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Macrorealities of the fonnation Economy STEPHEN S. ROACH The information economy and the associated surge in high tech- nology spending my well offer promise of renewed productivity growth in the Unzoned States, but at current exchange rates the re- suking improvements in living standards could well turn out to be built on a foundation offoreign-produced ar~foreign-owned capital. Technology has taken on a new role as a conditioner of economic change In He United States. Historically, economists have been preoccupied win technological change in the narrow or macroeconomic sensefocusing mainly on the process of innovation, its diffusion, and potential linkages to pros ductivity. A shortcoming of this approach is Hat it fails to consider He role of technology in the context of dramatic shifts that have occurred in He macros~cture of the economy. Indeed, it can now be demonstrated Hat high technology holds He key to the evolution of what can be called "~e information economy" a core of activities Hat increasingly has become a dominant source of economic progress in the United States. This discussion of He macro~mensions of the inflation economy draws, in large part, on work we have previously published at Morgan Stanley. The findings of Hat work can be summarized in a relatively s~aigh~orward way. First, He process of structural change in the U.S. economy began in earnest in He 1960s and started with a shift of output and earnings away tSee The industnalizabon of We infold non economy, Morgan Stanley Econonuc Perspectives, June 15, 1984; and S. S. Roach, The tuformanon economy comes of age, Infonnation Management Review, 1985 (1):9-18. 93

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94 STEPHEN S. ROACH from traditional manufacturing activities and toward industries engaged pre- dominan~cly in He creation, manipulation, and distribution of information. An important by-product of such trends was that job growth shifted dra- matically away from employment on the factory assembly line and toward the white-collar work force. Such workers had labored for years at a distinct disadvantage because they had relatively limited productive capital at their disposal. With the explosion in high technology spending in the late 1970s, however, Hat all began to change, and by 1983 U.S. capital endowment per worker had shifted dramatically away from the factory sector and into the information economy. Therein lies the potential for a resumption of improved longer-term performance of He U.S. economy: the industrialization of the ntorrnat~on economy. SHIFTS IN OUTPUT AND EARNINGS Information has become a reality for most industrieswhether they are in the factory or the so-called service sector. The information intensity of a firm's output is highest in such areas as communications, finance, and in- surance, as well as in some of the more traditional service areas, such as those provided by business consultants and professionals. ~ such informa- tion-intensive industries, companies usually do not produce physical prod- ucts, but instead combine the flow of information with their skilled labor force and high technology capital to generate a knowledge-based "com- modity." Even in manufacturing the growing use of robotics, computer- aided design/computer-aided manufacturing (CAD/CAM), and management information systems (MIS)-based control underscores the potential applica- tions that information technologies can have on the traditional factory as- sembly line. Figure 1 lays out the broad boundaries of the information economy. Shown in the upper panel of the figure is a decomposition of private nonfann output into two broad groupings of industries. Defined in this context, the "infor- mation sector" includes not only traditional services but also finance, in- surance, real estate, Lade, transportation, communications, and public utilities. The "goods sector" is what is left over: mar~ufactunug, mining, and con- struction. The share of output going to the goods sector has declined steadily since the mid-1960s from about 45 percent to about 37 percent in 1984. By contrast, the output share of the infonnation sector has risen to over 60 percent, and our Morgan Stanley projections suggest that this group of in- dustries will generate close to two out of every Tree dollars of national output by the end of 1985. As the lower panel of Figure 1 indicates, similar shifts can be observed in the composition of corporate profits. In 1984 the information sector ac- counted for essentially half the volume of total corporate profits in the United

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MACROREALITIES OF THE INFORMATION ECONOMY Output Shares 45 40 cr LO rat 95 55 _ _ 50 60 65 60 Information Sector (right scale) . . Profit Shares 55 - Goods Se~_ (left scale) 50 55 _ /~\ Goods Sector \_ (left scale) 50 45 40 I I 1 964 1 968 1972 Phi: if\ Ad\ Information Sector \ ; (right scale) \l ~ I 1 ~ 1 1976 1980 1984 FIGS 1 The emergence of the infonnabon economy. NOTE: Dashed lines indicate Morgan Stanley economics projections. source: Morgan Stanley Economic Perspectives, June 15, 1984. 60 55 50 45 40 States increasing its earnings share almost 25 percent over the past decade. Moreover, on a per unit basis, the rise in profitability for information-inten- sive industnes exceeded the growth in output over the past 10 years a clear sign of an advantageous shift in earnings leverage that is another important by-product of an emerging information economy. INFORMATION WORKERS AND THE INVESTMENT RESPONSE Table 1 illustrates one of the most important charactenst~cs of the infor- mation sectorthe employment of a relatively large share of what tradi- tionally has been referred to as We economy's "white-collar" occupations. These workers, hereafter referred to as the information work force, are

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96 TABLE 1 Growing Information-Intensity of the Work Force (share of private nonfarm work force) STEPHEN 5. ROACH Average: 1962 to 1972 1983 Infoll~,aiion Production Information Production Workers Workers Workers Workers Private nonfarm work force 49.~% 50.8% 56.2% 43.8 Information sector 62.3 37.7 65.7 34.3 Finance, insurance, and real estate 92.9 7.1 92.4 7.6 Services - 61.9 38.1 66.6 33.4 Trade 62.5 37.5 61.6 38.4 Transportation and public utilities 40.8 59.2 49.7 50.3 Goods sector 28.7 71.3 33.6 66.4 Manufacn~nug 30.4 69.6 36.8 63.2 Mining 28.8 71.2 44.4 55.6 Construction 21.9 78.1 21.4 78.6 - SOURCE: B=eau of ~bor Smusucs ~cupation~-Indus~ Ma~. defined to include executives, administrators, managers, professional spe- cialists, technicians, salesworkers, and the support staffs of each of these groups. As the table-indicates, the concentration of information workers is clearly highest in the information sector of the economy. Indeed, in 1983 infonnanon-intensive industries employed, on average, two information workers for every production worker; in contrast, the ratio is reversed in the goods sector. Thus, we can tentatively conclude that the information sector includes not only the fastest-growing and most profitable industries of We economy but, as expected, ~ highly disproportionate share of the information work force. If shifts in the mix of output, earnings, and employment persist long enough, it is only natural to expect a complementary response in the com- posihon of the remaining factor of productionthe capital stock. It took more than 10 years for such a shift to occur, but when it did it came win a vengeance! Figure 2 overlays compositional shifts in capital spending with the mends in the mix of the work force just descnbed. The upper panel highlights the essence of an emerging information economy: a rising share of the inforrnanon work force together with an explosion of We high tech- nology portion of business capital spending. From the mid-1960s through 1984, high-tech spending defined as computers, office machines, com- - munications equipment, instruments, industrial control and measuring de- vices, and miscellaneous electrical components and machinery almost tripled as a portion of total business fixed investment, rising from about 12 percent to over 35 percent. Similarly, during Me same period, the employment share of infonnaiion workers climbed an estimated 10 percentage points to about 55 percent of the nonfarm work force.

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MACROREALITIES OF THE INFORMATION ECONOMY 40 30 20 it at: 30 25 20 1S 97 ....... ....... . ..~ I nvestment ~ .. 60 55 50 ~ , Basic I ndustria I Sector .~ ...... ,~Dg: ~ Production , _ .......... 2. , . .. .. ...... ...... ...2.2.. .... .. _1 ~ ........ ............. an 1 1 1 ~ . 1 ~ ~ . .,. _ ~ I ndustria I A. ..... ~leVfestmieelt .... ~ 1 1 2'.2' 1 1 ,,.,,.,.,,, \ to 1968 1972 1 976 1 980 1 984 ~0 45 40 FIGURE 2 Structural change and the information economy (investment and employ- ment shares). NOTE: Shaded areas indicate recessionary periods as designated by the National Bu- reau of Economic Research. Dashed lines indicate Morgan Stanley economics pro- . . . Jectlons. SOURCE: Morgan Stanley Economic Perspectives, June 15, 1984. A COMMON TREAD lithe shifts in the composition of employment and capital accumulation turn out to be far more than a mere coincidence. Indeed, it is increasingly important to view He extraordinary acceleration of spending on high tech- nology as the complementary investment response to the rapid expansion of the information work force. This conclusion is based on Be fact Hat high technology capital turns out to be the mainstay of 'production" in He information segment of our economy. This assertion can be verified by examining He intenudustry flows of shipments for a large number of high technology items. Figure 3 shows the

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98 STEPHEN S. ROACH sectoral allocations of such flows for 1982- the latest year for which there are reliable benchmark statistics. It is no surprise Mat industries Mat have been identified as being among Me most infosmation-intensive In the economy were also recipients of Me bunk of h~gh-tech equipment. Indeed, almost 85 percent of computers, other office machinery, and communications equip- ment was shipped to the information sector in 1982. To be sure, Me share was somewhat lower for instruments and photographic equipment, and clearly, most measunug and control devices are purchased by manufacturing com- panies. Nonetheless, about 70 percent of all purchases of high-tech equipment were made by information-intensive industries. Thus, high-tech investment and information-worker employment go hand in handmore Man a decade of parallel trends appears to be far more than just happenstance. Figure 4 brings together these compositional shifts in labor and capital. Shown in the figure are ratios (in real terms) of the stock of basic industrial capital per production worker and high-tech capital per ~nfonnation worker Me most logical way to match Me functional categories of productive capital win the workers who actually utilize such facilities in the production process. 20: 15 10 5 o ~ Production Sector $16.0 Information Sector S8.5 $8.1 . S7 0 Computers and Other Communications Instruments and Measuring and Office Machinery Equipment Photographic Equipment Control Devices S3.2 S0.6 FIGURE 3 WhO uses high-tech equipment? (Allocation of private domestic final shim meets in 1982.) SOURCE: Morgan Stanley economics estimates based on input-output industry dis~i- bution tables provided by the Interindustry Service of Data Resources, Inc.

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MACROREALITIES OF THE INFORMATION ECONOMY 1300 1 1 00 900 700 Oh 500 Cal I_ 6000 5000 4000 3000 2000 99 Investment per worker /Basic I rx~ustrial ~~\, / per Production Worker _, 1~ High-Tech per Information Worker ~ ~ \ _ ~ , \' Capital Stock per Worker /Basic Industrial per Production Worker tic_ high-Tech per Informnsion WnrkPr - I I ' 1 1 1 1 1 - _ _ 1 1 1964 1 968 1972 1976 1980 1984 FIGURE 4 Investment and capital stock per worker: high-tech versus basic industrial. NOTE: Invesunent and capital stock are expressed in constant 1972 dollars. Dashed lines indicate Morgan Stanley economics projections. SOURCE: Morgan Stanley Economics Projections, June 15, 1984. Figure 4 reveals a drmnatic convergence between these two components of the economy's overall capital:labor ratio. Over a span of 20 years, the stock of high-tech capital per infonnahon worker moved from about half the size of its basic industrial counterpart to a position of relative parity in 1983. This trend, perhaps more than anything else, brings the infonnation sector to the forefront of econormc change in Me United States; its workers are now

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100 STEPHEN S. ROACH as richly endowed with capital as are typical production workers on the factory assembly line. What has occurred is essentially a new process of industrialization one that should dispel any doubts about the potential vi- tality of the information economy. PRODUCTIVITY IMPLICATIONS During the long sweep of U.S. economic history, trends in capital:labor ratios and productivity change have tended to move together. While many point to the slower growth of the total stock of capital per worker as a key element in this nation's productivity shortfall, what has been over- looked is the dramatic shifts that have been taking place in the mix of capital endowment across sectors. Potentially, these relative movements may have even more to say about this nation's productivity potential than do summary ratios that lump together and weigh the many diverse types of capital against a variety of widely disparate occupational categories of the work force. A key question, of course, is whether the rapidly rising endowment of high-tech capital embodies efficiencies that ultimately could generate im- provements in infoImation-worker productivity. On that count, the verdict is still out. Some believe that there has been unnecessary and indiscriminate spending on new technologies. Others believe that the productivity payback of the information economy cannot be accomplished without major improve- ments in technology management. Over time, however, productivity change in the information economy should be less conditioned by managerial behavior and become more a func- tion of the extraordinary revolution in microprocessing. Critical in this regard are the steady miniaturization of the `'chip" and increasing economies in the costs of its production. Moreover, the rapidly changing technology of hardware is likely to be increasingly augmented by concomitant break- ~roughs in operating systems or software trends Mat ultimately hold the potential for We introductioII of efficiencies in We workplace that are well beyond the realm of present-day comprehension. Just as economies on the assembly line once were the engine of productivity growth in '~smokestack America," high technology also has the potential to spark even greater efficiencies in the information economy Of special note in this regard is the "leverage factor'' the fact that information workers currently account for about 60 percent of all hours worked in the economy. That implies, most critically, that improvements in information-worker productivity should add about 50 percent more to overall productivity change than would comparable increments for pro- duction workers. Thus, like it or not, productivity change in the aggregate

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MACROREAI]TIES OF THE INFORMATION ECONOMY i 101 s now increasingly in the hands of improved efficiencies in the information economy. A DARK SIDE Despite this constructive turn of events, the emergence of the information economy has a dark side. Unfortunately, it turns out Rat a strong dollar and an ever-widening foreign trade deficit have taken an unusually heavy toll on U.S. high technology producers. ~deed, in a recent report we at Morgan Stanley estimate that imports of high-tech equipment have risen to over twice We level prevailing in late 1982producing a 60 percent increase in the market share of foreign-produced technology items (Table 21.2 In the context of the steadily growing technological requirements of an expanding information economy, not only does such a development hint at a potentially chronic dimension of the U.S. trade deficit, but it also underscores We risk Rat American capital-goods producers could be squeezed out of participating in the most dramatic structural transformation of the U.S. economy since the Industrial Revolution. The information economy may well offer a promise of renewed productivity growth, but at current exchange rates, the resulting improvements in living standards could well turn out to be built on-a foundation of foreign-produced and foreign-owned capital. Such a problem underscores the notion Rat no matter how powerful We forces of ~nsforTnahon are, We dynamics of a technology-based infonnat~on economy are vulnerable to the same problems Rat have plagued Washington over the past two decades. Quite simply, an expansive fiscal policy in We context of monetary discipline and flexible exchange rates will continue to cause currency strains and heightened import penetration. And as recent trends strongly hint, Me high technology sector in Me United States could find itself as the new victim of this untenable imbalance in the mix of public policy. REALITIES OR VISIONS? Despite the caution flag raised by import penetration, the U.S. economy is clearly passing through a critical milestone in its postindustrial history. Much has been written about Me productivity shortfall of Me past decade. Little attention has been given, however, to the possibility that such an occurrence might well be the by-product of an economy making a rawer orderly transition from a basic industrial society to one Mat emphasizes 2See Trading away the capital spending recovery, Morgan Stanley Economic Perspectives, Febru- ary 6, 1985.

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102 TABLE 2 Functional Breakdown of Capital Goods Imports (billions of current dollars) STEPHEN S. ROACH Cumulative Change 1982 1983 1984 1984 1984 Over Quarter4 Quarter 4 Quoter 1 Quarter 2 Quarter 3 7 Quarters Total capital goods imports (excluding motor vehicles) $34.2 $45.5 $57.5 $55.9 $68.7 $34.5 High technology imports 19.7 29.9 36.8 35.8 42.9 23.2 Computers and office machinery 6.3 10.4 13.8 12.7 15.1 9.4 Communication equipment and electronic components 10.1 15.1 18.1 18.1 21.0 10.9 Instruments 3.3 4.4 4.9 4.9 6.1 2.8 Basic mdustnal imports 9.8 10.9 14.5 14.9 18.5 8.7 Construction and specialized machinery 3.5 4.2 5.3 5.8 7.0 3.5 Other industrial machinery 6.3 6.8 9.2 9.1 11.4 5.1 Over Imports 4.7 4.7 6.3 5.3 7.3 2.6 Memo items: Import share of High technology 26.6% 33.9% 40.7% 37.8% 43.0% n.a. Basic industrial 16.4 16.9 21.2 20.5 24.6 n.a. SOURCE: Census-based tabulation of U.S. international transactions. information-intensive activities. The dramatic improvements Mat have re- cently occurred in the high-tech capital endowment of the information world force suggest that this transitional interlude may be coming to an end. Instead, around the corner could very well lurk the long-awaited revival of productivity grown in the United States We seeds of which were sown Trough the industrialization of the information economy. There is no assurance, of course, that technology is the answer to pro- ductivity. One thing is certain, however. The structure of Me U.S. economy in the mid-1980s bears little resemblance to that of the past. The eroding market share of manufacturing output and the related loss of assembly-line jobs have forced business managers headlong into the Information Age. For a long time the steps were tentative, but in the last 7 years or so the steps

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AlACROREALITIES OF THE INFORMATION ECONOMY 103 have become more purposeful: a conscious effort has been made to build an infrastructure of productive capital in He information economy. Without that development corporate America would have found itself caught in something of a time warp outgrowing its industrial heritage but unwilling to look to the future. That hesitation has passed, and economic performance over Be next several decades now appears to depend critically on the new realities of the information economy.

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