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Tuesday, June 7, 2011

Some Good News For A Change

It has been so long since there was anything good about the economy that when I found this piece in the McKinsey Quarterly, I just had to share it.

Andrew McAfee and Erik Brynjolfsson

The digital revolution will transform the economy—again and again

We thank Tyler Cowen for bringing attention to the critical issue of productivity growth in his book The Great Stagnation. Over the long run, a society's living standards depend almost entirely on the productivity of its economy, so an extended period of stagnation like the one Cowen describes would be bad news indeed. As we look at many kinds of evidence, however, we see different patterns than he does. And we are optimistic that peak productivity growth lies ahead of—rather than behind—us.
Cowen's "great stagnation" is evident in the much slower productivity growth starting in the mid 1970s and continuing for a long time. According to the Bureau of Labor Statistics, labor productivity growth averaged 2.8 percent in the "big wave" of 1947–73. Unfortunately, it slowed to less than half that rate over the next 20 years. However, while Cowen brings new insights to the table, the slowdown that started in 1973 is old news. What has happened more recently? Starting in 1995, there was a notable increase in productivity growth, averaging to about 2.7 percent. In fact, in the past three years, productivity has averaged precisely 2.8 percent, just as in the golden era before 1973.
What's behind the uptick? A great deal of careful research has been focused on this question, and the emerging consensus is that it's driven largely by computer technologies—hardware, software, and networks. What's more, the surging productivity growth rate may understate what's actually happening, since it doesn't fully account for all the free goods we associate with the Internet these days, like Facebook, Google, Wikipedia, YouTube, and Pandora. These goods barely show up in GDP or productivity, even though they create enormous consumer value.
Even better, there's good reason to believe this ongoing productivity surge has legs. The computer, the foundation of the digital revolution, is a general purpose technology (GPT). That means it is one of those rare innovations like steam power or electricity that interrupts and accelerates the normal march of economic progress. As economists Tim Bresnahan and Manuel Trajtenberg note, GPTs are powerful engines of growth. Not only do they keep getting better over time (and this is certainly true of digital gear), but GPTs also spur later waves of complementary innovations as prices drop and innovators tinker. Greeting cards and hotel room doors now have embedded microchips, and cars have a hundred or more. This magnifies the impact of computers on growth and living standards.
This tendency to spark innovation over the long term means that the full economic impact of GPTs is not felt immediately. It takes time, often many years, for companies to understand their power and reconfigure themselves to take full advantage. This has certainly been the case for information and communication technology (ICT). As economists Susanto Basu and John Fernald put it,
The main feature of a GPT is that it leads to fundamental changes in the production process of those using the new invention...The availability of cheap ICT capital allows firms to deploy their other inputs in radically different and productivity-enhancing ways. In so doing, cheap computers and telecommunications equipment can foster an ever-expanding sequence of complementary inventions in industries using ICT.
Note that GPTs don't just benefit their "home" industries. Computers, for example, increase productivity not only in the high-tech sector but also in all industries that purchase and use digital gear. And these days, that means all industries; even the least IT-intensive American sectors like agriculture and mining are now spending billions of dollars each year to digitize themselves.
Note also the choice of words by Basu and Fernald: computers and networks bring an ever-expanding set of opportunities to companies. Digitization, in other words, is not a single project providing one-time benefits. Instead, it's an ongoing process of creative destruction; innovators use both new and established technologies to make deep changes at the level of the task, the job, the process, even the organization itself. And these changes build and feed on each other, so that the possibilities offered really are constantly increasing.
Cowen rightly highlights the power of the Internet, but this network, as powerful and transformative as it is, is only a part of the digital GPTs now transforming the business world. For example, the IBM supercomputer named Watson is not even connected to the Internet, yet is still able to play the game show Jeopardy! far better than even the most accomplished humans, as a recent televised tournament demonstrated.
This is an astonishing achievement. Jeopardy! requires contestants to understand complicated queries asked in natural language and to have knowledge on a huge and unspecified range of topics. It was thought until recently that people were innately superior at this combination of pattern recognition and complex communication, but we're clearly not. Watson-like tools will, in the coming years, be applied to tasks like customer service and troubleshooting, making them much more productive. Related innovations are already beginning to replace armies of lawyers and are transforming medicine.
Other recent digital innovations also leave us amazed and eager to see how they'll be applied more broadly. These include fully autonomous cars that can drive in traffic without mishap, software that can understand normal human speech and produce synthetic voices, and automatic translation among many languages that, while imperfect, is good enough for a lot of purposes, and the continued spread of what venture capitalist John Doerr calls "SoLoMo"— social, local, and mobile technologies. These are not just technical marvels; they will become powerful tools for increasing business productivity. In many cases, they already are.
But even before these examples of science fiction become economic reality, we predict that productivity growth will continue its recent healthy upward trend. We say this because we see no shortage of opportunities for applying yesterday's and today's technologies to current inefficiencies. And there's still plenty of inefficiency out there.
Here's a thought experiment. Think of the smoothest processes that you participate in as a worker, consumer, or citizen. For us, these include ordering goods from, recording a season's worth of TV shows on TiVo, and clearing US immigration and customs as part of the Global Entry program. It's not a coincidence that all of these are heavily digitized.
Now think of all your other processes. Aren't most of them well behind this leading edge? Aren't some of them, in fact, laughably bad? If you're like us, you see plenty of low-hanging fruit left throughout the economy—plenty of chances to improve efficiency and productivity via the smart application of technology.
Leading organizations are showing how to do this, reminding us of writer William Gibson's great observation that "The future is already here—it's just not evenly distributed." And as the laggards catch up, the leaders will have moved on, using the large and ever-growing tool kit of digital technology to make improvements elsewhere.
This work began in earnest right around the time that The Great Stagnation, according to the data, began to turn into what we might call The Digital Frontier. It's a new set of opportunities driven by information technology, the latest human invention powerful enough to be called a GPT. Because of it, we're not harvesting diminishing yields from old fields, as described by Cowen. Instead, we are facing a new set of opportunities, with no limitations in sight.

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