Tuesday, September 2, 2014

The IT Boom Was a Myth Only in Europe

America's economy remains on the brink of a double dip recession, the dollar is weak, and Wall Street seems unable to recover. An apocalyptic scenario in the making? Hardly. The US economy, it should be remembered, finished 2002 with an annual growth rate of 2.5%--above the long-run trend estimated for the Euro area by many experts, including the European Central Bank.

The point is that, despite the excesses of 1999-2000, the economic difficulties of the last two years, and the tendency to think of the technology boom of the 1990's as mere hype, the US underwent deep structural changes in its economy during that decade. Productivity growth almost doubled, increasing from just above 1% in the period 1990-95 to over 2% in 1995-2000. Moreover, we see no sign of a slowdown: in 2001-02 productivity growth averaged almost 3%.

New information technologies account for perhaps 80% of the acceleration in US productivity. Moreover, because much of the recent technological progress seen in the US largely remains to be exploited, the acceleration of productivity is not a temporary phenomenon, but a lasting one. Looking ahead, this is of crucial importance, because the long-term economic well being of any country depends on steady productivity growth.

Since the new information technologies are easily available in all advanced countries, one would think that productivity would have accelerated everywhere, not just in the US. But this did not happen. While productivity was accelerating in the US, it was slowing down markedly in the largest EU economies. What accounts for this divergence? Why aren't the large EU economies benefiting from IT, despite its diffusion on the "Old" continent as well?

One reason, not necessarily worrying, has to do with labor-market reforms. Towards the end of the 1990's, the large EU countries encouraged employment of less qualified workers through temporary work contracts. One partial result of this is that production in Europe has in many places become more labor-intensive, with the capital-to-labor ratio tightening markedly. This undoubtedly had a negative impact on productivity growth.

A second reason is that IT investment in Europe is a more recent phenomenon than in the US. Even though in 2001 the share of GDP devoted to IT investment was about the same in the EU and in the US, this was due to recent, concentrated bursts in Europe, as well as to the rapid investment slowdown in the US after the dot.com bubble burst. Because the period of rapid IT spending in Europe coincided with a cyclical downturn in the world economy, it may still be too early to see its benefits.

But there is a third, more worrisome, difference between Europe and the US. Between the first and second half of the 1990's, the "residual component of yearly productivity growth" (the part measuring the efficiency with which all the factors of production are used), declined by over 1% in Italy, Spain, and the UK. It remained constant in France and Germany, while going up by 0.66% in the US.

Some of the data suggest that European performance was particularly disappointing in the sectors that are intensive users of IT. In wholesale and retail distribution, but also in financial services and in other advanced service sectors, productivity was roughly constant in Europe, while it was growing at 4-5% a year on average in the US. Moreover, the hi-tech sectors that produce IT, and that typically grow faster than the rest of the economy, are much smaller and less dynamic in Europe than in the US.

In other words, Europe has not been able to exploit the new technologies for productive purposes, both as a user and as a producer of IT. With regard to IT use , Europe has spent a lot of money investing in IT, but often not for productive purposes. For example, cell phones are widespread in Europe; this probably improves the quality of free time, but does little to enhance labor productivity.

With regard to IT production , the large EU countries lag far behind the US. Sectors producing advanced technologies are much smaller in Europe, and their share in world exports has shrunk. It is no coincidence that the only European countries with fast productivity growth in the second half of the 1990's were Ireland, Finland, and Sweden, where IT production accounts for a large share of aggregate output and employment.

But why does Europe find it so hard to exploit IT for productive purposes? Perhaps this has to do with other differences between Europe and the US. Many of the institutions of the large EU economies stifle individual incentives, hamper the mobility of resources, and make it difficult to select the most efficient and dynamic enterprises.

It would not be surprising if these institutions also retard efficient exploitation of the new technological advances in the workplace. If this interpretation is correct, the contrast between the dynamism of the US and the small countries in Northern Europe on the one hand, and the stagnation of the large EU countries on the other hand, is likely to become starker.

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