II
FINDINGS AND RECOMMENDATIONS



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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age II FINDINGS AND RECOMMENDATIONS

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Findings and Recommendations INTRODUCTION The findings and recommendations found in this section reflect the Committee’s consensus based on its own deliberations as well as on the proceedings of five previous conferences that explored the operation of the new, information-based economy. The Committee’s aim is to understand the sources of productivity growth in this new economy, to measure more accurately the contributions of different components of growth, and to develop policies to encourage and increase that growth. A. THE NATURE OF THE NEW U.S. ECONOMY Findings The New Economy refers to technological and structural changes in the U.S. economy as individuals capitalize on new technologies, new opportunities, and national investments in computing, information, and communications technologies. These structural changes have resulted in a long-term positive productivity shift of major significance.1 1 Dale W. Jorgenson and Kevin J. Stiroh, “Raising the Speed Limit: Economic Growth in the Information Age,” in National Research Council, Measuring and Sustaining the New Economy, Dale W. Jorgenson and Charles W. Wessner, eds., Washington, D.C.: National Academy Press, 2002, Appendix A.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Despite differences in methodology and data sources, a consensus has emerged among economists that the remarkable behavior of information technology (IT) prices provides the key to the surge in U.S. economic growth after 1995. The relentless decline in the prices of information technology equipment has steadily enhanced the role of IT investment across the economy.2 Productivity growth in IT-producing industries has risen in importance and a productivity revival is under way in the rest of the economy. The decline in IT prices refers to more than just a reduction in the price of a key economic input. The widespread use of IT, made possible by this price reduction, has changed and continues to change how individuals and businesses in the economy work, consume, communicate, and transact. New products and capabilities made possible by lower-cost computing and communications facilities are already restructuring the economy and accelerating the globalization of manufacturing and trade in services, with major positive implications for productivity growth. New information technologies have a broad and positive impact on U.S. productivity growth through industries that produce new information technologies and the many more that apply them. New IT applications are also contributing to enhanced workplace productivity as a wide variety of firms adapt to changes in information flows and take advantage of new organizational structures made possible by these innovations.3 These developments are changing the structure of firms, creating more innovative and more agile enterprises, with positive indirect and long-term implications for productivity growth.4 2 Kevin Stiroh notes that over the last decade, U.S. firms have invested over $2.4 trillion in IT assets, such as computer hardware, computer software, and telecommunications equipment and that these three assets accounted for more than 40 percent of private fixed investment in equipment and software in 2000. Kevin J. Stiroh, “Measuring Information Technology and Productivity in the New Economy,” World Economics 3(1):43-59, 2002. 3 These indirect effects are captured in a now substantial literature. For example, see Sandra E. Black and Lisa M. Lynch, “What’s Driving the New Economy?: The Benefits of Workplace Innovation,” Economic Journal, 114(493):F97-F116, 2004. See also Timothy Bresnahan, Erik Brynjolfsson and Lorin M. Hitt, “Information Technology, Workplace Organization and the Demand for Skilled Labor: Firm-level Evidence,” Quarterly Journal of Economics, 117(1):339-376, 2002. For a discussion of how IT interacts with other aspects of firm structure, labor policies, and innovation such as human capital, improved organizational structure, and incentives, see Erik Brynjolfsson and Lorin M. Hitt, “Computing Productivity: Firm-Level Evidence,” Review of Economics and Statistics, 85(4):793-808, 2003. 4 See Amar Bhidé, “Venturesome Consumption, Innovation, and Globalization,” Paper prepared for a joint conference of CESIFO and the Center on Capitalism and Society on “Perspectives on the Performance of the Continent’s Economies,” Venice, July 21-22, 2006. Bhidé notes that an important part of innovation centers on the incentives facing firms and individuals in trying new products and reorganizing themselves to take advantage of new products.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Cheaper information technology has given greater importance to more productive forms of capital. The rising contribution of investments in information technology since 1995 has been a key contributor to the U.S. growth resurgence and has boosted growth by close to a percentage point. The contribution of investment in information technology accounts for more than half of this increase. Within information technology, computers have been the predominant impetus for faster growth. Communications equipment and software have also made important contributions to growth. Altogether, 31 industries (out of the 44 industry categories that make up the U.S. economy) contributed to the acceleration in economic growth after 1995. The four IT-producing industries discussed here are responsible for only 2.9 percent of the Gross Domestic Product (GDP) but a remarkable quarter of the U.S. growth resurgence.5 The 17 IT-using industries account for another quarter of the surge in growth and about the same proportion of the GDP, while the non-IT industries with 70 percent of value added are responsible for half the resurgence. The contribution of the IT-producing industries is far out of proportion to their relatively small size in relation to the economy as a whole. These industries have grown at double-digit rates throughout the period 1977-2000, but their growth jumps sharply after 1995, when the GDP share of these industries also increases.6 The accelerated IT price decline also signals faster total factor productivity growth in IT-producing industries.7 The four IT-producing industries contributed more to the growth of total factor productivity during the period 1977-2000 than all other industries combined.8 5 Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, Productivity, Volume 3: Information Technology and the American Growth Resurgence, Cambridge, MA: The MIT Press, 2005, p. 10. 6 Ibid., p. 11. 7 Total factor productivity is defined as output per unit of input, where input includes capital, labor, and intermediate inputs. There is some debate among economists about how easy it is to infer growth rates of total factor productivity growth from relative price declines. While Aizcorbe concludes that quality change was the dominant source of the increase in relative price declines in the mid-1990s, others might disagree. (See Ana Aizcorbe, “Why Are Semiconductor Prices Falling so Fast? Industry Estimates and Implications for Productivity Growth,” Economic Inquiry, forthcoming.) For example, Hobijn argues that declining margins cloud this linkage and Aizcorbe presents a model where increased competition leads to accelerated price declines. See Bart Hobijn, “Is Equipment Price Deflation a Statistical Artifact?” Federal Reserve Bank of New York Staff Report #139, November 2001. Also see Ana Aizcorbe, “Moore’s Law, Competition, and Intel’s Productivity in the Mid 1990s,” American Economic Review, 95:305-308, May 2005. 8 Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, Productivity, Volume 3: Information Technology and the American Growth Resurgence, op. cit.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Gains in the U.S. terms of trade, especially for information technology products, may have contributed to the acceleration in U.S. productivity in the late 1990s.9 Information technology is one of the most globally engaged sectors of the U.S. economy. Liberalization of information technology trade began in the 1980s, helping to decrease the cost of semiconductors and increase the availability of IT products and services.10 The International Technology Agreement of 1996 also eliminated all world tariffs on hundreds of IT products in four stages from early 1997 through 2000, helping to lower the prices of imported intermediate IT products.11 While such trade effects are likely to explain only a small portion of the productivity speed-up, foreign trade practices do appear to matter for the measurement of productivity. Improved productivity associated with the introduction of advanced information and communications technologies appears to have raised the long-term growth trajectory of the U.S. economy. This gain appears to be robust, having survived the dot-com crash, the short recession of 2001, and the tragedy of 9/11. Since the end of the previous recession in 2001, productivity growth has been running at about two-tenths of a percentage point higher than in any recovery of the post-World War II period.12 A structural change most associated with the New Economy today is the transformation of the Internet from a communication media to a platform for service delivery.13 This has contributed to the remarkable growth of the U.S. service 9 Robert C. Feenstra, Marshall B. Reinsdorf, and Michael Harper, “Terms of Trade Gains and U.S. Productivity Growth,” paper prepared for NBER-CRIW Conference, July 25, 2005. 10 For a detailed analysis of trade in semiconductors, see Kenneth Flamm, Mismanaged Trade, Washington, D.C.: Brookings Institution Press, 1996. For a review of the impact of the 1986 semiconductor trade agreement on the revival of the U.S. semiconductor industry, see National Research Council, Securing the Future: Regional and National Programs to Support the Semiconductor Industry, Charles W. Wessner, ed., Washington, D.C.: The National Academies Press, 2003, p. 82. The report points out that the resurgence of the U.S. semiconductor industry was based in part on the success of the SEMATECH consortium, in part on the 1986 Semiconductor Trade Agreement, and in part on the repositioning of the U.S. industry away from DRAM chips and towards microprocessor design and production. The recovery of the U.S. industry was thus like a three-legged stool; it is unlikely that any one factor would have proved sufficient independently. 11 For an overview of the Information Technology Agreement and its implementation, access the World Trade Organization Web site at <http://www.wto.org/english/tratop_e/inftec_e/itaintro_e.htm>. 12 Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, “Will the U.S. Productivity Resurgence Continue?” Federal Reserve Bank of New York Current Issues in Economics and Finance, 10(13), 2004. 13 This transformation is sometimes referred to as “Web 2.0.” For a description of this new version of the Web, see Tim O’Reilly, “What Is Web 2.0—Design Patterns and Business Models for the Next Generation of Software” September 30, 2005. Accessed at <http://www.oreillynet.com/pub/a/oreilly/tim/news/2005/09/30/what-is-web-20.html>.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age economy, as companies like Google and eBay increasingly exploit information services in new ways. As new business models, enabled by the Web, continue to emerge, they will contribute to sustaining the productivity growth of U.S. economy. Recommendations Given the benefits of rapid technical innovation, the measurement issues associated with this change should be addressed on a systematic basis by the responsible agencies of the federal government in a coordinated fashion. Swiftly falling IT prices provide powerful economic incentives for the diffusion of information technology. Given that the rate of the IT price decline is a key component of the cost of capital, it is essential to develop constant quality indexes, such as those for computers, for use in the U.S. National Income and Product Accounts (NIPA). Substantial resources to develop price indexes and related analyses are needed to understand the sources of productivity growth in the economy and to develop the policies to sustain it. The growing synergies and new economic opportunities of the New Economy need to be understood better if they are to be sustained through appropriate policies. The rapid pace of these changes means that they require regular and systematic monitoring in order to bring significant changes to the attention of policy makers. The rapid business and workplace transformations made possible by information technology are not only a product of globalization but also a factor that is advancing globalization.14 For the United States, success in this new global paradigm requires technological leadership as well as strategic use of information technology. To remain a leader in information and communications technologies, the United States must foster and attract the best human resources. Both the federal and state governments must also adequately support research funding, and maintain a superior business environment and encourage the public-private partnerships that foster innovation and the timely transition of research to the marketplace.15 It must also update regulations that inhibit wider access to and use of information networks.16 14 Catherine L. Mann, High-Technology and the Globalization of America, forthcoming. 15 National Research Council, Government-Industry Partnerships for the Development of New Technologies: Summary Report, Charles W. Wessner, ed., Washington, D.C.: The National Academies Press, 2003. 16 National Academy of Sciences, National Academy of Engineering, and Institute of Medicine, Rising Above the Gathering Storm: Energizing and Employing America for a Brighter Economic Future, Washington, D.C.: The National Academies Press, 2007 Forthcoming.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age B. MOORE’S LAW AND THE NEW ECONOMY Findings Faster and cheaper semiconductors are a key driver of the productivity gains associated with the recent growth of the U.S. economy.17 Price-performance improvement in semiconductors has been a major source of price-performance improvement in information technology. Declines in cost for electronics functionality embedded in semiconductors are the linchpin of improvement in price-performance for computers and communications, which in turn has been a major factor in the increase in long-term growth performance.18 A substantial acceleration in the pace of IT price decline occurred in 1995, triggered by a much sharper acceleration in the price decline of semiconductors—the key component of modern information technology.19 (See Figure 1.20) This acceleration can be traced to a shift in the product cycle from 3 years to 2 years as a result of intensifying competition in markets for semiconductor products.21 17 Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, Productivity, Volume 3: Information Technology and the American Growth Resurgence, op. cit. 18 Jack E. Triplett, “High-Tech Productivity and Hedonic Price Indexes,” in Organisation for Economic Co-operation and Development, Industry Productivity, Paris: Organisation for Economic Cooperation and Development, 1996; Kenneth Flamm, “Technological Advance and Costs: Computers vs. Communications,” in Changing the Rules: Technological Change, International Competition, and Regulation in Communications, Robert C. Crandall and Kenneth Flamm, eds., Washington, D.C.: The Brookings Institution, 1989; Ana Aizcorbe, Kenneth Flamm, and Anjum Khurshid, “The Role of Semiconductor Inputs in IT Hardware Price Declines” in Hard to Measure Goods and Services: Essays in Honor of Zvi Griliches, E. Berndt, ed., Chicago, IL: National Bureau of Economic Research, forthcoming. 19 Using industry estimates on Intel’s operations to decompose a price index, Ana Aizcorbe finds that virtually all of the declines in a price index for Intel’s chips can be attributed to quality increases associated with product innovation, rather than declines in the cost per chip. She adds that consistent with the inflection point that Jorgenson noted in the overall price index for semiconductors, the Intel price index falls faster after 1995 than in the earlier period, but that the decomposition attributes virtually all of the inflection point to an acceleration in quality increases. These increases in quality push down constant quality costs. See Ana Aizcorbe, “Why Are Semiconductor Price Indexes Falling So Fast? Industry Estimates and Implications for Productivity Growth,” op. cit. See also Dale W. Jorgenson, “Information Technology and the U.S. Economy,” American Economic Review, 91(1), 2001. 20 The output price index referred to in Figure 1 is the GDP deflator, but differs from the typical Bureau of Economic Analysis (BEA) GDP deflator due to methodology. We impute a capital service flow for government and consumer durable capital and use Tornqvist aggregation to add components of GDP. 21 For an analysis of the break points in prices of microprocessors, see Ana Aizcorbe, Stephen D. Oliner, and Daniel E. Sichel, “Shifting Trends in Semiconductor Prices and the Pace of Technological Progress,” mimeo, Federal Reserve Board, April. Other analyses focus on an acceleration in the pace of technological innovation in semiconductor manufacturing as accelerating the decline in prices: see Kenneth Flamm, “Microelectronics Innovation: Understanding Moore’s Law and Semiconductor

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age FIGURE 1 Relative prices of computers and semiconductors, 1959-2004. NOTE: All price indexes are divided by the output price index. Although the decline in semiconductor prices has been projected to continue for at least another decade, the magnitude of recent acceleration may be temporary. Moore’s Law has played a significant role in the expectations and development of the semiconductor industry. While by no means dictating an actual law, Gordon Moore correctly foresaw in 1965 the rapid doubling of the feature density of a chip, now interpreted as approximately every 18 months.22 While not pretending to be deterministic, Moore’s formulation has endured in part by setting expectations among participants in the semiconductor industry of the pace of innovation and the introduction of Price Trends,” International Journal of Technology, Policy, and Management, 3(2), 2003; Kenneth Flamm, “The New Economy in Historical Perspective: Evolution of Digital Technology,” in New Economy Handbook, Derek C. Jones, ed., Academic Press, 2003; and Kenneth Flamm, “Moore’s Law and the Economics of Semiconductor Price Trends,” in Dale W. Jorgenson and Charles W. Wessner, eds., Productivity and Cyclicality in Semiconductors: Trends, Implications, and Questions, Washington, D.C.: The National Academies Press, 2004. 22 Observing that the number of transistors per square inch on integrated circuits had doubled every year since the integrated circuit was invented, Gordon Moore predicted in 1965 that this trend would continue for the near future. (See Gordon E. Moore, “Cramming More Components onto Integrated Circuits,” Electronics, 38(8), April 19, 1965.) The current definition of Moore’s Law, which has been acknowledged by Dr. Moore, holds that the data density of a chip will double approximately every 18 months. Many experts expect Moore’s Law to hold for another 15 years.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age new products to market.23 Each firm believes that its competitors will release the next model in an 18-month timeframe, leading each to set the pace of its own work on this basis—in effect making Moore’s Law a self-fulfilling prophecy.24 Currently, the industry expects to remain on the trajectory envisioned by Moore’s Law for another 10 to 15 years.25 Making additional assumptions, an economic corollary to Moore’s Law is a rapid fall in the relative prices of semiconductors. With the acceleration in manufacturing innovation in the late 1990s came an increase in the rate of price decline—from roughly 15 percent annually in the early 1990s to 28 percent annually after 1995 until 2003. The increase in chip capacity and the concurrent fall in price—the “faster-cheaper” effect—have created powerful incentives for firms to substitute information technology for other forms of capital. These investments, when effectively integrated, have led to the productivity increases that are the hallmark of the phenomenon known as the New Economy.26 The Semiconductor Industry Roadmap has helped to sustain Moore’s Law. The International Technology Roadmap for Semiconductors (ITRS) helps set the competitive pace of the semiconductor industry. By identifying common research challenges and reducing costs by identifying redundancies and technical “showstoppers,” the ITRS process helps the semiconductor industry commit to the investments necessary to stay on the growth trajectory of Moore’s Law.27 In 1997, the ITRS reported the presence of a faster two-year semiconductor cycle beginning in 1995 that has helped to accelerate the pace of Moore’s Law. However, the 2003 edition of the ITRS has predicted that (given the difficulties encountered at the 90 nm technology node among other reasons) chipmakers will soon return to a 3-year cycle between technology nodes, significantly slowing the pace of semiconductor development.28 23 These expectations are reflected in the International Technology Roadmap for Semiconductors. Accessed at <http://public.itrs.net/>. 24 See Kenneth Flamm, “Moore’s Law and the Economics of Semiconductor Price Trends,” op. cit., 2004, and “Microelectronics Innovation: Understanding Moore’s Law and Semiconductor Price Trends,” op. cit., 2003. See also Ana Aizcorbe, “Moore’s Law, Competition, and Intel’s Productivity in the Mid-1990s,” BEA Working Paper WP2005-8, September 1, 2005. 25 See remarks by Robert Doering, “Physical Limits of Silicon CMOS Semiconductor Roadmap Predictions,” in National Research Council, Productivity and Cyclicality in Semiconductors: Trends, Implications, and Questions, op. cit. 26 Dale W. Jorgenson, “Information Technology and the U.S. Economy,” op. cit. 27 William Spencer, Linda Wilson, and Robert Doering, “The Semiconductor Technology Roadmap,” Future Fab International, 18, January 12, 2005. 28 Access the ITRS homepage at <http://public.itrs.net/>.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age The semiconductor industry is characterized by high annual growth averaging around 15 percent per annum.29 This high growth rate is accompanied by considerable market volatility, reflected in significant cyclical swings in production. In large part, this volatility is because the semiconductor industry is highly capital-intensive, requiring significant capital expenditures for each fabrication facility and a very high intensity of R&D (sometimes up to 20 percent of revenue). This high level of investment underpins the high rate of innovation evident through increased performance, miniaturization, cost reduction, and short design cycles.30 High sunk costs, steep learning curves, and rapid shifts in product cycles all contribute to a high level of industry cyclicality, which is one of the semiconductor industry’s distinguishing features.31 A further aspect of the industry’s steep learning curves is the need for the research and at least some of the production facilities to be in close geographic proximity. This permits the many adjustments required to improve performance and yields and to adapt new equipment, production processes, and design features while adjusting to changing market conditions. The learning and synergies among university research, private laboratories, production and changing customer needs is a recognized feature of the semiconductor industry.32 This does not mean that the benefits of proximity require all production to be located within a particular geographic area. This would imply a freezing of the allocation of global semiconductor production that would be neither possible nor desirable. On the other hand, having no on-shore production would inevitably erode the quality and robustness of research, design, equipment and materials production in the United States. 29 Despite industry cyclicality, the semiconductor industry achieved a 16.1 percent compound annual growth rate (CAGR) from 1975 to 2000. Growth during this period was driven by technological advances, the increasing pervasiveness of electronics in society, and the increasing capability of the semiconductors that powered new products and systems. This growth rate began to slow gradually starting in the mid-1980s, reaching about 15 percent in 1998. The severity of the 2001 downturn then prompted a reevaluation of the industry’s long-term growth rate. With semiconductor sales of $213 billion in 2004, the rate is now expected to be in the 8-10 percent range. The Semiconductor Industry Association forecast, released in June 2005, reflects this consensus and predicts a CAGR for the industry of 9.2 percent from 2004 to 2008. Accessed on the Semiconductor Industry Association Web site at <http://www.sia-online.org/iss_economy.cfm>. 30 European Semiconductor Industry Association, The European Semiconductor Industry: 2005 Competitiveness Report, op. cit. 31 Kenneth Flamm, “Factors Underpinning Cyclicality in the Semiconductor Industry,” in National Research Council, Productivity and Cyclicality in Semiconductors: Trends, Implications, and Questions, op. cit., pp. 61-64. 32 See, for example, European Semiconductor Industry Association, The European Semiconductor Industry: 2005 Competitiveness Report, op. cit.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age forms is needed to complement the networked characteristic of the New Economy.100 The value of intellectual property is increasingly recognized, and the use of patents has increased dramatically. Yet, businesses have faced serious challenges of protecting intellectual property in the era of digital distribution. Recently available technologies, for example, have allowed consumers to share music and content with each other for free.101 The trend towards improved security of intellectual property, such as the recent success of the iPod and related legitimate forms of on-line music diffusion, is encouraging and can help stimulate the creation of new content and applications.102 The move towards virtualization, grid computing, and Web services is leading to a major shift in the nature of information technology assets from computers, software, and myriad related components that companies own to services that firms purchase from on-line utility providers.103 Recommendations The varying complexity and rates of technical innovation make the contribution of telecommunications equipment to productivity growth a challenge to measure. Current BEA methodologies for making intertemporal comparisons in price and quality understate true price declines in communications equipment because they do not fully track evolving technological changes.104 For most of the 1990s, manufacturers focused on features such as greater port density, faster speeds, and support for an increasing number of communication protocols in designing new switches and routers. After the 2001 collapse in demand for telecommunications equipment, manufacturers began to differentiate their products in new and innovative ways that are difficult to quantify on a quality-adjusted basis. Better data and analysis are needed to get a clear idea of what happened with regard to 100 Peter Tenhula, “Technological Change and Economic Opportunity: The View from the Federal Communications Commission,” in National Research Council, The Telecommunications Challenge: Changing Technologies and Evolving Policies, op. cit. 101 However, in the case of the music-swapping service Napster, a U.S. federal appeals court ruled in 2001 that the file-sharing Internet company must stop trading in copyrighted material. 102 Steve Metalitz, “The View from the Copyright Industries,” in National Research Council, The Telecommunications Challenge: Changing Technologies and Evolving Policies, op. cit. 103 Nicholas G. Carr, “The End of Corporate Computing,” op. cit. 104 BEA estimated that prices for communications gear fell an average of 3.2 percent per year between 1994 and 2000. Recent analysis by Marc Doms however suggests that communications equipment prices actually fell about 8 to 10 percent over that period. Mark Doms, “Communications Equipment: What has Happened to Prices?” Federal Reserve Bank of San Francisco Working Paper, 2003-15.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age technological change in and prices of communications equipment from 2001 on. Valuing the improvements built into new switches and routers is difficult. While the Producer Price Index has tried to address some of these changes using hedonic techniques, data that consistently identify important current period product characteristics and transaction prices are not yet readily available.105 Research into alternative quality valuation techniques and improved data transparency is required to respond to the technological changes in telecommunications equipment. BEA and other statistical agencies require increased funding to follow evolving trends in the communications arena with more accuracy. As noted above with regard to software, greater attention to standards and the national and international process of their establishment is required. The economic stakes of standard setting are of great consequence. Some nations and regions see standards as a competitive tool and devote substantial resources to this end. The role and resources of the National Institute of Standards and Technology have to be seen in this light. The standard-making process must be recognized as a key component of U.S. competitiveness and provided commensurate resources and policy attention. Uncertainty created by a multiplicity of standards and a lack of clarity in regulatory policy are retarding progress in the growth of wireless and fiber networks needed to convey this commoditized information to the curb.106 Technical standards, especially for wireless devices, are an important element in sustaining U.S. success in the global economy. Without effective standard-making capabilities and active U.S. participation in international standard-making bodies, the United States will not be able to maximize its advantages.107 The supply as well as the demand side of the market for high-speed Internet access needs to be elaborated. While international comparisons show that U.S. broadband adoption for households lags that of other countries, relatively little is known about factors that affect the broadband adoption path 105 For additional perspective on the types of technological changes in telecom equipment that, at least conceptually, could be valued in a hedonic model, see Michael Holdway, “Confronting the Challenge of Estimating Constant Quality Price Indexes for Telecommunications Equipment in the Producer Price Index,” Bureau of Economic Analysis Working Paper, 2002. 106 See Action D-4 on ensuring ubiquitous broadband Internet access in NAS/NAE/IOM, Rising Above the Gathering Storm: Energizing and Employing America for a Brighter Economic Future, op. cit. 107 See National Research Council, Standards, Conformity Assessment, and Trade into the 21st Century, Washington, D.C.: National Academy Press, 1995.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age in the United States, particularly for businesses. Further data are required to understand the scope and nature of broadband use by businesses, and more study is required to understand why a significant percentage of households are not linked to the computer and Internet culture that is central to the new, more productive U.S. economy.108 Revising outdated regulation and addressing issues of security and intellectual property protection are necessary for the nation to realize productivity gains from advances in communications technology. To address the technology convergence now under way, sector-specific telecom regulation—for radio, CDs and DVDs, television, telephony, and mobile telephony—must be replaced with a more horizontal (as opposed to a vertically stovepiped) regulatory regime. Internet-based services, through such means as grid computing, have the potential to improve productivity. Improved security in the broadband network, which stands as a major obstacle to more widespread use of the technology, has to be addressed. Developing a legitimate market for copyrighted materials over broadband—for entertainment, software, services, video games, research and reference works—is needed for the long-term viability of these industries. G. GLOBALIZATION AND OFFSHORING Findings Rapid progress in information and communications technologies combined with continuing efforts to liberalize international trade and investment in services, have increased the tradability of services and created new types of tradable services.109 This has led to a new wave of globalization in the services sector, with offshoring of particular types of services now becoming increasingly common. The development of the Internet, in particular, has generated great economic opportunity, facilitated growth, and improved peoples’ lives in many ways. The Internet is also making possible new forms of business organization. 108 John B. Horrigan, “Broadband Adoption at Home in the United States: Growing but Slowing,” op. cit. 109 Desirée van Welsum and Xavier Reif, “Potential Offshoring: Evidence from Selected OECD Countries,” OECD-DSTI-ICCP, July 2005.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age The declining cost of computing and communications is changing the structure of industrial organizations—replacing vertically integrated industries with newly economical horizontal platforms.110 A new model for value delivery to businesses is based on an intelligent infrastructure, where this infrastructure spans the globe. Here the network becomes a repository of intelligence across a broad spectrum of applications, such as caching, security, multicasting, and network management.111 Greater horizontal integration across the globe created by faster and cheaper information and communications technologies is opening new opportunities for U.S. firms to compete worldwide. The globalization of IT hardware and software research, production, and trade, as well as new competition from lower-wage producers, have helped reduce IT prices and should contribute to technological advance, helping to maintain Moore’s Law.112 These, in turn, have facilitated the wider adoption of information technologies, making available the efficiencies that arise from their use.113 From the perspective of many firms, cost savings through the outsourcing of research and production offshore provides a compelling business motive. It has rapidly become “best practice” for the business plans of new high-technology manufacturing and service companies.114 Globalization is also giving rise to a shift in the comparative advantage of nations, raising major policy challenges—including questions concerning national competency, capacity, and autonomy in strategic technologies.115 Access to low-cost, highly trained workers located around the world and the advantages of round-the-clock development cycles—made possible by low-cost computing and communications—have led to the relocation abroad of many business functions that can be outsourced. This phenom- 110 See comments by William Raduchel, “The End of Stovepiping,” in National Research Council, The Telecommunications Challenge: Changing Technologies and Evolving Policies, op. cit. 111 David S. Isenberg, “Rise of the Stupid Network,” Computer Telephony, pp. 16-26, August 1997. 112 24/7 research cycles and larger R&D teams made possible by less expensive skilled labor can accelerate research and product cycles. See Businessweek, “The Rise of India,” December 8, 2005. 113 Catherine Mann, High-tech and the Globalization of America, op. cit. 114 See comments by Jack Harding, “Current Trends and Implications: An Industry View,” in National Research Council, Software, Growth, and the Future of the U.S. Economy, op. cit. See also recent comments by Michael Mortiz, a prominent venture capitalist, who notes that “we can barely imagine investing in a company without at least asking what their plans are for India.” See Business-week, “The Rise of India,” op. cit. 115 See the recent findings by the National Academies’ Committee on Materials Research and Development in National Research Council, Globalization of Materials R&D: Time for a National Strategy, Washington, D.C.: The National Academies Press, 2005.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age enon is popularly known as “offshoring.” In addition to the moving of existing jobs to other countries, another dimension of offshoring is likely to be the creation of new service jobs in countries other than the United States—a trend that will be difficult to measure. By diffusing technology and research capabilities around the world, globalization enables other countries, including newly emerging econo-mies like China and India, to pursue technological leadership in key areas. Some analysts and business leaders believe that this diffusion of expertise abroad is eroding U.S. comparative advantages in high-technology innovation and manufacturing.116 For the United States, the economic and strategic risks associated with offshoring include a loss of within-country expertise and future talent, dependency on other countries for key technologies, and increased vulnerability to political and financial instabilities abroad.117 The Internet enables trade in services to a greater extent than before. The types of jobs subject to offshoring are increasingly moving from low-end services (such as call centers and help desks) to higher-technology services (such as software and microchip design, business consulting, medical analysis, and drug development) where the United States has traditionally enjoyed a comparative advantage. These trends notwithstanding, some analysts believe that there are limits to near-term globalization. On the demand side, recent experience seems to reveal that offshoring is proving successful for businesses only in 116 Some recent studies have questioned whether “offshoring” is simply another form of trade with mutual benefits. David Levy, for example, argues that reducing wages through offshore outsourcing leads to wealth creation for shareholders but not necessarily for countries and employees, and that many displaced workers have difficulty “trading up” to higher-skilled jobs. The result, he noted, is the creation of global commodity markets for particular skills and a shift in the balance of market power among firms, workers, and countries. David L. Levy, “The New Global Political Economy,” Journal of Management Studies, 42(3):685, May 2005. This caution has been echoed in industry. Andy Grove of Intel has noted that firms need to strike a balance between maximizing shareholder value and their obligation to U.S. workers who helped build the nation’s technology industry but who are now being replaced by cheaper labor. Forbes, “Grove Says U.S. Is Losing Its Edge in High-Tech Sector,” October 10, 2003. See also the discussion by William Bonvillian, “Offshoring Policy Options,” in National Research Council, Software, Growth, and the Future of the U.S. Economy, op. cit. 117 In his dissent from the mainstream economic consensus about outsourcing and globalization, Paul Samuelson has argued that the assumption that the laws of economics dictate that the U.S. economy will benefit in the long run from all forms of trade, including the outsourcing of call-center and software programming jobs abroad, is a “popular polemical untruth.” Trade does not always work to all parties’ advantage, according to Samuelson. See Paul Samuelson, “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization,” Journal of Economic Perspectives, 18(3), 2004.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age selected contexts due to operational and management limitations.118 On the supply side, some believe that there are only a limited number of low-wage knowledge workers abroad in the market today who possess the necessary language skills, technical qualifications, and related abilities needed for successful international collaboration.119 Even if these limits to near-term globalization hold true, it is not clear whether this condition will persist. Further research is necessary to estimate how quickly these limitations may be overcome. Recommendations Although the offshoring phenomenon—particularly the offshoring of service-sector jobs—is a topic of much currency, the scope of the phenomenon remains to be adequately documented. Despite extensive media attention, there is relatively little hard information about the causes and impact of offshoring on manufacturing and service-sector employment in the United States or on other related economic and structural developments.120 A sustained effort to measure the dimensions and implications of off-shoring is necessary for informed policymaking. Further research is needed to make adequate evaluations of the effects of outsourcing, including the impact of high-tech job creation abroad rather than in the United States.121 To overcome the lack of appropriate, adequate data for 118 According to the McKinsey Global Institute, internal barriers within firms, most notably operational issues, management attitude to offshoring, and structural issues can limit demand. Adding that external regulatory barriers also play a small role overall, it concludes that the “potential for global resourcing varies depending on the industry.” See McKinsey Global Institute, The Emerging Global Labour Market, Part I: “Demand for Offshore Talent and Sector Cases,” 2005. 119 McKinsey Global Institute, The Emerging Global Labour Market, Part II: “Synthesis of Findings: Supply of Offshore Talent,” 2005. Some statements about the numbers and qualifications of Indian and Chinese engineers may be overstated, while U.S. graduates and qualifications may be understated. See Gary Gereffi and Vivek Wadhwa, “Framing the Engineering and Outsourcing Debate: Placing the United States on a Level Playing Field with China and India,” Duke University School of Engineering, December 12, 2005. 120 While preliminary analysis has not found that outsourcing of business services has had much effect on the growth of the U.S. economy (Ralph Kozlow and Maria Borga, “Offshoring and the US Balance of Payments,” Washington, D.C.: Bureau of Economic Analysis, 2004), popular evaluations argue that the world of technology is becoming increasingly international (see, for example, Thomas Friedman, The World is Flat, New York, NY: Farrar Straus & Giroux, 2005). 121 The 2006 report of the Association for Computing Machinery’s Job Migration Task Force similarly finds that “while offshoring will increase, determining the specifics of this increase is difficult given the current quantity, quality, and objectivity of data available. Skepticism is warranted regarding claims about the number of jobs to be offshored and the projected growth of software industries in developing countries.” Association of Computing Machinery, “Globalization and Offshoring of Software,” William Aspray, Frank Mayadas, and Moshe Y. Vardi, eds., New York, NY, 2006. Lastly, assessments of jobs outsourced do not necessarily take into account the impact of foreign investment, increasingly for countries such as India and China, on U.S. employment.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age this analysis, the necessary resources should be made available to provide better information both to policymakers and to the general public about the evolution and performance of the American economy. In any event, we must recognize that the global competitive environment is shifting. According to several recent reports, the pace of global competition is accelerating and the United States will need to redouble support for existing strengths (e.g., research), strengthen proven commercialization programs, and experiment with new efforts.122 To thrive in the globally competitive environment, the United States has to maintain its technological leadership. This requires continuing investments in the nation’s science and technology infrastructure. This, in turn, requires both substantial investments in science and technology education as well as experimentation with policy mechanisms that can capitalize on these investments. The United States’ current leadership in high technology draws from substantial federal investments starting in the postwar period in the nation’s science and technology infrastructure. Key elements of this policy have included building a system of research universities and attracting foreign talent though scholarships and by providing academic freedoms and research facilities not available elsewhere. This institutional capital has to be upgraded and adapted to new needs and opportunities if the United States is to maintain its leadership as a knowledge-based economy. U.S. information technology firms, and the U.S. economy, will forgo the benefits of leadership unless they can attract the best human resources, garner sufficient research funding, develop and support robust mechanisms for technology transfer,123 and maintain an internationally competitive business environment. Four specific steps to retain and develop the semiconductor industry and U.S. research capacity in this sector would include: Substantial additional research funding should be provided at the 10 percent per year recommended in the NAS/NAE/IOM report, 122 For example, see Council on Competitiveness, Innovate America: Thriving in a World of Challenge and Change, Washington, D.C., 2004. 123 In this regard, the recent flattening of research funding and the elimination of funding for new awards from the Advanced Technology Program are troubling. The recent NAS/NAE/IOM report, Rising Above the Gathering Storm: Energizing and Employing America for a Brighter Economic Future, op. cit., argues for additional R&D funding and new efforts to transition them to market. Previous Academy analysis, led by Intel’s Gordon Moore, documented the substantial positive accomplishments of the Advanced Technology Program. See National Research Council, The Advanced Technology Program: Assessing Outcomes, op. cit., pp. 87-98. The NRC study found the program’s industry-driven, cost-shared approach to funding promising technological opportunities to be effective. It also found a high standard for assessment. Indeed, the quality of the assessment lends credence to the program’s evaluation of its accomplishments.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age Rising Above the Gathering Storm,124 with particular emphasis on the physical sciences and engineering. U.S. policymakers would benefit from evaluations of current worldwide policy and programs in support of this enabling industry.125 The federal government should continue to provide support for proven mechanisms to transfer technology and commercialize promising technologies.126 The United States needs to adopt measures to encourage research in the United States, including providing an attractive business environment involving competitive tax regimes, infrastructure support, cooperative research programs, and generous tax credits for corporate R&D. These measures are essential to maintain a competitive advantage for the U.S. economy in the locational competition for high-technology industries.127 H. NEW ARCHITECTURE FOR THE U.S. NATIONAL ACCOUNTS Findings The U.S. national accounts were originally constructed to deal with issues arising from the Great Depression of the 1930s, and the basic architecture of the national accounts has not been substantially altered in 50 years. In the meantime, the success of monetary and fiscal policies has shifted the policy focus from stabilization of the economy to enhancing the economy’s growth potential. In addition, the economy is confronted with new challenges arising from rapid changes in technology and globalization. America’s economy is large and diverse, and it is not surprising that accounting for this vast range of economic activity requires a decentralized statistical system. The major agencies involved in generating the national accounts include the Bureau of Economic Analysis (BEA) in the Department of Commerce, the Bureau of Labor Statistics (BLS) in the Department of Labor, and the Board of Governors of the Federal Reserve System. 124 NAS/NAE/IOM, Rising Above the Gathering Storm: Energizing and Employing America for a Brighter Economic Future, op. cit. 125 The Board on Science, Technology, and Economic Policy has an analysis of foreign programs under way that is focused on best practices, Comparative Innovation Policy: Best Practice in National Technology Programs, under the direction of William Spencer. 126 National Research Council, The Advanced Technology Program: Assessing Outcomes, op. cit. 127 Similar priorities have been identified in Europe. See ESIA, “The European Semiconductor Industry 2005 Competitiveness Report,” op. cit.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age The BEA has responsibility for the core system of accounts, the National Income and Product Accounts. The BLS generates employment statistics, wage and salary data, and productivity statistics, as well as almost all of the underlying price information. The Board of Governors produces the Flow of Funds Accounts, including balance sheets for major financial sectors. Many other agencies and private sector organizations provide source data for the national accounts. As an illustration, both BEA and BLS measure industry output. BEA’s estimates are used to allocate the GDP to individual industries. BLS generates its own estimates in arriving at measures of industry-level productivity growth. Unfortunately, the BEA and BLS estimates of industry output do not always agree. As a second illustration, the Board of Governors generates a measure of national saving from the income statements and balance sheets that comprise the Flow of Funds Accounts. BEA produces an estimate of national saving from the income and product accounts. Although both estimates agree that the saving rate has declined sharply over the past 20 years, they employ different data sources and sometimes arrive at conflicting results. Recommendations The U.S. national accounts require a new architecture to guide the future development of this decentralized system. The National Income and Product Accounts, the productivity statistics, and the Flow of Funds have different origins, reflecting diverse objectives and data sources. However, they are intimately linked. An important motivation for developing a new architecture is to integrate the different components and make them as consistent as possible.128 An important objective of the new architecture is to combine the data sources employed by BEA and BLS in order to arrive at a common set of estimates. This is a crucial ingredient in long-term projections of the U.S. economy that depend on the disparate trends in productivity in key industries, such as information technology producers and intensive users of information technology. Another goal of this new architecture is to bring the flow of funds and the national income accounts into consistency in order to provide better data for 128 More details about the new architecture are presented in Dale W. Jorgenson, J. Steven Landefeld, and William Nordhaus, eds., A New Architecture for the U.S. National Accounts, Chicago, IL: University of Chicago Press, 2006. Accessed at <http://www.nber.org/books/CRIW-naccts/index.html>.

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Measuring and Sustaining the New Economy: Enhancing Productivity Growth in the Information Age anticipating future financing needs of both public and private sectors.129 This proposed system of accounts integrates the National Income and Product Accounts with the productivity statistics generated by BLS and balance sheets produced by the Federal Reserve Board. The proposed system would feature GDP, as does the National Income and Product Accounts; however, GDP and domestic income are generated along with productivity growth. BEA’s accounts for reproducible assets and the U.S. International Investment Position are extended to encompass a balance sheet for the U.S. economy as a whole. The cost of capital for productive assets employed in the U.S. economy provides a unifying methodology for integrating the National Income and Product Accounts generated by BEA and the productivity statistics constructed by BLS.130 The next step is to develop a complete version of the BLS productivity statistics that is consistent with a new system of official industry accounts recently released by BEA.131 To further explore these proposals for a new architecture, additional resources should be made available. The drivers of the U.S. economy have evolved, indeed shifted quite dramatically, and it is essential that a new architecture for the national accounts be put into place to better capture this new reality.132 129 The key elements of the new architecture are outlined in a “Blueprint for Expanded and Integrated U.S. Accounts,” by Dale W. Jorgenson and J. Steven Landefeld, 1995. Accessed at <http://post.economics.harvard.edu/faculty/jorgenson/papers/Blueprint_051905.pdf>. 130 A detailed set of productivity statistics for the United States is presented by Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, Productivity, Volume 3: Information Technology and the American Growth Resurgence, op. cit. 131 Access at <http://www.bea.doc.gov/bea/newsrel/gdpindnewsrelease.htm>. 132 The BEA is currently working with the National Science Foundation on accounts for research and development that could ultimately lead to recognition of R&D investment and capital stocks. The results of this accounting should assist future evaluations of high-tech investment and its effects on the economy.

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