Arnold Kling  

The Internet and Productivity

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Yesterday, having been lured downtown by an opportunity to gaze into Virginia Postrel's eyes, I stumbled on Nobel Laureate Michael Spence giving a talk on the Internet and productivity. Some major points were:

1. Before the Internet, computing was a stand-alone affair. This severely limited the economic benefits of computers.

2. With the advent of the Internet, computers now can create new markets. Consider eBay, for example.

3. Also with the Internet, it has become easier for companies to outsource and to optimize along the supply chain.

4. These capabilities are quite new. The first wave of e-commerce enthusiasts over-estimated and somewhat mis-guessed the short-run prospects, but the medium-term opportunity is real.

5. Remember that technology diffuses slowly. There is a classic study by Zvi Griliches on hybrid corn. Or, consider Paul David's analysis of the computer and the dynamo, as updated by Paul Krugman, for example.

Put all this together, and it suggests that the Internet's effect on productivity is only just beginning. We could see dramatic gains in economic growth in the next decades.

Spence was not trying to be wildly original. Based on my informal reading, quite a number of economists agree with his formulation. However, the optimistic medium-term outlook for productivity may itself be an example of slow diffusion. I have not seen it discussed much in the press.

For the role that Postrel and others played yesterday, click on the link to "more" below, and then scroll down.

On her weblog, Virginia Postrel provided an extended synopsis of her recent eye surgery, in the middle of which she dropped this teaser:

I'm off to Washington for a Hoover Institution/Policy Review conference on "The Politics of Prosperity." I'm on the opening panel with David Brooks, HOlman Jenkins, and Sebastian Mallaby. (It's at the St. Regis tomorrow.

I had never met her, and I was free that morning, so I got on the subway to go to the St. Regis (having first called the hotel to verify that they indeed had such an event taking place.) My intention was to stay for her panel--or part of it--and then go back to the suburbs to teach my afternoon high school economics class.

However, when I arrived, I found that Postrel had somewhat understated the program. The rest of the day's events were to include two Nobel laureates as well as a free lunch. So I wound up ditching my class.

The journalists on the morning panel were reasonably sophisticated...for journalists. I thought Postrel was more insightful and in tune with the anti-establishment thinking of Internet geeks. Unless you count me, she was the only propeller-head in a roomful of Suits.

David Brooks' best moment was when he offered the insight that the current political strength of Republicans comes not from the fact that they are viewed as favoring the market but from the fact that they are viewed as favoring restoring authority and maintaining order. I admit that he is probably right, but it bothered me that he looked so darned happy about it.

Brooks' worst moment came when he said that he saw the growth in government as a share of GDP as a trend that would continue indefinitely. Moderator Tod Lindberg felt obliged to step in and invoke (Herbert) Stein's Law, which is that things that can't go on forever, stop.

After the panel came the keynote address. I thought Spence's best moment was when he put up the classic New Yorker cartoon, "On the Internet, no one knows you're a dog," and pointed out that it illustrates asymmetric information. I thought his worst moment was when he tried to justify dwelling on the topic of Supply Chain Management by making a reference to Wassily Leontief. We were all like, yeah, right, Mike, whatever. Of course, it wouldn't have anything to do with the fact that you spent all those years hanging around business schools or anything, would it?

Postrel might have been a good follow-on to Spence. What led me to start an Internet business was the the low barriers to entry, rather than extending markets or rationalizing supply chain management. I think that Postrel shares my appreciation of the Schumpeterian aspects of the Net. (By the way, this month Econlib is featuring a biography of Schumpeter.)


The afternoon panel consisted of Glenn Hubbard, Edward Lazear, Robert Hall, and Gary Becker. All of them turned out to be cheerleaders for President Bush's economic program. The only way you could tell that Hubbard was the one who is a member of the administration is that he began every sentence with "The President believes that..."

(To find out what Hubbard himself believes, I recommend this EconLib interview.)

Hall, whose style of delivery has a way of making everything he says sound like he's kidding (and then he gets really hurt when people don't take him seriously), said that getting rid of dividend taxes at the personal level was a step in the direction of the Utopian tax system of a progressive consumption tax. He had an argument for why getting rid of dividend taxes at the corporate level instead would have made it less easy to reach Utopia. He spoke quickly and glibly, as if this argument were simple and widely understood, which made it all the more humbling for me when I could not follow it or even take adequate notes.

Nobel Laureate Becker noted that the positions of Democrats and Republicans on deficits have reversed. (Jeff Frankel also has made this observation.) Becker argued that cutting taxes improves welfare twice: first, by reducing the deadweight loss from taxes; later, by constraining government spending--he implied that spending also imposes deadweight loss.

I thought that Becker's worst moment was when he supported adding a prescription drug benefit to Medicare. His point was that it would reduce the distortionary incentive to substitute more expensive alternatives, but it seemed a little dissonant, given his earlier sonata.

Overall, attendance at the event was sparse, considering the caliber of the panelists. Next time, the Suits at Hoover might want to ask for more help from the propeller heads in stirring up interest.


Comments and Sharing





COMMENTS (17 to date)
Jon writes:

I think that you should take into account a study published last year that I recall being quoted in either the WSJ or Forbes. I believe that the study was published by the Harvard Business Review but could be mistaken. The argument of the study was that WalMarts' (a) aggressive adoption of new technology and (b) requirements that its suppliers keep up drove not only the national acquisition of new technology but also the measured increase in productivity as WalMart's suppliers had to use what they acquired and meet WalMart's standards.

David Thomson writes:

“...an example of slow diffusion.”

Robert Solow claimed a few years back that there was no evidence the growing use of computers increased our productivity. We probably had to initially endure an expensive learning curve. That is over with and we will now reap the benefits. I recently read a article indicating that the price of tracking chips had dropped to the point where they could be used in items previously unheard of. This should further eliminate a large number of warehouses, and remove a lot of the guess work in determining which products are popular with customers.

Arnold Kling writes:

The Wal-Mart study was done by McKinsey. Virginia Postrel mentioned it during her remarks. For more information, see http://arnoldkling.com/gqe/arch11.html#106

Solow was involved in the study, as an advisor. He is less bearish than he was in 1987 when he wrote that "we see computers everywhere but in the productivity statistics." But he is still more agnostic than many other economists.

David Thomson writes:

In 1987 computers were often not a practical purchase. A top level executive may have egotistically demanded one to be placed on his desk---but he rarely had a clue on how to put it to good use. I remember reading a funny account about a boss who finally got his new $5,000 computer. It initially sat there as an unintentionally very expensive oversize paperweight that took up much of his desk. About a week later, it was discretely put into his closet never to appear again. In other words, his company lost money on the purchase. This incident would definitely support Robert Solow’s earlier pessimistic evaluation. That is hardly the norm in today’s business world. My guess is that the typical computer now costs about $800 and pays for itself almost immediately.

Bernard Yomtov writes:

Interesting conjunction. A few days ago we read that the government can not create wealth. Here we learn that the Internet, a government research project, is enhancing productivity all over the place and will make us much richer.

David Thomson writes:

The government cannot directly create wealth, but it can sometimes fund activities which indirectly are wealth producing. It was indeed the money of the federal government that substantially assisted the computer revolution. There's simply no way to get around that fact. Still, society is better served when the private sector eventually is on its own. In the long run, government bureaucrats and politicians will cause far more harm than good.

Bernard Yomtov writes:

"The government cannot directly create wealth, but it can sometimes fund activities which indirectly are wealth producing......
In the long run, government bureaucrats and politicians will cause far more harm than good. "

Well, if that's your religion there's no point in arguing. But like most religious claims it leaves a lot to be desired in the way of logic or empirical support.

David Thomson writes:

Religious claims? One would think that the enormous historical evidence would easily support my argument. Have we already forgotten the former Soviet Union, or the current decline of the Old European nations like Germany and France. If nothing else, the pricing issue as pointed out by Ludwig Von Mises alone renders government incapable of running the economy.

Bernard Yomtov writes:

The economic failures of some governments does nothing to prove your general proposition. Lots of businesses fail. Does that mean business cannot produce wealth?

Anyway, who said anything about the government "running the economy?"

The claim I disputed was that the government cannot create wealth. I think it can. You gave an example yourself, though you tried to weasel by calling it "indirect."


More broadly, lots of government activities create wealth. We are, for example, more secure in our property, hence wealthier, by virtue of having a strong military.

Our economy is sounder because we have a good central banking system.

State universities educate students who can't afford private schools. Why doesn't that create wealth?

These are just some examples.

David Thomson writes:

“The economic failures of some governments does nothing to prove your general proposition. Lots of businesses fail. Does that mean business cannot produce wealth?

You vastly underestimate the value of allowing businesses to fail. This is the only way to discourage similar mistakes in the future. Government bureaucrats are rarely under such pressure and sometimes are even rewarded for their gross failures. Companies eventually run out of money. Alas, a government run organization merely needs to successfully beg for more funds.

“You gave an example yourself, though you tried to weasel by calling it "indirect."”

Have we already forgotten the government wasteful spending on coffee-makers ($7,600), hammers ($435), and toilet seats ($640)? Regrettably, there’s simply no way that the private sector can militarily defend our nation. This is indeed a duty only the government can aptly perform. We sometimes do economically benefit from the technological advances resulting from government spending. However, do we really want to normally spend so much money to get so little in return?

“More broadly, lots of government activities create wealth. We are, for example, more secure in our property, hence wealthier, by virtue of having a strong military.”

The examples you provide have absolutely nothing to with the government running businesses. Perhaps you would like to point to the U.S. Post Office, or better yet, Amtrak?

“Our economy is sounder because we have a good central banking system.”

Yep, and this still has nothing to do with the government deciding on which companies are allowed to fail or succeed.

“State universities educate students who can't afford private schools. Why doesn't that create wealth?”

One wonders if the private sector couldn’t do a better job. Do we really get our money’s worth?

Bernard Yomtov writes:

"You vastly underestimate the value of allowing businesses to fail."

I made no estimate of the value of allowing businesses to fail.

You said, in effect,

"The USSR was an economic disaster, therefore all governments are economic disasters."

My response is that that is like saying,

"WorldCom is an economic disaster, therefore all private businesses are economic disasters."

Yes, there are many examples of goverment waste. Private companies, even successful ones, are sometimes wasteful. Their waste does not come to light so readily. But because an organization is wasteful does not mean it cannot create wealth.

"The examples you provide have absolutely nothing to with the government running businesses. "

Once again, I said nothing about government running businesses. I said government creates wealth.

I wrote,

“Our economy is sounder because we have a good central banking system.”

And you said,

"Yep, and this still has nothing to do with the government deciding on which companies are allowed to fail or succeed."

Please read more carefully. I did not say the government should decide which businesses are allowed to fail or succeed. I said the Fed creates wealth. It does this by making our economic system stronger. That makes it more productive, and makes us wealthier.

I wrote,

“State universities educate students who can't afford private schools. Why doesn't that create wealth?”

You said,

"One wonders if the private sector couldn’t do a better job. Do we really get our money’s worth? "

Your wonderings are not an argument. Instead they indicate again the lack of any real basis for your beliefs.

Let's review.

Government does many things that make our economy stronger, our country safer, and our people better off and more productive. That means it creates wealth. This has nothing, NOTHING, nil, rien, nada, gar nicht, niente, to do with claiming the government ought to be running businesses.

David Thomson writes:

"Government does many things that make our economy stronger, our country safer, and our people better off and more productive. That means it creates wealth. This has nothing, NOTHING, nil, rien, nada, gar nicht, niente, to do with claiming the government ought to be running businesses."

This is a definition of wealth creation not shared by the consensus majority. You seemingly confuse wealth creation with the philosophical principles dealing with the positive good. They are not one and the same thing. The police, for instance, who protect our property are performing a noble service. Nonetheless, they are not directly creating wealth.

Bernard Yomtov writes:

If you don't think making people, and the economy as a whole, more productive increases wealth then it is you, not I, who do not understand what wealth is.

Russ Roberts writes:


Bernard and David have been arguing over whether government creates wealth. Seems to me you are arguing over a semantic difference. I agree with David that government does not create wealth in the standard sense of the term "create." But I also agree with Bernard that government can do things that contribute to the creation of wealth. Seems to me that the interesting question is whether a particular government policy (public schools, subsidizing hydrogen-powered cars, enforce contracts) increases or decreases the ability of individuals to create wealth.

Bernard Yomtov writes:

I think the difference is more than semantic.

What do you take to be the meaning of the phrase "create wealth?"

If an organization does things that "contribute to the creation of wealth," how and why is that different from "creating wealth?"

Russ Roberts writes:

That IS the semantic difference. Some want to reserve the phrase "creating wealth" to refer to the actual production of the goods and services. Others would include the environment or legislation or infrastructure that allows that creation to move forward. I like your construction. Government "contributes to creating wealth." Or at least it can, if it follows wise policies. Again, the real issue for me isn't whether you call what government does "creating wealth" or "contributing to the creating of wealth." The real issue is whether government policies enhance our lives or make them harder.

Bernard Yomtov writes:

Russ,

I largely agree. Building a road doesn't grow any crops. But it does create infrastructure that makes crops more valuable.

I think the broad question you raise needs to be discussed on a case-by-case, or policy-by-policy, basis. General rules don't work. Clearly, some government programs are not worth their cost. Others provide great benefits.

Serious discussion needs to look at individual items. That's much harder than enunciating a general principle and trying to cover everything with it. Take the three items you mentioned, public schools, hydrogen cars, and enforcing contracts. Few people would deny that the government should enforce contracts, and that this makes a significant contribution to our economy.

Public schools and hydrogen cars, on the other hand, are controversial, but I see no reason they should necessarily end up on the same side of the public/private divide. Indeed, in the public school arena, lots of proposals for change are sort of public/private hybrids. Nothing wrong with that either.

The critical point, in my opinion, is not to cram everything into a one-size-fits-all ideology. That saves a lot of thinking, but it doesn't give good answers.

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