlantic Research, Inc.; and Dr. Daryl Hatano, Semiconductor Industry Association. Although the reviewers listed above have provided many constructive comments and suggestions, they were not asked to endorse the conclusions or recommendations, nor did they see the final draft of the report before its release. The review of this report was overseen by Dr. Robert White, University Professor and Director, Data Storage Systems Center, Carnegie Mellon University. Appointed by the National Research Council, he was responsible for making certain that an independent examination of this report was carried out in accordance with institutional procedures and that all review comments were carefully considered. Responsibility for the final content of this report rests entirely with the authoring committee and the institution.

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Measuring and Sustaining the New Economy: Report of a Workshop STRUCTURE This report has three parts: an Introduction which summarizes the proceedings and issues associated with the New Economy, followed by the Proceedings themselves, and supplemented by a recent research paper. This report represents the first step of a major research effort by the Board on Science, Technology, and Economic Policy designed to advance our understanding of the factors shaping the New Economy, the metrics necessary to better understand it, and the policies best suited to sustaining the greater productivity and prosperity that it promises. Dale W. Jorgenson Charles W. Wessner