The New Economy in Historic Perspective

Summary of working paper 7833
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Computers and the Internet do not measure up to the Great Inventions of the late nineteenth and early twentieth century.

The modern world was made possible by a set of "great inventions" discovered during 1860-1900, including electricity, the internal combustion engine, the telephone, phonograph, motion pictures, and a host of subsidiary inventions, including air transport. In turn, the great inventions made possible the great spurt of growth in U. S. productivity, often called the "golden age," between 1910 and 1970. Will recent inventions like the computer, telecom gear, and the Internet spur a major economic transformation as did the great inventions of the past? In part thanks to information technology and the "New Economy," the United States has experienced a marked acceleration in productivity growth since 1995 that has convinced a number of economists, journalists, and researchers that American indeed is on the verge of another industrial revolution.

Yet NBER Research Associate Robert Gordon is deeply skeptical. In a paper rich with economic analysis and historic research, Does The "New Economy" Measure Up to the Great Inventions of the Past? (NBER Working Paper No. 7833), he questions the more extreme New Economy claims. Gordon doesn't doubt that U.S. productivity improved in recent years, but he carefully argues that the long-term improvements in productivity and living standards are incremental compared to the cluster of inventions that fundamentally changed the economy and society at the turn of the previous century. "Our central theme is that computers and the Internet do not measure up to the Great Inventions of the late nineteenth and early twentieth century, and in this do not merit the label of 'Industrial Revolution'," he writes.

The New Economy productivity gains of recent years are real, but largely confined to the durable manufacturing sector, including the making of computers and semi-conductors. Yet that industrial sector only comprises 12 percent of the economy. The New Economy productivity increases haven't spread to the remaining 88 percent of the economy. Dissecting the 1.35 percentage point acceleration in productivity growth achieved in 1995-9 as compared to 1972-95, Gordon calculates that 0.54 of that acceleration is unsustainable, reflecting a temporary upsurge in the growth of output that cannot continue. The remaining, sustainable part of the acceleration has occurred only within the durable manufacturing sector (including the production of computers), leading to the surprising conclusion that the trend in multi-factor productivity (MFP) has actually slowed since 1995 outside of durable manufacturing.

Gordon also finds that the computer, telecom, and Internet technologies pale next to the five "great inventions" of 1860 to 1900. Electricity, the internal combustion engine, the chemical and pharmaceutical industries, the entertainment, information, and communication industries, and the rise of an urban sanitation infrastructure defined the Second Industrial Revolution of 1860 to 1900. These innovations not only led to a dramatic upsurge in productivity from 1913 to 1972, but they also changed everyday life. In the last third of the 19th century, city streets were filthy, a chaotic mass of horse drawn carriages and wandering pigs. Railroad accidents were frequent, and urban sanitation abysmal. For instance, in 1882, only 2 percent of New York City houses had water connections. For many workers, conditions in factories and sweatshops were Dickensian. Yet, thanks to the great inventions of the turn of the century, a fundamental divide opened between work and home life in the late nineteenth century and the twentieth--and for the better. The gains in productivity and living standards affected all of society. To give just one telling example: Electricity revolutionized the manufacturing process and working conditions, and led to generation of consumer appliances that eliminated manual laundry (washing machines), reduced food spoilage (refrigeration), and opened the southern United States for modern economic development (air conditioning).

The computer and the Internet don't measure up by this tough standard. The drop in computer prices and the quality enhancements have been stunning. Yet time is an important brake on the transforming power of computers. As Gordon notes, he can't think or type any faster than he did on his 1983 personal computer that operated with 1/100th of the memory and 1/60th of the speed of his present model. Much of the economic activity involving the Internet, while dazzling, is little more than a substitution of one form of entertainment or communication for another.

Gordon's careful investigation into the New Economy builds on the insights of an earlier paper, Interpreting The "One Big Wave" In U.S. Long-Term Productivity Growth (NBER Working Paper No. 7752). Economists have written hundreds of papers attempting to understand the abrupt slowdown in U.S. productivity growth some three decades ago. Gordon changes the focus of research by asking a different question. He notes that the slow productivity growth of the last part of the twentieth century is a resumption of slow productivity growth in the late 19th century. The mystery to be explained, he says, is the post-1913 surge in productivity growth that lasted until the beginning of the 1970s. " In explaining the big wave, we give primary attention to the many great inventions of the late 19th and early 20th century," he writes.

The paper is largely devoted to making adjustments in MFP measurements back to 1870, including taking into account the shifting mix of the labor force in terms of education and gender as well as adding types of capital owned by the government but valuable to the private sector. The "big productivity wave" remains, although his new MFP series grows somewhat more slowly than previously reported, and the upsurge in productivity growth begins earlier than in standard data, continuing at a steady pace between 1891 and 1972 rather than peaking in 1928-50.

Again, the explanation for the productivity gains prior to 1970 lies mostly with the cluster of inventions developed from 1860 to 1900. A complementary explanation is that the closing of American labor markets to immigration, and of goods markets to trade, between the 1920s and 1960s gave a boost to real wages which, in turn, made labor expensive and promoted productivity growth. The post-1972 slowdown in productivity growth coincided with a reopening of labor markets to immigration and of goods markets to foreign trade.

-- Chris Farrell