microchip flexes its muscle, The

Federal Reserve Bank of St. Louis - Regional Economist, Jul 2001 by Kliesen, Kevin L, Wheelock, David C

Can It Compete with History's Best?

The U.S. economy has experienced more than 18 years of uninterrupted growth since the end of the 1981-82 recession. The lone blemish during this so-called Long Boom was a recession lasting just nine months, from July 1990 to March 1991. But what has so enthralled many economists is not the length of the boom but the acceleration in the economy's rate of productivity growth during the last half of the 1990s. Most economists who have attempted to explain the cause of this productivity boom point to the spate of innovations and technological advances associated with the microchip, which has spurred heavy investment in high-tech information and communications technology equipment and software. Many questions about the productivity boom remain, however:

Why did it take so long to begin?

How long will it last?

Can public policy do anything to encourage productivity booms and lasting increases in economic growth?

Our current boom period appears similar to past eras of rapid technological progress and economic growth. In the late 19th and early 20th centuries, advances in the distribution and usage of electric power, new processes for making steel, development and application of the internal combustion engine, and expansion of the chemical industry and numerous other important sectors delivered impressive gains in manufacturing productivity and the standard of living. Like our current experience, however, a considerable delay occurred between the introduction of new technologies and measurable increases in aggregate productivity growth. Once productivity and economic growth began to accelerate, however, they remained high for several decades.

What can we learn from history that might be relevant for understanding our current productivity boom and for understanding whether public policy can play a constructive role in fostering sustained growth in living standards?

The Importance of Productivity Growth

Economists and policy-makers pay so much attention to productivity growth for a simple reason: The more productive the nation's workforce becomes, the higher will be its citizens' standard of living. In the United States, per capita real gross domestic product rose by 2.2 percent per year on average from 1929 to 1994. At this rate, the average American's living standard doubles about every 33 years. But if per capita GDP increases at a 3.4 percent annual rate-its growth from 1995 to 2000-then only 21 years would be needed for living standards to double. (See chart Page 7.)

What causes productivity growth rates to speed up or slow down? Clearly, improvements in the quality of labor input, such as a more educated workforce, do. An increase in the quantity of capital per worker-known as capital deepening-also increases average labor productivity over time. In recent years, this phenomenon has been especially important, as sharp declines in the prices of computers, software and other information and communications technology equipment have caused businesses to dramatically ramp up their spending on such thins.

Besides changes in measured labor and capital inputs, productivity can increase for other reasons. To capture these reasons, economists use the concept of total, or multi, factor productivity (TP). In general, labor productivity growth-and, hence, growth of living standards-is a function of capital deepening and TFP growth.

Broadly, TFP growth is a measure of the economy's rate of innovation, or technical progress, over time. Though perhaps a nebulous concept to noneconomists, technical progress can be thought of as the myriad improvements to standard of living arising from innovations that allow firms to produce new goods and services or to reduce the cost of existing goods and services. Some examples are:

Medical advances that improve health care;

More-powerful computers and improved software;

Increased efficiencies associated with the Internet, such as e-commerce;

Satellite- and land-based communications technologies that lower the cost of acquiring and disseminating information;

Cars and airplanes that use less fuel; and

More-efficient means of growing and producing food.

Historically, TFP growth has been an important cause of economic growth. To see this, consider the First Industrial Revolution, which occurred in Britain during the 18th and early 19th centuries, and the Second Industrial Revolution, which was centered in the United States at the end of the 19th century. Faster TFP growth explains more than 70 percent of the acceleration in British per capita income during the First Industrial Revolution, according to Northwestern University Professor Joel Mokyr. An examination of the Second Industrial Revolution also shows that aggregate output growth accelerated once the new technologies had become widely adopted in U.S. manufacturing and had precipitated a marked acceleration in TFP growth.

Economists now debate whether the computer revolution measures up to the great industrial revolutions of the past. If so, we may see a sustained acceleration in TFP growth as in past industrial revolutions. That the U.S. economy has stretched the bounds of growth previously thought unattainable a generation ago suggests that the microchip revolution has engendered some economywide benefits. Nonetheless, some reputable economists believe that previous episodes of innovation were much more significant and that the strong productivity growth of recent years is but a temporary phenomenon. The jury is still out. But since maintaining this prosperity for future generations is the overarching goal of public policy, policy-makers would like to have some insight into those forces driving the recent acceleration in labor productivity. Maybe something can be learned from the past.