29 May 2002 • ICT Investment and Growth of Output and Productivity • Hannes Leo

The growing consensus that the positive growth and productivity performance in the USA is related to increased investment and diffusion of ICT goods and services has raised fears that the weaker economic performance of European Union member states is caused by a reluctance to adopt these new technologies.

Overall, the ICT spending gap between Europe and the USA widened in the 1990s, even though both regions increased their expenditures: in 1992, European ICT expenditure per GDP (5.2 percent) was 2.3 percentage points below the US level. Figures for ICT as a percentage of GDP somewhat hide the more dynamic development in the USA: in 1992, European ICT expenditure still amounted to 90 percent of US expenditure, but by 1999 it had dropped to about 75 percent of the US level. The gap is even larger for ICT investment in the business sector: in 1999, the US economy invested about 4.5 percent of GDP in information technologies. This is almost twice the European level of 2.4 percent.

The situation in the European Union is marked by heterogeneous spending levels in the member states: While the UK and Sweden have already surpassed, and the Netherlands, Denmark and Ireland have drawn close to the US level of overall ICT expenditure, some of the larger countries are depressing the European average.

Recent growth-accounting studies have demonstrated the increasing contribution of ICT to aggregate economic growth. In the USA, ICT investment accounted for 0.8 to 1 percentage point of output growth in the second half of the 1990s. Most studies found that the importance of ICT for economic growth more than doubled compared to the first half of the past decade. Estimates for European countries generally arrive at a lower contribution of ICT to output growth. On average, about 0.4 to 0.5 percentage point of output growth in Europe are due to ICT. Compared to the USA, Europe seems to lose 0.3 to 0.5 percentage point of economic growth due to lacking investment in ICT.

The acceleration of labour productivity is mainly due to capital deepening (0.1 to 0.33 percentage point) and multi-factor productivity growth (0.3 to 0.9 percentage point). Both categories are substantially influenced by IT usage and production. Nonetheless, the contribution of ICT to multi-factor productivity growth is strongly disputed. It is argued that the increase in labour productivity is a normal, cyclical acceleration as the economy expands. If this cyclical contribution is deducted, the contribution of the non-ICT-producing sector to multi-factor productivity growth is negligible (or even negative). If productivity growth is confined to the ICT sector alone, without any ICT-induced productivity increase in other sectors, it could be argued that there is no such thing as a "new" economy. Instead, the massive ICT investments outside the ICT-producing sector may be focused on unproductive activities, such as market share protection, duplication of existing operations, or on-the-job consumption, and thus have a negative productivity impact.

Advocates of a more fundamental impact of ICT stress that productivity should have picked up at the beginning of the business cycle rather than in the middle of it. The latter indicates that something structural in the economic process has changed. This productivity increase happens exactly at the time when a significant increase in ICT spending was observed in USA. Furthermore, if the productivity increase is a cyclical phenomenon, it should be evenly distributed across industries and not be connected to ICT usage in the industry.

Recent research rather emphasises the second interpretation: evidence is mounting that ICT does have a positive productivity impact in ICT-using industries. Studies from the USA and by OECD have demonstrated that both ICT producers and ICT users experienced significant productivity gains, which is consistent with the idea that ICT has real economic benefits. In contrast, industries which were not impacted by ICT initially made no contribution to the productivity revival. To be successful, these technologies have to be coupled with organisational changes and upskilling of the labour force. Given the complementary investments necessary, it is not surprising that most of the evidence of the positive productivity impact of ICT usage was obtained only recently. The size of the ICT capital stock was too small and the time to implement the technology too short, the consequence being that the impact was not visible until the second half of the 1990s.

In general – as is also demonstrated by a number of studies – it has to be emphasised that there is no single factor to explain the divergence in growth performance between countries. Countries that have improved performance in the 1990s have generally been able to draw more people into employment, have increased investment, and have improved multi-factor productivity (MFP). ICT investment is playing a crucial and probably growing role in laying the foundation for future growth. Policies to stimulate ICT investment and use have to ensure that competition (and regulation) will further lower prices for ICT equipment and services, and provide adequate skill upgrading which makes it possible to draw more people into employment and support complementary organisational innovation at the firm level.

For further information, please refer to Mr. Hannes Leo, phone (1) 798 26 01, ext. 248.