DIGITAL ECONOMY 2000

INTRODUCTION<= /SPAN>

CHAPTER I: INFORMATION TECHNOLOGY AND THE = NEW=20 ECONOMY

CHAPTER = II: =20 ELECTRONIC COMMERCE: THE LEADING EDGE OF THE DIGITAL ECONOMY

CHAPTER III: =20 INFORMATION TECHNOLOGY INDUSTRIES=20

CH= APTER=20 IV: =20 CONTRIBUTION OF INFORMATION TECHNOLOGY TO U. S. PRODUCTIVITY = GROWTH=20

CHA= PTER=20 V: =20 THE INFORMATION TECHNOLOGY WORKFORCE=20

CHAPTER VI: =20 TRADE IN INFORMATION TECHNOLOGY GOODS AND = SERVICES

CHAPTER VII: =20 WHAT IS NEW IN "THE NEW ECONOMY?"

ACKNOWLEDGMENT= S=20

DIGITAL ECONOMY 2000

ECONOMICS AND STATISTICS=20 ADMINISTRATION

Office of Policy = Development

AUTHORS

Chapter II

Patricia Buckley &nbs= p; = ; = =20 &nbs= p; = ; =20 Sabrina Montes

patricia.buckley@mail.doc.gov &nbs= p; = ;=20 &nbs= p; =20 sabrina.montes@mail.doc.gov

Chapter=20 III

David Henry &nbs= p; = ; = &= nbsp; &n= bsp; &nb= sp; &nbs= p; =20 Donald Dalton

david.henry@mail.doc.gov &nbs= p; = ; = &= nbsp; &n= bsp; =20 donald.dalton@mail.doc.gov

Chapter IV

Gurmukh Gill &nbs= p; = ; = &= nbsp; &n= bsp; &nb= sp; &nbs= p; =20 Jesus Dumagan

gurmukh.gill@mail.doc.gov &nbs= p; = ; = &= nbsp; &n= bsp; =20 jesus.dumagan@mail.doc.gov

Susan LaPorte

susan.laporte@mail.doc.gov

Chapter V

Sandra Cooke

sandra.cooke@mail.doc.gov

Chapter VI

Dennis Pastore

dennis.pastore@mail.doc.gov

Chapter VII

Lee Price

lee.price@mail.doc.gov

Contributing Editors

Robert Shapiro &nbs= p; = ; = &= nbsp; &n= bsp; =20 Lee Price

Under Secretary for Economic Affairs = &nbs= p; = ; = =20 Deputy Under Secretary for Economic Affairs

robert.shapiro.@mail.doc.gov &nbs= p; = ; = &= nbsp; =20 lee.price@mail.doc.gov

Jeffrey Mayer &nbs= p; = ; = &= nbsp; &n= bsp; &nb= sp;=20 For further information, contact:

Director of Policy Development &nbs= p; = ; = =20 Secretariat on Electronic Commerce

jeff.mayer@mail.doc.gov &nbs= p; = ; = &= nbsp; =20 U. S. Department of Commerce

Washington, DC 20230

(202) 482-8369

http://www.ecommerce.gov/ =

THE=20 SECRETARY OF COMMERCE

Washington, DC 20230

I am pleased to release Digital Economy 2000, the Commerce = Department's third annual report on the information-technology = revolution and=20 its impact on our economy. Understanding sweeping economic changes as = they are=20 happening is a formidable challenge. In government agencies and research = institutions around the world, analysts are trying to meet this = challenge.=20 Digital Economy 2000 is an important contribution to this effort = and a=20 measure of its progress. =

In the twelve months since our previous digital economy report, = confidence=20 has increased among both experts and the American public that the new,=20 proliferating forms of e-business and the extraordinary dynamism of the=20 industries that produce information-technology products and services are = harbingers of a new economic era. For most economists, the key measure = of our=20 new condition is the exceptional increase in productivity of the last = five=20 years, which has helped drive a welcome combination of falling inflation = and=20 very strong growth. For many people, however, the clearest evidence lies = in the=20 extraordinary increase in the electronic connectedness among individuals = and=20 businesses through the Internet. Three hundred million people now use = the=20 Internet, compared to three million in 1994. They can access more than = one=20 billion web pages, with an estimated three million new pages added every = day.

These numbers do not tell the full story. We are witnessing an = explosive=20 increase in innovation. Using open standards, people around the world = are=20 creating new products and services that are instantly displayed to a = global=20 audience. We are witnessing myriad new forms of business activity, such = as=20 electronic marketplaces linking buyers and sellers in seamless global = bazaars,=20 and changes in business processes from customer service to product = design that=20 harness the new technologies to make businesses more efficient and = responsive.=20

Nor are our numbers complete. Surveys by the Census Bureau, for = example, now=20 measure business to consumer e-commerce or "e-tailing" and have begun to = measure=20 business-to-business e-commerce. Hard questions of definition and = measurement=20 will still have to be resolved, however, before we can understand the = full=20 impact of these changes on our economy.

What we can see clearly are expanding opportunities. To meet these=20 opportunities, we will have to ensure a stable and conducive economic = and legal=20 environment for continuing innovation in information technologies and=20 e-commerce. We need to encourage the building of a broadband = infrastructure that=20 allows all Americans to have access to the advanced services that = support the=20 Internet, and take the steps necessary with respect to privacy, consumer = protection, security, reliability and intellectual property rights that = will=20 inspire confidence in the Internet. =20 To realize the full potential of this digital economy, every = person and=20 every business must be able to participate fully and make their own = unique=20 contribution to its development.

William M. Daley=20

EXECUTIVE = SUMMARY

The U.S. = economic=20 expansion is now in its tenth year, showing no signs of slowing down. = The rate=20 of labor productivity growth has doubled in recent years, instead of = falling as=20 the expansion matured as in previous postwar expansions. Moreover, core=20 inflation remains low despite record employment and the lowest jobless = rates in=20 a generation. Our sustained economic strength with low inflation = suggests that=20 the U.S. economy may well have crossed into a new era of greater = economic=20 prosperity and possibility, much as it did after the development and = spread of=20 the electric dynamo and the internal combustion engine.

The advent of this new era has coincided with dramatic cost = reductions in=20 computers, computer components, and communications equipment. Declines = in=20 computer prices, which were already rapid--roughly 12 percent per year = on=20 average between 1987 and 1994--accelerated to 26 percent per year during = 1995-1999. Between 1994 and 1998 (the last four years for which data are = available), the price of telecommunications equipment declined by 2 = percent a=20 year.

Declining IT prices and years of sustained economic growth have = spurred=20 massive investments not only in computer and communications equipment, = but in=20 new software that harnesses and enhances the productive capacity of that = equipment. Real business investment in IT equipment and software more = than=20 doubled between 1995 and 1999, from $243 billion to $510 billion. The = software=20 component of these totals increased over the period from $82 billion to = $149=20 billion.

The new economy is being shaped not only by the development and = diffusion of=20 computer hardware and software, but also by much cheaper and rapidly = increasing=20 electronic connectivity. The Internet in particular is helping to level = the=20 playing field among large and small firms in business-to-business = e-commerce. In=20 the past, larger companies had increasingly used private networks to = carry out=20 electronic commerce, but high costs kept the resulting efficiencies out = of reach=20 for most small businesses. The Internet has altered this equation by = making it=20 easier and cheaper for all businesses to transact business and exchange=20 information.

There is growing evidence that firms are moving their supply networks = and=20 sales channels online, and participating in new online marketplaces. = Firms are=20 also expanding their use of networked systems to improve internal = business=20 processes--to coordinate product design, manage inventory, improve = customer=20 service, and reduce administrative and managerial costs. Nonetheless, = the=20 evolution of digital business is still in an early stage. A recent = survey by the=20 National Association of Manufacturers, for example, found that more than = two-thirds of American manufacturers still do not conduct business=20 electronically.

Advances in information technologies and the spread of the Internet = are also=20 providing significant benefits to individuals. In 2000, the number of = people=20 with Internet access will reach an estimated 304 million people = world-wide, up=20 almost 80 percent from 1999; and, for the first time, the United States = and=20 Canada account for less than 50 percent of the global online population. = Further, according to Inktomi and the NEC Research Institute, the amount = of=20 information available online has increased ten-fold over the last three = years,=20 to more than a billion discrete pages.

As more people have moved online, so have many everyday activities. = In March=20 2000, the Census Bureau released the first official measure of an = important=20 subset of business-to-consumer e-commerce, "e-retail." Census found that = in the=20 fourth quarter of 1999, online sales by retail establishments totaled = $5.3=20 billion, or 0.64 percent of all retail sales. People increasingly use = the=20 Internet not only to make purchases, but also to arrange financing, take = delivery of digital products, and get follow-up service.

The vitality of the digital economy is grounded in IT-producing=20 industries--the firms that supply the goods and services that support = IT-enabled=20 business processes, the Internet and e-commerce. Analysis of growth and=20 investment patterns shows that the economic importance of these = industries has=20 increased sharply since the mid-1990s. Although IT industries still = account for=20 a relatively small share of the economy's total output--an estimated 8.3 = percent=20 in 2000--they contributed nearly a third of real U.S. economic growth = between=20 1995 and 1999.

In addition, the falling prices of IT goods and services have reduced = overall=20 U.S. inflation--for the years 1994 to 1998, by an average of 0.5 = percentage=20 points a year, or from 2.3 percent to 1.8 percent. The rates of decline = in IT=20 prices accelerated through the 1990s--from about 1 percent in 1994, to = nearly 5=20 percent in 1995, and an average of 8 percent for the years 1996 to 1998. =

IT industries have also been a major source of new R&D = investment.=20 Between 1994 and 1999, U.S. R&D investment increased at an average = annual=20 (inflation adjusted) rate of about 6 percent--up from roughly 0.3 = percent during=20 the previous five-year period. The lion's share of this growth--37 = percent=20 between 1995 and 1998--occurred in IT industries. In 1998, IT industries = invested $44.8 billion in R&D, or nearly one-third of all = company-funded=20 R&D.

New investments in IT are helping to generate higher rates of U.S. = labor=20 productivity growth. Six major economic studies have recently concluded = that the=20 production and use of IT contributed half or more of the acceleration in = U.S.=20 productivity growth in the second half of the 1990s. This has occurred = despite=20 the fact that IT capital accounts for only 6 percent of private business = income.=20 Such remarkable leverage reflects in part the fact that businesses must = earn=20 immediate rates of return on investments in IT hardware high enough to=20 compensate for the rapid obsolescence (i.e., depreciation) and = falling=20 market value of these assets. In short, IT investments must be = extraordinarily=20 productive during their short lives. Recent firm-level evidence = indicates that=20 IT investments are most effective when coupled with complementary = investments in=20 organizational change, and not very effective in the absence of such=20 investments.

Although the official data show declining productivity for a number = of major=20 service industries that invest heavily in IT (e.g., health, = business=20 services), this probably reflects the inadequacy of official output = measures for=20 those industries. Until these measures are improved, the full effect of = IT on=20 service industry productivity will remain clouded.

In 1998, the number of workers in IT-producing industries, together = with=20 workers in IT occupations in other industries, totaled 7.4 million or = 6.1=20 percent of all American workers. Growth in the IT workforce accelerated = in the=20 mid-1990s, with the most rapid increases coming in industries and job = categories=20 associated with the development and use of IT applications. Employment = in the=20 software and computer services industries nearly doubled, from 850,000 = in 1992=20 to 1.6 million in 1998. Over the same period, employment in those IT job = categories that require the most education and offer the highest = compensation,=20 such as computer scientists, computer engineers, systems analysts and = computer=20 programmers, increased by nearly 1 million positions or almost 80 = percent.

At the same time, the rapid pace of technological change and = increased=20 competition have added an element of uncertainty to IT employment. The = number of=20 jobs has declined in some IT industries, such as computers and household = audio=20 and video equipment. Moreover, while IT-producing industries as a whole = paid=20 higher-than-average wages in 1998, some IT jobs remain low-skilled and = low-paid.=20

Paradoxically, although America's IT-producing companies are clearly=20 world-class, the United States regularly runs large trade deficits in IT = goods--an estimated $66 billion in 1999. One reason is that American IT = firms=20 more often service foreign customers with sales from their overseas = affiliates=20 than by exports from their U.S. operations. In 1997, foreign sales by = overseas=20 affiliates of American IT companies totaled $196 billion, compared to = U.S.=20 exports by firms in comparable industries of $121 billion. In the same = year,=20 American affiliates of foreign-owned IT companies operating in the = United States=20 reported sales here of $110 billion. Therefore, while the U.S. balance = of trade=20 in IT products was negative, the "balance of sales" favored American = companies=20 by $86 billion.

IT has not only propelled faster growth during this expansion, but it = will=20 have a tendency to dampen the next business cycle downturn. Because IT=20 investment is driven by competitive pressures to innovate and cut costs = more=20 than to expand capacity, it will be less affected by a slowdown in = demand. In=20 addition, by creating supply chain efficiencies that reduce inventories, = IT=20 should dampen the inventory effect that has worsened past = recessions.

The strong performance of the U.S. economy since 1995 contrasts both = with=20 U.S. performance from 1973 to 1995 and with the rest of the industrial = world in=20 recent years. Historically, there have been long lags between = fundamental=20 technological breakthroughs, such as electricity and electric motors, = and large=20 economic effects from them. Although IT is generally available in world = markets,=20 the U.S. economy to date has achieved greater gains from IT than other = countries=20 at least partly because of favorable monetary and fiscal policies, a=20 pro-competitive regime of regulation, and a financial system and = business=20 culture prepared to take risks. =20

Even in this country, however, the diffusion of IT has been uneven. = Although=20 the number of homes with computers and Internet connections has been = rising=20 rapidly, the majority of Americans do not have online connections at = home. Those=20 on the wrong side of the digital divide--disproportionately people with = lower=20 incomes, less education, and members of minority groups--are missing out = on=20 increasingly valuable opportunities for education, job search, and = communication=20 with their families and communities.

In conclusion, a growing body of evidence suggests that the U.S. = economy has=20 crossed into a new period of higher, sustainable economic growth and = higher,=20 sustainable productivity gains. These conditions are driven in part by a = powerful combination of rapid technological innovation, sharply falling = IT=20 prices, and booming investment in IT goods and services across virtually = all=20 American industries. Analysis of the computer and communications = industries in=20 particular suggests that the pace of technological innovation and = rapidly=20 falling prices should continue well into the future. Moreover, = businesses=20 outside the IT sector almost daily announce IT-based organizational and=20 operating changes that reflect their solid confidence in the benefit of = further=20 substantial investments in IT goods and services. The largest and = clearest=20 recent examples come from the automobile, aircraft, energy and retail=20 industries, which all have announced new Internet-based forms of market=20 integration that should generate large continuing investments in IT=20 infrastructure. These examples mark only the beginning of the digital=20 economy.

=20

INTRODUCTION

Robert J. Shapiro

Under Secretary of Commerce for = Economic=20 Affairs

This is the third annual report = from the=20 Commerce Department on the digital economy. The first two reports were = titled,=20 The Emerging Digital Economy. This third edition has a new title, = because=20 the digital economy and digital society are no longer "emerging." They = are here.=20 Americans have definitively crossed into a new era of economic and = social=20 experience bound up in digitally-based technological changes that are = producing=20 new ways of working, new means and manners of communicating, new goods = and=20 services, and new forms of community.

This report, like its two=20 predecessors, measures the economic performance of information = technology (IT)=20 industries and their substantial impact on growth and inflation, and = sketches=20 the emerging dimensions of e-commerce. For the first time, it can be = reasonably=20 claimed that the extraordinary dynamism of the IT sector and the new,=20 proliferating forms of e-business and e-commerce are part of an enduring = and=20 broad economic pattern. The rapid pace and proliferation of innovation=20 associated with IT, and the substantial increases in U.S. productivity = and=20 growth associated with IT-related innovation, now appear to be=20 persistent. =20

At the core of the = proposition that=20 the digital economy can produce higher long-term productivity gains and = national=20 growth than we knew in the 1970s and 1980s are certain singular = qualities=20 associated with information technologies. Most obviously, these = technologies=20 provide new ways of managing and using a resource that is common to = every sector=20 and aspect of economic life; namely information. Compared, for example, = to the=20 introduction of refrigeration or jet propulsion, IT innovations can be = applied=20 across the economy and throughout the economic process. As a result, = economic=20 gains directly associated with improving the capacity to obtain, process = and=20 transmit information mount up. =20

Further, many IT markets = exhibit=20 what economists call "network effects": The more the technology is = deployed, the=20 greater its value. Compare certain information technologies to = automobiles. When=20 you own a car, its value to you is basically the same whether 5,000 or 1 = million=20 other people own the same brand of automobile. When you buy a computer = operating=20 system or graphics program, its value to you increases as more people = buy it,=20 because their purchases of the same program increase your ability to = digitally=20 communicate and interact. As these forms of innovation spread, the = productivity=20 benefits may increase at a faster rate than simply arithmetically. =

The spread of IT = innovations in the=20 digital economy affect growth in other ways. For example, IT innovations = appear=20 to raise business investment in equipment. The last seven years have = seen the=20 fastest growth of business investment in equipment on record, and IT = investments=20 have accounted for almost two-thirds of that growth. The digital economy = also=20 can stimulate improvements in workers' skills, since many firms have to = train=20 their employees to use information technologies. This may be one reason = why=20 Americans across the work force are making real wage gains for the first = time in=20 two decades. Further, IT markets with the network effects described = above tend=20 to be dominated by a handful of products and companies, and this = tendency=20 creates the possibility of beneficial economies of scale.

Perhaps most important of = all, a=20 dynamic of cascading or continuous innovation has characterized the = development=20 and deployment of information technologies in this period. Productivity = gains=20 come not just from deploying innovative technologies that enable workers = to=20 process information faster. In addition, firms intent on taking = advantage of=20 innovative new technologies often have to rethink the way they operate = and=20 reorganize their operations, which can produce a round of organizational = innovation. Many firms also have discovered that the new technologies = can be=20 used to develop and produce new goods or services for themselves, = producing yet=20 another round of innovation. Furthermore, as these areas of potential = are widely=20 recognized and the process spreads from firm to firm, this generates = demand for=20 faster information processing. This can lead to another round of = innovation in=20 IT itself-- part of the basis for the doubling of chip capacity every 18 = months,=20 articulated as Moore's Law-- and the cascade can begin again. A leading = example=20 of this dynamic is the Internet itself. Regular and large increases in = chip=20 power provided a technological foundation for the Internet, which in = turn=20 generated myriad innovations first in software and then in how = businesses=20 organize themselves and operate, which in turn has led to more myriad=20 innovations in the goods and services available to businesses and=20 individuals.

The complex of hardware = and software=20 innovations that encompass the IT sector have made information the most=20 important basis for creating value in the economy. The process of = creating value=20 from information, throughout and across the economy, is the ultimate = basis for=20 the digital economy. This digital economy is just beginning today, and = this=20 report will provide a sketch of its current bounds.
=20

CHAPTER I =
=20
INFORMATION TECHNOLOGY AND

THE NEW ECONOMY

Two remarkable developments occurred in the second half of the 1990s. = After=20 quietly improving in speed, power, and convenience since 1969, the = Internet=20 burst onto the economic scene and began to change business strategy and=20 investment. At the same time, the U.S. economy has enjoyed a remarkable=20 resurgence. Productivity growth, one of the most important indicators of = economic health, doubled its pace from a sluggish 1.4-percent average = rate=20 between 1973 and 1995, to a 2.8-percent rate from 1995 to 1999 (Figure=20 1.1).⁽¹⁾

=20

Evidence is increasing = that these=20 two phenomena are not coincidental but derive substantially from the = same=20 phenomenon: the synergistic convergence of dramatic increases in = computer power,=20 an explosion in connectivity, and increasingly powerful new software. = These=20 advances in technology have produced sharp declines in the prices of = computer=20 processing, data storage and retrieval, and communications, that are in = turn=20 driving both the surge in Internet activity and the increases in = business=20 investment in IT hardware and software. Such investment has been a major = source=20 of recent U.S. economic strength.

The advances in computer = power=20 overwhelm imagination. Since the 1960s, the number of transistors per=20 microprocessor chip has been doubling roughly every 18 to 24 months, = resulting=20 in a massive increase in processing capability and sharply declining=20 costs.^=
(2)=20 (Figure 1.2)

Technologies associated = with=20 computer use, such as data storage technologies, have also shown = dramatic=20 improvements in performance and even more dramatic cost reductions. The = capacity=20 of today's hard- disk drives is doubling every nine months and the = average price=20 per megabyte for hard-disk drives has declined from $11.54 in 1988 to an = estimated $.02 in 1999.^=20
(3) As a consequence of technological advances in = microprocessors,=20 storage, and other components, already steep annual declines in computer = costs=20 from 1987 to 1994 accelerated sharply beginning in 1995 (Figure=20 1.3). =20

Similar improvements have = occurred=20 in communications technologies. In recent years, for example, wavelength = division multiplexing, digital subscriber lines, and cable modems have = produced=20 exponential increases in the speed of data communication and the = carrying=20 capacity of the communications infrastructure. The carrying capacity of = fiber is=20 currently doubling every 12 months.⁽⁴⁾ Between = 1994 and=20 1998 (the last four years for which data are available), the price of=20 telecommunications equipment declined by 2 percent per year.

Price declines for = computers and=20 peripheral equipment and for communications equipment have spurred major = increases in business IT investment and extraordinary growth in U.S. = production=20 of computers, communications equipment and semiconductors. (Figure 1.4) = Output=20 growth in these industries has jumped from about 12 percent a year in = the early=20 1990s to roughly 40 percent in the past six years.

In addition, the declining = costs of=20 computing and communications are helping to drive complementary = investment in=20 new software that harnesses and further enhances the productive capacity = of IT=20 hardware and infrastructure. Overall, U.S. businesses have increased = their=20 investments in new software from about $28 billion in 1987 to $149 = billion in=20 1999. (Figure 1.5)^=20
(5)=20

The new economy is being = shaped by=20 developments not only in computer hardware and software, but also in = electronic=20 connectivity. Larger businesses have been increasing efficiencies = through=20 standardizing and automating routine transactions electronically for = some time.=20 Until recently, however, most small and medium sized businesses found = that the=20 costs of necessary hardware, software, and communications service for = these=20 systems exceeded the benefits.=20

The advent of the Internet = as an=20 instrument of commerce fundamentally altered this equation by cutting = the costs=20 of software and communications services needed to conduct electronic=20 transactions. Beginning in the mid-1990s, as a result of the convergence = toward=20 digital formats and the development of de facto standards = for=20 digital networks, such as the Internet's technical specifications, the = expansion=20 and commercialization of the Internet made connecting computers and=20 communications devices easier and cheaper. Commercial opportunities on = the=20 Internet and the falling costs of computer and communications hardware = created=20 an extraordinarily fertile environment for innovations that are creating = new=20 value and new efficiencies for businesses of all sizes.

The Internet is both an = effect and a=20 cause of the new economy. It is, in part, a product of the powerful=20 technological and economic changes that are shaping a new epoch of = economic=20 experience. However, as this report shows, the Internet and related = networking=20 technologies are also increasingly the new economy's medium.

Networks, like telephone = networks or=20 the Internet, are subject to a phenomenon called "network effects" or = "network=20 externalities." Establishing a network involves large, up-front fixed = costs=20 (e.g., for purchasing equipment, laying new cable, or developing = new=20 software), but adding an additional user to an existing network costs = very=20 little. Conversely, the value of a network to participants is low when = the=20 number of participants on the network is low, but rises rapidly as = network=20 participation expands. For example, a network of a single telephone is = of no=20 use. Adding another telephone increases the value of the network because = now=20 calls can be made between the two phones. As phones are added, the = number of=20 possible connections rises almost as fast as the number of phones=20 squared.^=
(6) Any=20 person with a phone can reach more people, so the network's value to = them=20 increases.=20

Similarly, as the number = of people=20 online has grown, so has the value of being online to each Internet = user.=20 Moreover, as the Internet gains popularity, its technological = specifications=20 have become a default standard, encouraging new hardware and software=20 innovations that use Internet technology as a platform.

Fundamental engineering=20 breakthroughs alone do not have important economic effects until their = costs and=20 applications become favorable. For example, by the mid-1970s, Xerox PARC = had=20 already made several breakthroughs underpinning today's IT revolution: a = microcomputer with a mouse, graphical user interface, and Ethernet=20 communications capabilities. But there was no mass market for their = machine,=20 which at the time cost about $25,000 each to produce,⁽⁷⁾ especially = given its=20 slower processing speed and the absence of applications software that = drives=20 computer use today. In contrast, technological advances in recent years = have=20 brought IT costs down to a far more commercially attractive range, and = new=20 software applications for networked systems have been=20 developed.

Nothing approaching the = activities=20 now conducted over the Internet was possible a few years ago. Push back = the=20 technology or cost declines in any one of the four elements--computer=20 processing, data storage, software, or communications--just a few years = and the=20 Internet activities we now view as commonplace would be too frustrating = or too=20 costly for a mass market. Likewise, roll back any one of those elements = and=20 business would have found IT investment to be far less productive. As=20 applications software is developed to exploit the continuing plunge in = hardware=20 prices in coming years, businesses and consumers will find new ways to = create=20 value and increase efficiency.=20

=
=20

Chapter=20 II

ELECTRONIC COMMERCE:

THE LEADING EDGE OF THE DIGITAL ECONOMY⁽⁸⁾

The resurgence of the U.S. economy = coincides=20 with the growing use of the Internet, including the rapid growth of = electronic=20 commerce (e-commerce). In ever greater numbers, people are shopping, = looking for=20 jobs, and researching medical problems online. Businesses are moving = their=20 supply networks online, participating in and developing online = marketplaces, and=20 expanding their use of networked systems to improve a host of business=20 processes. And new products and services are being created and = integrated into=20 the networked world. This chapter explores activities at the leading = edge of the=20 digital economy.

We live in an increasingly = wired=20 world. The remarkable growth of the Internet in recent years shows no = signs of=20 abating. According to Nua Internet Surveys, during the past year = Internet=20 access has grown significantly in all regions of the world, rising from = 171=20 million people in March 1999 to 304 million in March 2000, an increase = of 78=20 percent (Figure 2.1).^=20
(9)

The United States and = Canada still=20 account for a large proportion of worldwide online users; but for the = first=20 time, they now account for less than 50 percent of the total (Table = 2.1). Over=20 the past year, Internet access in the United States and Canada grew by = more than=20 40 percent; over the same period, Internet access in all other parts of = the=20 world more than doubled.

=

Table 2.1

Number of=20 People Online

(in = Millions)

Mar-99

Mar-00

level

increase

percent

increase

Africa

1.1

2.6

1.5

136

Asia/Pacific

27.0

68.9

41.9

155

Europe

40.1

83.4

43.3

108

Middle=20 East

0.9

1.9

1.0

111

Canada &=20 US

97.0

136.9

39.9

South=20 America

5.3

10.7

5.4

102

Source: Nua = Internet=20 Surveys

The = amount of=20 information available online to people with Internet access has also = grown very=20 rapidly. A recent study by Inktomi and the NEC Research Institute, Inc., = for=20 example, indicates that in January 2000 the World Wide Web contained = more than=20 one billion unique pages,^=20
(10) compared to 100 million in October 1997.⁽¹¹⁾

CONSUMERS IN THE NEW = ECONOMY
=20

Consumers today--wherever they are in the world--go online to shop, = learn=20 about different products and providers, search for jobs, manage their = finances,=20 obtain health information and scan their hometown newspapers. While many = of=20 these activities are not captured by official output and productivity = measures,=20 a growing body of anecdotal evidence suggests that the digital = revolution is=20 improving many people's lives.

Business-to-Consumer Electronic=20 Commerce=20

Individuals with Internet access increasingly approach the Web as a = market=20 space.^=
(12) People online do research before = they buy,=20 make purchase commitments, arrange financing, take delivery of = digital=20

products, and obtain = followup=20 service. The "commerce" in e-commerce encompasses all of these = activities.=20 However, when measuring business-to-consumer (B2C) e-commerce in = particular, it=20 is the commitment to purchase--the transactional component--that both = buyers and=20 sellers can easily identify and quantify. This transactional component = is the=20 focus of most current e-commerce measurements.

In March 2000, the U.S. = Bureau of=20 the Census released the first official measure of e-retail, an important = subset=20 of business-to-consumer e-commerce. Census found that during the fourth = quarter=20 of 1999, online sales by retail establishments totaled $5.3 billion, or = 0.64=20 percent of all retail sales.⁽¹³⁾ =
=20

By contrast, private = estimates for=20 consumer e-commerce in the fourth quarter of 1999 ranged from = approximately $4=20 billion to $14 billion. However, many private estimates of B2C = e-commerce=20 include the value of a wide range of consumer online purchases such as = airline=20 tickets, hotel rooms, and shares of stocks that are not captured in The = Census=20 Bureau's survey of retail establishments. When these private estimates = are=20 adjusted to cover only those purchases included in the retail measure, = the=20 Census Bureau estimate of $5.3 billion appears to fall in the midrange. = For=20 example, Forrester Research estimated fourth-quarter online sales at $9 = billion,=20 but when travel and event tickets are subtracted--both categories that = are not=20 part of the official definition of retail sales--the Forrester estimate = falls to=20 a comparable $5.5 billion.^=20
(14)

Prior to the 1999 holiday = shopping=20 season, some analysts expressed concern that if online retailers = experienced the=20 problems filling orders that had plagued many of them in the 1998 online = holiday=20 season, consumers might turn away from online shopping. Private surveys=20 conducted shortly after the holiday season indicated that such problems = were=20 minimal and that online customer satisfaction was high.⁽¹⁵⁾ = Nonetheless, some=20 analysts believe that delivering goods ordered by consumers from = e-retailers=20 will prove to be more costly and complex than currently = appreciated.⁽¹⁶⁾ The = ultimate size=20 of online consumer sales will depend on resolving these fulfillment = issues,=20 along with other important matters such as taxation, consumer = protection,=20 privacy, intellectual property rights, security, and network = reliability.=20

Online Pricing =

In the consumer realm, the most significant impact of e-commerce may = be on=20 the pricing of goods and services. Potential buyers can check the price = and=20 availability of products from a variety of sites in far less time than = it would=20 take to conduct store-to-store comparisons in the world of bricks and = mortar.=20 Furthermore, online digital shopping spaces can be perused for consumers = by=20 software specialized to operate as digital shoppers. Such digital = agents, known=20 as "bots," cruise through numbers of Internet sites almost = instantaneously,=20 searching for the most favorable price and feature combinations. =20

One would expect that this ability to easily and cheaply gather = information=20 on prices and product characteristics would force Internet retailers to = charge=20 the same low price--one that would approach their cost--on the same or=20 comparable products. One might also expect these online prices to = influence=20 prices charged in physical stores. Thus far, however, the data on these = matters=20 are mixed. For example, a study of 20 book titles and 20 CD titles sold = by 41=20 Internet and conventional retail outlets between February 1998 and May = 1999=20 found that Internet prices were between 9 and 16 percent lower than = prices in=20 conventional outlets, depending on whether taxes, shipping, and shopping = costs=20 were included in the price.⁽¹⁷⁾ However, = another=20 study of book prices covering 107 titles sold by 13 online and two = physical=20 bookstores during the week of April 19, 1999, found that prices online = and in=20 physical bookstores were the same. This suggests that certain Web sites = have=20 sufficiently differentiated themselves through factors other than price = (e.g.,=20 convenience, product reviews) that they can attract sales even when they = are not=20 the lowest-price seller.^=20
(18)

Even if the jury is out on the price sensitivity of online shoppers, = online=20 commerce has fostered a variety of pricing schemes. One of these is = online=20 auctions. Live auctions have existed for a long time, but their = practical uses=20 have been limited by the expense and difficulty of getting prospective = buyers to=20 a single location at the same time. Sealed bid auctions are less = expensive, but=20 they often do not produce the highest possible return to the seller. By=20 contrast, the Internet provides a relatively low-cost and convenient way = of=20 bringing buyers and sellers together, and the use of auction sites such = as eBay=20 has grown rapidly. Variations on the standard auctions are also gaining=20 popularity. In the reverse auction format of PriceLine.com, the consumer = names=20 the price and the seller decides whether or not to accept it. In the = Mercata.com=20 format, price is determined by the number of people that want to buy a=20 product--the greater the number of buyers, the lower the price. =
=20

A "single price" model holds for most offline goods and services = since most=20 offline sellers do not have sufficient information to vary their prices = from=20 customer-to-customer and because changing the price of individually = tagged items=20 may involve considerable cost. Where providers do have sufficient = customer=20 information and price adjustments are relatively easy to make, however, = variable=20 pricing can produce benefits to both seller and consumer. For example, = airlines=20 have long set lower fares for tickets issued 21 days in advance that = include a=20 Saturday night stay (that is, tickets sold to more price-sensitive and=20 time-flexible travelers who can plan ahead) and much higher fares for = next-day=20 tickets (tickets sold to less price- and more time-sensitive business=20 travelers). More recently, airlines have developed an e-mail strategy to = attract=20 "spur of the moment" travelers with last minute travel deals. As a = result, while=20 vacation travelers obtain fares at a lower cost than if the airline = charged a=20 single price for all seats on the plane, business travelers can be = confident=20 that they can secure seats with little advanced notice, and airlines = operate=20 with a higher proportion of their seats filled.

The Internet opens up this airline-type variable pricing to many = other types=20 of goods and services, creating the potential for greater specificity in = variable pricing. By gauging the price sensitivity of particular = consumers=20 relative to the marginal cost of the good and its availability, online = sellers=20 can fine tune prices for individual customers to maximize profits. The = study of=20 20 book titles and 20 CD titles cited above (Brynjolfsson and Smith) = found that=20 Internet retailers regularly make price adjustments that are smaller = than the=20 smallest price changes observed in conventional stores.
=

Electronic = Information =

Product and Service Information. Regardless of = where=20 people are, those with Internet access have at their finger tips a = repository of=20 information on product and service prices, quality, and availability = that would=20 have been unimaginable before the Web. Manufacturers, retailers, and = online=20 magazines now offer detailed product, warranty, and repair information, = along=20 with comparisons of competitive products. Rather than comparison = shopping at=20 brick-and-mortar stores, consumers can now get reliable information = conveniently=20 on the Web.

Consider the information about automobiles now available online, from = dealer=20 costs and expert reviews to the availability of options and detailed = product=20 specifications. Consumers cannot test drive an automobile on the Web, so = auto=20 buyers still want to visit car dealerships. (Consumers are also = constrained by=20 laws in most states that restrict the sale of new cars to licensed auto = dealers=20 who cannot also be car manufacturers.) However, consumers who do their = homework=20 online can approach dealers with a wealth of information that can = strengthen=20 their bargaining position and reduce some of the stress of car buying. = According=20 to J.D. Powers and Associates, while only 2.7 percent of the people who=20 purchased a new vehicle during the first quarter of 1999 purchased their = car=20 through an online buying service, the percentage of new-vehicle shoppers = using=20 the Internet to help them shop increased from 25 percent in 1998 to 40 = percent=20 in the first quarter of 1999, and it is projected to reach more than 65 = percent=20 by the end of 2000.^=20
(19) After purchasing a car, consumers can find other valuable = information online, including authorized repair locations, warranty = information,=20 recalls, and information to troubleshoot problems.

Health Care. The Internet increases the ability of = patients to=20 participate more actively in matters related to their own health. A = recent study=20 by the California HealthCare Foundation cites estimates that the = Internet offers=20 at least 17,000 different health care sites and that some 24.8 million = U.S.=20 adults have searched for health information. This number is projected to = grow to=20 over 30 million during 2000.⁽²⁰⁾ Jupiter=20 Communications has estimated that 45 percent of online consumers access = the=20 Internet for health information.⁽²¹⁾ Today, = some=20 patients arrive at their doctors' offices carrying possible diagnoses = downloaded=20 from sites such as Healtheon/WebMD or America Online Health Channel. In=20 addition, people with Internet access can obtain information about their = healthcare plans, find doctors, and in some cases submit claims for fee=20 reimbursement. Doctors, too, are increasing their use of the Internet as = a=20 source of information on the latest news in medical research. Other = aspects of=20 health care delivery, including laboratory results reporting, = prescriptions,=20 office visit scheduling, and records transmittal may move online once = issues=20 such as privacy and authentication are resolved.

Employment. Many private companies now post job = openings on=20 their company's Web site, and in some cases these sites can accept = online=20 applications. In their 2000 survey, recruitsoft.com and iLogos Research = found=20 that 79 percent of the Global 500 used their Web sites for recruitment = compared=20 with 29 percent in 1998. Approximately one-half (46 percent) of the = Global 500=20 both posted openings and accepted applications online, while one-third = listed=20 openings online, but encouraged application by mail or fax. Web site = recruiting=20 among the North American-based Global 500 was even more prevalent, with = over 90=20 percent of such firms participating and 71 percent accepting = applications=20 online.^=
(22)=20

In addition to firm-specific online recruiting, a growing number of = Web sites=20 offer online employment classifieds, grouping together requests from = multiple=20 employers. Some of these sites are maintained by newspaper companies,=20 traditional providers of employment classifieds. Others have been = established to=20 specialize in specific employment areas. For example, the U.S. = Government=20 maintains www.usajobs.opm.gov, a site containing a listing of current = Federal=20 job openings, as well as general employment information. =

Some observers believe that effective online recruiting faces = substantial=20 barriers. A recent Forrester Research study, for example, noted that = "[t]o reach=20 a critical mass of Web users, recruiters must manage multiple job = postings,=20 multiple site relationships, and a flood of resumes. Meanwhile, job = seekers must=20 explore listings from both companies and recruitment agencies and submit = multiple resumes."^=20
(23) As a result, Forrester and other analysts believe that = these=20 job-classified sites will be superceded by consolidated online career = networks=20 that aggregate training, assessment, and placement services. =
=20

Research. The Internet's original purpose was to=20 disseminate research and information, and this use continues to be = important=20 today. Educational research and technical materials are available online = to=20 students, researchers, scientists, and engineers anywhere in the world. = Many=20 universities make their research papers available on the Internet, and = most=20 academic and professional journals are available online (though often on = a cost=20 basis). In addition, previously unpublished information is increasingly=20 available on the Internet. For example, students can download lectures = at their=20 convenience, and live classroom presentations are broadcast on the = Internet with=20 students submitting questions via e-mail.

The Internet also provides access to research of a more general or=20 recreational nature. News with frequent updates is available from local, = national, and foreign sources, as are weather and traffic information. = Numerous=20 online services also provide information covering everything from the = floor=20 plans of museums and restaurant reviews, to local television and radio = listings.=20 During several recent foreign conflicts and natural disasters, the = Internet=20 played a role in providing news and information when traditional media = outlets=20 were closed. For example, in 1999 the independent Belgrade radio = station, B-92,=20 continued to broadcast over the Internet even after its radio broadcasts = had=20 been shut-down.
=

Digital Government. Federal, state and local = governments also=20 are rapidly developing new ways of using the Internet to communicate = with=20 clients and to provide public services to businesses and individuals. = Activities=20 at the Federal level include:

The=20 Patent and Trademark Office X-Search system, available at = www.uspto.gov,=20 enables anyone to use an Internet browser to search and retrieve more = than 2.6=20 million pending, registered, abandoned, cancelled or expired trademark = records. This is the same database and search system used by PTO's = examining=20 attorneys.=20
The=20 National Institutes of Health offers an online service,=20 www.ClinicalTrials.gov, that provides information about the latest = clinical=20 research into cancer, heart disease, and other life-threatening = illnesses.=20
At=20 the Internal Revenue Service site, www.irs.gov, taxpayers can download = any tax=20 forms and instructions they need.

Many state and local governments are also moving = services=20 online. Interested individuals and businesses can find information on a = wide=20 variety of topics such as registration (voter, business, property, = pets), parks,=20 and trash removal. In addition, people can pay their local property = taxes and=20 parking tickets on commercial sites such as www.govworks.com or=20 www.ezgov.com.^=20
(24)

Online Communities

The spread of Internet access is being accompanied by a proliferation = of new=20 community spaces online. Some of these are commercial spaces such as = online=20 auctions that allow consumers to sell or trade goods and services. = Others are=20 meeting spaces where individuals interact around a particular interest = or=20 topic--from chat rooms for hobbyists, and online current events = discussions, to=20 support groups for people facing similar challenges. In the process of = providing=20 places for individuals to interact, these online spaces create virtual=20 communities.

We=20 Media, Inc, a multimedia company providing services for people with=20 disabilities, includes on their www.wemedia.com site a WeHomePlace for = members=20 to meet and interact with people of similar interests and backgrounds. =
A=20 community center in Arlington, Virginia provides Internet access to = immigrants=20 from many parts of the world--including South and Central America, = Morocco,=20 Bangladesh, and Albania--so they can e-mail friends abroad, use chat = rooms=20 where discussion is conducted in their native language, and read = online=20 versions of newspapers from their home countries.⁽²⁵⁾=20
At=20 www.geneticalliance.org individuals can search for support groups and = resource=20 information for almost any genetic condition.

The Internet has also become a popular sharing = tool for=20 people to research their family trees, organize family reunions, and = share news=20 and photographs--all without long-distance charges.
=
=20

THE RISE OF THE DIGITAL = BUSINESS=20

While business-to-consumer e-commerce is the most visible aspect of=20 e-commerce, it is only a small part of what is now possible due to = recent=20 technological advances. Increasingly, business-to-business (B2B) = e-commerce is=20 emerging as an area of critical importance for businesses faced with = rapidly=20 changing markets and opportunities. Transactions between businesses = account for=20 the lion's share of commercial activity, and e-commerce technologies = appear to=20 have an enormous potential to make these transactions more efficient. = Companies=20 are also using these technologies to increase the efficiency of their = internal=20 operations.

Business-to-Business=20 E-Commerce

Estimates of the dollar value of B2B e-commerce transactions vary=20 widely.^=
(26)=20 According to a summary prepared by The Industry Standard, = forecasts for=20 2003 of the dollar value of transactions between U.S. businesses that = are=20 conducted electronically range from $634 billion to $2.8 trillion. This = wide=20 disparity is due to a combination of methodological and definitional=20 differences.^=20
(27) One important difference is the degree to which = non-Internet=20 network transactions, such as those conducted over electronic data = interchange=20 (EDI) systems, are included in the estimates of B2B e-commerce. = Irrespective of=20 the dollar amounts, the market researchers all expect strong growth as = companies=20 seek to cut costs and increase efficiency by streamlining their = purchasing,=20 sales, and other business processes. =20

At present, many firms are at the beginning stages of implementing = e-commerce=20 technologies in their business processes. A recent National Association = of=20 Manufacturers survey found that 68 percent of manufacturers are not yet = using=20 electronic commerce to conduct business transactions. While 80 percent = of the=20 surveyed firms reported having a Web site, far fewer firms reported = using the=20 Internet for business processes such as requests for proposals, = purchasing,=20 etc.^=
(28)

In contrast, a recent = Purchasing=20 Magazine survey shows that 38 percent of buyers currently use the = Web to=20 conduct at least some of their company's transactions. The survey also = finds=20 that of those who do not currently conduct transactions over the = Internet,=20 approximately 35 percent say they will begin to conduct transactions=20 electronically within the next year and 54 percent say they will do so = within=20 the next three years. Only 11 percent of those not currently online have = no=20 expectation of using the Internet for procurement.⁽²⁹⁾ =
=20

Transforming the Market = Place=20

The potential of e-commerce technologies to transform business = practices is=20 evident in the new marketplaces that are developing online. These = important=20 intermediaries have emerged rapidly in virtually all industries, = providing new=20 places for buyers and sellers to meet, allowing a variety of pricing = schemes to=20 flourish, altering the roles of traditional intermediaries, enabling = complex=20 transactions, and, by making vast amounts of information available at = very low=20 costs, shifting the balance of power among market participants. The = expanded=20 reach of these online market spaces enables buyers to solicit bids from = a=20 broader range of suppliers and, in turn, allows suppliers to develop=20 relationships with additional buyers.

According to a recent estimate by the Economist, over 750 = networked=20 marketplaces have been developed worldwide.⁽³⁰⁾ Some of = these=20 cover a wide variety of products and a diffuse group of buyers and = sellers.=20 E-Bay, for example, which started out providing a marketplace for = consumers=20 selling to other consumers (C2C) in online auctions, has expanded to = include B2C=20 and B2B transactions.

Some sites offer broader functions for more targeted client groups. = Onvia,=20 for example, is one of the many sites seeking to be the small business = portal=20 for goods and services. Other sites leverage existing relationships = within=20 specific industries on a global basis. One prominent example is the = new=20 online marketplace under development in the automotive industry. In = November=20 1999, both General Motors Corporation and Ford Motor Company = independently=20 announced plans to move their purchasing operations online. Then, in = late=20 February 2000, these two companies announced that together with = DaimlerChrysler=20 AG, they would work to form the world's largest online = marketplace.⁽³¹⁾ = According to press=20 reports, if completed, this exchange is expected to handle the nearly = $250=20 billion worth of parts and other items that these companies purchase = each year.=20 Auto executives estimate that they will be able to reduce purchasing = costs by up=20 to 10 percent over several years with the new system. These savings are = expected=20 to arise from increased competition, as the number of bidders for each = contract=20 increases, and by eliminating many of the meetings now required before a = parts=20 order is placed. "Since half of the cost of a $20,000 car lies in = purchased=20 parts, the new system could reduce the cost of producing a typical = automobile by=20 $1,000."^=
(32)=20

Similarly, Sears, Roebuck = and=20 Company, the second largest U.S. retailer, is joining with Carrefour SA, = a=20 Paris-based retailer, to create GlobalNetXchange, an online marketplace = for the=20 retail industry. These two companies buy a combined $80 billion in goods = and=20 services a year from 50,000 suppliers, and they are seeking other = retailers to=20 join with them.^=20
(33) While Sears's current EDI system costs the company = approximately=20 $150 per hour; their new Internet-based exchange could reduce these = costs to $1=20 per hour.^=
(34)=20 In addition, on March 28, 2000, Boeing, Lockheed Martin, BAE Systems, = and=20 Raytheon Company unveiled plans to develop an Internet trading exchange = for the=20 global aerospace and defense industry. Together these companies have = procurement=20 outlays of $71 billion.^=20
(35)

While the large buyers = organizing=20 these online marketplaces hope to achieve significant cost savings, it = is=20 difficult to gauge a priori the impact these new arrangements may = have on=20 their supply communities. Some suppliers and potential suppliers that = had been=20 unable to justify the cost of EDI connections may be much more willing = to use=20 the Internet to bid on work that they would otherwise have missed. = Concerns have=20 been raised, however, about the potential for these large players to use = these=20 markets to reduce competition. The overall impact will depend on the = extent to=20 which actual efficiencies can be achieved as opposed to squeezing = supplier=20 margins. One probable side effect of moving these supply networks to the = Internet will be to increase the level of investment in Internet=20 technologies.

E-commerce technologies = also appear=20 to be driving changes among traditional intermediaries--i.e., firms such = as=20 wholesalers, travel agents, or shippers, that add value between the = production=20 of a good or service and its sale to the final consumer. Early = predictions were=20 that the Internet and e-commerce would create efficiencies by = eliminating the=20 need for intermediaries. Manufacturers and service providers would begin = selling=20 directly to the customer and "middlemen" would disappear. However, the = early=20 speculation failed to appreciate the important role that intermediaries = play or=20 the resourcefulness some intermediaries would exhibit in finding new = ways to add=20 value in an online world.

Instead of vanishing, = traditional=20 intermediaries are adapting to exploit new possibilities as providers of = logistical, financial, and information services. Take the case of = ChemConnect,=20 an online suppliers directory that has evolved into a global Internet = exchange.=20 ChemConnect brings suppliers and buyers of chemicals and plastics into=20 negotiations where the providers of intermediary functions offer their = services=20 for bid. As buyer and seller work to reach agreement on a purchase,=20 intermediaries provide estimates of costs, including carriers (ocean, = inland=20 marine, and truck), documentation (customs clearing, regulatory/tax, = insurance,=20 cargo surveying), and warehousing (terminal operations,=20 consolidation).

Internet-based market = spaces also=20 broaden market participation by decreasing the costs of participating in = B2B=20 markets. For decades, large companies have used EDI to automate routine=20 paperwork surrounding business transactions, to manage arrangements such = as=20 automatic inventory replenishment, and to make purchases according to=20 pre-established terms. Until recently, the use of this e-business = activity was=20 limited to large volume supplier/customer relationships because EDI = required a=20 fairly sizable investment in dedicated hardware and proprietary software = and use=20 of expensive leased telecommunications lines. As costs of computing = power,=20 memory, and storage declined throughout the 1990s, the size threshold at = which=20 EDI became cost-effective also declined, but still remained too high for = many=20 trading applications. Now, however, the Internet with its open = nonproprietary=20 protocols and global reach has emerged as a platform for spreading the=20 efficiencies achievable through the automation of business processes to = firms of=20 all sizes.

The bulk of B2B e-commerce = remains=20 EDI-based, although analysts are predicting that most of the future = growth of=20 B2B e-commerce will be Internet-based. The National Association of = Manufacturers=20 estimates that among businesses that currently use the Web for business, = 17=20 percent are using it in place of EDI.⁽³⁶⁾ The = Boston=20 Consulting Group estimates that 86 percent of the $671 billion in B2B = e-commerce=20 in 1998 was EDI conducted over private networks. However, they estimate = that the=20 EDI component will fall to 28 percent by 2003.⁽³⁷⁾ =

In addition, businesses = and even=20 governments have discovered the potential of the Internet as an auction = space.=20 Businesses are using auctions to sell off surplus goods, dispose of used = equipment, and post requests for purchase. More than 10,000 companies = have=20 posted, sold, or bought goods on the Tradeout.com site, which focuses = solely on=20 auctioning surplus goods.^=20
(38) Dovebid, an established used-capital asset disposition=20 auctioneer, has set up an online auction site with more that 200,000 = items and=20 is reaching out to a global market.⁽³⁹⁾ =

Business purchasers are = also using=20 online auctions to request bids. Owens Corning used an online reverse = auction=20 run by Freemarkets, an online auction company, to put bids out for = corrugated=20 packaging materials for its 21 U.S. plants. At the end of the day the = company=20 had 17 two-year contracts with corrugated packaging material suppliers = and had=20 saved an estimated 10 percent.⁽⁴⁰⁾ =
=20

E-Business=20 Processes

E-commerce transactions represent only one way in which innovations = in=20 computers and communications can add value and make business processes = more=20 productive. All business processes have some information component.=20 Specifications for a design must be shared between architects and = engineers. The=20 latest maintenance information must be delivered to the mechanic working = on the=20 airplane. The manufacturer of auto interiors needs to know how many blue = interiors must be delivered for a manufacturing run at the auto plant. = All of=20 these processes benefit when information flows faster, more accurately, = and in=20 greater detail to the people who need it.

Many companies are experimenting with processes that enable them to = share=20 information over a network or the Internet. For example, BOC Gases = replaced a=20 slower, more costly certification procedure with a process that sends = product=20 certification results over the Internet for customers that need = specialized gas=20 products.^=
(41)=20 Similarly, John Deere Construction Equipment Company uses the Internet = to=20 improve customer service by creating a portal providing component life = cycle=20 data to enable customers to manage component replacement before = failure.⁽⁴²⁾

Businesses are also using = networking=20 technologies to improve processes, such as design and engineering, = reducing=20 development time, simplifying manufacturing processes, and integrating = design=20 processes. Examples include:

Using Internet technologies to = coordinate=20 product design. = Conexant,=20 a semiconductor producer, has created Web-enabled tools for its new = product=20 development process. The company's 2,000 engineers use a standard Web = browser=20 to access the company's portfolio of projects and obtain information = on phase=20 of development, team composition, deliverables, and time frame.^=
(43) =20

Using communications networks to = improve=20 human resource functions.=20 Shaw Industries, a manufacturer of floor coverings, uses an internal = network=20 to support compensation planning and retention initiatives for the = company's=20 36,000 worldwide employees.⁽⁴⁴⁾ =

Using wireless networks to manage = inventory=20 more efficiently.=20 Cablevision, a telecommunications and entertainment company, uses = wireless=20 mobile computer appliances over a local area network to process = inventory=20 transactions in real time, at the point of activity. Previously, = Cablevision=20 workers made inventory transactions, such as transferring inventory = between=20 warehouses or scanning new shipments, by filling out forms by hand for = later=20 entry into a central computer. The new system eliminates the daylong = wait to=20 update the main database, so that inventory, such as cable boxes, can = be=20 located instantly. When the installation is complete, the project will = cover=20 43 warehouses across four states.^=
(45)
Using extranets to provide=20 training. = Service Experts,=20 a company specializing in the installation and maintenance of heating = and=20 cooling systems with 150 locations in 34 states, established an = extranet to=20 serve as an online resource library that includes "3-D diagrams with = training=20 manuals and step-by-step instructions for solving problems."^=
(46) =20

Using the Internet to provide = customer=20 services and answer frequently asked questions. Many companies are using their = company Web=20 site to offer customer services and product information. Ford offers = product=20 information and links to dealers, and their "Owner Connection" Web = page=20 provides Ford car owners with maintenance information, safety tips, = service=20 reminders, do-it-yourself pointers, and online manuals.^=
(47) =20

Using the Internet to reduce = project=20 administration and management costs. Over the year-long process of = building a=20 hotel in San Francisco, contractor Swinerton & Walberg estimates = that by=20 using an Internet-based project management system they will squeeze = about=20 $110,000 out of the project's $11 million budget.^=
(48) =20

AN INCREASINGLY WIRED = WORLD

Not only are individuals, businesses, and other organizations going = online in=20 increasing numbers, but the products and services used in everyday life = are=20 becoming increasingly integrated into the networked economy. Certain = goods and=20 services can now be delivered directly to the buyer over the Internet. = And=20 Internet connectivity is no longer tied to the desktop = computer. =20

The Internet provides a new way to have goods and services delivered. = Music,=20 legal advice, software, opera tickets, news reports, books, photographs, = movies,=20 and product designs--can all be downloaded directly into a computer. = According=20 to Forrester Research, while only 3 percent of all current online B2C = sales=20 consist of digitally-downloaded products, this level could reach 22 = percent of=20 all online sales by 2004. The most dramatic growth in direct, digital = download=20 sales will probably be in the music sector, where such sales could rise = from 0.1=20 percent of online sales in 1999 to 25 percent in 2004, followed by = software=20 (rising from 7 percent of online sales in 1999 to 40 percent in 2004) = and books=20 (rising from 1 percent of book sales online in 1999 to 13 percent in=20 2004).^=
(49)=20

Digitalization is also changing the design of products, so these = products can=20 be networked. For example, home-electronics producers have joined = together to=20 develop Home Audio Video Interoperability (HAVi), an open,=20 consumer-electronics-industry standard that will allow digital audio and = video=20 devices from different vendors to work together when connected to a = network in=20 the consumer's home.^=20
(50) Appliances that can be networked are beginning to emerge = in other=20 areas as well.

New home electronics and appliances will not only be networkable, = many of=20 them also will be "network appliances"--that is, appliances that can = access the=20 Internet. The television has long been viewed as a potential portal for = Internet=20 access. More recently, simple, low cost dedicated Internet access = devices have=20 been introduced. In addition, connectivity is increasingly being viewed = as an=20 important feature to add to existing products. At recent trade shows, = for=20 example, home appliance manufacturers have unveiled prototype = Internet-enabled=20 refrigerators and ovens that offer features such as e-mail, calendar = management,=20 automated grocery ordering, and tracking of the service requirements of = the=20 appliance.

We are only in the early stages of designing and developing new = products that=20 take advantage of open networks. This development is still limited by = slow=20 connection and transmission speeds and the lack of standards to = facilitate=20 individual appliances communicating with one another. As these = limitations are=20 addressed, however, the developmental pace of digital products is likely = to=20 increase. New technologies that exploit the potential of wireless = connections=20 are already creating new ways of communicating and conducting business,=20 reconfiguring many traditional industry and product definitions. As = Internet=20 access migrates from the desktop computer to a range of products, the = lines that=20 now separate the transmission of voice, data, and pictures will = disappear. New=20 devices under development today will combine cellular telephone, = geopositioning,=20 and Internet access in a handheld or automobile device. The major = automakers,=20 for example, have already announced plans to equip some of their = automobiles=20 with voice activated Internet access and handheld and automobile = Internet access=20 is already available in Japan.⁽⁵¹⁾

The technologies that make the digital economy possible are still = evolving,=20 as is the environment in which these technologies are being used. Many=20 businesses and individuals remain hesitant about e-commerce because the = business=20 environment online does not yet have the same predictability and = reliability as=20 it does offline. And the medium itself offers new challenges. For = example,=20 our ability to deliver digital goods electronically has, in many ways, = outpaced=20 the resolution of difficult legal and policy questions associated with = it, such=20 as how to protect intellectual property rights in an environment where = it is=20 easy and inexpensive to make virtually perfect copies of digital = originals.=20 Efforts are underway, within the U.S. Government, in multilateral = organizations,=20 and within the private sector, to resolve thorny issues related to = privacy,=20 safeguards for children, consumer protection, information security,=20 authentication, intellectual property rights, jurisdiction, taxes, and = tariffs.=20 Full realization of the economic promise of information technology = depends on=20 the development of the same safeguards and predictable legal environment = that=20 individuals and businesses have come to expect in the offline = world. =20

CHAPTER III

INFORMATION TECHNOLOGY INDUSTRIES⁽⁵²⁾

The prodigious vitality of the digital economy is grounded in = Information=20 Technology (IT) producing industries--the firms that supply the goods = and=20 services that support IT-enabled business practices across the economy, = as well=20 as the Internet and e-commerce. (See Table 3.1, below). Over the past = decade,=20 and especially since the mid-1990s, these industries have been a = powerful factor=20 in the economy's rapid and sustained growth, a significant restraint on=20 inflation, and a focal point of prolific technological innovation. This = chapter=20 examines the performance of IT-producing industries and analyzes their=20 contribution to the new economy.

Table=20 3.1

Information=20 Technology Producing Industries

     = Hardware=20 Industries           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;      =20 Software/Services Industries

Computers=20 and equipment           &nbs= p;            = ;            =             &= nbsp;           &n= bsp; =20 Computer programming services

Wholesale=20 trade of computers and equipment           &nbs= p;            = ;   =20 Prepackaged software

Retail=20 trade of computers and equipment           &nbs= p;            = ;            = =20 Wholesale trade of software

Calculating=20 and office machines           &nbs= p;            = ;            =             &= nbsp;   =20 Retail trade of software

Magnetic=20 and optical recording media           &nbs= p;            = ;            =        =20 Computer-integrated system design

Electron=20 tubes           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;           &nbs= p;=20 Computer processing, data preparation

Printed=20 circuit boards           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           =20 Information retrieval services

Semiconductors           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;        =20 Computer services management

Passive=20 electronic components           &nbs= p;            = ;            =             &= nbsp;     =20 Computer rental and leasing

Industrial=20 instruments for measurement           &nbs= p;            = ;            =   =20 Computer maintenance and repair

Instruments=20 for measuring electricity           &nbs= p;            = ;            =          =20 Computer related services, nec.

Laboratory=20 analytical instruments           &nbs= p;            = ;            =             &= nbsp;  =20

   Communications = Equipment=20 Industries           &nbs= p;       =20   =20 Communications Services = Industries

Household=20 audio and video equipment           &nbs= p;            = ;            =     =20 Telephone and telegraph = communications

Telephone=20 and telegraph equipment           &nbs= p;            = ;            =         =20 Radio and TV broadcasting

Radio=20 and TV communications equipment           &nbs= p;            = ;          =20 Cable and other pay TV services

Note:=20 Industries represented and measured here are defined in a manner=20 consistent with the 1987 Standard Industrial Classification (SIC)=20 categories, rather than the newly implemented North American = Industry=20 Classification System. = This=20 was done both to provide a consistent GPO time series prior to = 1997 and=20 because Census revenue data for computer services and = communication=20 services through 1998 continued to be released according to their = SIC=20 categories.

IT-PRODUCING=20 INDUSTRIES—

GROWTH ACCELERATES = COMPOSITION SHIFTS TOWARD SOFTWARE AND COMPUTER SERVICES

Since the mid-1990s, IT-producing industries have shown extraordinary = dynamism. Prepackaged software and computer services had the highest = growth=20 rate, increasing their output (gross product originating or GPO) from = 1995 to=20 2000 at a remarkable average annual rate of 17 percent (nominal = dollars).⁽⁵³⁾ (Figure = 3.1) Over=20 the same period, the computer hardware and communications equipment = industries=20 increased their output at a 9 percent annual rate, and output in the=20 communications services sector rose at a 7 percent annual pace. =

This=20 dynamic growth increased IT industries' share of total output from 6.3 = percent=20 in 1994 to an estimated 8.3 percent this year. (Figure 3.2) By contrast, = between=20 1990 and 1994, these same industries' share of the economy grew much = more=20 slowly--by only about 0.5 percentage points overall.⁽⁵⁴⁾ The = rapid increase=20 in these industries' share of the economy after 1994 is particularly = impressive=20 in view of both the rapid growth of the economy as a whole and the = accelerated=20 decline in IT prices over the period.

=20

The recent swift growth of = IT=20 industries has also coincided with sharply declining prices of IT goods = and the=20 rapid expansion of both the Internet and network-related business = processes. A=20 modest share of IT growth also reflected spending related to addressing=20 Y2K-related computer problems. ESA analysts have estimated that = Y2K-related=20 spending accounted for roughly 7 percent of the output of IT-producing=20 industries in 1998 and 1999.⁽⁵⁵⁾ =
=20

FALLING IT PRICES HAVE REDUCED OVERALL U.S.=20 INFLATION

The declining prices of IT goods and services have worked, directly = and=20 indirectly, to reduce overall inflation in the U.S. economy. Since the=20 mid-1990s, the price decline for IT products has accelerated--from about = 1=20 percent in 1994, to nearly 5 percent in 1995, and an average 8 percent = for the=20 years 1996, 1997, and 1998. (Figure 3.3 and Table 3.2) The steepest = price=20 declines occurred in the computer and semiconductor industries, where = prices=20 fell at average annual rates of 24 percent and 29 percent respectively, = for the=20 years 1995 to 1998.

Over the same period, lower prices in the IT sector reduced overall = U.S.=20 inflation directly, on average, by about 0.5 percentage points a = year--from 2.3=20 percent to 1.8 percent. In 1998, falling IT prices helped hold overall = inflation=20 to just over 1 percent--the smallest increase in the GDP chain-type = price index=20 since 1963. (Figure 3.4 and Table 3.2)

Table=20 3.2

Price=20 Changes:

IT-Producing and All Other Industries

           &nbs= p;            = ;            =             &= nbsp;          =20            =20    = 94        95         = 96          =20 97         =20 98

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;          =20          =20          (Percen= t)

           =20 IT-Producing Industries           &n= bsp;      =20     =20 -1.4      = -4.5      =20 -8.1       =20 -7.1    =     -8.0

           =20 GDP, not including IT industries            =   2.3       =20 2.5       =20 2.5        =20 2.3         =20 1.8

           =20 GDP, including IT industries      =          =20   2.1       =20 2.1       =20 1.8        =20 1.9         =20 1.2

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;          =20

           =20 Source: ESA = estimates=20 based on BEA and Census data.

           =20            &nbs= p;            = ;            =            =20

Moreover, because these estimates focus only on the direct effects = and ignore=20 the indirect effects of lower prices, they almost certainly understate = IT's full=20 importance in keeping inflation low. A more complete estimate of IT's = role would=20 cover not only the direct effects on inflation of price reductions in 8 = percent=20 of the U.S. economy that produces IT goods and services, but also the = price=20 effects of the increased competition and efficiency induced by IT = deployment in=20 the 92 percent of the economy outside the IT-producing sector. We have = no way to=20 disaggregate and measure these effects on their own. But their embedded=20 influence is reflected in the upper line in Figure 3.4, which shows = declining=20 inflation in non-IT producing industries between 1996 and 1998. =

IT-PRODUCING INDUSTRIES ACCOUNT = FOR=20 NEARLY ONE-THIRD OF REAL GDP = GROWTH BETWEEN=20 1995 AND 1999

IT industries produce less than 10 percent of total U.S. output.=20 Nevertheless, between 1995 and 1999, because of IT industries' = extraordinary=20 growth and falling prices, they accounted for an average 30 percent of = total=20 real U.S. economic growth.^=20
(56) (Figure = 3.5 and=20 Table 3.3)

USE OF IT EQUIPMENT INCLUDING = SOFTWARE=20

A critical factor in IT's predominant role in recent U.S. growth is = the=20 increasingly dominant part that IT equipment, including software, plays = in=20 business investment activity. In current dollars, industry spending on = IT=20 equipment and software rose from $198 billion in 1992, or 44 percent of = all=20 equipment spending, to $407 billion in 1999, or 46 percent.⁽⁵⁷⁾ (Figure = 3.6) Over=20 the same period, "other capital equipment," including industrial = equipment, fell=20 from 38 percent of total equipment and software investment spending to = 32=20 percent, and transportation equipment ranged between 18 percent and 21 = percent.=20

Because prices for IT equipment and software have been falling, = investment=20 spending shifts are even more pronounced when expressed in real dollars, = rather=20 than nominal amounts. (Figure 3.7) Since 1995, prices of IT capital = equipment=20 and software have dropped by an average 6.7 percent per year, while = prices for=20 transportation capital equipment have increased at a 0.6-percent average = annual=20 rate and prices for other types of capital equipment have increased at a = 1.5-percent rate.

Table=20 3.3

IT-Producing = Industries:

Contribution = to Real=20 Economic Growth

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;  =20

           &nbs= p;            = ;            =            =20 94          =20 95          =20 96          =20 97          =20 98 est.   =20 99 est.

(1) Changes = in=20 Real           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;=20        =20 (Percent)

Gross Domestic = Income*           &nbs= p;            = ;         =20 4.2          =20 3.3          =20 3.5          =20 4.7          =20 4.8         =20 5.0

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;      =20         =20       =20 (Percentage Points)

(2) IT=20 Contribution           &nbs= p;            = ;            =           =20 0.8          =20 1.0          =20 1.2          =20 1.3          =20 1.3         =20 1.6

(3) All = Other=20 Industries           &nbs= p;            = ;            =   =20 3.4          =20 2.3          =20 2.3          =20 3.4          =20 3.5         =20 3.4

(4) IT = Portion           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;          =20 (Percentage Share)

       = Of GDI=20 Change (2)=F7(1)           &nbs= p;    =20 19           =20 30          =20 34          =20 28          =20 27         =20 32

*GDI is equal = to the=20 income that originates in the production of goods and services=20 attributable to labor and property located in the=20 U.S.

Sources: = ESA estimates=20 derived from BEA and Census data for 1994 -97.

As a result, real business investment spending on IT equipment and = software=20 more than doubled between 1995 and 1999, from $243 billion to $510 = billion (1996=20 dollars), while real spending on transportation equipment increased by = about=20 half and real spending on other capital equipment increased slightly. =

Over the decade of the 1990s, growing industry spending on IT = equipment and=20 software was a significant factor in the high rate of growth of U.S. = spending on=20 all categories of equipment to 9-to-10 percent per year, compared to = 5-to-6=20 percent a year in the 1980s.⁽⁵⁸⁾ In 1999, = business=20 spending for IT equipment and software represented more than = three-fourths=20 of the 12 percent real growth in total equipment and software = spending that=20 year, compared to 65 percent of the real growth in equipment spending = for=20 1995-1998 and less than 50 percent for 1993-1994. (Figure 3.8 and Table=20 3.4)

=20

Table=20 3.4

Contribution=20 of IT Equipment*

To Growth in=20 Capital Equipment and Software

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;      =20 = 93        =20 94          =20 95          =20 96         =20 97         =20 98         =20 99

(1) Change = in real=20 spending           &nbs= p;            = ;            =             &= nbsp;           &n= bsp; =20        =20 (Percent)           &nbs= p;            = ;            =    =20

      = for=20 capital equipment           &nbs= p;            = ;            = =20 11.4        =20 11.8        =20 11.9        =20 11.0        =20 11.5        =20 15.8        =20 12.1

(2) = Contribution of=20 real spending     =20       =20         =20                &nbs= p;            = ;   =20 (Percentage=20 Points)

       = for=20 IT equipment           &nbs= p;            = ;            =       =20 5.4        =20 5.3         =20 7.4         =20 7.5         =20 7.5        =20 9.8        =20 =20 9.4

(3) = Contribution for=20 all other types

       = of=20 capital equipment           &nbs= p;        =20            &nbs= p;  =20   6.0        =20 6.5         =20 4.5         =20 3.5         =20 4.0        =20 6.0        =20 2.7

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;           &nbs= p;            = ;            =             &= nbsp;     =20

(4) = IT’s contribution=20 to change in           &nbs= p;        =20               &nbs= p;            = ;    =20          (Percen= t)

      = real=20 capital equipment spending =20            &nbs= p; =20 47           =20 45          =20 62          =20 69          =20 66          =20    = 62        =20 78=20

           &nbs= p;   =20

* Defined by BEA as = information=20 processing and related equipment      =

Source: ESA = estimates=20 derived from BEA=20 data

In nominal dollars, investment patterns within IT industries also = show a=20 substantial shift to software. As a share of total IT equipment = investment,=20 spending for software increased from just over 30 percent in 1992-1995 = to 35=20 percent in 1999. (Figure 3.9) Despite the rapid decline in computer = prices=20 (Figure 3.3, above), computers' share of IT equipment investment in = nominal=20 dollars remained relatively constant over the 1992-1999 period. Other IT = equipment, including spending on communications equipment, remained the = largest=20 category of IT equipment purchases, although its share declined from 47 = percent=20 in 1992 to 41 percent in 1999.

Analysis of the composition of IT investment in real rather than = nominal=20 dollars yields a somewhat different picture because prices have declined = far=20 more rapidly for computer than for other kinds of IT equipment and = software.=20 Measured in real dollars, beginning in 1994, investment in computers = accelerated=20 more rapidly than investment in the two other IT categories, surpassing=20 investment in these categories by 1998. (Figure 3.10) In 1999, = price-adjusted=20 spending for computers totaled $222 billion, compared with $149 billion = for=20 software and $170 billion for other IT equipment.
=

=20

R&D INVESTMENT IN IT = INDUSTRIES=20

The surge in IT investment since 1994 has been accompanied by sharp = increases=20 in R&D investment in the economy as a whole and in IT-producing = industries=20 in particular. Between 1994 and 1999, total U.S. R&D investment grew = at an=20 average annual (inflation adjusted) rate of 6 percent. In contrast, = between 1989=20 and 1994, R&D investment grew at an average annual rate of roughly = 0.3=20 percent.

All of the growth in R&D investment in the 1990s came from the = private=20 sector.^=
(59)=20 Between 1995 and 1998, IT industry investment accounted for 37 percent = of this=20 growth.^=
(60) In=20 1998, IT industries invested $45.7 billion on R&D, nearly half as = much again=20 as total R&D investment by the motor vehicle, pharmaceutical and = aerospace=20 industries--industries that traditionally invest large amounts on = R&D.=20 (Table 3.5)

Table=20 3.5

Company-funded R&D Investment by Sector, = 1998

           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;           &nbs= p;          =20 $billions           &nbs= p;    =20 Percent

All = Industries           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;          =20 45.0        =20            &nbs= p; =20 100.0

IT-Producing*           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;        =20 45.7        =20               &nbs= p;=20   31.5

Computers           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp; =20 8.9        =20               &nbs= p;=20     6.1

Communication = equip.                 &nbs= p;            = ;            =          =20 10.2        =20               &nbs= p;=20     7.1

Electronic = components                &nbs= p;   =20               &nbs= p;            = ;    =20   9.8        =20               &nbs= p;=20     6.8

Communication = services              &nbs= p;            = ;            =            =20   1.7        =20            &nbs= p;  =20     1.2

Software & computer=20 services    =                   &nbs= p;            = ;     =20 14.3           &nbs= p;            = ;=20    =20 9.9

Motor = Vehicles           &nbs= p;        =20      =20          =20              &nbs= p;            = ;     =20 13.5           &nbs= p;            = ;=20    =20 9.3

Pharmaceuticals           &nbs= p;      =20          =20      =20              &nbs= p;            = ;     =20 12.6           &nbs= p;            = ;=20    =20 8.7

Aerospace           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;   =20 5.1           &nbs= p;            = ;=20    =20 3.5

All Other=20 Industries           &nbs= p;            = ;            =             &= nbsp;           =20 68.1           &nbs= p;            = ;=20 =20 47.0

*R&D data for IT = industries=20 from the Instrument sector are not available for 1998.           &nbs= p; =20

Source: = National=20 Science Foundation               =20

Between 1992 and 1994, IT-industries' share of all company-funded = R&D=20 grew moderately, from 27 percent to 29 percent. Beginning in 1995, = however,=20 IT-industries' share of company funded R&D increased to about = one-third,=20 spurred by increases in R&D for computer services and software. = (Figure=20 3.11)

Growth in IT industries' share of private R&D is largely the = result of=20 increased R&D investment by manufacturers of electronic components = and=20 software. (Figure 3.12) In the computer industry, annual R&D = investment=20 dropped from an average $11 billion during 1990-92, to $5 billion during = 1993-95, then rose to $10 billion during 1996-98.⁽⁶¹⁾ One = reason for=20 this lack of overall growth may be that as computer demand has shifted = toward=20 micro- computers, more computer-related R&D has shifted to component = manufacturers and software firms.

CONCLUSION

Analysis of IT industry growth and investment patterns demonstrates = not only=20 that IT industries are now a major force in the U.S. economy, but also = that=20 their economic importance began to grow dramatically in the middle of = the last=20 decade. Although many factors contributing to the digital revolution = were in=20 place well before the mid-1990s, it was then that their combined effect = and=20 potential first became evident and the new economy began to take = shape. =20

CHAPTER IV

CONTRIBUTION OF = INFORMATION=20 TECHNOLOGY

TO U.S. PRODUCTIVITY GROWTH⁽⁶²⁾ =
=20

This chapter examines recent studies of the impact of information = technology=20 (IT) on labor productivity in the United States. Our analysis of these = studies=20 concludes that, based on macroeconomic and firm-level evidence, IT does=20 contribute significantly to productivity growth. However, studies at the = industry level continue to produce mixed results.

=
MACROECONOMIC ASSESSMENTS

The current U.S. productivity pattern, in which productivity gains = have=20 strengthened as the expansion has matured, is unprecedented for the = postwar=20 period. In previous postwar expansions, productivity growth has slowed = as the=20 expansion enters its mature phase. (Figure 4.1)

One reason for the extraordinary pattern of productivity in the = current=20 expansion appears to be the rapid growth in the real net stock of IT = capital per=20 labor hour, especially computer hardware (including peripheral = equipment). This=20 rapid growth of real net IT capital created significant IT "capital = deepening,"=20 beginning in 1991 and accelerating sharply after 1995.⁽⁶³⁾ The = ratio of the=20 capital stock of computer hardware to hours worked increased, on = average, by=20 16.3 percent per year over the period 1991-95, and 33.7 percent per year = during=20 1996-99. (Figure 4.2) Capital deepening in computer software also grew = at=20 double-digit rates during both periods, while the growth rate in = communications=20 equipment increased from 2.4 to 5.0 percent. By contrast, over the = 1990s, the=20 rate of capital deepening for all other forms of capital--covering over = 95=20 percent of the total U.S. capital stock--averaged only about one-half of = one=20 percent per year.^=20
(64)

A major factor behind IT capital deepening has been the falling = prices of IT,=20 especially computer hardware, reflecting rapid and continuous = improvements in=20 quality.^=
(65)=20 The quality-adjusted price deflator for computer hardware fell 14 = percent per=20 year during the first half of the 1990s and 29 percent per year during=20 1996-98.^=
(66)=20 (See also Figure 1.3, Chapter I.)

Figure 4.3, comparing the = 1991-95=20 and 1996-99 periods, shows that IT capital deepening accounts for a = large and=20 increasing share of the economy's rising productivity gains. The figure = also=20 shows that the acceleration of labor productivity growth has been=20 accompanied by an acceleration in "multifactor productivity" (MFP) = growth within=20 the IT-producing sector itself. Multifactor productivity growth reflects = the=20 impact of factors in addition to quality-adjusted capital and labor = inputs--for=20 example, technical changes not directly incorporated in capital and = labor (such=20 as new production processes), organizational improvements, and economies = of=20 scale. As discussed below, growth in multifactor productivity has been=20 especially strong in the computer and semiconductor industries. =

All categories of IT capital contribute disproportionately to labor=20 productivity growth, compared to their shares of the total private = nonfarm=20 business sector and their shares of the total net capital stock. = However, the=20 contribution of computer hardware to productivity growth has been=20 extraordinarily large. Recent research indicates that during the years = 1996-99,=20 computer hardware deepening accounted for 24 percent of all labor = productivity=20 growth.⁽⁶⁷⁾ (Figure 4.4) = The size=20 of this contribution is especially remarkable because computers = constitute just=20 1.8 percent of the private nonfarm business sector and less than 1 = percent of=20 overall capital stock (1998).

The reason that IT, with = such a=20 small share of the economy and of the total capital stock, has = contributed so=20 powerfully to productivity growth is that the rapidly growing IT = investments=20 have been unusually productive. Market conditions dictate that business=20 investments in computer hardware must earn very high rates of return. = For one=20 thing, the rapid and continuous improvements in IT quality mean that = existing=20 computer hardware becomes obsolete and hence depreciates very quickly. = In=20 addition, sharply falling hardware prices mean that businesses investing = in IT=20 equipment face rapid capital losses as purchased equipment quickly loses = market=20 value. Oliner and Sichel estimate that investment in computer hardware = must=20 produce gross rates of return of about 68 percent in order to cover an = estimated=20 depreciation rate of 30 percent and capital loss of 34 percent per year, = and a=20 competitive net rate of return of 4 percent per year. By their = estimates, the=20 payback period for computer hardware investments is less than two = years.=20

The = Emerging=20 Consensus on Resolving the "Computer Productivity Paradox" =
=20

Economists who held until recently that the impact of computers on = U.S.=20 productivity could be a transitory effect of unusually favorable = economic=20 circumstances have begun to credit IT for dramatic increases in the = trend growth=20 rates of U.S. output and productivity since 1995. One reason for this = change in=20 view has been the increasing attention paid by researchers to the = productivity=20 effects of software and communications equipment, in addition to = computer=20 hardware. This shift in attention follows the 1998 and 1999 editions of = this=20 report that introduced a broader definition of IT⁽⁶⁸⁾ and the=20 reclassification by the Bureau of Economic Analysis (BEA) of software = spending=20 from current expenditures to investments.

Thus, Oliner and Sichel conclude that surging use of IT (including = computer=20 hardware, software, and communications equipment) in the second half of = the=20 1990s, together with advances in the production of computers and = semiconductors,=20 contributed about two-thirds of an estimated 1.06-percentage point = acceleration=20 in productivity growth between the first and second halves of the = decade.=20

Consistent with Oliner and Sichel's findings, the Congressional = Budget=20 Office, the Economic Report of the President, Jorgenson and = Stiroh,=20 Whelan, and Macroeconomic Advisers, LLC find strong evidence that the = mid-1990s=20 acceleration in productivity growth was due largely to IT capital = deepening=20 among IT users and also to technical advances and innovations made by IT = producers. These analysts' recent estimates of IT's contribution both in = computer use (capital deepening) and computer and semiconductor = production=20 (technical advance) are summarized in Table 4.1.⁽⁶⁹⁾ =

When one takes into account the differences in the periods studied = and in the=20 coverage of economic activity, idiosyncratic adjustments for limitations = in the=20 available data, and other factors, these estimates appear to be = remarkably=20 consistent.

Recent studies also suggest that robust productivity growth is likely = to=20 continue. For example, Macroeconomic Advisers found that: "Given the = large gap=20 between discovery and application in the computer industry, it is = reasonable to=20 conclude that real computer prices, which on average have declined 20 = percent=20 per year since 1996, will continue falling rapidly. As long as they do, = the=20 special contribution to productivity growth coming from the technology = sector=20 will persist."^=20
(70)

Table 4.1

Contribution of IT Capital to = the=20 Acceleration of Labor Productivity Growth

in the U.S. Private Nonfarm = Business=20 Sector

Studies*

Capital Deepening

Technical Advance

Total IT Contribution

Productivity = Acceleration

IT Share of = Acceleration

(Percentage Point)

(Percent)

Other

(a)

(b)

(a/b)x100

Oliner and=20 Sichel

1996-99 over=20 1991-95

0.45

0.03

0.26

0.41

0.71

1.04

68.3

Congressional = Budget=20 Office

1996-99 over=20 1974-99

0.40

0.20

0.60

1.10

54.5

Economic = Report of the=20 President

1995-99 over=20 1973-95

0.47

0.23

0.70

1.47

47.6

Jorgenson = and=20 Stiroh

1995-98 over=20 1990-95

0.31

0.18

0.19

0.44

0.50

1.00

50.0

Whelan

1996-98 over=20 1974-95

0.46

0.27

0.73

0.99

73.7

*The studies = summarized are not strictly comparable because they use different=20 definitions of IT capital and examine different time periods. = Oliner and=20 Sichel define IT capital to include "computer hardware, software, = and=20 communication equipment." The Congressional Budget Office talks = about=20 "computers," distinguishing between computer "use" (capital = deepening) and=20 computer "production" (technical advance), while the Economic = Report of=20 the President refers to "computers and software." Jorgenson and = Stiroh=20 include in IT "capital services" those from computer, software, = and=20 communications capital. Finally, = Whelan's=20 "computing equipment" includes mainframes, terminals, storage = devices,=20 printers, and personal computers.
=20

In = the above=20 table, "IT capital deepening" means increase in IT capital per = labor hour=20 and "other capital deepening" means increase in other types of = capital per=20 labor hour. "Technical advance" covers capital quality = improvements and=20 multifactor productivity growth from IT and other sources. = Finally, there=20 are factors contributing to labor productivity growth acceleration = other=20 than capital deepening and technical advance that are not = identified in=20 the table (e.g., improvements in labor quality). These other = factors are=20 omitted since the table is intended to highlight IT's contribution = to the=20 acceleration of labor productivity growth.

=20
SECTORAL = AND=20 INDUSTRY-LEVEL ASSESSMENTS

Since IT investments improve productivity, those industries making = the most=20 intensive use of IT should show higher productivity growth than = industries that=20 use IT less intensively (all other factors held constant). Evidence of = such a=20 pattern at the industry level, however, remains mixed. IT-producing = industries=20 have recorded astonishingly high productivity gains and have been a = dominant=20 force in aggregate U.S. productivity growth.⁽⁷¹⁾ = Furthermore,=20 outside the IT-producing sector itself, goods-producing industries that = are IT=20 intensive have achieved higher productivity gains than their = counterparts that=20 have not invested heavily in IT. However, official output measures for=20 IT-intensive service industries do not indicate significant productivity = gains.=20 Indeed, between 1990 and 1997, despite heavy investments in IT and a=20 three-decade buildup of the real net IT capital stock, IT-using service=20 industries as a group recorded declining productivity.

The following sections review analyses that show significant = multifactor=20 productivity growth in IT-producing industries, improved labor = productivity=20 growth in both IT-producing and IT-using goods industries, and = alternative views=20 of IT's effect on productivity in service industries.

Computer Production =

A study conducted by Kevin Stiroh examined the relationship between = computers=20 and economic growth, at both the aggregate and sectoral levels, over the = period=20 1947 to 1991. This study found strong labor productivity, as well as = multifactor=20 productivity gains in the computer-producing sector, implying that this = sector=20 positively contributes to overall productivity growth.⁽⁷²⁾ = Estimates by the=20 Bureau of Labor Statistics (BLS) confirm Stiroh's finding that = IT-producing=20 industries make an outstanding contribution to multifactor productivity=20 growth.^=
(73) The=20 BLS estimates show that industrial machinery and equipment (SIC 35) and=20 electronic and electric equipment (SIC 36)--the categories that include = the=20 computer and semiconductor industries--ranked highest in multifactor=20 productivity growth among all manufacturing industries between 1990 and=20 1996. Similarly, a May 2000 analysis by Dale Jorgenson and Stiroh = concluded=20 that IT production is a major force behind the current resurgence in = multifactor=20 productivity growth.^=20
(74)
=

Computer Use

Analyses of computer-using industries outside the IT sector, however, = continue to show mixed results. For the period prior to 1991, Stiroh = found that=20 in computer-using sectors, rapidly falling computer prices led firms to=20 substitute capital for labor and other inputs. The result was that = remaining=20 workers had more capital to work with, and labor productivity rose. = However,=20 Stiroh found little evidence that investments in computers affected = multifactor=20 productivity growth in these sectors. These findings have been broadly = confirmed=20 by Jorgenson and Stiroh himself in studies in 1999 and 2000. Both = researchers=20 note that price declines in IT have led to capital deepening in IT-using = industries, but they still see "no corresponding eruption of = industry-level=20 [multifactor] productivity growth in these sectors."⁽⁷⁵⁾

By contrast, evidence of multifactor productivity growth in some = IT-using=20 industries has been documented in a study by Jack Triplett and Barry = Bosworth.=20 They estimate that from 1987 to 1997, multifactor productivity grew 9.0 = percent=20 per year among security and commodity brokers, 2.1 percent a year among=20 insurance carriers, and 2.2 percent among holding and investment = offices.⁽⁷⁶⁾ These = estimates of=20 productivity growth for the period 1987 to 1997 significantly exceeded=20 productivity gains for the same industries in the years 1960 to 1973. =

ESA's own industry-level analysis covering the 1990-97 period = supports=20 Stiroh's conclusion.^=20
(77) We found that gross product originating per worker = (GPO/W), an=20 approximate measure of labor productivity, was stronger in IT-using = goods=20 industries than in non-IT-intensive goods industries--2.4 percent per = year=20 compared to 1.3 percent. No similar pattern emerged, however, among = service=20 industries. IT-using service industries actually showed a negative = growth rate=20 of 0.3 percent a year, compared to 1.3 percent annual productivity gains = by=20 non-IT intensive service industries. These results largely reflect the = difficult=20 problems in conceptualizing and measuring output in many service = industries.=20

In view of these measurement problems, we compared growth in GPO/W of = IT-using service industries with that of the non-IT intensive service=20 industries, but excluding 10 hard-to-measureservice industries.⁽⁷⁸⁾ We found = that when=20 the hard-to-measure industries are excluded, IT-using service industries = show=20 slightly greater GPO/W growth than non-IT intensive service industries, = and the=20 overall annual average GPO/W growth for 1990-97 rises from 1.38 percent = to 2.34=20 percent. (Figure 4.5) Because hard-to-measure service industries = together=20 account for 44 percent of the total GPO by IT-using service industries, = the=20 effect of IT on service industry productivity will remain clouded until=20 development of better output measures.

BEA, BLS, and other statistical agencies are currently grappling with = the=20 challenge of improving output measurements for service = industries. BEA=20 plans to release new GPO-by-industry data this summer. We expect that, = based on=20 this new data, estimates for some hard-to-measure service industries = will show=20 productivity gains.^=20
(79)

FIRM-LEVEL EVIDENCE
=20

Like the macroeconomic studies, recent firm-level analyses show that = IT=20 contributes substantially to productivity growth. This contribution is=20 especially strong where businesses undertake organizational and other = changes=20 that complement the adoption of IT.

In one study, Erik Brynjolfsson and Lorin Hitt analyzed firms in four = groups=20 based on their levels of IT investment and degree of decentralization. = While=20 they found that average productivity was highest among firms that were = high in=20 both IT investment and decentralized organization, they also found that=20 productivity was lowest among those firms that were high in IT = investment but=20 low in decentralization. In fact, the productivity of firms that = invested=20 heavily in IT but remained highly centralized declined relative to firms = which=20 were low on both measures.^=20
(80)

Another study by the same researchers similarly concluded that while=20 computers make a positive contribution to productivity growth at the = firm level,=20 "the greatest benefit of computers appears to be realized when computer=20 investment is coupled with other complementary investments; new = strategies, new=20 business processes, and new organizations all appear to be = important."⁽⁸¹⁾

Another analysis, by Brynjolfsson and Shinkyu Yang, found that a = one-dollar=20 increase in computer capital is associated with a $10 increase in the = valuation=20 of the firm by the stock market, based on eight years of data for 820=20 non-financial U.S. firms.^=20
(82) This finding does not imply that the market values a = dollar of=20 computers at $10, but rather that "the firm that has a dollar of = computers=20 typically has another $9 of related intangibles."⁽⁸³⁾ In order = to make=20 effective use of computers, firms have to make expensive investments in=20 software, training, and organizational changes, which together create = intangible=20 assets. The researchers estimate that when the costs of these intangible = assets=20 and other adjustment costs are added to the direct expenditures on = computers,=20 the firms had normal returns on investment. No other category of capital = investment shows such high valuations relative to tangible investments. =

In conclusion, based on both macroeconomic and firm-level analyses, = IT makes=20 a substantial contribution to overall productivity growth. The = firm-level=20 studies show that firms that have made the organizational and other = changes=20 necessary to effectively use IT become more productive over time than = those that=20 have not. However, analyses of the impact of IT on productivity at the = industry=20 level have produced mixed results, largely reflecting the limitations of = measuring the output of many service industries. Until these measures = are=20 improved, the full effect of IT on service industry productivity will = remain=20 clouded.

CHAPTER V

THE INFORMATION TECHNOLOGY = WORKFORCE^=
(84)=20

Information technology workers not only produce and maintain the = Nation's=20 computing and communications infrastructure, they also generate the = knowledge,=20 ideas and information critical to the development of the digital = economy. =20

Demand for IT workers has increased with the spread of networked = computers,=20 the Internet, e-commerce, and the associated growing demand for = high-quality=20 digitized products and services. Moreover, the demand for IT workers is=20 increasingly focused on more highly-skilled and highly paid people, as = the rapid=20 pace of innovation rewards high skills and technology reduces the number = of=20 less-skilled and lower paid IT jobs.

In 1998, the IT workforce--covering workers in IT-producing = industries and=20 workers in IT occupations in other industries-- totaled roughly 7.4 = million=20 workers, or 6.1 percent of all workers. While IT employment has grown = faster=20 than overall employment for many years, the growth in both IT-producing=20 industries and IT occupations accelerated in the mid-1990s. IT industry=20 employment grew almost 28 percent from 1994 to 1998, and employment in = IT=20 occupations increased by 22 percent over the same period. By contrast, = over=20 those same years, total U.S. nonfarm employment rose by about 11 = percent.

Table=20 5.1

IT-Related=20 Occupations

           &nbs= p;            = ;            =            =20

Engineering, science, = and=20 computer           &nbs= p;            = ;            =          =20 Electrical and electronics engineers

systems managers           &nbs= p;            = ;            =       =20            &nbs= p; =20 Computer engineers         =20

Database = administrators           &nbs= p;            = ;            =             &= nbsp;=20 Computer support specialists

Systems analysts           &nbs= p;            = ;            =             &= nbsp;           &n= bsp;           &nb= sp;      =20 All other computer scientists           &nbs= p;            = ;   =20            &nbs= p;   =20

Computer = programmers           &nbs= p;            = ;            =             &= nbsp; =20 Electrical and electronics = technicians

Broadcast = technicians           &nbs= p;            = ;            =             &= nbsp;     =20 Duplicating, mail and other office machine=20 operators

Computer equipment=20 operators           &nbs= p;            = ;            = =20 Billing, posting and calculating machine=20 operators

Data processing = equipment=20 repairers           &nbs= p;            = ;  =20 Data entry keyers

Communications = equipment=20 operators           &nbs= p;            = ;=20 Electronics repairers, commercial and industrial=20 equip.

Electrical powerline = installers=20 and repairers           &nbs= p;    =20 Electrical and electronic equipment assemblers,=20 precision

Telephone and cable = TV=20 installers and repairers       =20 Electromechanical equipment assemblers,=20 precision

Central office and = PBX=20 installers and repairers           =20 Electronic semiconductor processors

           &nbs= p;   =20

Source: ESA in = consultation=20 with BLS.

This chapter examines past and recent employment = trends, wage=20 trends and skill requirements in IT-producing industries and IT = occupations.=20 (See Table 5.1 for a list of IT occupations and Appendix Table 5.4 for=20 descriptions of duties.)^=20
(85) We also analyze the factors affecting the supply of IT = workers=20 and how the public and private sectors are responding to the growing = demand for=20 IT workers.

IT-PRODUCING INDUSTRIES

Employment in IT-Producing = Industries=20 Accelerates After 1994

Jobs in IT-producing firms, after growing more slowly than overall = employment=20 in 1993 and 1994, increased dramatically in 1995 and thereafter, growing = at an=20 average annual rate of 6.5 percent. (Figure 5.1) The number of workers = in=20 IT-producing firms grew from 3.9 million in 1992 to 5.2 million workers = in 1998.=20 Even at this level, employment in IT-producing firms in 1998 accounted = for less=20 than 5 percent of total private employment.

The overall growth in IT-producing industry employment masks a = churning of IT=20 jobs, with significant job increases in some areas and significant = declines in=20 others. Among all IT-producing industries, software and computer = services=20 recorded the fastest employment growth.⁽⁸⁶⁾ Job = positions in=20 these areas nearly doubled, from 850,000 in 1992 to more than 1.6 = million in=20 1998. (Appendix Table 5.1) Over the same period, job growth in the = hardware and=20 communications services industries was close to the growth in overall=20 employment. Within these areas, computer hardware retailers and pay = television=20 service providers saw the fastest growth, while other sub-industries = experienced=20 job reductions, including manufacturers of computers, electron tubes and = some=20 types of communications equipment. (See Appendix Table 5.1 for industry = detail.)=20

A vibrant economy always produces significant job creation and job=20 destruction. However, some recent job churning appears to be directly = related to=20 several factors associated with the digital revolution:
=

Many=20 information technologies have short life cycles, and employers intent = on=20 quickly getting a product or service to market often prefer to hire = workers=20 skilled in new technologies rather than retrain their current = workers.⁽⁸⁷⁾ =

Computing=20 and communications technologies have lowered barriers to entry, = especially to=20 markets that provide information technology and other services. These=20 technologies provide small businesses with size and resource = advantages=20 usually available to larger, established companies.⁽⁸⁸⁾ By = using the=20 Internet, they can compete outside of local markets, even in global = markets.=20 The same technologies allow foreign companies greater access to U.S. = markets.=20 More players in the market means more job churning as there will be = winners=20 and losers.

Employment=20 in IT-producing industries is also affected by the increasing use of=20 outsourcing to other industries. For example, Fortune 1000 companies = outsource=20 an estimated 60 percent of their e-commerce projects.⁽⁸⁹⁾ =

IT Industry Wages Consistently = Higher Than=20 Average

The average annual wage for workers in=20 IT-producing industries was $58,000 in 1998, or 85 percent higher than = the=20 $31,400 average wage for all private workers. Since 1992, wages paid by=20 IT-producing industries have grown by 5.8 percent per year, compared = with=20 private-industry average wage growth of 3.6 percent annually. As a result, the wage gap = between these=20 IT workers and all workers widened by more than $10,000, or two-thirds, = over=20 this period. (Figure 5.2)

Among workers in all IT-producing industries, those in software and = computer=20 services industries, including computer programming services and = software=20 development, earned the highest average wage of $65,300 in 1998. = (Appendix Table=20 5.2) The wages of these workers also grew at the fastest rate over this = period,=20 an average of 6.7 percent per year.

All IT-producing industries paid wages that were higher than the = total=20 private industry average wage in 1998, and almost all of them had higher = than=20 average annual wage growth from 1992 to 1998. Nonetheless, some IT jobs = and=20 non-IT jobs in IT industries remain low-skilled, low paying positions. = The wages=20 for these positions have increased very slowly, if at all.⁽⁹⁰⁾ =

IT OCCUPATIONS

Employment in IT Occupations = Accelerates=20 After 1994

One could define the class of jobs considered "IT occupations" in = many=20 different ways. The broadest definition would recognize that, as the = economy=20 becomes more digitized, most occupations will involve the manufacture or = operation of equipment that includes forms of information technology, = such as a=20 computer chip. A more narrow definition might include only the "core" IT = occupations of computer scientists, computer engineers, systems analysts = and=20 computer programmers; these are the IT positions that require the most = education=20 and skills, are the highest paid, and are in greatest demand. Here, we = adopt a=20 middle ground and include as "IT occupations" those positions involved = in=20 creating, operating and maintaining the IT infrastructure required to = facilitate=20 e-commerce and other Internet or network-related activities. (See Table = 5.1 for=20 list of IT occupations.)

Employment levels in these IT occupations were flat during the early = 1990s=20 and have risen steadily since 1994. In 1992, there were 4.3 million = workers in=20 these IT occupations. By 1998 the number had grown to 5.3 million. = (Figure 5.3)=20 The fastest growth occurred among the core IT occupations, where the = number of=20 jobs increased by 957,000 between 1992 and 1998, or almost 80 = percent.

Highest Skilled IT Workers in=20 Demand

The number of highly-skilled IT workers, or IT workers in occupations = that=20 generally require at least an associate degree, increased from 2.2 = million in=20 1992 to 3.2 million in 1998. The fastest growth occurred among those = with the=20 highest skills - core IT occupations - who increased their share of = total IT=20 employment from 28 percent to 41 percent. (Figure 5.4 and Appendix Table = 5.3)=20

Between 1994 and 1998, total high-skilled IT employment increased 35 = percent,=20 more than three times as much as the national average, and core IT = occupations=20 grew more than five times faster than all other jobs. By contrast, = employment in=20 lower-skilled IT occupations, such as computer operators, communications = equipment operators and billing and posting clerks, declined from = 926,000 to=20 852,000, or 9 percent. During the same period, employment among=20 moderately-skilled IT workers, including telephone and electronic = equipment=20 installers, assemblers and repairers, grew somewhat more slowly than the = national average.

Private surveys and interviews with Chief Information Officers = provide=20 additional insight into the specific IT skills in greatest demand. The = growth in=20 e-commerce, for example, has increased demand for workers with = Internet-related=20 technical skills, including network specialists, help desk/end user = support=20 staff and Internet/intranet developers. E-commerce growth has also = increased the=20 demand for workers with a knowledge of sales, marketing and business = planning.=20 Many IT workers that used to work in back offices are now required to = learn how=20 to deal with customers and convince them to make online = purchases.⁽⁹¹⁾ In = addition, as=20 more firms outsource for IT services, demand has increased for project = managers=20 and people who can negotiate and manage vendor contracts.⁽⁹²⁾ =
=20

High Skilled IT = Occupations Pay=20 High Wages

The earnings of IT workers vary greatly, based on their skills and=20 educational levels. For example, the Bureau of Labor Statistics (BLS) = estimates=20 that in 1998 computer engineers, who typically have at least a = bachelor's=20 degree, earned an average of $59,900. (Appendix Table 5.4) By contrast, = lower=20 skilled occupations such as billing, posting and calculating machine = operators,=20 which usually do not require a college degree, earned on average only=20 $21,300.

Historical wage data are available for only a few IT occupations, = including=20 core IT workers. From 1992 to 1998, weekly earnings of computer = programmers=20 increased from $685 to $843 or 23 percent. (Figure 5.5) The median = weekly=20 earnings of computer scientists, computer engineers and systems = analysts,=20 although higher than average, increased from $810 in 1992 to $952 in = 1998, or at=20 the same 17.5-percent rate as the average for all occupations. =

=20

Private wage surveys provide more current wage estimates of new = occupations=20 and new skills in great demand. According to Computerworld's 13th = annual=20 survey, 1998 and 1999 pay increases for IT positions averaged 4-to-5 = percent,=20 much less than the 11 percent increase in 1997.

RHI Consulting estimates that starting salaries for IT workers in = 2000 will=20 be 6.8 percent more than in 1999, with jobs related to Internet = development,=20 networking, consulting, and systems integration seeing even larger than = average=20 increases. IT consultants with skills such as the ability to work with = Oracle,=20 PeopleSoft and SAP software can earn more than $100 per hour, depending = on level=20 of expertise.^=20
(93)

Earnings in IT occupations also vary by geographic location and = company size,=20 as they do for many other industries. Computerworld estimates = that in=20 1999, webmasters/web designers earned on average $53,100, including=20 bonuses.^=
(94)=20 However, this compensation ranged from $43,800 in New England to $59,600 = in the=20 Pacific region. Further, larger companies with more than $500 million in = revenue=20 paid webmasters/web designers an average of $58,600, compared to smaller = companies with less than $100 million in revenue which paid an average = of=20 $48,400.

IT LABOR MARKET IMBALANCES

The IT Worker Supply = Debate

The question of whether the U. S. is producing an adequate supply of = IT=20 workers has been much debated in recent years. There is no single common = definition of "IT worker" and no agreed-upon method for identifying an=20 occupational shortfall. In theory, market forces will eventually resolve = any=20 imbalance between supply and demand. However, the evidence on short-term = market=20 responses is inconclusive.^=20
(95)

The Bureau of Labor Statistics examined the available national = employment and=20 wage data for core IT occupations over the period 1992 to 1997. They = reasoned=20 that an imbalance should produce above-average growth in both employment = and=20 wages, and below-average unemployment rates. BLS found that while the=20 unemployment rates for core IT occupations were consistently lower than = the=20 national average for this period, employment and wage growth had not = been=20 consistently above average for all core IT occupations. They = concluded=20 that the evidence on IT labor market imbalances remains = ambiguous.⁽⁹⁶⁾

A more detailed examination of employment and wages in core IT = occupations=20 supports this judgment. Between 1992 and 1994, employment among computer = programmers fell; in the following four years, this employment grew by = an=20 average of 5 percent a year. Over the same period, the number of = computer=20 scientists, computer engineers and systems analysts grew at a 16.5 = percent=20 annual rate. (Figure = 5.6) The fact that median weekly = earnings for=20 both occupations grew at 3.0 and 3.4 percent annually - little faster = than the=20 2.9 percent national average - seems inconsistent with a serious = imbalance in=20 labor supply and demand. One possible explanation is that businesses = have been=20 using non-wage benefits such as stock options to attract employees. = Other=20 reasons may be that the rapid growth of employment in these areas has = reduced=20 the median experience and skill level, suppressing median wage growth, = or that=20 high relative pay and a sense of job security may be keeping down = additional=20 wage gains. Finally, the recent moderate growth in wages may also = indicate that=20 growth in the supply of IT workers (whether from foreign sources or = graduates=20 from IT and other technical training programs) is keeping pace with = demand.

A study by the Computing Research Association evaluated past = assessments of=20 the supply of IT workers.^=20
(97) The study found evidence of temporarily tight labor = markets in=20 specific regions and occupations and argued that such tightness should = be=20 expected in any field undergoing rapid technological change. The report = further=20 noted that more useful findings could be produced by segmenting the = market by=20 geographical area or occupation, but that the data needed to conduct = such=20 analyses do not exist. Several Federal initiatives are currently = underway to=20 improve IT-related employment data collection.⁽⁹⁸⁾

Meeting the Demand for = IT=20 Workers

As the importance of IT to the American economy continues to grow, so = will=20 the demand for IT workers. In response, government and business are = taking steps=20 to increase the numbers of IT workers.

One such step is the Federal Government's H-1B visa program, which = admits=20 foreign skilled workers to the United States. Congress raised the H-1B = visa=20 limit from 65,000 to 115,000 in 1998. This year, this ceiling was = reached in=20 March, with employers demanding 50,000 more H-1B visas than at the same = time in=20 1999.^=
(99)=20 Consequently, several bills have been introduced in Congress to either = raise the=20 limit (up to 200,000) or to temporarily remove the cap. Although many = workers=20 who enter the country under the H-1B visa program hold jobs other than = IT jobs,=20 a recent Immigration and Naturalization Service (INS) survey found that = over 60=20 percent of H-1B visa petitioners are IT workers.⁽¹⁰⁰⁾ = Applying the INS=20 estimate to the current H-1B visa limit of 115,000 suggests that the = H-1B=20 program currently fills over 70,000 IT jobs, equivalent to 28 percent of = the=20 average annual demand for IT workers with at least a bachelor's degree = during=20 the 1996 to 1998 period.

A number of public/private partnerships also have been created to = increase=20 the supply of IT workers from various sources, including the current = pool of=20 workers, retired people, and high school and college students. Outlined = below=20 are some representative examples of recent initiatives by the Federal=20 government, public/private partnerships, and private companies to = increase the=20 supply of IT workers and raise the technical IT competency of American=20 workers.

Federal Efforts

The=20 Department of Labor (using funds from the $500 H-1B visa filing fee) = plans to=20 award grants of $12.4 million in FY 2000 to train U.S. workers for IT = and=20 health care jobs often filled by immigrants. The Department also will = fund an=20 additional $40 million for projects to train workers in local markets. = Under=20 these programs, private companies seeking IT workers can work with = local=20 governments and educational institutions to develop training.=20 (www.dol.eta.gov)

The=20 Department of Education is providing $135 million in grants to train = 400,000=20 teachers to use information technologies more effectively in the = classroom.=20 (www.ed.gov/ PressReleases/08-1999/wh-0824.html)
The=20 Department of Commerce's Technology Administration created and = maintains the=20 GO4IT website that provides access to a searchable database containing = descriptions of a wide variety of IT work force initiatives around the = country.(www.go4it.gov) The Department of Labor maintains America's = Career Kit=20 consisting of America's Career InfoNet (www.acinet.org), America's Job = Bank=20 (www.ajb.dni.us) and America's Learning Exchange=20 (www.alx.org).

Public/Private Partnerships

Cisco=20 Systems, the Communications Workers of America, Arizona State = University and=20 the Departments of Labor and Education are developing an online system = to help=20 retired military personnel and others to assess and improve their IT = skills.=20

The = National=20 Association of Manufacturers encourages its member companies to spend = at least=20 3 percent of their payroll on worker training.

The = Department of=20 Labor with the American Society for Training and Development are = expanding=20 America's Learning Exchange, (www.alx.org) a clearinghouse for = information on=20 education and training, financial aid and skills analysis.

The=20 Department of Education and the Conference Board disseminate = information about=20 the economic benefits of workplace learning to U.S. businesses and = unions.=20

Private Efforts

Ford=20 Motor Co., Intel Corp, Delta Airlines and American Airlines recently = announced=20 plans to provide computers and low-priced Internet access to all their = employees, as a way of raising the technical literacy of their = workforce.
Some=20 firms are taking advantage of distance learning systems, such as those = provided by Saba Corp, which provide electronic learning platforms and = infrastructure for a number of companies, including Qwest = Communications,=20 Ford, and Continental Airlines. Saturn, P&G and IBM also have = intranets or=20 online technologies that provide information and training services to=20 employees, suppliers and customers throughout the world. =

CHAPTER VI

TRADE IN INFORMATION = TECHNOLOGY

GOODS AND SERVICES^=20
(101)

American IT companies are powerful competitors in markets around the = world.=20 Yet the United States ran a trade deficit in information technology = goods of=20 almost $66 billion in 1999. (Figure 6.1, and Appendix Table 6.1) The = growing=20 imbalance in cross-border flows of IT goods overwhelms the small = surpluses that=20 the United States has earned in recent years in IT services trade. = (Figure 6.2,=20 below, and Appendix Table 6.2)

The paradox of large trade deficits in an area where U.S. firms = are world=20 leaders is largely explained by the fact that America's leading IT firms = are=20 global operations that service foreign customers through their overseas=20 affiliates, rather than by exporting goods made in this country. The = most recent=20 published data show that in 1997, when the United States exported $121.4 = billion=20 of IT goods and services, foreign sales by overseas IT affiliates of = American=20 companies totaled $196 billion.⁽¹⁰²⁾ In the = same=20 year, American-based IT affiliates of foreign companies reported U.S. = sales=20 totaling $110.5 billion. (Table 6.2) U.S. deficits in IT trade also = reflect=20 strong growth in the U.S. economy compared to the slower pace virtually=20 everywhere else and the boom in IT investment by American firms. =

TRADE IN IT GOODS
=

Both exports and imports of IT goods have exhibited strong growth in = recent=20 years, with imports growing faster than exports. Through the 1990s, U.S. = exports=20 of these goods, including pre-packaged software, rose at an average = annual rate=20 of about 9.5 percent. Over the same period, U.S. imports of IT goods = increased=20 at an average rate of 12.3 percent a year. As a result, the U.S. trade = deficit=20 in IT goods jumped from $11.5 billion in 1990 to $65.9 billion in 1999. = (Figure=20 6.1) In fact, the United States has run trade deficits since 1983 in = many=20 categories of IT hardware, including semiconductors, household audio and = video=20 equipment, and computer storage devices.⁽¹⁰³⁾ Trade = surpluses=20 in computer peripheral equipment turned negative in 1994; and in 1999 = the nation=20 posted its first trade deficit in electronic computers. (Appendix Table = 6.1)=20

At the same time, the United States continues to run trade surpluses = in some=20 high value-added IT products. The U.S. trade surplus in pre-packaged = software=20 reached $2.8 billion in 1999, a record level. The trade surplus in = scientific=20 instruments has also generally been on the rise. And following a long = series of=20 trade deficits dating from 1983, telecommunications equipment = manufacturers=20 enjoyed export surpluses in three of the five years after 1994. =

TRADE IN IT SERVICES =
=20

The U.S. trade position in IT services strengthened throughout the = 1990s.=20 Exports of IT services, including royalties from the licensing of U.S. = software,=20 increased at an average annual rate of 13.2 percent from 1990 to 1998, = while=20 imports of IT services grew at a 6-percent rate. As a result, the United = States=20 ran trade surpluses in IT services of $0.9 billion in 1997 and $1.8 = billion in=20 1998, the first such surpluses since BEA began collecting comprehensive = data on=20 services trade in 1986.(Figure 6.2, and Appendix Table 6.2) =

Within IT services, U.S. exports of computer and information = services,=20 including software royalties, increased at a 23.7-percent average annual = rate in=20 the 1990s. Even though imports of these services rose even more rapidly, = by 33.1=20 percent per year, in 1998 they still remained just under $1 billion, or = less=20 than one-seventh of the value of exports. In 1998, U.S. firms exported = $4.0=20 billion in computer and information services, compared to $0.5 billion = in=20 imports of such services. In addition, software royalties paid by = foreign firms=20 to U.S. producers surpassed $3.2 billion, compared to U.S. = software-royalty=20 payments to foreign producers of less than $0.5 billion.

By contrast, U.S. payments to other countries for telecommunications = services=20 consistently outpace foreign payments to U.S. carriers. In 1998, the = deficit was=20 $4.4 billion, down modestly from the record $5 billion in 1996. = (Appendix Table=20 6.2) The negative balance of payments on cross-border sales of=20 telecommunications services is a reflection of calling patterns and = differences=20 in national telecommunications rates. More international calls originate = here=20 than in other countries because of the strong U.S. economy, relatively = high U.S.=20 income levels, and large immigrant populations in this country. In = addition,=20 because American markets are more open and competitive, foreign callers = pay less=20 to U.S. carriers to complete calls to the United States than Americans = pay to=20 foreign carriers to complete calls going the other way.
=

TRADE BETWEEN U.S. IT FIRMS = AND =20

AFFILIATED FIRMS ABROAD =

Many U.S. IT firms, spurred by competition from low-cost foreign = producers=20 and the liberalization by a growing number of countries of controls on = direct=20 investment and capital flows, have moved lower value-added production = overseas.=20 As a result, intra-firm trade, defined as cross-border sales between = parents and=20 affiliates of U.S. and foreign multinational companies, accounts for a=20 significant portion of our trade in IT products. In 1997, for instance, = U.S.=20 exports to affiliated firms in core IT hardware industries--computer and = office=20 equipment; electronic components and accessories; and audio, video and=20 communications equipment--amounted to roughly 60 percent of U.S. exports = of=20 goods in these classes of IT = hardware.=20 (Appendix Table 6.1)

Trade between U.S. parent companies and their overseas affiliates has = contributed to a reduction in the size of the U.S. trade deficit = in=20 information technology products. Trade between foreign parents and their = U.S.=20 affiliates has had the opposite effect. (Table 6.1) On balance, the = combined=20 impact of intra-firm trade remains positive. In 1997, exports by U.S. parents and = U.S. IT=20 affiliates of foreign-owned companies to affiliated firms overseas = exceeded $65=20 billion, while imports from foreign parents or foreign affiliates of = U.S.=20 parents totaled $52 billion, resulting in a net surplus of $13.2 = billion. (Table=20 6.1) In other words, the U.S. trade deficit in IT goods and = services=20 is due to the imbalance in trade between unaffiliated companies.

SALES BY U.S. AND FOREIGN IT=20 AFFILIATES

As a group, American companies that make IT products for sale outside = the=20 United States are more likely to supply these markets with goods and = services=20 produced by their overseas IT affiliates, than to export to these = markets from=20 the United States. The global competitiveness of the U.S. IT industry is = apparent in the comparison of sales by U.S. IT affiliates abroad with = sales by=20 foreign-owned IT affiliates stationed in the United States. In 1997, for = example, foreign sales by U.S.-owned overseas affiliates in the computer = and=20 office equipment industry exceeded sales in this country by = foreign-owned U.S.=20 affiliates in the same industry by $67 billion. Similarly, the balance = of sales=20 in 1997 favored American-owned foreign providers of computer processing = and=20 information retrieval services by $41 billion and U.S.-owned foreign = producers=20 in the electronic components and accessories industry by $20 billion. In = contrast, the comparable balance in the audio, video, and = communications=20 equipment industry was roughly zero, while U.S. sales by American = affiliates of=20 foreign firms in the communications services industry topped foreign sales by American-owned = affiliates=20 providing the same services overseas by $35.8 billion.⁽¹⁰⁴⁾ (Table = 6.2)

CHAPTER=20 VII

WHAT IS NEW IN "THE NEW ECONOMY"?⁽¹⁰⁵⁾ =
=20

Compared to the period from 1973 to 1995, the American economy has = turned in=20 a remarkable record for the last four and a half years. Productivity = gains,=20 investment rates, and real wage growth are all higher; unemployment and=20 inflation are lower; and the expansion has now set an all-time U.S. = endurance=20 record. Increasing confidence that the future of the real economy⁽¹⁰⁶⁾ will = look more=20 like the last four years than the preceding 22 years has led more = analysts and=20 even economists to accept the media label, "The New Economy." Although = slowdowns=20 and recessions will occur at some point, the economy's trajectory = appears to=20 have shifted upward.

The information technology sector has played a critical role in the = economic=20 success of recent years. Businesses across the economy have been = investing=20 heavily in IT hardware and software to harness the potential created by = falling=20 prices and by the increasing capacities of computer processing, storage = media=20 and communications links. Business strategies and even the structures of = companies and industries are being transformed as communication within = companies=20 and among the members of corporate alliances occurs more rapidly, with = more=20 customized information, and with greater security, interactivity, and = timeliness=20 than before. The same quality (or "richness") of communication that once = was=20 limited to a narrow group of close contacts can now be extended to a = much wider=20 "reach" of contacts.^=20
(107)

The IT revolution is affecting everyone's life. The advances and = spread of IT=20 are part of the reason why we now have the lowest unemployment rate and = fastest=20 growth in real wages in three decades and the longest expansion on = record.=20 Consumers are making a small but increasing amount of their purchases = online and=20 using the Internet to make more informed purchases offline. IT is also=20 transforming the way most firms operate. As employers substitute IT for = labor,=20 workers have to develop new skills.

LONG TERM FORECASTS ARE BEING = RAISED=20

The hallmark of the New Economy is higher sustainable growth due to = faster=20 improvement in labor productivity. Recently, most economists have begun = to=20 accept that the U.S. economy can sustain growth at a substantially = higher rate=20 than the 2.5 percent a year average for the 1973 to 1995 period. For = example,=20 the Blue Chip consensus growth forecast released in January of each year = from=20 1996 to 1999 forecast growth for the coming year of 2.3 and 2.4 = percent.⁽¹⁰⁸⁾ In = each of those=20 four years, actual growth surpassed 4 percent. (Figure 7.1) However, = this past=20 January, the consensus forecast for 2000 came in at 3.2 percent. = Furthermore,=20 the Blue Chip longer term outlook has also shifted upward. After many = years of=20 forecasting 2.45 to 2.7 percent average annual growth over the coming 10 = years,=20 the consensus in the latest forecast shifted up to 3.1 percent. (Figure = 7.2)=20 Since the U.S. labor force tends to grow by little more than 1 percent = per year,=20 the hike in growth forecasts strongly implies that in the last year Blue = Chip=20 economists have raised their expectations of annual labor productivity = growth=20 from roughly 1.5 percent to about 2 percent.

This more sanguine view of our future economic prospects comes from = greater=20 confidence that the faster labor productivity of the last four years = (see Figure=20 1.1), based significantly on developments in IT investment, has some = staying=20 power.^=
(109) It=20 is noteworthy that this optimism is still somewhat conservative, since = the labor=20 productivity growth assumed in the ten-year forecast is still much = slower than=20 the recent pace. However, since strong output growth tends to raise = labor=20 productivity growth, Robert Solow has recently cautioned, probably = speaking for=20 many economists, that he "will feel better about the endurance of the=20 productivity improvement after it survives its first recession."⁽¹¹⁰⁾

IT can support higher rates of labor productivity gains and output = growth, so=20 long as IT innovation and price declines persist, and non-IT industries = continue=20 to invest heavily in IT products and services. Both of these conditions = are=20 expected to persist into the future. Experts in the semiconductor, = computer,=20 storage, and communications industries have expressed confidence that = rapid=20 rates of product innovation and price decline can continue for at least = another=20 decade. Experts in non-IT industries also have expressed confidence in = their=20 capacity to benefit enormously from further substantial investments in=20 IT.

The prospect of healthier productivity gains over both a medium term = and a=20 longer run has significant implications for our future standard of = living and a=20 range of fiscal issues facing government at all levels. For example, = faster=20 productivity growth translates into more tax revenue, which in turns = creates=20 larger budget surpluses and longer positive balances for trust funds = such as=20 those for Social Security and Medicare. Faster productivity growth also = means=20 lower inflation, reducing the additional costs of COLAs for most = entitlement=20 programs.

IMPLICATIONS OF IT-FOCUSED INVESTMENT=20 FOR

THE BUSINESS CYCLE
=

The boom in IT investment has implications for the business cycle = that go=20 beyond the impact on underlying trend growth. As Martin Baily, chairman = of the=20 President's Council of Economic Advisers, has noted, the current = nine-year-old=20 expansion has not developed the "geriatric" conditions that we have come = to=20 expect after several years of solid economic growth. In particular, the = improved=20 labor productivity growth (see Table 4.1) has been a "fountain of youth" = for the=20 expansion. As previous postwar expansions matured, labor productivity = and output=20 slowed, inflation rose, real wages stagnated, and profits declined. The = unusual=20 pattern of conditions continuing to improve as this expansion has aged = can be=20 seen clearly by charting the progression of five basic indicators over = the long=20 business expansions of the 1960s, 1980s, and 1990s. (Figures 4.1, = 7.3-7.6)=20 Although real wages did continue to grow throughout the 1960s expansion, = recent=20 real wage growth has been even faster than in the 1960s. Although growth = in real=20 profits has slowed in recent years, by this stage in previous business=20 expansions, profits were declining sharply.

The strong output growth and continued improvements in profits in the = current=20 expansion have, in turn, fueled unusual vigor in real spending for = private=20 investment generally and for research and development in particular. = (Figures=20 7.7 and 7.8)

Much as IT has boosted growth in the expansion, it could have a = dampening=20 effect on the next business slowdown.⁽¹¹¹⁾ In the = past, a=20 substantial slowdown or decline in overall demand has led to even = greater=20 slowdowns or even declines in investment as capacity and inventories = suddenly=20 became excessive. At some time in the future, the economy will slow = down,=20 squeezing the corporate cash flow that helps finance new investment and = creating=20 involuntary excess capacity and inventories. While this should curb new=20 investments to expand capacity, investments in IT should be far less = affected.=20 In most industries, IT investments do not expand capacity; rather, they = provide=20 general cost savings, reduce errors, provide the basis for more prompt = and=20 informed decisions, and increase customer satisfaction. For industries = in which=20 IT investments directly expand capacity to provide services (e.g., = finance, real=20 estate, retail) a slowdown in demand should directly slow IT investment. = Because=20 IT investments are commonly driven by pressures to keep pace with = competitors,=20 in terms of costs and satisfying customer demand for more responsive = products,=20 IT investment should weather a slowdown in demand better than capacity = expanding=20 investments

The spread of IT could also moderate the sharp declines in = manufacturing=20 inventories that occur in recessions. By improving communications with = suppliers=20 and customers, IT has facilitated manufacturers' efforts to limit their=20 inventory exposure. As a result, durable goods manufacturers have = reduced their=20 inventory ratios from 16.3 percent of annual shipments in 1988 (the = lowest=20 period in the 1982-90 expansion) to just 12.0 percent in the last 12 = months.=20 (Figure 7.9)

If U.S. manufacturers of durable goods today held inventories at the = 1988=20 inventory to sales ratio, they would be holding an additional $115 = billion in=20 inventory (Figure 7.10). The cost savings from reduced inventories = takes=20 several forms. First, there is the average savings of about $10 billion = a year=20 from not having to pay to accumulate as much new inventory in each of = the eleven=20 years. Second, the cumulative $115 billion in funds that would have been = spent=20 for inventory have been used to invest elsewhere or pay down debt. By = this=20 point, the financial benefit of the second effect exceeds the benefit = from the=20 first. Third, the companies are spared the expense of storing and = securing=20 one-third more inventory than they now hold. Fourth, they avoid the = inevitable=20 losses from holding inventories for products that lose favor in the = marketplace.=20 All told, lower inventories were a significant factor in the sector's = $99=20 billion of profit in 1999 (and in keeping down prices to their = customers). =20

=20

Adjustments to inventory have aggravated all recent recessions = because, as=20 Figure 7.11 indicates, recessions tend to have bigger declines in output = than in=20 sales. (Sales actually continued to rise during the recessions of 1960 = and=20 1969.) Reductions in inventory accumulation account for the gap between = the=20 change in output and the change in sales. On average, inventory = corrections in=20 the six recessions since 1960 made the change in GDP 1.6 percentage = points=20 greater than the change in final sales. Today's leaner inventories = should, other=20 things equal, cushion the depth of the next recession by narrowing the = gap=20 between declines in output and demand.

WHY NOW? WHY HERE?

The U.S. labor productivity boom of the last four years has outpaced = not only=20 its own performance from 1973 to 1995, but also the labor productivity = gains of=20 other major industrial countries in recent years. Since information = technologies=20 and IT prices have been steadily improving since the early 1970s, why = didn't=20 U.S. labor productivity improve sooner? Since IT is readily available on = the=20 world market, why hasn't labor productivity accelerated in most other = industrial=20 countries?

The U.S. macroeconomic environment since the early 1990s has = stimulated an=20 investment boom. Both fiscal and monetary policy have contributed. The = 1990s=20 began with very large budget deficits projected to grow even larger. = However,=20 prudent policies to curb spending and raise revenues were introduced, = and the=20 fiscal picture has reversed. Another reason for the current long boom is = that=20 Federal Reserve policymakers have generally paid more attention to the = fact that=20 inflation has kept on falling, than to traditional concerns that low=20 unemployment would reignite inflation. Back when the unemployment rate = first=20 reached the once-worrisome range of 5.5 percent to 6 percent, the Fed = could have=20 dampened growth to keep unemployment from falling further. Had they done = so, the=20 United States would not have seen the broad gains in output, investment, = and=20 labor productivity that have occurred.

Sound macroeconomic policies have helped lower unemployment and = inflation,=20 but they cannot account for the recent multi-year doubling of labor = productivity=20 growth. For that, look to more technologically based explanations. For = example,=20 there is the view that fundamental technological changes, from = electricity to=20 IT, take a very long time to generate labor productivity breakthroughs - = and=20 when they do, labor productivity rises very sharply. Comparing the = economic=20 history of electricity and electrical motors to our recent experience = with=20 computers, Paul David and Gavin Wright have documented that labor = productivity=20 in U.S. manufacturing grew less than 1 percent a year from the = commercial=20 introduction of electric motors in the three decades prior to the 1920s, = and=20 then soared to 5 percent per year in the 1920s.⁽¹¹²⁾

Another explanation uses the model of "recombinant growth" drawn from = the=20 biological sciences.^=20
(113) Hal Varian observes that "Every so often innovations = come along=20 that can be broken down into separate parts and recombined to create a = host of=20 new inventions." As businesses bring together different elements in = creative=20 combinations, some flourish while many others are ephemeral. Varian = cites the=20 historical examples of the periods following Eli Whitney's "uniformity = system"=20 to produce muskets, and Edison's invention of the "invention = factory."⁽¹¹⁴⁾ He = also gives=20 the more recent example of integrated circuits leading to circuit boards = for=20 many modern devices and predicts that "the Web's components - URLs, CGI = scripts,=20 HTTP protocols and the HTML language" provide the basis for another = period of=20 recombinant growth. Recent and now predictable "recombinant growth" = includes not=20 only Web components but hardware innovations that can be creatively = taken apart=20 and recombined for innovative products.

Perhaps most important of all are the broad market conditions that = support=20 innovation. Deregulation has helped drive the development of the largest = and=20 most creative financial markets in the world, including equity markets, = credit=20 markets, and venture capital. Reallocation of resources is facilitated = not only=20 by nimble capital markets but by relatively few barriers to bankruptcy.=20 Americans also enjoy a lower tax burden, and much more fluid and = deregulated=20 labor markets, than most other countries. Cultural factors probably also = matter,=20 especially the admiration many Americans feel for entrepreneurism and=20 risk-taking.

PRODUCTIVITY ACCELERATION = AND

JOB DISPLACEMENT
=

Another important issue concerning the dynamics of the New Economy is = their=20 effect on jobs. In an aggregate or macroeconomic sense, the New Economy = has been=20 characterized by strong job and wage growth. With lower inflation and=20 accommodating monetary policy, unemployment has fallen below 4 percent, = the=20 lowest rate since 1969. The unemployment rate of those with less = education and=20 experience has fallen along with the rates of everyone else, although it = remains=20 higher than those of better educated and experienced workers. Similarly, = with=20 everyone else, workers near the bottom of the ladder in recent years = have=20 enjoyed strong real wage growth.

The effect of the New Economy on jobs at an industry and firm level = is more=20 difficult to analyze. As shown in Chapter V, we can detect some = important=20 effects of IT on IT-related employment, but we can only speculate on the = effect=20 of IT on non-IT related jobs. The number of well-paid jobs in the IT = producing=20 and IT-using sectors is growing rapidly, even as the number of = lower-paid=20 IT-related jobs is shrinking. It is reasonable to assume that IT, by = raising=20 labor productivity, must displace jobs somewhere in the economy. = However, there=20 is no clear evidence about what types of jobs are displaced most rapidly = by IT.=20 A significant percentage of jobs in modern America involve collecting = and/or=20 processing information, and/or making decisions based on information; = but some=20 sectors, such as education and financial services, have a higher = proportion of=20 information-intensive jobs than other sectors. However, all sectors have = information-based functions, such as sales, purchasing and finance, in = which IT=20 investments could displace many current jobs and raise labor = productivity.

AFTER SOFTWARE, SHOULD OTHER INTANGIBLE = INVESTMENTS=20 ENTER THE NATIONAL ACCOUNTS?

Among the statistical issues raised by the New Economy is the = significance of=20 business investments in intangibles. When the Bureau of Economic = Analysis (BEA)=20 recently reclassified software as a form of investment, rather than as = business=20 expenditure or intermediate input, this change substantially increased = the size=20 and growth of IT in our national accounts. Drawing the curtain to reveal = a=20 sector that grew from $28 billion in 1987 to $149 billion in 1999 had a=20 catalytic effect on economists' perceptions of non-computer aspects of = the IT=20 sector. Much as businesses expect to earn a return on their investments = in=20 software over several years, business spending on intangibles such as = training,=20 workplace reorganization, and consultants can also be viewed as = investments with=20 long-term payoffs.

The work of Erik Brynjolfsson and his coauthors discussed in Chapter = IV=20 strongly suggests that such intangibles are important investments = supporting and=20 complementing tangible IT investments. Not long after BEA recognized = software as=20 investments, Federal Reserve Board Chairman Alan Greenspan urged that = the=20 national accounts go beyond software to include other intangible=20 investments.^=20
(115)

The treatment of business spending on other intangible investments = could have=20 significant effects on a range of measures central to our understanding = of the=20 economy. Since such intangible investment has no doubt been growing = faster than=20 GDP, its inclusion as investments would raise our measure of GDP growth. = This=20 change also would likely improve our ability to account for growth = attributable=20 to specific inputs, and leave less unexplained.⁽¹¹⁶⁾ Since = these=20 intangibles often complement computer and other IT investments, this = change=20 would also help resolve the paradox of the supernormal returns on = computer=20 investments found in some firm-level studies.

On the other hand, incorporating other intangible investments into = the GDP=20 measure would highlight the limitations of GDP as the almost-exclusive = gauge of=20 longer term growth trends. IT investments tend to have short lifespans = and thus=20 faster depreciation rates than average. As the IT share of investment = rises,=20 depreciation rises faster than GDP. Net Domestic Product (GDP less = depreciation)=20 provides a better indication of sustainable growth. As IT has become a = larger=20 share of total investment, the gap between GDP growth and NDP growth has = widened. In the 1960s, GDP and NDP both grew at the same 4.4 percent = rate. By=20 1999, however, GDP grew by 4.1 percent, but depreciation was growing so = much=20 faster that NDP grew by only 3.6 percent.

=

TO SOLVE THE PRODUCTIVITY PUZZLE, BETTER = MEASURES OF=20 SERVICE INDUSTRY OUTPUT ARE NEEDED

As a practical matter, the question of precisely how much IT has = contributed=20 to our stellar economic performance will remain largely a mystery at = least until=20 BEA develops ways of better measuring output in several key IT-intensive = services industries. As noted in Chapter IV, the view that IT has made a = large=20 contribution to labor productivity growth, based on evidence at the=20 macroeconomic and firm levels, cannot yet be confirmed at the industry = level. As=20 Dale Jorgenson and Kevin Stiroh caution:

The apparent combination of slow productivity growth and heavy = computer-use=20 [in specific service industries] remains an important obstacle for new = economy=20 proponents who argue that the use of information technology is = fundamentally=20 changing business practices and raising productivity throughout the U.S. = economy.^=
(117)=20

The fact that official measures show flat or declining labor = productivity for=20 several IT-intensive service industries, such as health and business = services,=20 does not mean that labor productivity has not improved in those = industries. The=20 techniques used to measure output in these industries either assume no = labor=20 productivity change or otherwise fail to capture increases in their = output=20 fully.

A case in point is the measurement of output in the banking industry. = Until=20 recently, output in the banking industry was constructed with the same = basis=20 still used for some major service industries - assuming no labor = productivity=20 change - by using labor input growth as a measure for output growth. = With its=20 benchmark revisions released in October 1999, BEA adopted a new method = for=20 measuring bank industry output based on the industry's transaction = activities.=20 As a result, measures of the IT-intensive banking industry now indicate=20 significant annual labor productivity gains, in contrast to the negative = labor=20 productivity changes portrayed under the old method.

Producing true output measures for all service industries presents a = daunting=20 task. The Bureau of the Census should do more complete surveys of = service=20 industries broken down into more detailed and current categories. Even = with such=20 data, BEA faces difficult conceptual challenges in developing = satisfactory=20 methods for measuring the output of health, legal, business, and other = services.=20 However, BEA has pioneered the use of creative new methods for measuring = the=20 quality, price and output changes for computers, semiconductors, and = certain=20 telecommunications equipment, along with the development and use of=20 sophisticated methods such as chain-weighted indexes to properly gauge = real=20 output changes in a world with some sharply falling prices. Without = these=20 statistical advances, it would not have been possible to assess the = contribution=20 of IT at the macroeconomic level. (Indeed, the fact that the GDP = accounts of=20 other major industrial countries do not include these advances makes=20 international growth comparisons very problematic.)

In the absence of more accurate measures of output for IT-intensive = services=20 industries, we cannot rule out the possibility that IT has made a very = modest=20 contribution to labor productivity outside the IT producing sector = itself. With=20 better measures of output for individual service industries' output, we = may=20 learn that IT has contributed strongly to service industry productivity = or,=20 conversely, that IT has not contributed as much to overall labor = productivity=20 improvement as technical change outside of IT, including organizational = change.=20

THE DIGITAL DIVIDE: COMMUNITIES WITH=20 LOW

INTERNET=20 ACCESS RATES

Internet access has grown across every group and state in America, = but this=20 growth has been most rapid among those households with higher incomes, = more=20 education, computers at work, white or Asian backgrounds, and headed by = persons=20 age 35 to 50.^=20
(118) Serious concerns about other groups that are currently = "falling=20 through the Net" are based on the fact that the Internet is not = merely a=20 place to shop, but also a space where students learn, people find = employment,=20 and communities communicate.

Robert W. Taylor, the director of the Defense Department agency that = created=20 the original Internet in 1969, co-authored a remarkably prescient paper = in 1968,=20 "The Computer as a Communication Device," raising concerns about what is = now=20 called the Digital Divide:

For the society, the impact will be good or bad, depending mainly on = the=20 question: Will to be 'online' be a privilege or a right? If only a = favored=20 segment of the population gets a chance to enjoy the advantages . . . = the=20 network may exaggerate the discontinuity in the spectrum of intellectual = opportunity.^=20
(119)

In more affluent and better educated communities, Internet access has = reached=20 a critical mass. Students are assigned to do their research on the Web, = at home=20 and not just in the library. Increasingly, job-seekers find job openings = on the=20 Web. Sign-up lists passed around at the PTA or other local organizations = include=20 a column for e-mail addresses, along with name and telephone number. In = each=20 instance, the Internet provides the means for communicating information = critical=20 for students, job-seekers, and members of organizations, that could not = occur as=20 effectively in other ways.

In 1998, 42 percent of all American households had computers at home, = and 22=20 percent had Internet connections at home. Some groups, however, are = better=20 networked. Among the 5.5 million White, Asian, and Pacific Islander = families=20 with incomes of at least $75,000, living in a metropolitan area, headed = by=20 someone with at least a college education and age 30 to 55, 87 percent = had=20 computers at home, and 68 percent had Internet connections. Among = households=20 with these levels of income, education, age and living in a metropolitan = area,=20 Black and Hispanic households were just as likely to have home computers = - but=20 roughly 14 percent less likely to have Internet access at home - as = White,=20 Asian, and Pacific Islander households in the same income, education and = age=20 group.^=
(120)=20

At the other extreme, the 1.2 million Black and Hispanic urban = households=20 with incomes below $15,000, in which all adults lack a high school = diploma or=20 GED, and headed by someone age 30 to 55, only 7 percent had computers at = home=20 and only 2 percent had Internet service. Among Whites, Asians, and = Pacific=20 Islanders with similar low income, lack of education, and age, 14 = percent had=20 computers at home, and 5 percent had home Internet connections.⁽¹²¹⁾

Since 1998, more households have obtained computers and Internet = access and=20 alternative points of access, such as state employment commission = offices,=20 public libraries, and community centers and clubs, have expanded. When = the=20 results from a new Census Bureau August survey of households become = available=20 this Fall, we will learn the extent to which different groups have = improved=20 their access to the Web and capacity to create networks on the Internet. =

Nonetheless, many Americans - particularly those with less income and = education - are still missing out on the network benefits of the = Internet age.=20 And as more and more everyday activities migrate to the Internet, the = gap in=20 opportunities available to those on either side of the digital divide = increases.=20

CONCLUSION

The dynamism of the New Economy presents opportunities and challenges = for=20 almost everyone. IT can offer cost savings, expanded markets, and more = intense=20 competition for private businesses in almost every industry. As = employers are=20 less readily finding workers with appropriate skills, they have had to = provide=20 more training for current employees and to modify technology to match = the skills=20 of available workers. Workers are more readily finding better paid jobs, = but to=20 do so they must often adapt to new technologies. Because many of the = jobs=20 potentially displaced by IT investments now require average or better = education=20 and skills, those displaced may well find new jobs quickly, possibly = with the=20 same employer. The New Economy is expanding the revenues for government, = even as=20 it presents many new and difficult policy issues. Finally, economists = and=20 statistical agencies are now able to obtain better information, more = quickly,=20 but they also have to redesign their frameworks to capture this = fast-changing=20 economy.

ACKNOWLEDGMENTS

The authors would like to express their appreciation to the many = people who=20 contributed substantially to the production of this report. These = include at the=20 Department of Commerce: Elliot Maxwell, Special Advisor to the Secretary = for=20 E-Commerce; Carol A. Meares, Technology Administration; Barbara = Fraumeni, Ralph=20 Kozlow, Christopher Bach, Michael Mann, John Rutter, Mai-Chi Hoang, Obie = Whichard and Ray Mataloni, Bureau of Economic Analysis; Thomas = Mesenbourg,=20 Harvey Monk, Donna Wade and Minh Nguyen, Bureau of the Census; Carl Cox, = John=20 Tschetter and George McKittrick, Office of Chief Economist, Economics = and=20 Statistics Administration; Roger Pomeroy and Marjorie Pavliscak, = International=20 Trade Administration; and James McConnaughey, National = Telecommunications and=20 Information Administration. The authors would also like to thank Daniel = Hecker=20 and James Franklin, Bureau of Labor Statistics, U.S. Department of = Labor; Scott=20 Ki, International Trade Commission; Raymond Wolfe and John Jankowski, = National=20 Science Foundation; and Daniel E. Sichel and Stephen D. Oliner, Board of = Governors of the Federal Reserve System.

=
=20

=
=20

1. If = productivity=20 growth had remained at 1.4 percent for the last four years, nonfarm = output would=20 have been $300 billion lower in 1999, the equivalent of about $1,100 in = lost=20 output for every person in the country.

2. Doubling every = 18 months is=20 closely equivalent to increasing by a factor of 10 every 5 years and by = a factor=20 of 100 every 10 years. This phenomenon is know as "Moore's Law" and was = first=20 noted by Gordon Moore, co-founder of Intel, in 1965. Intel. "What is = Moore's=20 Law" Intel Museum Home Page. (http://intel.com/intel/museum/=20 25anniv/hof/moore.htm)

3. Jon William = Toigo,=20 "Avoiding a Data Crunch." Scientific American. May 2000.=20 (http://www.scientificamerican.com/ 2000/0500issue/0500toig.html)=20

4. David Clark, = senior=20 research scientist at MIT's Laboratory for Computer Science, cited in = Jeff=20 Hecht, "Wavelength Division Multiplexing." MIT's Technology = Review.=20 March/April 1999. (http://www.techreview.com/articles/ma99/ hecht.htm)=20

5. Skeptics argue = that=20 software upgrades do not represent increases in performance, but only = the=20 addition of bells and whistles that offset improvements in processing = speed.=20 However, that view ignores the directions taken in the business uses of = their=20 software investments. Businesses are deploying software to combine = cheaper=20 computer power with more reliable communications to create extraordinary = efficiencies and improve decision making within their own operations and = supply=20 networks. For example, over a three-year period, Wal-Mart achieved a 47 = percent=20 increase in sales on only a 7 percent increase in inventories by using a = relational database system running on massively parallel computers. The = system=20 allows vendors to access almost realtime information on sales and = customer=20 transactions and handles 120,000 queries each week from 7,000 suppliers. = Businesses are also investing in software to integrate information and = reduce=20 staffing in other activities, such as production operations, human = resource=20 management, payroll, and sales force activities. "High-tech Complements = Human=20 Touch." Discount Store News. October 1999.

6. The number of = possible=20 connections is technically n(n-1). This contrast between the change in = cost and=20 value of a network as it grows is sometimes labeled "Metcalfe's Law." = Shapiro,=20 Carl and Varian, Hal. Information Rules: A Strategic Guide to = the=20 Network Economy, Boston: Harvard Business School Press. 1998. p. = 184.=20

7. Robert X.=20 Cringely, Accidental Empires, New York: Harper Business. = 1992. P.=20 83.

8. This chapter = was written by=20 Patricia Buckley, Senior Policy Advisor, and Sabrina Montes, Economist, = in the=20 Office of Policy Development.

9. Specific estimates = from=20 private sources and company-specific examples are included in this = report to be=20 illustrative of developing trends and their inclusion does not signify=20 Department of Commerce validation or approval. Disparities among private = estimates can result from differences in definitions, methods, data, = model and=20 sampling error, and product coverage. Variations also reflect the = research needs=20 of customers. While data used for estimates and forecasts are based on a = combination of surveys and interviews, the survey questions and answers = are not=20 made public, sample sizes vary considerably across surveys, and little=20 information is available on the respondents.

10. Inktomi, = "Inktomi=20 WebMap," Press Release, January 2000 (http:/www.inktomi.com/webmap). = Although=20 over one billion unique pages exist, it should be noted that even the = most=20 sophisticated search engines cover only a relatively small proportion of = the=20 total number of existing Web sites.

11. David = Peterschmidt,=20 President of Inktomi, quoted by Yahoo, "Internet Volume is Doubling = Every 90=20 Days," October 3, 1997 (http://www.nua.ie).

12. This analysis follows the draft definition of = electronic=20 commerce developed by the U.S. Bureau of the Census. According to this=20 definition, electronic commerce is a specific type of e-business = processes--one=20 that involves a transaction, the transfer of ownership. See Thomas L.=20 Mesenbourg, "Measuring Electronic Business: Definitions, Underlying = Concepts,=20 and Measurement Plans," U.S. Bureau of the Census, 1999=20 (http://www.census.gov/epcd/ www/ebusines.htm).

13. The Census = retail=20 e-commerce estimate was obtained by surveying goods retailers. The = survey panel=20 included not only the traditional bricks and mortar retailers, but also = Internet=20 "pure plays," online versions of traditional retailers, and = manufacturers that=20 have set up a retail establishments (real or virtual) to sell directly = to the=20 public. The Census retail e-commerce estimate does not include=20 business-to-consumer sales of services, such as travel, entertainment, = or stock=20 transactions. Ongoing Census surveys will provide information on 1998 = and 1999=20 transactions in other areas of the business-to-consumer e-commerce = market space=20 (including services and food service and accommodations businesses).=20

14. Forrester = Research,=20 Forrester Findings (http://www.forrester.com/ER/Press/0,1772,0,FF.html). =

15. See for = example, Jupiter=20 Communications, "Online Holiday Sales Hit $7 Billion, Consumer = Satisfaction=20 Rising," Press Release, January 13, 2000 (http://www.jup.com) and PC = Data=20 Online, "Web Retailers Score High In Customer Satisfaction Study," Press = Release, January 11, 2000 (http://www.pcdataonline.com). =

16. Jonathan = Weber, "The Last=20 Mile," The Industry Standard, March 27, 2000 = (www.thestandard.com).=20

17. Erik = Brynjolfsson and=20 Michael D. Smith, "Frictionless Commerce? A Comparison of Internet and=20 Conventional Retailers," Management Science, April 2000=20 (http://ecommerce.mit.edu/papers/friction).

18. Karen Clay, = Ramayya=20 Krishnan, Eric Wolff, and Danny Fernandes, "Retail Strategies on the = Web: Price=20 and Non-price Competition in the Online Book Industry," Working Paper, = December=20 1, 1999. Differentiating factors include site brand name awareness, ease = of=20 navigation while on the site, and a reputation for reliability.=20 (http://dnet.heinz.cmu.edu/dcsrg/books/papers/paper1.pdf). In addition, = a recent=20 Activmedia Research report found that competing on price alone is not = enough for=20 an e-commerce site to sustain competitive advantage. See Nua Internet = Surveys, "Activmedia: Competitive Advantage is Not About Price," = March 2,=20 2000 (http://www.nua.ie. Another survey, this one by Cyber Dialogue, = found that=20 price was a decisive factor in online purchases. See Nua Internet = Surveys, "Cyber Dialogue: Price Still Drives Choice of = Shopping=20 Site," March 1, 2000 (http://www.nua.ie).

19. J.D. Powers = and=20 Associates, "More Than Five Million New-Vehicle Shoppers Nationwide Use = the=20 Internet to Shop for New Vehicles," Press Release, August 23, 1999=20 (http://www.jdpower.com).

20. Janlori = Goldman, Zoe=20 Hudson, and Richard Smith, "Privacy: Report on the Privacy Policies and=20 Practices of Health Web Sites," sponsored by California HealthCare = Foundation,=20 January 2000. Executive Summary, pp. 4-5 (http://ehealth.chcf.org).=20

21. Jupiter = Communications,=20 "Internet Health Commerce to Soar to $10 Billion, But Current Offerings = Don't=20 Deliver on Consumer Convenience," Press Release, January 26, 2000=20 (http://www.jup.com).

22. = Recruitsoft.com and=20 iLogos Research, Global 500 Web Site Recruiting 2000 Survey, An = Internet=20 Intelligence Report = (http://www.recruitsoft.com/iLogosSurvey/doc.html). The=20 Global 500 is a list of the largest companies in the world, by gross = revenue,=20 according to Fortune Magazine.

23. Forrester = Research,=20 "Forrester Predicts Career Networks Will Capture Majority of Online = Recruitment=20 Market in 2005," Press Release, February 14, 2000 = (http://www.forrester.com).=20

24. Glenn R. = Simpson, "The=20 Web's Final Frontier: City Hall--Two Internet Start-Ups Find Bureaucrats = a=20 Harder Sell Than Venture Capitalists," The Wall Street Journal, = May 17,=20 2000, p. B1.

25. Emily Wax, = "Immigrants=20 Use Internet As a Link With Past," The Washington Post, February = 3, 2000.=20

26. Although The = Census=20 Bureau has developed a measurement program to capture B2B e-commerce and = the=20 broader category of activities generally termed e-business processes, no = government estimates are currently available. For a discussion of the = surveys=20 currently scheduled see http://www.census.gov/epcd/www/ebusines.htm.=20

27. Stacy = Lawrence, "Behind=20 the Numbers: The Mystery of B2B Forecasts Revealed," The Industry=20 Standard, February 21, 2000 (http://www.thestandard.com).=20

28. National = Association of=20 Manufacturers, "New NAM Poll Shows that Despite Tech Advances, Most = Manufactures=20 Still Not Using E-commerce." Press Release. February 22, 2000=20 (http://www.nam.org/News/Releases/Feb00/ pr0222.htm). =

29. Mark A. = Brunelli, "What=20 Buyers Want From Web Sites," Purchasing Online, Special Internet = Report, December 16, 1999=20 (http://www.manufacturing.net/magazine/purchasing). =

30. "Seller = Beware," The=20 Economist, March 4, 2000, p. 61-2.

31. General = Motors=20 Corporation, Ford Motor Company, and DaimlerChrysler, "Ford, General = Motors and=20 DaimlerChrysler Create World's Largest Internet-Based Virtual Market = Place,"=20 Press Releases, February 25, 2000.

32. Keith = Bradsher,=20 "Carmakers to Buy Parts on Internet," The New York Times, = February=20 25, 2000, p.1.

33. Oracle, = "Sears,=20 Carrefour, Oracle to Form Retail's First Worldwide Online Marketplace," = Press=20 Release, February 28, 2000 (http://www.globalnetxchange.com).=20

34. Sandra Guy, = "Sears,=20 French Giant in Online Venture," Chicago Sun-Times. February = 29,=20 2000.

35. Boeing, = "Boeing, Lockheed=20 Martin, BAE Systems and Raytheon to Create B2B Exchange for the = Aerospace and=20 Defense Industry," Press Release, March 28, 2000 = (http://www.boeing.com).=20

36. National = Association of=20 Manufacturers, "New NAM Poll Shows that Despite Tech Advances, Most = Manufactures=20 Still Not Using E-commerce," Press Release, February 22, 2000=20 (http://www.nam.org/News/Releases/Feb00/ pr0222.htm). =

37. Boston Consulting Group, "New = BCG Study=20 Re-Evaluates Size, Growth and Importance of Business-to-Business = E-Commerce,"=20 Press Release, December 21, 1999=20 (http://www.bcg.com/media_center/media_press_release_ archive2.asp).=20

38. Clinton = Wilder, "Unload=20 your Surplus on the Web," Informationweek, August 30, 1999.=20

39. Ibid. =

40. Pat Reynolds, = "Corrugated=20 Comes Over the Internet," Packaging World Interactive. April = 2000.=20

41. BOC Gases, = "Electronic=20 Commerce as BOC Gases in the United States," Web site viewed February = 23, 2000=20 (http://www.boc.com/ecom/success.html).

42. John Deere, = "Deere=20 Announces Internet-Based Customer Support Program," News Release, = December 9,=20 1999 (http://www.deere.com).

43. David = Kleinbard, "Web=20 Puts a Charge into Electronics," InformationWeek, September = 27,=20 1999.

44. "Shaw = Industries=20 Optimizes Employee Compensation and Retention using Hyperion's Analytic=20 Application Software," Business Wire, Feb 23, 2000.=20

45. "Symbol = Partners With BPA=20 Systems To Provide Cablevision With Wireless ERP Warehouse=20 Solution," Business Wire, February 23, 2000. =

46. Richard W. = Oliver,=20 "Killer Keiretsu," Management Review, September 1999, p.11.=20

47. Ford Motor = Company Web=20 site, Viewed on May 9, 2000 (http://www.ford.com). =

48. Edward Cone, = "Building a=20 Stronger Economy," Zdnet, January 24, 2000=20 (http://www.zdnet.com/intweek/stories/ news/0,4164,2425874-1,00.html).=20

49. Forrester = Research,=20 "Spectacular Growth for Digital Delivery," February 7, 2000 reported by = Nua=20 Internet Surveys, (http://www.nua.ie). The ability to download = material=20 raises concerns about intellectual property protection. For example, = Napster,=20 creator of a software program that allows users to swap music stored in = the MP3=20 format, is facing multiple lawsuits, charging that it facilitates the = pirating=20 of digitized music.

50. See=20 (http://www.havi.org).

51. Emily = Thornton, "Digital=20 Wheels", BusinessWeek Online (International Edition), April 10, = 2000=20 (http://www.businessweek.com/2000/00_15/b3676012.htm ). For example, = Toyota=20 equips some high-end models with its Monet system that offers a online=20 navigational system as well as audio e-mail, weather, news, and = real-time video=20 pictures of traffic at major intersections.

52. This chapter = was written=20 by David Henry, Senior Industry Analyst, and Donald Dalton, Economist, = in the=20 Office of Business and Industrial Analysis. See the Appendix for data = sources=20 and the methodologies underlying the findings.

53. Estimates of = GPO in this=20 analysis are derived from BEA measures prior to the October 1999 = benchmark=20 revisions, but include the conceptual change made at that time in the = treatment=20 of prepackaged software and software services in the National Income and = Product=20 Accounts. Prior to this change, software purchases were treated as an=20 intermediate input with no lasting effect. Such purchases are now = classified as=20 fixed investments for both business and government sectors.=20

54.=20 IT-producing industries' share of the economy is calculated from = its Gross=20 Product Originating (GPO) as a percent of the economy, as measured by = Gross=20 Domestic Income (GDI). Theoretically, the nominal dollar value of GDI, = the=20 income associated with the output of all industries, should equal that = of Gross=20 Domestic Product (GDP); i.e., final demand or the market value of the = goods and=20 services produced by labor and property in the United States. In = practice,=20 growth in GDI and GDP have differed by half a percent in recent years.=20

55. Estimate = of percent=20 of output based on industry spending estimates in the The = Economics of=20 Y2K and the Impact on the United States, Economics and Statistics=20 Administration, U.S. Department of Commerce, November 17, 1999.=20

56. These = estimates are based=20 on inflation adjusted "income side" data; i.e., income = attributable to IT=20 industries compared to growth in Gross Domestic Income (GDI). Income = side data=20 were used here because "product side" data--the data used to estimate = GDP--are=20 not sufficiently disaggregated to describe the economic performance of = all=20 IT-producing industries. However, for a large segment of IT = output--i.e.,=20 computers, software, and telecommunications--product side data can be = used to=20 test the robustness of income side estimates. In fact, for this segment = of=20 output, estimates of IT industries' contribution to economic growth = based on=20 product side data coincide quite closely with growth estimates based on = income=20 side data. Since 1995, based on product-side data, computers and = software and=20 communications services have contributed about 23 percent to economic = growth;=20 the comparable estimate using income-side data is about 22 = percent.

57. Prior to the = inclusion=20 of software as an investment good, industry spending on IT equipment=20 consistently accounted for about one-third of all capital equipment = spending in=20 the 1990s.

58. Over the 20 = year period=20 since 1980, spending on IT equipment has grown at a steady annual rate = of 10-11=20 percent. In contrast, growth in spending in other categories of capital=20 equipment, including industrial equipment, averaged about 5-6 percent = over the=20 same period. Spending for transportation equipment grew by an average 5 = percent=20 per year in the 1980s, but accelerated to 11 percent in the 1990s.=20

59. Total R&D = spending=20 includes industry, federal government, universities and nonprofit = institutions.=20

60. R&D data = are=20 available for most, but not all, of the IT-producing industries = identified in=20 Table 3.1. Analysis in this section is based on data for the following = 3-digit=20 SIC categories: computers and office equipment, communications = equipment,=20 electronic components, communications services, and computer services = and=20 software.

61. See the = Appendix for the=20 National Science Foundation data on R&D spending. =

62. This chapter = was written=20 by Gurmukh Gill, Director of the Office of Business and Industrial = Analysis=20 (OBIA), Jesus Dumagan, Economist, OBIA and Susan LaPorte, Economist, = OBIA.=20

63. "Capital = deepening"=20 occurs when the amount of capital rises relative to the amount of labor = hours.=20

64. The rates of = capital=20 deepening in Figure 4.2 are obtained for each period by subtracting the = labor=20 hours growth rate from the growth rates of each type of capital, where = the labor=20 hours growth rate is equal to the growth rate of output minus the growth = rate of=20 labor productivity. All growth rates used in the figure can be obtained = from=20 Stephen D. Oliner and Daniel E. Sichel, "The Resurgence of Growth in the = Late=20 1990s: Is Information Technology the Story?," Washington, DC: Federal = Reserve=20 Board, May 2000, Tables 1 and 2, pp. 24-25.

65. Computing = speed has been=20 doubling every 18 months. This = phenomenon=20 is commonly called "Moore's Law." A number that doubles every 18 months = grows=20 exponentially 46.2 percent per year. Thus, by Moore's Law, computer = speed=20 increases roughly ten-fold every 5 years.

66. Daniel E. = Sichel,=20 "Computers and Aggregate Economic Growth: An Update," Business=20 Economics, April 1999, pp. 18-24, Table 1, p. 19. =

67. The = contribution of=20 capital deepening to labor productivity growth for each type of capital = equals=20 the rate of growth of the ratio of the capital type to labor hours = multiplied by=20 the income share of the same type of capital. For example, Oliner and=20 Sichel, op. cit., Tables 1 and 2, pp. 24-25, estimated that = the rate=20 of growth of computer hardware/labor-hour was 33.65 percent during = 1996-99 and=20 the corresponding income share of computer hardware was 1.8 percent. = Thus, they=20 estimated that the contribution of capital deepening in computer = hardware to=20 labor productivity growth was (33.65) x (0.018) =3D 0.606 percentage = points when=20 average labor productivity growth was 2.57 percent, yielding a = contribution of=20 0.606/2.57 or 23.6 percent.

68. U.S. = Department of=20 Commerce, The Emerging Digital Economy, April 1998 and The = Emerging=20 Digital Economy II, June 1999.

69. Oliner and = Sichel, op.=20 cit., Table 5, p. 28; Congressional Budget Office, The Budget and = Economic Outlook: Fiscal Years 2001-2010, January 2000, Appendix A;=20 Economic Report of the President, February 2000, Table 2-3, p. = 83; Dale=20 W. Jorgenson and Kevin J. Stiroh, "Raising the Speed Limit: U. S. = Economic=20 Growth in the Information Age," May 1, 2000, available from=20 kevin.stiroh@ny.frb.org; Karl Whelan, "Computers, Obsolescence, and=20 Productivity," February 2000, Table 4, p. 34, available from = kwhelan@frb.org;=20 and Macroeconomic Advisers, LLC, "Productivity and Potential GDP in the = 'New' US=20 Economy," September 1999, pp. 2-3. Table 4.1 excludes, however, results = from=20 Macroeconomic Advisers, LLC because they = pertain to=20 acceleration in potential productivity defined as the "level of=20 productivity consistent with sustainable utilization rates of capital = and=20 labor," which is different from measured or actual productivity in the = other=20 studies.

70. Macroeconomic=20 Advisers, op. cit., p. 6.

71. Emerging = Digital=20 Economy II, Table 3.2, p. 29.

72. = Kevin Stiroh,=20 "Computers, Productivity, and Input Substitution," Economic = Inquiry,=20 1998, v. 36, pp. 175-191.

73. This = finding was=20 reported originally in The Emerging Digital Economy II, p. = 35. More=20 recent BLS data also support the finding.

74. See Jorgenson = and=20 Stiroh, op. cit.

75. Ibid., = pp. 43-44.=20

76. See Jack E. = Triplett and=20 Barry P. Bosworth, "Productivity in the Services Sector," Washington, = DC:=20 Brookings Institution, January 2000, paper prepared for the American = Economic=20 Association Meetings, Boston, MA, January 7-9, 2000, Table 3, p. 24.=20

77. See citation = in footnote=20 8.

78. In Figure 4.5, = the ten=20 excluded industries are water transportation, transportation services,=20 depository institutions, nondepository institutions, holding and = investment=20 offices, business services, insurance agents, legal services, motion = pictures,=20 and health services. Based on the classification established in = Emerging=20 Digital Economy II, the first two are non-IT intensive and the = remaining=20 eight are IT-using. BEA estimates the real GPO of the first five = industries by=20 "extrapolation" based on "BEA persons engaged in production" and the GPO = of the=20 sixth industry based on "BLS employment weighted by Census Bureau = receipts." BEA=20 uses separate deflators for outputs and inputs ("double deflation") for = the=20 remaining four industries. See Robert E. Yuskavage, "Improved Estimates = of Gross=20 Product by Industry, 1959-94," Survey of Current Business, August = 1996,=20 p. 145.

79. However, there = will=20 still be many industries awaiting similar improvements in the future. A=20 comprehensive review of the problems and prospects for their resolution = is=20 available in Triplett and Bosworth, op. cit. =

80. Erik = Brynjolfsson=20 and Lorin M. Hitt, "Beyond the Productivity Paradox: Computers are the = Catalyst=20 for Bigger Changes," Communications of the ACM, August 1998.=20

81. Erik = Brynjolfsson and=20 Lorin M. Hitt, "Computing Productivity: Are Computers Pulling Their = Weight?,"=20 MIT Sloan School of Management, January 2000.

82. Erik = Brynjolfsson and=20 Shinkyu Yang, "The Intangible Costs and Benefits of Computer = Investments:=20 Evidence from the Financial Markets," MIT Sloan School of Management = (December=20 1999 revised draft). See also Erik Brynjolfsson, Lorin M. Hitt, and = Shinkyu=20 Yang, "Intangible Assets: How the Interaction of Computers and = Organizational=20 Structure Affects Stock Market Valuations," = (http://ccs.mit.edu/erik). A=20 related study by Timothy F. Bresnahan, Erik Brynjolfsson and Lorin M. = Hitt,=20 "Information Technology, Workplace Organization and the Demand for = Skilled=20 Labor: Firm-level Evidence," January 2000 draft, finds that "IT use is=20 complementary to a new workplace organization which includes broader job = responsibilities for line workers, more decentralized decision-making, = and more=20 self-managing teams. In turn, both IT and that new organization are = complements=20 with worker skill, measured in a variety of ways. ...Taken together, the = results=20 highlight the roles of both IT and IT-enabled organizational change as = important=20 components of the skill-biased technical change."

83. As interpreted = by Robert=20 E. Hall, "The Stock Market and Capital Accumulation," NBER Working Paper = 7180,=20 Cambridge, MA: National Bureau of Economic Research, June 1999, p. 28=20 (http://www.nber.org/papers/w7180).

84. This chapter = was written=20 by Sandra D. Cooke, Economist, in the Office of Business and Industrial=20 Analysis.

85. IT-producing=20 industries produce IT infrastructure and provide services that enable = electronic=20 commerce and the Internet. See Chapter 3 for a list of IT-producing=20 industries. Note: the focus of this analysis is on the IT workforce = only=20 and not the effects of technology on the general workforce.=20

86. Software and = computer=20 services include computer services management, rental and leasing, = computer=20 programming services and prepackaged software, all of which have grown = at well=20 above average rates for the past decade.

87. Carol A. = Meares and John=20 Sergeant, "The Digital Workforce: Building Infotech Skills at the Speed = of=20 Innovation," Office of Technology Policy, U.S. Department of Commerce, = 1999.=20

88. Don Tapscott, = "Strategy=20 in the New Economy," Strategy and Leadership, November/December, = 1997.=20

89. Saroja = Girishankar, "In=20 Focus: E-Commerce Outsourcing - Internet Time Forces Anxious Enterprises = to Seek=20 Outside Help," Internetweek, June 28, 1999. =

90. Aaron = Bernstein, "Down=20 and Out in Silicon Valley," Business Week, March 27, 2000, = reports the=20 fact that the success of IT-producing industries in Silicon Valley has = rapidly=20 raised the cost of living, but the earnings of workers in low-end jobs = have not=20 kept pace.

91. Bob Weistein,=20 "E-commerce Puts Techies Front and Center," Chicago Sun Times, July 18, = 1999.=20

92. Cole Gomolski, = "IT Job=20 Market, Now and Later," Computerworld, October 28, 1999.=20

93. RHI Consulting = press=20 release, December 2, 1999 and 2000 Salary Guide. RHI Consulting collects = and=20 reports starting salaries for IT workers. Starting salaries, unlike = occupational=20 averages, exclude bonuses and other factors that could influence pay, = such as=20 seniority and past job performance.

94. = Computerworld's=20 13^th Annual Salary Survey, September 6, 1999=20 (www.computerworld.com).

95. Carolyn = Veneri, "Can=20 Occupational Labor Shortages be Identified Using Available Data?" = Monthly=20 Labor Review, March 1999.

96. The BLS = analysis=20 concluded that there is no single empirical measure of labor market = tightness,=20 nor does it appear that one can be easily developed. Labor market data = such as=20 employment and wage trends and unemployment rates for a specific = occupation=20 should be examined in addition to supply information including = demographic=20 characteristics, employer requirements for education and training and = education=20 by field of study. For IT occupations in particular, analysis should be = done on=20 a case by case basis and should focus on one or a group of closely = related=20 occupations.

97. Peter Freeman = and=20 William Aspray, The Supply of Information Technology Workers, = Computing=20 Research Association, Washington, DC: 1999.

98. The National = Research=20 Council, in response to a Congressional mandate, will deliver two = reports to=20 Congress by October 1, 2000 on 1) older workers in the information = technology=20 field and 2) high technology labor market needs.
=20

The U.S. = Department=20 of Commerce's Technology Administration (TA) in July 1999 released = The=20 Digital Workforce: Building Infotech Skills at the Speed of = Innovation which=20 demonstrates the complexities of trying to define and measure the IT = workforce.=20 The TA will continue to be heavily involved in monitoring the needs of = the IT=20 workforce and making policy recommendations.
=

The = Bureau of Labor=20 Statistics' recently revised Standard Occupational Classification (SOC) = provides=20 more IT occupational detail than in previous years. The revised SOC=20 classification was used in the 1999 Occupational Employment Statistics = Survey=20 and will be reflected in the 2000-2010 employment projections and in the = 2002-03=20 edition of the Occupational Outlook Handbook. Both will be released in = late=20 2001. (http://stats.bls.gov/soc/soc_home.htm)

99. INS statistics = reported=20 in Wall Street Journal article. See Marjorie Valbrun,"Immigration Foe's = Reversal=20 Bodes Well for Silicon Valley," Wall Street Journal, May 2, 2000.=20

100. U.S. = Immigration and=20 Naturalization Service, "Characteristics of Specialty Occupations = Workers=20 (H-1B)", February 2000. Preliminary survey results are for the May 1998 = to July=20 1999 period.

101. This chapter = was=20 written by Dennis Pastore, Economist, in the Office of Business and = Industrial=20 Analysis.

102. Sales by = affiliates are=20 reported on an industry basis while U.S. trade data are organized by = type of=20 product. For this reason, the comparison between sales (by IT firms) and = exports=20 (of IT products) is intended only as an indication of the relative = magnitude of=20 the difference. Furthermore, estimates of sales by U.S.- and = foreign-owned=20 affiliates involve only a subset of the IT industries, since aggregate = data on=20 sales by instrument manufacturing affiliates are too broad to be = included, and=20 data on sales by affiliates of producers of magnetic and optical = recording media=20 are unavailable. The affiliate total also includes sales by firms in the = industries that manufacture prerecorded records and tapes (SIC 3652) and = communications equipment, n.e.c. (SIC 3669). (Table 6.2) The total for = IT=20 exports has been adjusted accordingly. Altogether in 1997, the United = States=20 exported $0.8 billion of prerecorded records and tapes and = communications=20 equipment, n.e.c.

103. The various = classes of=20 IT products include: computers and peripherals, prepackaged software, = electronic=20 components including semiconductors, several classes of scientific = instruments,=20 household audio and video devices, and telecommunications equipment, = primarily=20 telephones and broadcasting equipment.

104. Exports of = all goods=20 from the United States to U.S. Majority-owned IT affiliates in Table 6.2 = totaled=20 $35.6 billion in 1997.

105. This chapter = was=20 written by Lee Price, the Chief Economist of the Economics and = Statistics=20 Administration.

106. Contrary to = much of the=20 media's discussion, economists do not consider the strong rise in equity = prices=20 year after year to be an essential component of the "New Economy." = Indeed, at a=20 recent White House Conference on the New Economy, William Nordhaus = concluded=20 that the IT revolution has generated a new economy in productivity = terms, but=20 worried that unrealistically high stock prices were damaging on several = fronts:=20 national saving, management decisions, compensation structures, and job = choices.=20 William Nordhaus, "What Is the Shape of the New Economy?", White House=20 Conference on the New Economy, April 5, 2000=20 (http://www.econ.yale.edu/~nordhaus/homepage/=20 white%20house%20remarks%20040400%20final.htm).

107. Philip Evans = and Thomas=20 S. Wurster, Blown to Bits: How the New Economics of Information = Transforms=20 Strategy, Boston: Harvard Business School Press, 1999, pp. 24-25.=20

108. Actual = forecasts were=20 2.1 or 2.2 percent. For purposes of comparison, we have added 0.2 = percentage=20 points to account for definitional changes (e.g., treatment of software = as=20 investment and revision to the measure of banking) that BEA initiated in = October=20 1999 and applied to prior years.

109. The more = optimistic=20 outlook does not come from expectations of faster growth in hours = worked. If=20 anything, the continued reduction in unemployment leads many economists = to=20 anticipate slower hours growth in the medium term. =

110. Quote = contained in=20 Louis Uchitelle, "Productivity Finally Shows the Impact of Computers," = New=20 York Times, New York, March 12, 2000.

111. At some = point, U.S.=20 demand growth will slow from its 5+ percent pace of recent years back to = a level=20 consistent with the growth of labor productivity plus growth of the = labor force.=20 In recent years, falling unemployment and a rising trade deficit have = allowed=20 demand growth to exceed trend growth in potential output. Neither of the = first=20 two trends can continue indefinitely.

112. P.A. David = and G.=20 Wright, "Early Twentieth Century Growth Dynamics: An Inquiry into the = Economic=20 History of 'Our Ignorance'," Stanford: SIEPR Discussion Paper No. 98-3, = 1999.=20

113. Hal Varian, = "The Theory=20 of Recombinant Growth," The Industry Standard, February 23, 2000. =

114. Edison's = "invention=20 factory" did not invent the first or the best light bulb, electric = wiring, power=20 generator, or switch. But, recognizing the need for thin copper wire to = compete=20 with gas lighting, Edison and his team did create the first "lighting = system"=20 designed to optimize the interplay of all parts in a price competitive = system.=20 Using venture capital, he was the first to go beyond the "tinkering = inventor" to=20 create the first "invention factory" with teams assigned to develop = specific=20 related innovations, first in lighting, then in batteries, recording, = and movie=20 cameras.

115. Alan = Greenspan,=20 "Remarks," Survey of Current Business," January 2000, p. 12.=20

116. The growth = accounting=20 framework, discussed in Chapter IV, makes an estimate of the = contributions of=20 capital and labor to growth, with the residual part of growth not = accounted for=20 by capital or labor often called multi- or total factor productivity. = Although=20 this residual is often viewed as an indicator of technical change, = others have=20 called it a "measure of our ignorance" of all the factors contributing = to=20 growth.

117. Dale W. = Jorgenson and=20 Kevin J. Stiroh, "Raising the Speed Limit: U.S. Economic Growth in the=20 Information Age," May 1, 2000, forthcoming in Brookings Papers in = Economic=20 Activity, p. 37 (http://www.economics.harvard.edu/=20 faculty/jorgenson/papers/dj_ks5.pdf).

118. National=20 Telecommunications and Information Administration, (NTIA) U.S. = Department of=20 Commerce, "Falling Through the Net: Defining the Digital Divide," July = 1999=20 (http://www.ntia.doc.gov/ntiahome/digitaldivide/). =

119. Robert W. = Taylor and=20 J.C.R. Licklider quoted in David Plotnikoff, "A Father of the Net Looks = back and=20 asks, 'What took so long?'", San Jose Mercury News, March 12, = 2000=20 (http://www.mercurycenter.com/svtech/columns = /modemdriver/docs/dp031200.htm).=20

120. Calculations = by the=20 Office of the Chief Economist, U.S. Department of Commerce based on data = from=20 the Bureau of the Census' Current Population Survey Internet and = Computer Use=20 Supplement, 1998 (http://www.bls.census.gov/ cps/computer/computer.htm) = and=20 published in NTIA's "Falling Through the Net: Defining the Digital = Divide."=20

121. Ibid.=20

AUTHORS

THE=20 SECRETARY OF COMMERCE

INTRODUCTION

CHAPTER I = =20 INFORMATION TECHNOLOGY AND

THE NEW ECONOMY

ELECTRONIC COMMERCE:

THE LEADING EDGE OF THE DIGITAL ECONOMY (8)

INFORMATION TECHNOLOGY INDUSTRIES (52)

IT-Producing and All Other Industries