Subject: de2000
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DIGITAL ECONOMY 2000

AUTHORS/CONTRIBUTING
EDITORS

LETTER FROM
SECRETARY DALEY

EXECUTIVE
SUMMARY

INTRODUCTION

CHAPTER I:  INFORMATION TECHNOLOGY AND THE NEW
ECONOMY

CHAPTER II:
ELECTRONIC COMMERCE: THE LEADING EDGE OF THE DIGITAL ECONOMY

CHAPTER III:
INFORMATION TECHNOLOGY INDUSTRIES

CHAPTER
IV:
CONTRIBUTION OF INFORMATION TECHNOLOGY TO U. S. PRODUCTIVITY GROWTH

CHAPTER
V:
THE INFORMATION TECHNOLOGY WORKFORCE

CHAPTER VI:
TRADE IN INFORMATION TECHNOLOGY GOODS AND SERVICES

CHAPTER VII:
WHAT IS NEW IN "THE NEW ECONOMY?"

ACKNOWLEDGMENTS

DIGITAL ECONOMY 2000

ECONOMICS AND STATISTICS
ADMINISTRATION

Office of Policy Development

AUTHORS

Chapter II

Patricia Buckley

Sabrina Montes

[email-masked]

[email-masked]

Chapter
III

David Henry
Donald Dalton

[email-masked]
[email-masked]

Chapter IV

Gurmukh Gill
Jesus Dumagan

[email-masked]
[email-masked]

Susan LaPorte

[email-masked]

Chapter V

Sandra Cooke

[email-masked]

Chapter VI

Dennis Pastore

[email-masked]

Chapter VII

Lee Price

[email-masked]

Contributing Editors

Robert Shapiro
Lee Price

Under Secretary for Economic Affairs
Deputy Under Secretary for Economic Affairs

[email-masked]
[email-masked]

Jeffrey Mayer
For further information, contact:

Director of Policy Development
Secretariat on Electronic Commerce

[email-masked]
U. S. Department of Commerce

Washington, DC 20230

(202) 482-8369

http://www.ecommerce.gov/

THE
SECRETARY OF COMMERCE

Washington, DC 20230

I am pleased to release Digital Economy 2000, the Commerce
Department's third annual report on the information-technology revolution and
its impact on our economy. Understanding sweeping economic changes as they are
happening is a formidable challenge. In government agencies and research
institutions around the world, analysts are trying to meet this challenge.
Digital Economy 2000 is an important contribution to this effort and a
measure of its progress.

In the twelve months since our previous digital economy report, confidence
has increased among both experts and the American public that the new,
proliferating forms of e-business and the extraordinary dynamism of the
industries that produce information-technology products and services are
harbingers of a new economic era. For most economists, the key measure of our
new condition is the exceptional increase in productivity of the last five
years, which has helped drive a welcome combination of falling inflation and
very strong growth. For many people, however, the clearest evidence lies in the
extraordinary increase in the electronic connectedness among individuals and
businesses through the Internet. Three hundred million people now use the
Internet, compared to three million in 1994. They can access more than one
billion web pages, with an estimated three million new pages added every
day.

These numbers do not tell the full story. We are witnessing an explosive
increase in innovation. Using open standards, people around the world are
creating new products and services that are instantly displayed to a global
audience. We are witnessing myriad new forms of business activity, such as
electronic marketplaces linking buyers and sellers in seamless global bazaars,
and changes in business processes from customer service to product design that
harness the new technologies to make businesses more efficient and responsive.

Nor are our numbers complete. Surveys by the Census Bureau, for example, now
measure business to consumer e-commerce or "e-tailing" and have begun to measure
business-to-business e-commerce. Hard questions of definition and measurement
will still have to be resolved, however, before we can understand the full
impact of these changes on our economy.

What we can see clearly are expanding opportunities. To meet these
opportunities, we will have to ensure a stable and conducive economic and legal
environment for continuing innovation in information technologies and
e-commerce. We need to encourage the building of a broadband infrastructure that
allows all Americans to have access to the advanced services that support the
Internet, and take the steps necessary with respect to privacy, consumer
protection, security, reliability and intellectual property rights that will
inspire confidence in the Internet.
To realize the full potential of this digital economy, every person and
every business must be able to participate fully and make their own unique
contribution to its development.

William M. Daley

EXECUTIVE SUMMARY

The U.S. economic
expansion is now in its tenth year, showing no signs of slowing down. The rate
of labor productivity growth has doubled in recent years, instead of falling as
the expansion matured as in previous postwar expansions. Moreover, core
inflation remains low despite record employment and the lowest jobless rates in
a generation. Our sustained economic strength with low inflation suggests that
the U.S. economy may well have crossed into a new era of greater economic
prosperity and possibility, much as it did after the development and spread of
the electric dynamo and the internal combustion engine.

The advent of this new era has coincided with dramatic cost reductions in
computers, computer components, and communications equipment. Declines in
computer prices, which were already rapid--roughly 12 percent per year on
average between 1987 and 1994--accelerated to 26 percent per year during
1995-1999. Between 1994 and 1998 (the last four years for which data are
available), the price of telecommunications equipment declined by 2 percent a
year.

Declining IT prices and years of sustained economic growth have spurred
massive investments not only in computer and communications equipment, but in
new software that harnesses and enhances the productive capacity of that
equipment. Real business investment in IT equipment and software more than
doubled between 1995 and 1999, from $243 billion to $510 billion. The software
component of these totals increased over the period from $82 billion to $149
billion.

The new economy is being shaped not only by the development and diffusion of
computer hardware and software, but also by much cheaper and rapidly increasing
electronic connectivity. The Internet in particular is helping to level the
playing field among large and small firms in business-to-business e-commerce. In
the past, larger companies had increasingly used private networks to carry out
electronic commerce, but high costs kept the resulting efficiencies out of reach
for most small businesses. The Internet has altered this equation by making it
easier and cheaper for all businesses to transact business and exchange
information.

There is growing evidence that firms are moving their supply networks and
sales channels online, and participating in new online marketplaces. Firms are
also expanding their use of networked systems to improve internal business
processes--to coordinate product design, manage inventory, improve customer
service, and reduce administrative and managerial costs. Nonetheless, the
evolution of digital business is still in an early stage. A recent survey by the
National Association of Manufacturers, for example, found that more than
two-thirds of American manufacturers still do not conduct business
electronically.

Advances in information technologies and the spread of the Internet are also
providing significant benefits to individuals. In 2000, the number of people
with Internet access will reach an estimated 304 million people world-wide, up
almost 80 percent from 1999; and, for the first time, the United States and
Canada account for less than 50 percent of the global online population.
Further, according to Inktomi and the NEC Research Institute, the amount of
information available online has increased ten-fold over the last three years,
to more than a billion discrete pages.

As more people have moved online, so have many everyday activities. In March
2000, the Census Bureau released the first official measure of an important
subset of business-to-consumer e-commerce, "e-retail." Census found that in the
fourth quarter of 1999, online sales by retail establishments totaled $5.3
billion, or 0.64 percent of all retail sales. People increasingly use the
Internet not only to make purchases, but also to arrange financing, take
delivery of digital products, and get follow-up service.

The vitality of the digital economy is grounded in IT-producing
industries--the firms that supply the goods and services that support IT-enabled
business processes, the Internet and e-commerce. Analysis of growth and
investment patterns shows that the economic importance of these industries has
increased sharply since the mid-1990s. Although IT industries still account for
a relatively small share of the economy's total output--an estimated 8.3 percent
in 2000--they contributed nearly a third of real U.S. economic growth between
1995 and 1999.

In addition, the falling prices of IT goods and services have reduced overall
U.S. inflation--for the years 1994 to 1998, by an average of 0.5 percentage
points a year, or from 2.3 percent to 1.8 percent. The rates of decline in IT
prices accelerated through the 1990s--from about 1 percent in 1994, to nearly 5
percent in 1995, and an average of 8 percent for the years 1996 to 1998.

IT industries have also been a major source of new R&D investment.
Between 1994 and 1999, U.S. R&D investment increased at an average annual
(inflation adjusted) rate of about 6 percent--up from roughly 0.3 percent during
the previous five-year period. The lion's share of this growth--37 percent
between 1995 and 1998--occurred in IT industries. In 1998, IT industries
invested $44.8 billion in R&D, or nearly one-third of all company-funded
R&D.

New investments in IT are helping to generate higher rates of U.S. labor
productivity growth. Six major economic studies have recently concluded that the
production and use of IT contributed half or more of the acceleration in U.S.
productivity growth in the second half of the 1990s. This has occurred despite
the fact that IT capital accounts for only 6 percent of private business income.
Such remarkable leverage reflects in part the fact that businesses must earn
immediate rates of return on investments in IT hardware high enough to
compensate for the rapid obsolescence (i.e., depreciation) and falling
market value of these assets. In short, IT investments must be extraordinarily
productive during their short lives. Recent firm-level evidence indicates that
IT investments are most effective when coupled with complementary investments in
organizational change, and not very effective in the absence of such
investments.

Although the official data show declining productivity for a number of major
service industries that invest heavily in IT (e.g., health, business
services), this probably reflects the inadequacy of official output measures for
those industries. Until these measures are improved, the full effect of IT on
service industry productivity will remain clouded.

In 1998, the number of workers in IT-producing industries, together with
workers in IT occupations in other industries, totaled 7.4 million or 6.1
percent of all American workers. Growth in the IT workforce accelerated in the
mid-1990s, with the most rapid increases coming in industries and job categories
associated with the development and use of IT applications. Employment in the
software and computer services industries nearly doubled, from 850,000 in 1992
to 1.6 million in 1998. Over the same period, employment in those IT job
categories that require the most education and offer the highest compensation,
such as computer scientists, computer engineers, systems analysts and computer
programmers, increased by nearly 1 million positions or almost 80 percent.

At the same time, the rapid pace of technological change and increased
competition have added an element of uncertainty to IT employment. The number of
jobs has declined in some IT industries, such as computers and household audio
and video equipment. Moreover, while IT-producing industries as a whole paid
higher-than-average wages in 1998, some IT jobs remain low-skilled and low-paid.

Paradoxically, although America's IT-producing companies are clearly
world-class, the United States regularly runs large trade deficits in IT
goods--an estimated $66 billion in 1999. One reason is that American IT firms
more often service foreign customers with sales from their overseas affiliates
than by exports from their U.S. operations. In 1997, foreign sales by overseas
affiliates of American IT companies totaled $196 billion, compared to U.S.
exports by firms in comparable industries of $121 billion. In the same year,
American affiliates of foreign-owned IT companies operating in the United States
reported sales here of $110 billion. Therefore, while the U.S. balance of trade
in IT products was negative, the "balance of sales" favored American companies
by $86 billion.

IT has not only propelled faster growth during this expansion, but it will
have a tendency to dampen the next business cycle downturn. Because IT
investment is driven by competitive pressures to innovate and cut costs more
than to expand capacity, it will be less affected by a slowdown in demand. In
addition, by creating supply chain efficiencies that reduce inventories, IT
should dampen the inventory effect that has worsened past recessions.

The strong performance of the U.S. economy since 1995 contrasts both with
U.S. performance from 1973 to 1995 and with the rest of the industrial world in
recent years. Historically, there have been long lags between fundamental
technological breakthroughs, such as electricity and electric motors, and large
economic effects from them. Although IT is generally available in world markets,
the U.S. economy to date has achieved greater gains from IT than other countries
at least partly because of favorable monetary and fiscal policies, a
pro-competitive regime of regulation, and a financial system and business
culture prepared to take risks.

Even in this country, however, the diffusion of IT has been uneven. Although
the number of homes with computers and Internet connections has been rising
rapidly, the majority of Americans do not have online connections at home. Those
on the wrong side of the digital divide--disproportionately people with lower
incomes, less education, and members of minority groups--are missing out on
increasingly valuable opportunities for education, job search, and communication
with their families and communities.

In conclusion, a growing body of evidence suggests that the U.S. economy has
crossed into a new period of higher, sustainable economic growth and higher,
sustainable productivity gains. These conditions are driven in part by a
powerful combination of rapid technological innovation, sharply falling IT
prices, and booming investment in IT goods and services across virtually all
American industries. Analysis of the computer and communications industries in
particular suggests that the pace of technological innovation and rapidly
falling prices should continue well into the future. Moreover, businesses
outside the IT sector almost daily announce IT-based organizational and
operating changes that reflect their solid confidence in the benefit of further
substantial investments in IT goods and services. The largest and clearest
recent examples come from the automobile, aircraft, energy and retail
industries, which all have announced new Internet-based forms of market
integration that should generate large continuing investments in IT
infrastructure. These examples mark only the beginning of the digital
economy.

INTRODUCTION

Robert J. Shapiro

Under Secretary of Commerce for Economic
Affairs

This is the third annual report from the
Commerce Department on the digital economy. The first two reports were titled,
The Emerging Digital Economy. This third edition has a new title, because
the digital economy and digital society are no longer "emerging." They are here.
Americans have definitively crossed into a new era of economic and social
experience bound up in digitally-based technological changes that are producing
new ways of working, new means and manners of communicating, new goods and
services, and new forms of community.

This report, like its two
predecessors, measures the economic performance of information technology (IT)
industries and their substantial impact on growth and inflation, and sketches
the emerging dimensions of e-commerce. For the first time, it can be reasonably
claimed that the extraordinary dynamism of the IT sector and the new,
proliferating forms of e-business and e-commerce are part of an enduring and
broad economic pattern. The rapid pace and proliferation of innovation
associated with IT, and the substantial increases in U.S. productivity and
growth associated with IT-related innovation, now appear to be
persistent.

At the core of the proposition that
the digital economy can produce higher long-term productivity gains and national
growth than we knew in the 1970s and 1980s are certain singular qualities
associated with information technologies. Most obviously, these technologies
provide new ways of managing and using a resource that is common to every sector
and aspect of economic life; namely information. Compared, for example, to the
introduction of refrigeration or jet propulsion, IT innovations can be applied
across the economy and throughout the economic process. As a result, economic
gains directly associated with improving the capacity to obtain, process and
transmit information mount up.

Further, many IT markets exhibit
what economists call "network effects": The more the technology is deployed, the
greater its value. Compare certain information technologies to automobiles. When
you own a car, its value to you is basically the same whether 5,000 or 1 million
other people own the same brand of automobile. When you buy a computer operating
system or graphics program, its value to you increases as more people buy it,
because their purchases of the same program increase your ability to digitally
communicate and interact. As these forms of innovation spread, the productivity
benefits may increase at a faster rate than simply arithmetically.

The spread of IT innovations in the
digital economy affect growth in other ways. For example, IT innovations appear
to raise business investment in equipment. The last seven years have seen the
fastest growth of business investment in equipment on record, and IT investments
have accounted for almost two-thirds of that growth. The digital economy also
can stimulate improvements in workers' skills, since many firms have to train
their employees to use information technologies. This may be one reason why
Americans across the work force are making real wage gains for the first time in
two decades. Further, IT markets with the network effects described above tend
to be dominated by a handful of products and companies, and this tendency
creates the possibility of beneficial economies of scale.

Perhaps most important of all, a
dynamic of cascading or continuous innovation has characterized the development
and deployment of information technologies in this period. Productivity gains
come not just from deploying innovative technologies that enable workers to
process information faster. In addition, firms intent on taking advantage of
innovative new technologies often have to rethink the way they operate and
reorganize their operations, which can produce a round of organizational
innovation. Many firms also have discovered that the new technologies can be
used to develop and produce new goods or services for themselves, producing yet
another round of innovation. Furthermore, as these areas of potential are widely
recognized and the process spreads from firm to firm, this generates demand for
faster information processing. This can lead to another round of innovation in
IT itself-- part of the basis for the doubling of chip capacity every 18 months,
articulated as Moore's Law-- and the cascade can begin again. A leading example
of this dynamic is the Internet itself. Regular and large increases in chip
power provided a technological foundation for the Internet, which in turn
generated myriad innovations first in software and then in how businesses
organize themselves and operate, which in turn has led to more myriad
innovations in the goods and services available to businesses and
individuals.

The complex of hardware and software
innovations that encompass the IT sector have made information the most
important basis for creating value in the economy. The process of creating value
from information, throughout and across the economy, is the ultimate basis for
the digital economy. This digital economy is just beginning today, and this
report will provide a sketch of its current bounds.

CHAPTER I

INFORMATION TECHNOLOGY AND

THE NEW ECONOMY

Two remarkable developments occurred in the second half of the 1990s. After
quietly improving in speed, power, and convenience since 1969, the Internet
burst onto the economic scene and began to change business strategy and
investment. At the same time, the U.S. economy has enjoyed a remarkable
resurgence. Productivity growth, one of the most important indicators of
economic health, doubled its pace from a sluggish 1.4-percent average rate
between 1973 and 1995, to a 2.8-percent rate from 1995 to 1999 (Figure
1.1). (1)

Evidence is increasing that these
two phenomena are not coincidental but derive substantially from the same
phenomenon: the synergistic convergence of dramatic increases in computer power,
an explosion in connectivity, and increasingly powerful new software. These
advances in technology have produced sharp declines in the prices of computer
processing, data storage and retrieval, and communications, that are in turn
driving both the surge in Internet activity and the increases in business
investment in IT hardware and software. Such investment has been a major source
of recent U.S. economic strength.

The advances in computer power
overwhelm imagination. Since the 1960s, the number of transistors per
microprocessor chip has been doubling roughly every 18 to 24 months, resulting
in a massive increase in processing capability and sharply declining
costs. (2)
(Figure 1.2)

Technologies associated with
computer use, such as data storage technologies, have also shown dramatic
improvements in performance and even more dramatic cost reductions. The capacity
of today's hard- disk drives is doubling every nine months and the average price
per megabyte for hard-disk drives has declined from $11.54 in 1988 to an
estimated $.02 in 1999.
(3) As a consequence of technological advances in microprocessors,
storage, and other components, already steep annual declines in computer costs
from 1987 to 1994 accelerated sharply beginning in 1995 (Figure
1.3).

Similar improvements have occurred
in communications technologies. In recent years, for example, wavelength
division multiplexing, digital subscriber lines, and cable modems have produced
exponential increases in the speed of data communication and the carrying
capacity of the communications infrastructure. The carrying capacity of fiber is
currently doubling every 12 months. (4) Between 1994 and
1998 (the last four years for which data are available), the price of
telecommunications equipment declined by 2 percent per year.

Price declines for computers and
peripheral equipment and for communications equipment have spurred major
increases in business IT investment and extraordinary growth in U.S. production
of computers, communications equipment and semiconductors. (Figure 1.4) Output
growth in these industries has jumped from about 12 percent a year in the early
1990s to roughly 40 percent in the past six years.

In addition, the declining costs of
computing and communications are helping to drive complementary investment in
new software that harnesses and further enhances the productive capacity of IT
hardware and infrastructure. Overall, U.S. businesses have increased their
investments in new software from about $28 billion in 1987 to $149 billion in
1999. (Figure 1.5)
(5)

The new economy is being shaped by
developments not only in computer hardware and software, but also in electronic
connectivity. Larger businesses have been increasing efficiencies through
standardizing and automating routine transactions electronically for some time.
Until recently, however, most small and medium sized businesses found that the
costs of necessary hardware, software, and communications service for these
systems exceeded the benefits.

The advent of the Internet as an
instrument of commerce fundamentally altered this equation by cutting the costs
of software and communications services needed to conduct electronic
transactions. Beginning in the mid-1990s, as a result of the convergence toward
digital formats and the development of de facto standards for
digital networks, such as the Internet's technical specifications, the expansion
and commercialization of the Internet made connecting computers and
communications devices easier and cheaper. Commercial opportunities on the
Internet and the falling costs of computer and communications hardware created
an extraordinarily fertile environment for innovations that are creating new
value and new efficiencies for businesses of all sizes.

The Internet is both an effect and a
cause of the new economy. It is, in part, a product of the powerful
technological and economic changes that are shaping a new epoch of economic
experience. However, as this report shows, the Internet and related networking
technologies are also increasingly the new economy's medium.

Networks, like telephone networks or
the Internet, are subject to a phenomenon called "network effects" or "network
externalities." Establishing a network involves large, up-front fixed costs
(e.g., for purchasing equipment, laying new cable, or developing new
software), but adding an additional user to an existing network costs very
little. Conversely, the value of a network to participants is low when the
number of participants on the network is low, but rises rapidly as network
participation expands. For example, a network of a single telephone is of no
use. Adding another telephone increases the value of the network because now
calls can be made between the two phones. As phones are added, the number of
possible connections rises almost as fast as the number of phones
squared. (6) Any
person with a phone can reach more people, so the network's value to them
increases.

Similarly, as the number of people
online has grown, so has the value of being online to each Internet user.
Moreover, as the Internet gains popularity, its technological specifications
have become a default standard, encouraging new hardware and software
innovations that use Internet technology as a platform.

Fundamental engineering
breakthroughs alone do not have important economic effects until their costs and
applications become favorable. For example, by the mid-1970s, Xerox PARC had
already made several breakthroughs underpinning today's IT revolution: a
microcomputer with a mouse, graphical user interface, and Ethernet
communications capabilities. But there was no mass market for their machine,
which at the time cost about $25,000 each to produce, (7) especially given its
slower processing speed and the absence of applications software that drives
computer use today. In contrast, technological advances in recent years have
brought IT costs down to a far more commercially attractive range, and new
software applications for networked systems have been
developed.

Nothing approaching the activities
now conducted over the Internet was possible a few years ago. Push back the
technology or cost declines in any one of the four elements--computer
processing, data storage, software, or communications--just a few years and the
Internet activities we now view as commonplace would be too frustrating or too
costly for a mass market. Likewise, roll back any one of those elements and
business would have found IT investment to be far less productive. As
applications software is developed to exploit the continuing plunge in hardware
prices in coming years, businesses and consumers will find new ways to create
value and increase efficiency.

Chapter
II

ELECTRONIC COMMERCE:

THE LEADING EDGE OF THE DIGITAL ECONOMY (8)

The resurgence of the U.S. economy coincides
with the growing use of the Internet, including the rapid growth of electronic
commerce (e-commerce). In ever greater numbers, people are shopping, looking for
jobs, and researching medical problems online. Businesses are moving their
supply networks online, participating in and developing online marketplaces, and
expanding their use of networked systems to improve a host of business
processes. And new products and services are being created and integrated into
the networked world. This chapter explores activities at the leading edge of the
digital economy.

We live in an increasingly wired
world. The remarkable growth of the Internet in recent years shows no signs of
abating. According to Nua Internet Surveys, during the past year Internet
access has grown significantly in all regions of the world, rising from 171
million people in March 1999 to 304 million in March 2000, an increase of 78
percent (Figure 2.1).
(9)

The United States and Canada still
account for a large proportion of worldwide online users; but for the first
time, they now account for less than 50 percent of the total (Table 2.1). Over
the past year, Internet access in the United States and Canada grew by more than
40 percent; over the same period, Internet access in all other parts of the
world more than doubled.

Table 2.1

Number of
People Online

(in Millions)

Mar-99

Mar-00

level

increase

percent

increase

Africa

1.1

2.6

1.5

136

Asia/Pacific

27.0

68.9

41.9

155

Europe

40.1

83.4

43.3

108

Middle
East

0.9

1.9

1.0

111

Canada &
US

97.0

136.9

39.9

41

South
America

5.3

10.7

5.4

102

Source: Nua Internet
Surveys

The amount of
information available online to people with Internet access has also grown very
rapidly. A recent study by Inktomi and the NEC Research Institute, Inc., for
example, indicates that in January 2000 the World Wide Web contained more than
one billion unique pages,
(10) compared to 100 million in October 1997. (11)

CONSUMERS IN THE NEW ECONOMY

Consumers today--wherever they are in the world--go online to shop, learn
about different products and providers, search for jobs, manage their finances,
obtain health information and scan their hometown newspapers. While many of
these activities are not captured by official output and productivity measures,
a growing body of anecdotal evidence suggests that the digital revolution is
improving many people's lives.

Business-to-Consumer Electronic
Commerce

Individuals with Internet access increasingly approach the Web as a market
space. (12) People online do research before they buy,
make purchase commitments, arrange financing, take delivery of digital

products, and obtain followup
service. The "commerce" in e-commerce encompasses all of these activities.
However, when measuring business-to-consumer (B2C) e-commerce in particular, it
is the commitment to purchase--the transactional component--that both buyers and
sellers can easily identify and quantify. This transactional component is the
focus of most current e-commerce measurements.

In March 2000, the U.S. Bureau of
the Census released the first official measure of e-retail, an important subset
of business-to-consumer e-commerce. Census found that during the fourth quarter
of 1999, online sales by retail establishments totaled $5.3 billion, or 0.64
percent of all retail sales. (13)

By contrast, private estimates for
consumer e-commerce in the fourth quarter of 1999 ranged from approximately $4
billion to $14 billion. However, many private estimates of B2C e-commerce
include the value of a wide range of consumer online purchases such as airline
tickets, hotel rooms, and shares of stocks that are not captured in The Census
Bureau's survey of retail establishments. When these private estimates are
adjusted to cover only those purchases included in the retail measure, the
Census Bureau estimate of $5.3 billion appears to fall in the midrange. For
example, Forrester Research estimated fourth-quarter online sales at $9 billion,
but when travel and event tickets are subtracted--both categories that are not
part of the official definition of retail sales--the Forrester estimate falls to
a comparable $5.5 billion.
(14)

Prior to the 1999 holiday shopping
season, some analysts expressed concern that if online retailers experienced the
problems filling orders that had plagued many of them in the 1998 online holiday
season, consumers might turn away from online shopping. Private surveys
conducted shortly after the holiday season indicated that such problems were
minimal and that online customer satisfaction was high. (15) Nonetheless, some
analysts believe that delivering goods ordered by consumers from e-retailers
will prove to be more costly and complex than currently appreciated. (16) The ultimate size
of online consumer sales will depend on resolving these fulfillment issues,
along with other important matters such as taxation, consumer protection,
privacy, intellectual property rights, security, and network reliability.

Online Pricing

In the consumer realm, the most significant impact of e-commerce may be on
the pricing of goods and services. Potential buyers can check the price and
availability of products from a variety of sites in far less time than it would
take to conduct store-to-store comparisons in the world of bricks and mortar.
Furthermore, online digital shopping spaces can be perused for consumers by
software specialized to operate as digital shoppers. Such digital agents, known
as "bots," cruise through numbers of Internet sites almost instantaneously,
searching for the most favorable price and feature combinations.

One would expect that this ability to easily and cheaply gather information
on prices and product characteristics would force Internet retailers to charge
the same low price--one that would approach their cost--on the same or
comparable products. One might also expect these online prices to influence
prices charged in physical stores. Thus far, however, the data on these matters
are mixed. For example, a study of 20 book titles and 20 CD titles sold by 41
Internet and conventional retail outlets between February 1998 and May 1999
found that Internet prices were between 9 and 16 percent lower than prices in
conventional outlets, depending on whether taxes, shipping, and shopping costs
were included in the price. (17) However, another
study of book prices covering 107 titles sold by 13 online and two physical
bookstores during the week of April 19, 1999, found that prices online and in
physical bookstores were the same. This suggests that certain Web sites have
sufficiently differentiated themselves through factors other than price (e.g.,
convenience, product reviews) that they can attract sales even when they are not
the lowest-price seller.
(18)

Even if the jury is out on the price sensitivity of online shoppers, online
commerce has fostered a variety of pricing schemes. One of these is online
auctions. Live auctions have existed for a long time, but their practical uses
have been limited by the expense and difficulty of getting prospective buyers to
a single location at the same time. Sealed bid auctions are less expensive, but
they often do not produce the highest possible return to the seller. By
contrast, the Internet provides a relatively low-cost and convenient way of
bringing buyers and sellers together, and the use of auction sites such as eBay
has grown rapidly. Variations on the standard auctions are also gaining
popularity. In the reverse auction format of PriceLine.com, the consumer names
the price and the seller decides whether or not to accept it. In the Mercata.com
format, price is determined by the number of people that want to buy a
product--the greater the number of buyers, the lower the price.

A "single price" model holds for most offline goods and services since most
offline sellers do not have sufficient information to vary their prices from
customer-to-customer and because changing the price of individually tagged items
may involve considerable cost. Where providers do have sufficient customer
information and price adjustments are relatively easy to make, however, variable
pricing can produce benefits to both seller and consumer. For example, airlines
have long set lower fares for tickets issued 21 days in advance that include a
Saturday night stay (that is, tickets sold to more price-sensitive and
time-flexible travelers who can plan ahead) and much higher fares for next-day
tickets (tickets sold to less price- and more time-sensitive business
travelers). More recently, airlines have developed an e-mail strategy to attract
"spur of the moment" travelers with last minute travel deals. As a result, while
vacation travelers obtain fares at a lower cost than if the airline charged a
single price for all seats on the plane, business travelers can be confident
that they can secure seats with little advanced notice, and airlines operate
with a higher proportion of their seats filled.

The Internet opens up this airline-type variable pricing to many other types
of goods and services, creating the potential for greater specificity in
variable pricing. By gauging the price sensitivity of particular consumers
relative to the marginal cost of the good and its availability, online sellers
can fine tune prices for individual customers to maximize profits. The study of
20 book titles and 20 CD titles cited above (Brynjolfsson and Smith) found that
Internet retailers regularly make price adjustments that are smaller than the
smallest price changes observed in conventional stores.

Electronic Information

Product and Service Information. Regardless of where
people are, those with Internet access have at their finger tips a repository of
information on product and service prices, quality, and availability that would
have been unimaginable before the Web. Manufacturers, retailers, and online
magazines now offer detailed product, warranty, and repair information, along
with comparisons of competitive products. Rather than comparison shopping at
brick-and-mortar stores, consumers can now get reliable information conveniently
on the Web.

Consider the information about automobiles now available online, from dealer
costs and expert reviews to the availability of options and detailed product
specifications. Consumers cannot test drive an automobile on the Web, so auto
buyers still want to visit car dealerships. (Consumers are also constrained by
laws in most states that restrict the sale of new cars to licensed auto dealers
who cannot also be car manufacturers.) However, consumers who do their homework
online can approach dealers with a wealth of information that can strengthen
their bargaining position and reduce some of the stress of car buying. According
to J.D. Powers and Associates, while only 2.7 percent of the people who
purchased a new vehicle during the first quarter of 1999 purchased their car
through an online buying service, the percentage of new-vehicle shoppers using
the Internet to help them shop increased from 25 percent in 1998 to 40 percent
in the first quarter of 1999, and it is projected to reach more than 65 percent
by the end of 2000.
(19) After purchasing a car, consumers can find other valuable
information online, including authorized repair locations, warranty information,
recalls, and information to troubleshoot problems.

Health Care. The Internet increases the ability of patients to
participate more actively in matters related to their own health. A recent study
by the California HealthCare Foundation cites estimates that the Internet offers
at least 17,000 different health care sites and that some 24.8 million U.S.
adults have searched for health information. This number is projected to grow to
over 30 million during 2000. (20) Jupiter
Communications has estimated that 45 percent of online consumers access the
Internet for health information. (21) Today, some
patients arrive at their doctors' offices carrying possible diagnoses downloaded
from sites such as Healtheon/WebMD or America Online Health Channel. In
addition, people with Internet access can obtain information about their
healthcare plans, find doctors, and in some cases submit claims for fee
reimbursement. Doctors, too, are increasing their use of the Internet as a
source of information on the latest news in medical research. Other aspects of
health care delivery, including laboratory results reporting, prescriptions,
office visit scheduling, and records transmittal may move online once issues
such as privacy and authentication are resolved.

Employment. Many private companies now post job openings on
their company's Web site, and in some cases these sites can accept online
applications. In their 2000 survey, recruitsoft.com and iLogos Research found
that 79 percent of the Global 500 used their Web sites for recruitment compared
with 29 percent in 1998. Approximately one-half (46 percent) of the Global 500
both posted openings and accepted applications online, while one-third listed
openings online, but encouraged application by mail or fax. Web site recruiting
among the North American-based Global 500 was even more prevalent, with over 90
percent of such firms participating and 71 percent accepting applications
online. (22)

In addition to firm-specific online recruiting, a growing number of Web sites
offer online employment classifieds, grouping together requests from multiple
employers. Some of these sites are maintained by newspaper companies,
traditional providers of employment classifieds. Others have been established to
specialize in specific employment areas. For example, the U.S. Government
maintains www.usajobs.opm.gov, a site containing a listing of current Federal
job openings, as well as general employment information.

Some observers believe that effective online recruiting faces substantial
barriers. A recent Forrester Research study, for example, noted that "[t]o reach
a critical mass of Web users, recruiters must manage multiple job postings,
multiple site relationships, and a flood of resumes. Meanwhile, job seekers must
explore listings from both companies and recruitment agencies and submit
multiple resumes."
(23) As a result, Forrester and other analysts believe that these
job-classified sites will be superceded by consolidated online career networks
that aggregate training, assessment, and placement services.

Research. The Internet's original purpose was to
disseminate research and information, and this use continues to be important
today. Educational research and technical materials are available online to
students, researchers, scientists, and engineers anywhere in the world. Many
universities make their research papers available on the Internet, and most
academic and professional journals are available online (though often on a cost
basis). In addition, previously unpublished information is increasingly
available on the Internet. For example, students can download lectures at their
convenience, and live classroom presentations are broadcast on the Internet with
students submitting questions via e-mail.

The Internet also provides access to research of a more general or
recreational nature. News with frequent updates is available from local,
national, and foreign sources, as are weather and traffic information. Numerous
online services also provide information covering everything from the floor
plans of museums and restaurant reviews, to local television and radio listings.
During several recent foreign conflicts and natural disasters, the Internet
played a role in providing news and information when traditional media outlets
were closed. For example, in 1999 the independent Belgrade radio station, B-92,
continued to broadcast over the Internet even after its radio broadcasts had
been shut-down.

Digital Government. Federal, state and local governments also
are rapidly developing new ways of using the Internet to communicate with
clients and to provide public services to businesses and individuals. Activities
at the Federal level include:

The
Patent and Trademark Office X-Search system, available at www.uspto.gov,
enables anyone to use an Internet browser to search and retrieve more than 2.6
million pending, registered, abandoned, cancelled or expired trademark
records. This is the same database and search system used by PTO's examining
attorneys.

The
National Institutes of Health offers an online service,
www.ClinicalTrials.gov, that provides information about the latest clinical
research into cancer, heart disease, and other life-threatening illnesses.

At
the Internal Revenue Service site, www.irs.gov, taxpayers can download any tax
forms and instructions they need.

Many state and local governments are also moving services
online. Interested individuals and businesses can find information on a wide
variety of topics such as registration (voter, business, property, pets), parks,
and trash removal. In addition, people can pay their local property taxes and
parking tickets on commercial sites such as www.govworks.com or
www.ezgov.com.
(24)

Online Communities

The spread of Internet access is being accompanied by a proliferation of new
community spaces online. Some of these are commercial spaces such as online
auctions that allow consumers to sell or trade goods and services. Others are
meeting spaces where individuals interact around a particular interest or
topic--from chat rooms for hobbyists, and online current events discussions, to
support groups for people facing similar challenges. In the process of providing
places for individuals to interact, these online spaces create virtual
communities.

We
Media, Inc, a multimedia company providing services for people with
disabilities, includes on their www.wemedia.com site a WeHomePlace for members
to meet and interact with people of similar interests and backgrounds.

A
community center in Arlington, Virginia provides Internet access to immigrants
from many parts of the world--including South and Central America, Morocco,
Bangladesh, and Albania--so they can e-mail friends abroad, use chat rooms
where discussion is conducted in their native language, and read online
versions of newspapers from their home countries. (25)

At
www.geneticalliance.org individuals can search for support groups and resource
information for almost any genetic condition.

The Internet has also become a popular sharing tool for
people to research their family trees, organize family reunions, and share news
and photographs--all without long-distance charges.

THE RISE OF THE DIGITAL BUSINESS

While business-to-consumer e-commerce is the most visible aspect of
e-commerce, it is only a small part of what is now possible due to recent
technological advances. Increasingly, business-to-business (B2B) e-commerce is
emerging as an area of critical importance for businesses faced with rapidly
changing markets and opportunities. Transactions between businesses account for
the lion's share of commercial activity, and e-commerce technologies appear to
have an enormous potential to make these transactions more efficient. Companies
are also using these technologies to increase the efficiency of their internal
operations.

Business-to-Business
E-Commerce

Estimates of the dollar value of B2B e-commerce transactions vary
widely. (26)
According to a summary prepared by The Industry Standard, forecasts for
2003 of the dollar value of transactions between U.S. businesses that are
conducted electronically range from $634 billion to $2.8 trillion. This wide
disparity is due to a combination of methodological and definitional
differences.
(27) One important difference is the degree to which non-Internet
network transactions, such as those conducted over electronic data interchange
(EDI) systems, are included in the estimates of B2B e-commerce. Irrespective of
the dollar amounts, the market researchers all expect strong growth as companies
seek to cut costs and increase efficiency by streamlining their purchasing,
sales, and other business processes.

At present, many firms are at the beginning stages of implementing e-commerce
technologies in their business processes. A recent National Association of
Manufacturers survey found that 68 percent of manufacturers are not yet using
electronic commerce to conduct business transactions. While 80 percent of the
surveyed firms reported having a Web site, far fewer firms reported using the
Internet for business processes such as requests for proposals, purchasing,
etc. (28)

In contrast, a recent Purchasing
Magazine survey shows that 38 percent of buyers currently use the Web to
conduct at least some of their company's transactions. The survey also finds
that of those who do not currently conduct transactions over the Internet,
approximately 35 percent say they will begin to conduct transactions
electronically within the next year and 54 percent say they will do so within
the next three years. Only 11 percent of those not currently online have no
expectation of using the Internet for procurement. (29)

Transforming the Market Place

The potential of e-commerce technologies to transform business practices is
evident in the new marketplaces that are developing online. These important
intermediaries have emerged rapidly in virtually all industries, providing new
places for buyers and sellers to meet, allowing a variety of pricing schemes to
flourish, altering the roles of traditional intermediaries, enabling complex
transactions, and, by making vast amounts of information available at very low
costs, shifting the balance of power among market participants. The expanded
reach of these online market spaces enables buyers to solicit bids from a
broader range of suppliers and, in turn, allows suppliers to develop
relationships with additional buyers.

According to a recent estimate by the Economist, over 750 networked
marketplaces have been developed worldwide. (30) Some of these
cover a wide variety of products and a diffuse group of buyers and sellers.
E-Bay, for example, which started out providing a marketplace for consumers
selling to other consumers (C2C) in online auctions, has expanded to include B2C
and B2B transactions.

Some sites offer broader functions for more targeted client groups. Onvia,
for example, is one of the many sites seeking to be the small business portal
for goods and services. Other sites leverage existing relationships within
specific industries on a global basis. One prominent example is the new
online marketplace under development in the automotive industry. In November
1999, both General Motors Corporation and Ford Motor Company independently
announced plans to move their purchasing operations online. Then, in late
February 2000, these two companies announced that together with DaimlerChrysler
AG, they would work to form the world's largest online marketplace. (31) According to press
reports, if completed, this exchange is expected to handle the nearly $250
billion worth of parts and other items that these companies purchase each year.
Auto executives estimate that they will be able to reduce purchasing costs by up
to 10 percent over several years with the new system. These savings are expected
to arise from increased competition, as the number of bidders for each contract
increases, and by eliminating many of the meetings now required before a parts
order is placed. "Since half of the cost of a $20,000 car lies in purchased
parts, the new system could reduce the cost of producing a typical automobile by
$1,000." (32)

Similarly, Sears, Roebuck and
Company, the second largest U.S. retailer, is joining with Carrefour SA, a
Paris-based retailer, to create GlobalNetXchange, an online marketplace for the
retail industry. These two companies buy a combined $80 billion in goods and
services a year from 50,000 suppliers, and they are seeking other retailers to
join with them.
(33) While Sears's current EDI system costs the company approximately
$150 per hour; their new Internet-based exchange could reduce these costs to $1
per hour. (34)
In addition, on March 28, 2000, Boeing, Lockheed Martin, BAE Systems, and
Raytheon Company unveiled plans to develop an Internet trading exchange for the
global aerospace and defense industry. Together these companies have procurement
outlays of $71 billion.
(35)

While the large buyers organizing
these online marketplaces hope to achieve significant cost savings, it is
difficult to gauge a priori the impact these new arrangements may have on
their supply communities. Some suppliers and potential suppliers that had been
unable to justify the cost of EDI connections may be much more willing to use
the Internet to bid on work that they would otherwise have missed. Concerns have
been raised, however, about the potential for these large players to use these
markets to reduce competition. The overall impact will depend on the extent to
which actual efficiencies can be achieved as opposed to squeezing supplier
margins. One probable side effect of moving these supply networks to the
Internet will be to increase the level of investment in Internet
technologies.

E-commerce technologies also appear
to be driving changes among traditional intermediaries--i.e., firms such as
wholesalers, travel agents, or shippers, that add value between the production
of a good or service and its sale to the final consumer. Early predictions were
that the Internet and e-commerce would create efficiencies by eliminating the
need for intermediaries. Manufacturers and service providers would begin selling
directly to the customer and "middlemen" would disappear. However, the early
speculation failed to appreciate the important role that intermediaries play or
the resourcefulness some intermediaries would exhibit in finding new ways to add
value in an online world.

Instead of vanishing, traditional
intermediaries are adapting to exploit new possibilities as providers of
logistical, financial, and information services. Take the case of ChemConnect,
an online suppliers directory that has evolved into a global Internet exchange.
ChemConnect brings suppliers and buyers of chemicals and plastics into
negotiations where the providers of intermediary functions offer their services
for bid. As buyer and seller work to reach agreement on a purchase,
intermediaries provide estimates of costs, including carriers (ocean, inland
marine, and truck), documentation (customs clearing, regulatory/tax, insurance,
cargo surveying), and warehousing (terminal operations,
consolidation).

Internet-based market spaces also
broaden market participation by decreasing the costs of participating in B2B
markets. For decades, large companies have used EDI to automate routine
paperwork surrounding business transactions, to manage arrangements such as
automatic inventory replenishment, and to make purchases according to
pre-established terms. Until recently, the use of this e-business activity was
limited to large volume supplier/customer relationships because EDI required a
fairly sizable investment in dedicated hardware and proprietary software and use
of expensive leased telecommunications lines. As costs of computing power,
memory, and storage declined throughout the 1990s, the size threshold at which
EDI became cost-effective also declined, but still remained too high for many
trading applications. Now, however, the Internet with its open nonproprietary
protocols and global reach has emerged as a platform for spreading the
efficiencies achievable through the automation of business processes to firms of
all sizes.

The bulk of B2B e-commerce remains
EDI-based, although analysts are predicting that most of the future growth of
B2B e-commerce will be Internet-based. The National Association of Manufacturers
estimates that among businesses that currently use the Web for business, 17
percent are using it in place of EDI. (36) The Boston
Consulting Group estimates that 86 percent of the $671 billion in B2B e-commerce
in 1998 was EDI conducted over private networks. However, they estimate that the
EDI component will fall to 28 percent by 2003. (37)

In addition, businesses and even
governments have discovered the potential of the Internet as an auction space.
Businesses are using auctions to sell off surplus goods, dispose of used
equipment, and post requests for purchase. More than 10,000 companies have
posted, sold, or bought goods on the Tradeout.com site, which focuses solely on
auctioning surplus goods.
(38) Dovebid, an established used-capital asset disposition
auctioneer, has set up an online auction site with more that 200,000 items and
is reaching out to a global market. (39)

Business purchasers are also using
online auctions to request bids. Owens Corning used an online reverse auction
run by Freemarkets, an online auction company, to put bids out for corrugated
packaging materials for its 21 U.S. plants. At the end of the day the company
had 17 two-year contracts with corrugated packaging material suppliers and had
saved an estimated 10 percent. (40)

E-Business
Processes

E-commerce transactions represent only one way in which innovations in
computers and communications can add value and make business processes more
productive. All business processes have some information component.
Specifications for a design must be shared between architects and engineers. The
latest maintenance information must be delivered to the mechanic working on the
airplane. The manufacturer of auto interiors needs to know how many blue
interiors must be delivered for a manufacturing run at the auto plant. All of
these processes benefit when information flows faster, more accurately, and in
greater detail to the people who need it.

Many companies are experimenting with processes that enable them to share
information over a network or the Internet. For example, BOC Gases replaced a
slower, more costly certification procedure with a process that sends product
certification results over the Internet for customers that need specialized gas
products. (41)
Similarly, John Deere Construction Equipment Company uses the Internet to
improve customer service by creating a portal providing component life cycle
data to enable customers to manage component replacement before failure. (42)

Businesses are also using networking
technologies to improve processes, such as design and engineering, reducing
development time, simplifying manufacturing processes, and integrating design
processes. Examples include:

Using Internet technologies to coordinate
product design. Conexant,
a semiconductor producer, has created Web-enabled tools for its new product
development process. The company's 2,000 engineers use a standard Web browser
to access the company's portfolio of projects and obtain information on phase
of development, team composition, deliverables, and time frame. (43)

Using communications networks to improve
human resource functions.
Shaw Industries, a manufacturer of floor coverings, uses an internal network
to support compensation planning and retention initiatives for the company's
36,000 worldwide employees. (44)

Using wireless networks to manage inventory
more efficiently.
Cablevision, a telecommunications and entertainment company, uses wireless
mobile computer appliances over a local area network to process inventory
transactions in real time, at the point of activity. Previously, Cablevision
workers made inventory transactions, such as transferring inventory between
warehouses or scanning new shipments, by filling out forms by hand for later
entry into a central computer. The new system eliminates the daylong wait to
update the main database, so that inventory, such as cable boxes, can be
located instantly. When the installation is complete, the project will cover
43 warehouses across four states. (45)

Using extranets to provide
training. Service Experts,
a company specializing in the installation and maintenance of heating and
cooling systems with 150 locations in 34 states, established an extranet to
serve as an online resource library that includes "3-D diagrams with training
manuals and step-by-step instructions for solving problems." (46)

Using the Internet to provide customer
services and answer frequently asked questions. Many companies are using their company Web
site to offer customer services and product information. Ford offers product
information and links to dealers, and their "Owner Connection" Web page
provides Ford car owners with maintenance information, safety tips, service
reminders, do-it-yourself pointers, and online manuals. (47)

Using the Internet to reduce project
administration and management costs. Over the year-long process of building a
hotel in San Francisco, contractor Swinerton & Walberg estimates that by
using an Internet-based project management system they will squeeze about
$110,000 out of the project's $11 million budget. (48)

AN INCREASINGLY WIRED WORLD

Not only are individuals, businesses, and other organizations going online in
increasing numbers, but the products and services used in everyday life are
becoming increasingly integrated into the networked economy. Certain goods and
services can now be delivered directly to the buyer over the Internet. And
Internet connectivity is no longer tied to the desktop computer.

The Internet provides a new way to have goods and services delivered. Music,
legal advice, software, opera tickets, news reports, books, photographs, movies,
and product designs--can all be downloaded directly into a computer. According
to Forrester Research, while only 3 percent of all current online B2C sales
consist of digitally-downloaded products, this level could reach 22 percent of
all online sales by 2004. The most dramatic growth in direct, digital download
sales will probably be in the music sector, where such sales could rise from 0.1
percent of online sales in 1999 to 25 percent in 2004, followed by software
(rising from 7 percent of online sales in 1999 to 40 percent in 2004) and books
(rising from 1 percent of book sales online in 1999 to 13 percent in
2004). (49)

Digitalization is also changing the design of products, so these products can
be networked. For example, home-electronics producers have joined together to
develop Home Audio Video Interoperability (HAVi), an open,
consumer-electronics-industry standard that will allow digital audio and video
devices from different vendors to work together when connected to a network in
the consumer's home.
(50) Appliances that can be networked are beginning to emerge in other
areas as well.

New home electronics and appliances will not only be networkable, many of
them also will be "network appliances"--that is, appliances that can access the
Internet. The television has long been viewed as a potential portal for Internet
access. More recently, simple, low cost dedicated Internet access devices have
been introduced. In addition, connectivity is increasingly being viewed as an
important feature to add to existing products. At recent trade shows, for
example, home appliance manufacturers have unveiled prototype Internet-enabled
refrigerators and ovens that offer features such as e-mail, calendar management,
automated grocery ordering, and tracking of the service requirements of the
appliance.

We are only in the early stages of designing and developing new products that
take advantage of open networks. This development is still limited by slow
connection and transmission speeds and the lack of standards to facilitate
individual appliances communicating with one another. As these limitations are
addressed, however, the developmental pace of digital products is likely to
increase. New technologies that exploit the potential of wireless connections
are already creating new ways of communicating and conducting business,
reconfiguring many traditional industry and product definitions. As Internet
access migrates from the desktop computer to a range of products, the lines that
now separate the transmission of voice, data, and pictures will disappear. New
devices under development today will combine cellular telephone, geopositioning,
and Internet access in a handheld or automobile device. The major automakers,
for example, have already announced plans to equip some of their automobiles
with voice activated Internet access and handheld and automobile Internet access
is already available in Japan. (51)

The technologies that make the digital economy possible are still evolving,
as is the environment in which these technologies are being used. Many
businesses and individuals remain hesitant about e-commerce because the business
environment online does not yet have the same predictability and reliability as
it does offline. And the medium itself offers new challenges. For example,
our ability to deliver digital goods electronically has, in many ways, outpaced
the resolution of difficult legal and policy questions associated with it, such
as how to protect intellectual property rights in an environment where it is
easy and inexpensive to make virtually perfect copies of digital originals.
Efforts are underway, within the U.S. Government, in multilateral organizations,
and within the private sector, to resolve thorny issues related to privacy,
safeguards for children, consumer protection, information security,
authentication, intellectual property rights, jurisdiction, taxes, and tariffs.
Full realization of the economic promise of information technology depends on
the development of the same safeguards and predictable legal environment that
individuals and businesses have come to expect in the offline world.

CHAPTER III

INFORMATION TECHNOLOGY INDUSTRIES (52)

The prodigious vitality of the digital economy is grounded in Information
Technology (IT) producing industries--the firms that supply the goods and
services that support IT-enabled business practices across the economy, as well
as the Internet and e-commerce. (See Table 3.1, below). Over the past decade,
and especially since the mid-1990s, these industries have been a powerful factor
in the economy's rapid and sustained growth, a significant restraint on
inflation, and a focal point of prolific technological innovation. This chapter
examines the performance of IT-producing industries and analyzes their
contribution to the new economy.

Table
3.1

Information
Technology Producing Industries

Hardware
Industries
Software/Services Industries

Computers
and equipment
Computer programming services

Wholesale
trade of computers and equipment
Prepackaged software

Retail
trade of computers and equipment
Wholesale trade of software

Calculating
and office machines
Retail trade of software

Magnetic
and optical recording media
Computer-integrated system design

Electron
tubes
Computer processing, data preparation

Printed
circuit boards
Information retrieval services

Semiconductors
Computer services management

Passive
electronic components
Computer rental and leasing

Industrial
instruments for measurement
Computer maintenance and repair

Instruments
for measuring electricity
Computer related services, nec.

Laboratory
analytical instruments

Communications Equipment
Industries

Communications Services Industries

Household
audio and video equipment
Telephone and telegraph communications

Telephone
and telegraph equipment
Radio and TV broadcasting

Radio
and TV communications equipment
Cable and other pay TV services

Note:
Industries represented and measured here are defined in a manner
consistent with the 1987 Standard Industrial Classification (SIC)
categories, rather than the newly implemented North American Industry
Classification System.  This
was done both to provide a consistent GPO time series prior to 1997 and
because Census revenue data for computer services and communication
services through 1998 continued to be released according to their SIC
categories.

IT-PRODUCING
INDUSTRIES—

GROWTH ACCELERATES
COMPOSITION SHIFTS TOWARD SOFTWARE AND COMPUTER SERVICES

Since the mid-1990s, IT-producing industries have shown extraordinary
dynamism. Prepackaged software and computer services had the highest growth
rate, increasing their output (gross product originating or GPO) from 1995 to
2000 at a remarkable average annual rate of 17 percent (nominal dollars). (53) (Figure 3.1) Over
the same period, the computer hardware and communications equipment industries
increased their output at a 9 percent annual rate, and output in the
communications services sector rose at a 7 percent annual pace.

This
dynamic growth increased IT industries' share of total output from 6.3 percent
in 1994 to an estimated 8.3 percent this year. (Figure 3.2) By contrast, between
1990 and 1994, these same industries' share of the economy grew much more
slowly--by only about 0.5 percentage points overall. (54) The rapid increase
in these industries' share of the economy after 1994 is particularly impressive
in view of both the rapid growth of the economy as a whole and the accelerated
decline in IT prices over the period.

The recent swift growth of IT
industries has also coincided with sharply declining prices of IT goods and the
rapid expansion of both the Internet and network-related business processes. A
modest share of IT growth also reflected spending related to addressing
Y2K-related computer problems. ESA analysts have estimated that Y2K-related
spending accounted for roughly 7 percent of the output of IT-producing
industries in 1998 and 1999. (55)

FALLING IT PRICES HAVE REDUCED OVERALL U.S.
INFLATION

The declining prices of IT goods and services have worked, directly and
indirectly, to reduce overall inflation in the U.S. economy. Since the
mid-1990s, the price decline for IT products has accelerated--from about 1
percent in 1994, to nearly 5 percent in 1995, and an average 8 percent for the
years 1996, 1997, and 1998. (Figure 3.3 and Table 3.2) The steepest price
declines occurred in the computer and semiconductor industries, where prices
fell at average annual rates of 24 percent and 29 percent respectively, for the
years 1995 to 1998.

Over the same period, lower prices in the IT sector reduced overall U.S.
inflation directly, on average, by about 0.5 percentage points a year--from 2.3
percent to 1.8 percent. In 1998, falling IT prices helped hold overall inflation
to just over 1 percent--the smallest increase in the GDP chain-type price index
since 1963. (Figure 3.4 and Table 3.2)

Table
3.2

Price
Changes:

IT-Producing and All Other Industries

94        95         96
97
98

(Percent)

IT-Producing Industries

-1.4      -4.5
-8.1
-7.1        -8.0

GDP, not including IT industries              2.3
2.5
2.5
2.3
1.8

GDP, including IT industries
2.1
2.1
1.8
1.9
1.2

Source: ESA estimates
based on BEA and Census data.

Moreover, because these estimates focus only on the direct effects and ignore
the indirect effects of lower prices, they almost certainly understate IT's full
importance in keeping inflation low. A more complete estimate of IT's role would
cover not only the direct effects on inflation of price reductions in 8 percent
of the U.S. economy that produces IT goods and services, but also the price
effects of the increased competition and efficiency induced by IT deployment in
the 92 percent of the economy outside the IT-producing sector. We have no way to
disaggregate and measure these effects on their own. But their embedded
influence is reflected in the upper line in Figure 3.4, which shows declining
inflation in non-IT producing industries between 1996 and 1998.

IT-PRODUCING INDUSTRIES ACCOUNT FOR
NEARLY ONE-THIRD OF REAL GDP GROWTH BETWEEN
1995 AND 1999

IT industries produce less than 10 percent of total U.S. output.
Nevertheless, between 1995 and 1999, because of IT industries' extraordinary
growth and falling prices, they accounted for an average 30 percent of total
real U.S. economic growth.
(56)  (Figure 3.5 and
Table 3.3)

USE OF IT EQUIPMENT INCLUDING SOFTWARE

A critical factor in IT's predominant role in recent U.S. growth is the
increasingly dominant part that IT equipment, including software, plays in
business investment activity. In current dollars, industry spending on IT
equipment and software rose from $198 billion in 1992, or 44 percent of all
equipment spending, to $407 billion in 1999, or 46 percent. (57) (Figure 3.6) Over
the same period, "other capital equipment," including industrial equipment, fell
from 38 percent of total equipment and software investment spending to 32
percent, and transportation equipment ranged between 18 percent and 21 percent.

Because prices for IT equipment and software have been falling, investment
spending shifts are even more pronounced when expressed in real dollars, rather
than nominal amounts. (Figure 3.7) Since 1995, prices of IT capital equipment
and software have dropped by an average 6.7 percent per year, while prices for
transportation capital equipment have increased at a 0.6-percent average annual
rate and prices for other types of capital equipment have increased at a
1.5-percent rate.

Table
3.3

IT-Producing
Industries:

Contribution to Real
Economic Growth

94
95
96
97
98 est.
99 est.

(1) Changes in
Real

(Percent)

Gross Domestic Income*
4.2
3.3
3.5
4.7
4.8
5.0

(Percentage Points)

(2) IT
Contribution
0.8
1.0
1.2
1.3
1.3
1.6

(3) All Other
Industries
3.4
2.3
2.3
3.4
3.5
3.4

(4) IT Portion
(Percentage Share)

Of GDI
Change (2)÷(1)
19
30
34
28
27
32

*GDI is equal to the
income that originates in the production of goods and services
attributable to labor and property located in the
U.S.

Sources: ESA estimates
derived from BEA and Census data for 1994 -97.

As a result, real business investment spending on IT equipment and software
more than doubled between 1995 and 1999, from $243 billion to $510 billion (1996
dollars), while real spending on transportation equipment increased by about
half and real spending on other capital equipment increased slightly.

Over the decade of the 1990s, growing industry spending on IT equipment and
software was a significant factor in the high rate of growth of U.S. spending on
all categories of equipment to 9-to-10 percent per year, compared to 5-to-6
percent a year in the 1980s. (58) In 1999, business
spending for IT equipment and software represented more than three-fourths
of the 12 percent real growth in total equipment and software spending that
year, compared to 65 percent of the real growth in equipment spending for
1995-1998 and less than 50 percent for 1993-1994. (Figure 3.8 and Table
3.4)

Table
3.4

Contribution
of IT Equipment*

To Growth in
Capital Equipment and Software

93
94
95
96
97
98
99

(1) Change in real
spending

(Percent)

for
capital equipment
11.4
11.8
11.9
11.0
11.5
15.8
12.1

(2) Contribution of
real spending

(Percentage
Points)

for
IT equipment
5.4
5.3
7.4
7.5
7.5
9.8

9.4

(3) Contribution for
all other types

of
capital equipment

6.0
6.5
4.5
3.5
4.0
6.0
2.7

(4) IT’s contribution
to change in

(Percent)

real
capital equipment spending

47
45
62
69
66
62
78

*  Defined by BEA as information
processing and related equipment

Source: ESA estimates
derived from BEA
data

In nominal dollars, investment patterns within IT industries also show a
substantial shift to software. As a share of total IT equipment investment,
spending for software increased from just over 30 percent in 1992-1995 to 35
percent in 1999. (Figure 3.9) Despite the rapid decline in computer prices
(Figure 3.3, above), computers' share of IT equipment investment in nominal
dollars remained relatively constant over the 1992-1999 period. Other IT
equipment, including spending on communications equipment, remained the largest
category of IT equipment purchases, although its share declined from 47 percent
in 1992 to 41 percent in 1999.

Analysis of the composition of IT investment in real rather than nominal
dollars yields a somewhat different picture because prices have declined far
more rapidly for computer than for other kinds of IT equipment and software.
Measured in real dollars, beginning in 1994, investment in computers accelerated
more rapidly than investment in the two other IT categories, surpassing
investment in these categories by 1998. (Figure 3.10) In 1999, price-adjusted
spending for computers totaled $222 billion, compared with $149 billion for
software and $170 billion for other IT equipment.

R&D INVESTMENT IN IT INDUSTRIES

The surge in IT investment since 1994 has been accompanied by sharp increases
in R&D investment in the economy as a whole and in IT-producing industries
in particular. Between 1994 and 1999, total U.S. R&D investment grew at an
average annual (inflation adjusted) rate of 6 percent. In contrast, between 1989
and 1994, R&D investment grew at an average annual rate of roughly 0.3
percent.

All of the growth in R&D investment in the 1990s came from the private
sector. (59)
Between 1995 and 1998, IT industry investment accounted for 37 percent of this
growth. (60) In
1998, IT industries invested $45.7 billion on R&D, nearly half as much again
as total R&D investment by the motor vehicle, pharmaceutical and aerospace
industries--industries that traditionally invest large amounts on R&D.
(Table 3.5)

Table
3.5

Company-funded R&D Investment by Sector, 1998

$billions
Percent

All Industries
45.0

100.0

IT-Producing*
45.7

31.5

Computers
8.9

6.1

Communication equip.
10.2

7.1

Electronic components

9.8

6.8

Communication services
1.7

1.2

Software & computer
services
14.3

9.9

Motor Vehicles

13.5

9.3

Pharmaceuticals

12.6

8.7

Aerospace
5.1

3.5

All Other
Industries
68.1

47.0

*R&D data for IT industries
from the Instrument sector are not available for 1998.

Source: National
Science Foundation

Between 1992 and 1994, IT-industries' share of all company-funded R&D
grew moderately, from 27 percent to 29 percent. Beginning in 1995, however,
IT-industries' share of company funded R&D increased to about one-third,
spurred by increases in R&D for computer services and software. (Figure
3.11)

Growth in IT industries' share of private R&D is largely the result of
increased R&D investment by manufacturers of electronic components and
software. (Figure 3.12) In the computer industry, annual R&D investment
dropped from an average $11 billion during 1990-92, to $5 billion during
1993-95, then rose to $10 billion during 1996-98. (61) One reason for
this lack of overall growth may be that as computer demand has shifted toward
micro- computers, more computer-related R&D has shifted to component
manufacturers and software firms.

CONCLUSION

Analysis of IT industry growth and investment patterns demonstrates not only
that IT industries are now a major force in the U.S. economy, but also that
their economic importance began to grow dramatically in the middle of the last
decade. Although many factors contributing to the digital revolution were in
place well before the mid-1990s, it was then that their combined effect and
potential first became evident and the new economy began to take shape.

CHAPTER IV

CONTRIBUTION OF INFORMATION
TECHNOLOGY

TO U.S. PRODUCTIVITY GROWTH (62)

This chapter examines recent studies of the impact of information technology
(IT) on labor productivity in the United States. Our analysis of these studies
concludes that, based on macroeconomic and firm-level evidence, IT does
contribute significantly to productivity growth. However, studies at the
industry level continue to produce mixed results.

MACROECONOMIC ASSESSMENTS

The current U.S. productivity pattern, in which productivity gains have
strengthened as the expansion has matured, is unprecedented for the postwar
period. In previous postwar expansions, productivity growth has slowed as the
expansion enters its mature phase. (Figure 4.1)

One reason for the extraordinary pattern of productivity in the current
expansion appears to be the rapid growth in the real net stock of IT capital per
labor hour, especially computer hardware (including peripheral equipment). This
rapid growth of real net IT capital created significant IT "capital deepening,"
beginning in 1991 and accelerating sharply after 1995. (63) The ratio of the
capital stock of computer hardware to hours worked increased, on average, by
16.3 percent per year over the period 1991-95, and 33.7 percent per year during
1996-99. (Figure 4.2) Capital deepening in computer software also grew at
double-digit rates during both periods, while the growth rate in communications
equipment increased from 2.4 to 5.0 percent. By contrast, over the 1990s, the
rate of capital deepening for all other forms of capital--covering over 95
percent of the total U.S. capital stock--averaged only about one-half of one
percent per year.
(64)

A major factor behind IT capital deepening has been the falling prices of IT,
especially computer hardware, reflecting rapid and continuous improvements in
quality. (65)
The quality-adjusted price deflator for computer hardware fell 14 percent per
year during the first half of the 1990s and 29 percent per year during
1996-98. (66)
(See also Figure 1.3, Chapter I.)

Figure 4.3, comparing the 1991-95
and 1996-99 periods, shows that IT capital deepening accounts for a large and
increasing share of the economy's rising productivity gains. The figure also
shows that the acceleration of labor productivity growth has been
accompanied by an acceleration in "multifactor productivity" (MFP) growth within
the IT-producing sector itself. Multifactor productivity growth reflects the
impact of factors in addition to quality-adjusted capital and labor inputs--for
example, technical changes not directly incorporated in capital and labor (such
as new production processes), organizational improvements, and economies of
scale. As discussed below, growth in multifactor productivity has been
especially strong in the computer and semiconductor industries.

All categories of IT capital contribute disproportionately to labor
productivity growth, compared to their shares of the total private nonfarm
business sector and their shares of the total net capital stock. However, the
contribution of computer hardware to productivity growth has been
extraordinarily large. Recent research indicates that during the years 1996-99,
computer hardware deepening accounted for 24 percent of all labor productivity
growth. (67) (Figure 4.4) The size
of this contribution is especially remarkable because computers constitute just
1.8 percent of the private nonfarm business sector and less than 1 percent of
overall capital stock (1998).

The reason that IT, with such a
small share of the economy and of the total capital stock, has contributed so
powerfully to productivity growth is that the rapidly growing IT investments
have been unusually productive. Market conditions dictate that business
investments in computer hardware must earn very high rates of return. For one
thing, the rapid and continuous improvements in IT quality mean that existing
computer hardware becomes obsolete and hence depreciates very quickly. In
addition, sharply falling hardware prices mean that businesses investing in IT
equipment face rapid capital losses as purchased equipment quickly loses market
value. Oliner and Sichel estimate that investment in computer hardware must
produce gross rates of return of about 68 percent in order to cover an estimated
depreciation rate of 30 percent and capital loss of 34 percent per year, and a
competitive net rate of return of 4 percent per year. By their estimates, the
payback period for computer hardware investments is less than two years.

The Emerging
Consensus on Resolving the "Computer Productivity Paradox"

Economists who held until recently that the impact of computers on U.S.
productivity could be a transitory effect of unusually favorable economic
circumstances have begun to credit IT for dramatic increases in the trend growth
rates of U.S. output and productivity since 1995. One reason for this change in
view has been the increasing attention paid by researchers to the productivity
effects of software and communications equipment, in addition to computer
hardware. This shift in attention follows the 1998 and 1999 editions of this
report that introduced a broader definition of IT (68) and the
reclassification by the Bureau of Economic Analysis (BEA) of software spending
from current expenditures to investments.

Thus, Oliner and Sichel conclude that surging use of IT (including computer
hardware, software, and communications equipment) in the second half of the
1990s, together with advances in the production of computers and semiconductors,
contributed about two-thirds of an estimated 1.06-percentage point acceleration
in productivity growth between the first and second halves of the decade.

Consistent with Oliner and Sichel's findings, the Congressional Budget
Office, the Economic Report of the President, Jorgenson and Stiroh,
Whelan, and Macroeconomic Advisers, LLC find strong evidence that the mid-1990s
acceleration in productivity growth was due largely to IT capital deepening
among IT users and also to technical advances and innovations made by IT
producers. These analysts' recent estimates of IT's contribution both in
computer use (capital deepening) and computer and semiconductor production
(technical advance) are summarized in Table 4.1. (69)

When one takes into account the differences in the periods studied and in the
coverage of economic activity, idiosyncratic adjustments for limitations in the
available data, and other factors, these estimates appear to be remarkably
consistent.

Recent studies also suggest that robust productivity growth is likely to
continue. For example, Macroeconomic Advisers found that: "Given the large gap
between discovery and application in the computer industry, it is reasonable to
conclude that real computer prices, which on average have declined 20 percent
per year since 1996, will continue falling rapidly. As long as they do, the
special contribution to productivity growth coming from the technology sector
will persist."
(70)

Table 4.1

Contribution of IT Capital to the
Acceleration of Labor Productivity Growth

in the U.S. Private Nonfarm Business
Sector

Studies*

Capital Deepening

Technical Advance

Total IT Contribution

Productivity Acceleration

IT Share of Acceleration

(Percentage Point)

(Percentage Point)

(Percentage Point)

(Percentage Point)

(Percent)

IT

Other

IT

Other

(a)

(b)

(a/b)x100

Oliner and
Sichel

1996-99 over
1991-95

0.45

0.03

0.26

0.41

0.71

1.04

68.3

Congressional Budget
Office

1996-99 over
1974-99

0.40

-

0.20

-

0.60

1.10

54.5

Economic Report of the
President

1995-99 over
1973-95

0.47

-

0.23

0.70

0.70

1.47

47.6

Jorgenson and
Stiroh

1995-98 over
1990-95

0.31

0.18

0.19

0.44

0.50

1.00

50.0

Whelan

1996-98 over
1974-95

0.46

-

0.27

-

0.73

0.99

73.7

*The studies
summarized are not strictly comparable because they use different
definitions of IT capital and examine different time periods. Oliner and
Sichel define IT capital to include "computer hardware, software, and
communication equipment." The Congressional Budget Office talks about
"computers," distinguishing between computer "use" (capital deepening) and
computer "production" (technical advance), while the Economic Report of
the President refers to "computers and software." Jorgenson and Stiroh
include in IT "capital services" those from computer, software, and
communications capital. Finally, Whelan's
"computing equipment" includes mainframes, terminals, storage devices,
printers, and personal computers.

In the above
table, "IT capital deepening" means increase in IT capital per labor hour
and "other capital deepening" means increase in other types of capital per
labor hour. "Technical advance" covers capital quality improvements and
multifactor productivity growth from IT and other sources. Finally, there
are factors contributing to labor productivity growth acceleration other
than capital deepening and technical advance that are not identified in
the table (e.g., improvements in labor quality). These other factors are
omitted since the table is intended to highlight IT's contribution to the
acceleration of labor productivity growth.

SECTORAL AND
INDUSTRY-LEVEL ASSESSMENTS

Since IT investments improve productivity, those industries making the most
intensive use of IT should show higher productivity growth than industries that
use IT less intensively (all other factors held constant). Evidence of such a
pattern at the industry level, however, remains mixed. IT-producing industries
have recorded astonishingly high productivity gains and have been a dominant
force in aggregate U.S. productivity growth. (71) Furthermore,
outside the IT-producing sector itself, goods-producing industries that are IT
intensive have achieved higher productivity gains than their counterparts that
have not invested heavily in IT. However, official output measures for
IT-intensive service industries do not indicate significant productivity gains.
Indeed, between 1990 and 1997, despite heavy investments in IT and a
three-decade buildup of the real net IT capital stock, IT-using service
industries as a group recorded declining productivity.

The following sections review analyses that show significant multifactor
productivity growth in IT-producing industries, improved labor productivity
growth in both IT-producing and IT-using goods industries, and alternative views
of IT's effect on productivity in service industries.

Computer Production

A study conducted by Kevin Stiroh examined the relationship between computers
and economic growth, at both the aggregate and sectoral levels, over the period
1947 to 1991. This study found strong labor productivity, as well as multifactor
productivity gains in the computer-producing sector, implying that this sector
positively contributes to overall productivity growth. (72) Estimates by the
Bureau of Labor Statistics (BLS) confirm Stiroh's finding that IT-producing
industries make an outstanding contribution to multifactor productivity
growth. (73) The
BLS estimates show that industrial machinery and equipment (SIC 35) and
electronic and electric equipment (SIC 36)--the categories that include the
computer and semiconductor industries--ranked highest in multifactor
productivity growth among all manufacturing industries between 1990 and
1996. Similarly, a May 2000 analysis by Dale Jorgenson and Stiroh concluded
that IT production is a major force behind the current resurgence in multifactor
productivity growth.
(74)

Computer Use

Analyses of computer-using industries outside the IT sector, however,
continue to show mixed results. For the period prior to 1991, Stiroh found that
in computer-using sectors, rapidly falling computer prices led firms to
substitute capital for labor and other inputs. The result was that remaining
workers had more capital to work with, and labor productivity rose. However,
Stiroh found little evidence that investments in computers affected multifactor
productivity growth in these sectors. These findings have been broadly confirmed
by Jorgenson and Stiroh himself in studies in 1999 and 2000. Both researchers
note that price declines in IT have led to capital deepening in IT-using
industries, but they still see "no corresponding eruption of industry-level
[multifactor] productivity growth in these sectors." (75)

By contrast, evidence of multifactor productivity growth in some IT-using
industries has been documented in a study by Jack Triplett and Barry Bosworth.
They estimate that from 1987 to 1997, multifactor productivity grew 9.0 percent
per year among security and commodity brokers, 2.1 percent a year among
insurance carriers, and 2.2 percent among holding and investment offices. (76) These estimates of
productivity growth for the period 1987 to 1997 significantly exceeded
productivity gains for the same industries in the years 1960 to 1973.

ESA's own industry-level analysis covering the 1990-97 period supports
Stiroh's conclusion.
(77) We found that gross product originating per worker (GPO/W), an
approximate measure of labor productivity, was stronger in IT-using goods
industries than in non-IT-intensive goods industries--2.4 percent per year
compared to 1.3 percent. No similar pattern emerged, however, among service
industries. IT-using service industries actually showed a negative growth rate
of 0.3 percent a year, compared to 1.3 percent annual productivity gains by
non-IT intensive service industries. These results largely reflect the difficult
problems in conceptualizing and measuring output in many service industries.

In view of these measurement problems, we compared growth in GPO/W of
IT-using service industries with that of the non-IT intensive service
industries, but excluding 10 hard-to-measureservice industries. (78) We found that when
the hard-to-measure industries are excluded, IT-using service industries show
slightly greater GPO/W growth than non-IT intensive service industries, and the
overall annual average GPO/W growth for 1990-97 rises from 1.38 percent to 2.34
percent. (Figure 4.5) Because hard-to-measure service industries together
account for 44 percent of the total GPO by IT-using service industries, the
effect of IT on service industry productivity will remain clouded until
development of better output measures.

BEA, BLS, and other statistical agencies are currently grappling with the
challenge of improving output measurements for service industries. BEA
plans to release new GPO-by-industry data this summer. We expect that, based on
this new data, estimates for some hard-to-measure service industries will show
productivity gains.
(79)

FIRM-LEVEL EVIDENCE

Like the macroeconomic studies, recent firm-level analyses show that IT
contributes substantially to productivity growth. This contribution is
especially strong where businesses undertake organizational and other changes
that complement the adoption of IT.

In one study, Erik Brynjolfsson and Lorin Hitt analyzed firms in four groups
based on their levels of IT investment and degree of decentralization. While
they found that average productivity was highest among firms that were high in
both IT investment and decentralized organization, they also found that
productivity was lowest among those firms that were high in IT investment but
low in decentralization. In fact, the productivity of firms that invested
heavily in IT but remained highly centralized declined relative to firms which
were low on both measures.
(80)

Another study by the same researchers similarly concluded that while
computers make a positive contribution to productivity growth at the firm level,
"the greatest benefit of computers appears to be realized when computer
investment is coupled with other complementary investments; new strategies, new
business processes, and new organizations all appear to be important." (81)

Another analysis, by Brynjolfsson and Shinkyu Yang, found that a one-dollar
increase in computer capital is associated with a $10 increase in the valuation
of the firm by the stock market, based on eight years of data for 820
non-financial U.S. firms.
(82) This finding does not imply that the market values a dollar of
computers at $10, but rather that "the firm that has a dollar of computers
typically has another $9 of related intangibles." (83) In order to make
effective use of computers, firms have to make expensive investments in
software, training, and organizational changes, which together create intangible
assets. The researchers estimate that when the costs of these intangible assets
and other adjustment costs are added to the direct expenditures on computers,
the firms had normal returns on investment. No other category of capital
investment shows such high valuations relative to tangible investments.

In conclusion, based on both macroeconomic and firm-level analyses, IT makes
a substantial contribution to overall productivity growth. The firm-level
studies show that firms that have made the organizational and other changes
necessary to effectively use IT become more productive over time than those that
have not. However, analyses of the impact of IT on productivity at the industry
level have produced mixed results, largely reflecting the limitations of
measuring the output of many service industries. Until these measures are
improved, the full effect of IT on service industry productivity will remain
clouded.

CHAPTER V

THE INFORMATION TECHNOLOGY
WORKFORCE (84)

Information technology workers not only produce and maintain the Nation's
computing and communications infrastructure, they also generate the knowledge,
ideas and information critical to the development of the digital economy.

Demand for IT workers has increased with the spread of networked computers,
the Internet, e-commerce, and the associated growing demand for high-quality
digitized products and services. Moreover, the demand for IT workers is
increasingly focused on more highly-skilled and highly paid people, as the rapid
pace of innovation rewards high skills and technology reduces the number of
less-skilled and lower paid IT jobs.

In 1998, the IT workforce--covering workers in IT-producing industries and
workers in IT occupations in other industries-- totaled roughly 7.4 million
workers, or 6.1 percent of all workers. While IT employment has grown faster
than overall employment for many years, the growth in both IT-producing
industries and IT occupations accelerated in the mid-1990s. IT industry
employment grew almost 28 percent from 1994 to 1998, and employment in IT
occupations increased by 22 percent over the same period. By contrast, over
those same years, total U.S. nonfarm employment rose by about 11 percent.

Table
5.1

IT-Related
Occupations

Engineering, science, and
computer
Electrical and electronics engineers

systems managers

Computer engineers

Database administrators
Computer support specialists

Systems analysts
All other computer scientists

Computer programmers
Electrical and electronics technicians

Broadcast technicians
Duplicating, mail and other office machine
operators

Computer equipment
operators
Billing, posting and calculating machine
operators

Data processing equipment
repairers
Data entry keyers

Communications equipment
operators
Electronics repairers, commercial and industrial
equip.

Electrical powerline installers
and repairers
Electrical and electronic equipment assemblers,
precision

Telephone and cable TV
installers and repairers
Electromechanical equipment assemblers,
precision

Central office and PBX
installers and repairers
Electronic semiconductor processors

Source: ESA in consultation
with BLS.

This chapter examines past and recent employment trends, wage
trends and skill requirements in IT-producing industries and IT occupations.
(See Table 5.1 for a list of IT occupations and Appendix Table 5.4 for
descriptions of duties.)
(85) We also analyze the factors affecting the supply of IT workers
and how the public and private sectors are responding to the growing demand for
IT workers.

IT-PRODUCING INDUSTRIES

Employment in IT-Producing Industries
Accelerates After 1994

Jobs in IT-producing firms, after growing more slowly than overall employment
in 1993 and 1994, increased dramatically in 1995 and thereafter, growing at an
average annual rate of 6.5 percent. (Figure 5.1) The number of workers in
IT-producing firms grew from 3.9 million in 1992 to 5.2 million workers in 1998.
Even at this level, employment in IT-producing firms in 1998 accounted for less
than 5 percent of total private employment.

The overall growth in IT-producing industry employment masks a churning of IT
jobs, with significant job increases in some areas and significant declines in
others. Among all IT-producing industries, software and computer services
recorded the fastest employment growth. (86) Job positions in
these areas nearly doubled, from 850,000 in 1992 to more than 1.6 million in
1998. (Appendix Table 5.1) Over the same period, job growth in the hardware and
communications services industries was close to the growth in overall
employment. Within these areas, computer hardware retailers and pay television
service providers saw the fastest growth, while other sub-industries experienced
job reductions, including manufacturers of computers, electron tubes and some
types of communications equipment. (See Appendix Table 5.1 for industry detail.)

A vibrant economy always produces significant job creation and job
destruction. However, some recent job churning appears to be directly related to
several factors associated with the digital revolution:

Many
information technologies have short life cycles, and employers intent on
quickly getting a product or service to market often prefer to hire workers
skilled in new technologies rather than retrain their current workers. (87)

Computing
and communications technologies have lowered barriers to entry, especially to
markets that provide information technology and other services. These
technologies provide small businesses with size and resource advantages
usually available to larger, established companies. (88) By using the
Internet, they can compete outside of local markets, even in global markets.
The same technologies allow foreign companies greater access to U.S. markets.
More players in the market means more job churning as there will be winners
and losers.

Employment
in IT-producing industries is also affected by the increasing use of
outsourcing to other industries. For example, Fortune 1000 companies outsource
an estimated 60 percent of their e-commerce projects. (89)

IT Industry Wages Consistently Higher Than
Average

The average annual wage for workers in
IT-producing industries was $58,000 in 1998, or 85 percent higher than the
$31,400 average wage for all private workers. Since 1992, wages paid by
IT-producing industries have grown by 5.8 percent per year, compared with
private-industry average wage growth of 3.6 percent annually.  As a result, the wage gap between these
IT workers and all workers widened by more than $10,000, or two-thirds, over
this period. (Figure 5.2)

Among workers in all IT-producing industries, those in software and computer
services industries, including computer programming services and software
development, earned the highest average wage of $65,300 in 1998. (Appendix Table
5.2) The wages of these workers also grew at the fastest rate over this period,
an average of 6.7 percent per year.

All IT-producing industries paid wages that were higher than the total
private industry average wage in 1998, and almost all of them had higher than
average annual wage growth from 1992 to 1998. Nonetheless, some IT jobs and
non-IT jobs in IT industries remain low-skilled, low paying positions. The wages
for these positions have increased very slowly, if at all. (90)

IT OCCUPATIONS

Employment in IT Occupations Accelerates
After 1994

One could define the class of jobs considered "IT occupations" in many
different ways. The broadest definition would recognize that, as the economy
becomes more digitized, most occupations will involve the manufacture or
operation of equipment that includes forms of information technology, such as a
computer chip. A more narrow definition might include only the "core" IT
occupations of computer scientists, computer engineers, systems analysts and
computer programmers; these are the IT positions that require the most education
and skills, are the highest paid, and are in greatest demand. Here, we adopt a
middle ground and include as "IT occupations" those positions involved in
creating, operating and maintaining the IT infrastructure required to facilitate
e-commerce and other Internet or network-related activities. (See Table 5.1 for
list of IT occupations.)

Employment levels in these IT occupations were flat during the early 1990s
and have risen steadily since 1994. In 1992, there were 4.3 million workers in
these IT occupations. By 1998 the number had grown to 5.3 million. (Figure 5.3)
The fastest growth occurred among the core IT occupations, where the number of
jobs increased by 957,000 between 1992 and 1998, or almost 80 percent.

Highest Skilled IT Workers in
Demand

The number of highly-skilled IT workers, or IT workers in occupations that
generally require at least an associate degree, increased from 2.2 million in
1992 to 3.2 million in 1998. The fastest growth occurred among those with the
highest skills - core IT occupations - who increased their share of total IT
employment from 28 percent to 41 percent. (Figure 5.4 and Appendix Table 5.3)

Between 1994 and 1998, total high-skilled IT employment increased 35 percent,
more than three times as much as the national average, and core IT occupations
grew more than five times faster than all other jobs. By contrast, employment in
lower-skilled IT occupations, such as computer operators, communications
equipment operators and billing and posting clerks, declined from 926,000 to
852,000, or 9 percent. During the same period, employment among
moderately-skilled IT workers, including telephone and electronic equipment
installers, assemblers and repairers, grew somewhat more slowly than the
national average.

Private surveys and interviews with Chief Information Officers provide
additional insight into the specific IT skills in greatest demand. The growth in
e-commerce, for example, has increased demand for workers with Internet-related
technical skills, including network specialists, help desk/end user support
staff and Internet/intranet developers. E-commerce growth has also increased the
demand for workers with a knowledge of sales, marketing and business planning.
Many IT workers that used to work in back offices are now required to learn how
to deal with customers and convince them to make online purchases. (91) In addition, as
more firms outsource for IT services, demand has increased for project managers
and people who can negotiate and manage vendor contracts. (92)

High Skilled IT Occupations Pay
High Wages

The earnings of IT workers vary greatly, based on their skills and
educational levels. For example, the Bureau of Labor Statistics (BLS) estimates
that in 1998 computer engineers, who typically have at least a bachelor's
degree, earned an average of $59,900. (Appendix Table 5.4) By contrast, lower
skilled occupations such as billing, posting and calculating machine operators,
which usually do not require a college degree, earned on average only
$21,300.

Historical wage data are available for only a few IT occupations, including
core IT workers. From 1992 to 1998, weekly earnings of computer programmers
increased from $685 to $843 or 23 percent. (Figure 5.5) The median weekly
earnings of computer scientists, computer engineers and systems analysts,
although higher than average, increased from $810 in 1992 to $952 in 1998, or at
the same 17.5-percent rate as the average for all occupations.

Private wage surveys provide more current wage estimates of new occupations
and new skills in great demand. According to Computerworld's 13th annual
survey, 1998 and 1999 pay increases for IT positions averaged 4-to-5 percent,
much less than the 11 percent increase in 1997.

RHI Consulting estimates that starting salaries for IT workers in 2000 will
be 6.8 percent more than in 1999, with jobs related to Internet development,
networking, consulting, and systems integration seeing even larger than average
increases. IT consultants with skills such as the ability to work with Oracle,
PeopleSoft and SAP software can earn more than $100 per hour, depending on level
of expertise.
(93)

Earnings in IT occupations also vary by geographic location and company size,
as they do for many other industries. Computerworld estimates that in
1999, webmasters/web designers earned on average $53,100, including
bonuses. (94)
However, this compensation ranged from $43,800 in New England to $59,600 in the
Pacific region. Further, larger companies with more than $500 million in revenue
paid webmasters/web designers an average of $58,600, compared to smaller
companies with less than $100 million in revenue which paid an average of
$48,400.

IT LABOR MARKET IMBALANCES

The IT Worker Supply Debate

The question of whether the U. S. is producing an adequate supply of IT
workers has been much debated in recent years. There is no single common
definition of "IT worker" and no agreed-upon method for identifying an
occupational shortfall. In theory, market forces will eventually resolve any
imbalance between supply and demand. However, the evidence on short-term market
responses is inconclusive.
(95)

The Bureau of Labor Statistics examined the available national employment and
wage data for core IT occupations over the period 1992 to 1997. They reasoned
that an imbalance should produce above-average growth in both employment and
wages, and below-average unemployment rates. BLS found that while the
unemployment rates for core IT occupations were consistently lower than the
national average for this period, employment and wage growth had not been
consistently above average for all core IT occupations. They concluded
that the evidence on IT labor market imbalances remains ambiguous. (96)

A more detailed examination of employment and wages in core IT occupations
supports this judgment. Between 1992 and 1994, employment among computer
programmers fell; in the following four years, this employment grew by an
average of 5 percent a year. Over the same period, the number of computer
scientists, computer engineers and systems analysts grew at a 16.5 percent
annual rate.  (Figure 5.6)  The fact that median weekly earnings for
both occupations grew at 3.0 and 3.4 percent annually - little faster than the
2.9 percent national average - seems inconsistent with a serious imbalance in
labor supply and demand. One possible explanation is that businesses have been
using non-wage benefits such as stock options to attract employees. Other
reasons may be that the rapid growth of employment in these areas has reduced
the median experience and skill level, suppressing median wage growth, or that
high relative pay and a sense of job security may be keeping down additional
wage gains. Finally, the recent moderate growth in wages may also indicate that
growth in the supply of IT workers (whether from foreign sources or graduates
from IT and other technical training programs) is keeping pace with demand.

A study by the Computing Research Association evaluated past assessments of
the supply of IT workers.
(97) The study found evidence of temporarily tight labor markets in
specific regions and occupations and argued that such tightness should be
expected in any field undergoing rapid technological change. The report further
noted that more useful findings could be produced by segmenting the market by
geographical area or occupation, but that the data needed to conduct such
analyses do not exist. Several Federal initiatives are currently underway to
improve IT-related employment data collection. (98)

Meeting the Demand for IT
Workers

As the importance of IT to the American economy continues to grow, so will
the demand for IT workers. In response, government and business are taking steps
to increase the numbers of IT workers.

One such step is the Federal Government's H-1B visa program, which admits
foreign skilled workers to the United States. Congress raised the H-1B visa
limit from 65,000 to 115,000 in 1998. This year, this ceiling was reached in
March, with employers demanding 50,000 more H-1B visas than at the same time in
1999. (99)
Consequently, several bills have been introduced in Congress to either raise the
limit (up to 200,000) or to temporarily remove the cap. Although many workers
who enter the country under the H-1B visa program hold jobs other than IT jobs,
a recent Immigration and Naturalization Service (INS) survey found that over 60
percent of H-1B visa petitioners are IT workers. (100) Applying the INS
estimate to the current H-1B visa limit of 115,000 suggests that the H-1B
program currently fills over 70,000 IT jobs, equivalent to 28 percent of the
average annual demand for IT workers with at least a bachelor's degree during
the 1996 to 1998 period.

A number of public/private partnerships also have been created to increase
the supply of IT workers from various sources, including the current pool of
workers, retired people, and high school and college students. Outlined below
are some representative examples of recent initiatives by the Federal
government, public/private partnerships, and private companies to increase the
supply of IT workers and raise the technical IT competency of American
workers.

Federal Efforts

The
Department of Labor (using funds from the $500 H-1B visa filing fee) plans to
award grants of $12.4 million in FY 2000 to train U.S. workers for IT and
health care jobs often filled by immigrants. The Department also will fund an
additional $40 million for projects to train workers in local markets. Under
these programs, private companies seeking IT workers can work with local
governments and educational institutions to develop training.
(www.dol.eta.gov)

The
Department of Education is providing $135 million in grants to train 400,000
teachers to use information technologies more effectively in the classroom.
(www.ed.gov/ PressReleases/08-1999/wh-0824.html)

The
Department of Commerce's Technology Administration created and maintains the
GO4IT website that provides access to a searchable database containing
descriptions of a wide variety of IT work force initiatives around the
country.(www.go4it.gov) The Department of Labor maintains America's Career Kit
consisting of America's Career InfoNet (www.acinet.org), America's Job Bank
(www.ajb.dni.us) and America's Learning Exchange
(www.alx.org).

Public/Private Partnerships

Cisco
Systems, the Communications Workers of America, Arizona State University and
the Departments of Labor and Education are developing an online system to help
retired military personnel and others to assess and improve their IT skills.

The National
Association of Manufacturers encourages its member companies to spend at least
3 percent of their payroll on worker training.

The Department of
Labor with the American Society for Training and Development are expanding
America's Learning Exchange, (www.alx.org) a clearinghouse for information on
education and training, financial aid and skills analysis.

The
Department of Education and the Conference Board disseminate information about
the economic benefits of workplace learning to U.S. businesses and unions.

Private Efforts

Ford
Motor Co., Intel Corp, Delta Airlines and American Airlines recently announced
plans to provide computers and low-priced Internet access to all their
employees, as a way of raising the technical literacy of their workforce.

Some
firms are taking advantage of distance learning systems, such as those
provided by Saba Corp, which provide electronic learning platforms and
infrastructure for a number of companies, including Qwest Communications,
Ford, and Continental Airlines. Saturn, P&G and IBM also have intranets or
online technologies that provide information and training services to
employees, suppliers and customers throughout the world.

CHAPTER VI

TRADE IN INFORMATION TECHNOLOGY

GOODS AND SERVICES
(101)

American IT companies are powerful competitors in markets around the world.
Yet the United States ran a trade deficit in information technology goods of
almost $66 billion in 1999. (Figure 6.1, and Appendix Table 6.1) The growing
imbalance in cross-border flows of IT goods overwhelms the small surpluses that
the United States has earned in recent years in IT services trade. (Figure 6.2,
below, and Appendix Table 6.2)

The paradox of large trade deficits in an area where U.S. firms are world
leaders is largely explained by the fact that America's leading IT firms are
global operations that service foreign customers through their overseas
affiliates, rather than by exporting goods made in this country. The most recent
published data show that in 1997, when the United States exported $121.4 billion
of IT goods and services, foreign sales by overseas IT affiliates of American
companies totaled $196 billion. (102) In the same
year, American-based IT affiliates of foreign companies reported U.S. sales
totaling $110.5 billion. (Table 6.2) U.S. deficits in IT trade also reflect
strong growth in the U.S. economy compared to the slower pace virtually
everywhere else and the boom in IT investment by American firms.

TRADE IN IT GOODS

Both exports and imports of IT goods have exhibited strong growth in recent
years, with imports growing faster than exports. Through the 1990s, U.S. exports
of these goods, including pre-packaged software, rose at an average annual rate
of about 9.5 percent. Over the same period, U.S. imports of IT goods increased
at an average rate of 12.3 percent a year. As a result, the U.S. trade deficit
in IT goods jumped from $11.5 billion in 1990 to $65.9 billion in 1999. (Figure
6.1) In fact, the United States has run trade deficits since 1983 in many
categories of IT hardware, including semiconductors, household audio and video
equipment, and computer storage devices. (103) Trade surpluses
in computer peripheral equipment turned negative in 1994; and in 1999 the nation
posted its first trade deficit in electronic computers. (Appendix Table 6.1)

At the same time, the United States continues to run trade surpluses in some
high value-added IT products. The U.S. trade surplus in pre-packaged software
reached $2.8 billion in 1999, a record level. The trade surplus in scientific
instruments has also generally been on the rise. And following a long series of
trade deficits dating from 1983, telecommunications equipment manufacturers
enjoyed export surpluses in three of the five years after 1994.

TRADE IN IT SERVICES

The U.S. trade position in IT services strengthened throughout the 1990s.
Exports of IT services, including royalties from the licensing of U.S. software,
increased at an average annual rate of 13.2 percent from 1990 to 1998, while
imports of IT services grew at a 6-percent rate. As a result, the United States
ran trade surpluses in IT services of $0.9 billion in 1997 and $1.8 billion in
1998, the first such surpluses since BEA began collecting comprehensive data on
services trade in 1986.(Figure 6.2, and Appendix Table 6.2)

Within IT services, U.S. exports of computer and information services,
including software royalties, increased at a 23.7-percent average annual rate in
the 1990s. Even though imports of these services rose even more rapidly, by 33.1
percent per year, in 1998 they still remained just under $1 billion, or less
than one-seventh of the value of exports. In 1998, U.S. firms exported $4.0
billion in computer and information services, compared to $0.5 billion in
imports of such services. In addition, software royalties paid by foreign firms
to U.S. producers surpassed $3.2 billion, compared to U.S. software-royalty
payments to foreign producers of less than $0.5 billion.

By contrast, U.S. payments to other countries for telecommunications services
consistently outpace foreign payments to U.S. carriers. In 1998, the deficit was
$4.4 billion, down modestly from the record $5 billion in 1996. (Appendix Table
6.2) The negative balance of payments on cross-border sales of
telecommunications services is a reflection of calling patterns and differences
in national telecommunications rates. More international calls originate here
than in other countries because of the strong U.S. economy, relatively high U.S.
income levels, and large immigrant populations in this country. In addition,
because American markets are more open and competitive, foreign callers pay less
to U.S. carriers to complete calls to the United States than Americans pay to
foreign carriers to complete calls going the other way.

TRADE BETWEEN U.S. IT FIRMS AND

AFFILIATED FIRMS ABROAD

Many U.S. IT firms, spurred by competition from low-cost foreign producers
and the liberalization by a growing number of countries of controls on direct
investment and capital flows, have moved lower value-added production overseas.
As a result, intra-firm trade, defined as cross-border sales between parents and
affiliates of U.S. and foreign multinational companies, accounts for a
significant portion of our trade in IT products. In 1997, for instance, U.S.
exports to affiliated firms in core IT hardware industries--computer and office
equipment; electronic components and accessories; and audio, video and
communications equipment--amounted to roughly 60 percent of U.S. exports of
goods in these classes of IT hardware.
(Appendix Table 6.1)

Trade between U.S. parent companies and their overseas affiliates has
contributed to a reduction in the size of the U.S. trade deficit in
information technology products. Trade between foreign parents and their U.S.
affiliates has had the opposite effect. (Table 6.1) On balance, the combined
impact of intra-firm trade remains positive. In 1997, exports by U.S. parents and U.S. IT
affiliates of foreign-owned companies to affiliated firms overseas exceeded $65
billion, while imports from foreign parents or foreign affiliates of U.S.
parents totaled $52 billion, resulting in a net surplus of $13.2 billion. (Table
6.1) In other words, the U.S. trade deficit in IT goods and services
is due to the imbalance in trade between unaffiliated companies.

SALES BY U.S. AND FOREIGN IT
AFFILIATES

As a group, American companies that make IT products for sale outside the
United States are more likely to supply these markets with goods and services
produced by their overseas IT affiliates, than to export to these markets from
the United States. The global competitiveness of the U.S. IT industry is
apparent in the comparison of sales by U.S. IT affiliates abroad with sales by
foreign-owned IT affiliates stationed in the United States. In 1997, for
example, foreign sales by U.S.-owned overseas affiliates in the computer and
office equipment industry exceeded sales in this country by foreign-owned U.S.
affiliates in the same industry by $67 billion. Similarly, the balance of sales
in 1997 favored American-owned foreign providers of computer processing and
information retrieval services by $41 billion and U.S.-owned foreign producers
in the electronic components and accessories industry by $20 billion. In
contrast, the comparable balance in the audio, video, and communications
equipment industry was roughly zero, while U.S. sales by American affiliates of
foreign firms in the communications services industry topped foreign sales by American-owned affiliates
providing the same services overseas by $35.8 billion. (104) (Table
6.2)

CHAPTER
VII

WHAT IS NEW IN "THE NEW ECONOMY"? (105)

Compared to the period from 1973 to 1995, the American economy has turned in
a remarkable record for the last four and a half years. Productivity gains,
investment rates, and real wage growth are all higher; unemployment and
inflation are lower; and the expansion has now set an all-time U.S. endurance
record. Increasing confidence that the future of the real economy (106) will look more
like the last four years than the preceding 22 years has led more analysts and
even economists to accept the media label, "The New Economy." Although slowdowns
and recessions will occur at some point, the economy's trajectory appears to
have shifted upward.

The information technology sector has played a critical role in the economic
success of recent years. Businesses across the economy have been investing
heavily in IT hardware and software to harness the potential created by falling
prices and by the increasing capacities of computer processing, storage media
and communications links. Business strategies and even the structures of
companies and industries are being transformed as communication within companies
and among the members of corporate alliances occurs more rapidly, with more
customized information, and with greater security, interactivity, and timeliness
than before. The same quality (or "richness") of communication that once was
limited to a narrow group of close contacts can now be extended to a much wider
"reach" of contacts.
(107)

The IT revolution is affecting everyone's life. The advances and spread of IT
are part of the reason why we now have the lowest unemployment rate and fastest
growth in real wages in three decades and the longest expansion on record.
Consumers are making a small but increasing amount of their purchases online and
using the Internet to make more informed purchases offline. IT is also
transforming the way most firms operate. As employers substitute IT for labor,
workers have to develop new skills.

LONG TERM FORECASTS ARE BEING RAISED

The hallmark of the New Economy is higher sustainable growth due to faster
improvement in labor productivity. Recently, most economists have begun to
accept that the U.S. economy can sustain growth at a substantially higher rate
than the 2.5 percent a year average for the 1973 to 1995 period. For example,
the Blue Chip consensus growth forecast released in January of each year from
1996 to 1999 forecast growth for the coming year of 2.3 and 2.4 percent. (108) In each of those
four years, actual growth surpassed 4 percent. (Figure 7.1) However, this past
January, the consensus forecast for 2000 came in at 3.2 percent. Furthermore,
the Blue Chip longer term outlook has also shifted upward. After many years of
forecasting 2.45 to 2.7 percent average annual growth over the coming 10 years,
the consensus in the latest forecast shifted up to 3.1 percent. (Figure 7.2)
Since the U.S. labor force tends to grow by little more than 1 percent per year,
the hike in growth forecasts strongly implies that in the last year Blue Chip
economists have raised their expectations of annual labor productivity growth
from roughly 1.5 percent to about 2 percent.

This more sanguine view of our future economic prospects comes from greater
confidence that the faster labor productivity of the last four years (see Figure
1.1), based significantly on developments in IT investment, has some staying
power. (109) It
is noteworthy that this optimism is still somewhat conservative, since the labor
productivity growth assumed in the ten-year forecast is still much slower than
the recent pace. However, since strong output growth tends to raise labor
productivity growth, Robert Solow has recently cautioned, probably speaking for
many economists, that he "will feel better about the endurance of the
productivity improvement after it survives its first recession." (110)

IT can support higher rates of labor productivity gains and output growth, so
long as IT innovation and price declines persist, and non-IT industries continue
to invest heavily in IT products and services. Both of these conditions are
expected to persist into the future. Experts in the semiconductor, computer,
storage, and communications industries have expressed confidence that rapid
rates of product innovation and price decline can continue for at least another
decade. Experts in non-IT industries also have expressed confidence in their
capacity to benefit enormously from further substantial investments in
IT.

The prospect of healthier productivity gains over both a medium term and a
longer run has significant implications for our future standard of living and a
range of fiscal issues facing government at all levels. For example, faster
productivity growth translates into more tax revenue, which in turns creates
larger budget surpluses and longer positive balances for trust funds such as
those for Social Security and Medicare. Faster productivity growth also means
lower inflation, reducing the additional costs of COLAs for most entitlement
programs.

IMPLICATIONS OF IT-FOCUSED INVESTMENT
FOR

THE BUSINESS CYCLE

The boom in IT investment has implications for the business cycle that go
beyond the impact on underlying trend growth. As Martin Baily, chairman of the
President's Council of Economic Advisers, has noted, the current nine-year-old
expansion has not developed the "geriatric" conditions that we have come to
expect after several years of solid economic growth. In particular, the improved
labor productivity growth (see Table 4.1) has been a "fountain of youth" for the
expansion. As previous postwar expansions matured, labor productivity and output
slowed, inflation rose, real wages stagnated, and profits declined. The unusual
pattern of conditions continuing to improve as this expansion has aged can be
seen clearly by charting the progression of five basic indicators over the long
business expansions of the 1960s, 1980s, and 1990s. (Figures 4.1, 7.3-7.6)
Although real wages did continue to grow throughout the 1960s expansion, recent
real wage growth has been even faster than in the 1960s. Although growth in real
profits has slowed in recent years, by this stage in previous business
expansions, profits were declining sharply.

The strong output growth and continued improvements in profits in the current
expansion have, in turn, fueled unusual vigor in real spending for private
investment generally and for research and development in particular. (Figures
7.7 and 7.8)

Much as IT has boosted growth in the expansion, it could have a dampening
effect on the next business slowdown. (111) In the past, a
substantial slowdown or decline in overall demand has led to even greater
slowdowns or even declines in investment as capacity and inventories suddenly
became excessive. At some time in the future, the economy will slow down,
squeezing the corporate cash flow that helps finance new investment and creating
involuntary excess capacity and inventories. While this should curb new
investments to expand capacity, investments in IT should be far less affected.
In most industries, IT investments do not expand capacity; rather, they provide
general cost savings, reduce errors, provide the basis for more prompt and
informed decisions, and increase customer satisfaction. For industries in which
IT investments directly expand capacity to provide services (e.g., finance, real
estate, retail) a slowdown in demand should directly slow IT investment. Because
IT investments are commonly driven by pressures to keep pace with competitors,
in terms of costs and satisfying customer demand for more responsive products,
IT investment should weather a slowdown in demand better than capacity expanding
investments

The spread of IT could also moderate the sharp declines in manufacturing
inventories that occur in recessions. By improving communications with suppliers
and customers, IT has facilitated manufacturers' efforts to limit their
inventory exposure. As a result, durable goods manufacturers have reduced their
inventory ratios from 16.3 percent of annual shipments in 1988 (the lowest
period in the 1982-90 expansion) to just 12.0 percent in the last 12 months.
(Figure 7.9)

If U.S. manufacturers of durable goods today held inventories at the 1988
inventory to sales ratio, they would be holding an additional $115 billion in
inventory (Figure 7.10). The cost savings from reduced inventories takes
several forms. First, there is the average savings of about $10 billion a year
from not having to pay to accumulate as much new inventory in each of the eleven
years. Second, the cumulative $115 billion in funds that would have been spent
for inventory have been used to invest elsewhere or pay down debt. By this
point, the financial benefit of the second effect exceeds the benefit from the
first. Third, the companies are spared the expense of storing and securing
one-third more inventory than they now hold. Fourth, they avoid the inevitable
losses from holding inventories for products that lose favor in the marketplace.
All told, lower inventories were a significant factor in the sector's $99
billion of profit in 1999 (and in keeping down prices to their customers).

Adjustments to inventory have aggravated all recent recessions because, as
Figure 7.11 indicates, recessions tend to have bigger declines in output than in
sales. (Sales actually continued to rise during the recessions of 1960 and
1969.) Reductions in inventory accumulation account for the gap between the
change in output and the change in sales. On average, inventory corrections in
the six recessions since 1960 made the change in GDP 1.6 percentage points
greater than the change in final sales. Today's leaner inventories should, other
things equal, cushion the depth of the next recession by narrowing the gap
between declines in output and demand.

WHY NOW? WHY HERE?

The U.S. labor productivity boom of the last four years has outpaced not only
its own performance from 1973 to 1995, but also the labor productivity gains of
other major industrial countries in recent years. Since information technologies
and IT prices have been steadily improving since the early 1970s, why didn't
U.S. labor productivity improve sooner? Since IT is readily available on the
world market, why hasn't labor productivity accelerated in most other industrial
countries?

The U.S. macroeconomic environment since the early 1990s has stimulated an
investment boom. Both fiscal and monetary policy have contributed. The 1990s
began with very large budget deficits projected to grow even larger. However,
prudent policies to curb spending and raise revenues were introduced, and the
fiscal picture has reversed. Another reason for the current long boom is that
Federal Reserve policymakers have generally paid more attention to the fact that
inflation has kept on falling, than to traditional concerns that low
unemployment would reignite inflation. Back when the unemployment rate first
reached the once-worrisome range of 5.5 percent to 6 percent, the Fed could have
dampened growth to keep unemployment from falling further. Had they done so, the
United States would not have seen the broad gains in output, investment, and
labor productivity that have occurred.

Sound macroeconomic policies have helped lower unemployment and inflation,
but they cannot account for the recent multi-year doubling of labor productivity
growth. For that, look to more technologically based explanations. For example,
there is the view that fundamental technological changes, from electricity to
IT, take a very long time to generate labor productivity breakthroughs - and
when they do, labor productivity rises very sharply. Comparing the economic
history of electricity and electrical motors to our recent experience with
computers, Paul David and Gavin Wright have documented that labor productivity
in U.S. manufacturing grew less than 1 percent a year from the commercial
introduction of electric motors in the three decades prior to the 1920s, and
then soared to 5 percent per year in the 1920s. (112)

Another explanation uses the model of "recombinant growth" drawn from the
biological sciences.
(113) Hal Varian observes that "Every so often innovations come along
that can be broken down into separate parts and recombined to create a host of
new inventions." As businesses bring together different elements in creative
combinations, some flourish while many others are ephemeral. Varian cites the
historical examples of the periods following Eli Whitney's "uniformity system"
to produce muskets, and Edison's invention of the "invention factory." (114) He also gives
the more recent example of integrated circuits leading to circuit boards for
many modern devices and predicts that "the Web's components - URLs, CGI scripts,
HTTP protocols and the HTML language" provide the basis for another period of
recombinant growth. Recent and now predictable "recombinant growth" includes not
only Web components but hardware innovations that can be creatively taken apart
and recombined for innovative products.

Perhaps most important of all are the broad market conditions that support
innovation. Deregulation has helped drive the development of the largest and
most creative financial markets in the world, including equity markets, credit
markets, and venture capital. Reallocation of resources is facilitated not only
by nimble capital markets but by relatively few barriers to bankruptcy.
Americans also enjoy a lower tax burden, and much more fluid and deregulated
labor markets, than most other countries. Cultural factors probably also matter,
especially the admiration many Americans feel for entrepreneurism and
risk-taking.

PRODUCTIVITY ACCELERATION AND

JOB DISPLACEMENT

Another important issue concerning the dynamics of the New Economy is their
effect on jobs. In an aggregate or macroeconomic sense, the New Economy has been
characterized by strong job and wage growth. With lower inflation and
accommodating monetary policy, unemployment has fallen below 4 percent, the
lowest rate since 1969. The unemployment rate of those with less education and
experience has fallen along with the rates of everyone else, although it remains
higher than those of better educated and experienced workers. Similarly, with
everyone else, workers near the bottom of the ladder in recent years have
enjoyed strong real wage growth.

The effect of the New Economy on jobs at an industry and firm level is more
difficult to analyze. As shown in Chapter V, we can detect some important
effects of IT on IT-related employment, but we can only speculate on the effect
of IT on non-IT related jobs. The number of well-paid jobs in the IT producing
and IT-using sectors is growing rapidly, even as the number of lower-paid
IT-related jobs is shrinking. It is reasonable to assume that IT, by raising
labor productivity, must displace jobs somewhere in the economy. However, there
is no clear evidence about what types of jobs are displaced most rapidly by IT.
A significant percentage of jobs in modern America involve collecting and/or
processing information, and/or making decisions based on information; but some
sectors, such as education and financial services, have a higher proportion of
information-intensive jobs than other sectors. However, all sectors have
information-based functions, such as sales, purchasing and finance, in which IT
investments could displace many current jobs and raise labor productivity.

AFTER SOFTWARE, SHOULD OTHER INTANGIBLE INVESTMENTS
ENTER THE NATIONAL ACCOUNTS?

Among the statistical issues raised by the New Economy is the significance of
business investments in intangibles. When the Bureau of Economic Analysis (BEA)
recently reclassified software as a form of investment, rather than as business
expenditure or intermediate input, this change substantially increased the size
and growth of IT in our national accounts. Drawing the curtain to reveal a
sector that grew from $28 billion in 1987 to $149 billion in 1999 had a
catalytic effect on economists' perceptions of non-computer aspects of the IT
sector. Much as businesses expect to earn a return on their investments in
software over several years, business spending on intangibles such as training,
workplace reorganization, and consultants can also be viewed as investments with
long-term payoffs.

The work of Erik Brynjolfsson and his coauthors discussed in Chapter IV
strongly suggests that such intangibles are important investments supporting and
complementing tangible IT investments. Not long after BEA recognized software as
investments, Federal Reserve Board Chairman Alan Greenspan urged that the
national accounts go beyond software to include other intangible
investments.
(115)

The treatment of business spending on other intangible investments could have
significant effects on a range of measures central to our understanding of the
economy. Since such intangible investment has no doubt been growing faster than
GDP, its inclusion as investments would raise our measure of GDP growth. This
change also would likely improve our ability to account for growth attributable
to specific inputs, and leave less unexplained. (116) Since these
intangibles often complement computer and other IT investments, this change
would also help resolve the paradox of the supernormal returns on computer
investments found in some firm-level studies.

On the other hand, incorporating other intangible investments into the GDP
measure would highlight the limitations of GDP as the almost-exclusive gauge of
longer term growth trends. IT investments tend to have short lifespans and thus
faster depreciation rates than average. As the IT share of investment rises,
depreciation rises faster than GDP. Net Domestic Product (GDP less depreciation)
provides a better indication of sustainable growth. As IT has become a larger
share of total investment, the gap between GDP growth and NDP growth has
widened. In the 1960s, GDP and NDP both grew at the same 4.4 percent rate. By
1999, however, GDP grew by 4.1 percent, but depreciation was growing so much
faster that NDP grew by only 3.6 percent.

TO SOLVE THE PRODUCTIVITY PUZZLE, BETTER MEASURES OF
SERVICE INDUSTRY OUTPUT ARE NEEDED

As a practical matter, the question of precisely how much IT has contributed
to our stellar economic performance will remain largely a mystery at least until
BEA develops ways of better measuring output in several key IT-intensive
services industries. As noted in Chapter IV, the view that IT has made a large
contribution to labor productivity growth, based on evidence at the
macroeconomic and firm levels, cannot yet be confirmed at the industry level. As
Dale Jorgenson and Kevin Stiroh caution:

The apparent combination of slow productivity growth and heavy computer-use
[in specific service industries] remains an important obstacle for new economy
proponents who argue that the use of information technology is fundamentally
changing business practices and raising productivity throughout the U.S.
economy. (117)

The fact that official measures show flat or declining labor productivity for
several IT-intensive service industries, such as health and business services,
does not mean that labor productivity has not improved in those industries. The
techniques used to measure output in these industries either assume no labor
productivity change or otherwise fail to capture increases in their output
fully.

A case in point is the measurement of output in the banking industry. Until
recently, output in the banking industry was constructed with the same basis
still used for some major service industries - assuming no labor productivity
change - by using labor input growth as a measure for output growth. With its
benchmark revisions released in October 1999, BEA adopted a new method for
measuring bank industry output based on the industry's transaction activities.
As a result, measures of the IT-intensive banking industry now indicate
significant annual labor productivity gains, in contrast to the negative labor
productivity changes portrayed under the old method.

Producing true output measures for all service industries presents a daunting
task. The Bureau of the Census should do more complete surveys of service
industries broken down into more detailed and current categories. Even with such
data, BEA faces difficult conceptual challenges in developing satisfactory
methods for measuring the output of health, legal, business, and other services.
However, BEA has pioneered the use of creative new methods for measuring the
quality, price and output changes for computers, semiconductors, and certain
telecommunications equipment, along with the development and use of
sophisticated methods such as chain-weighted indexes to properly gauge real
output changes in a world with some sharply falling prices. Without these
statistical advances, it would not have been possible to assess the contribution
of IT at the macroeconomic level. (Indeed, the fact that the GDP accounts of
other major industrial countries do not include these advances makes
international growth comparisons very problematic.)

In the absence of more accurate measures of output for IT-intensive services
industries, we cannot rule out the possibility that IT has made a very modest
contribution to labor productivity outside the IT producing sector itself. With
better measures of output for individual service industries' output, we may
learn that IT has contributed strongly to service industry productivity or,
conversely, that IT has not contributed as much to overall labor productivity
improvement as technical change outside of IT, including organizational change.

THE DIGITAL DIVIDE: COMMUNITIES WITH
LOW

INTERNET
ACCESS RATES

Internet access has grown across every group and state in America, but this
growth has been most rapid among those households with higher incomes, more
education, computers at work, white or Asian backgrounds, and headed by persons
age 35 to 50.
(118) Serious concerns about other groups that are currently "falling
through the Net" are based on the fact that the Internet is not merely a
place to shop, but also a space where students learn, people find employment,
and communities communicate.

Robert W. Taylor, the director of the Defense Department agency that created
the original Internet in 1969, co-authored a remarkably prescient paper in 1968,
"The Computer as a Communication Device," raising concerns about what is now
called the Digital Divide:

For the society, the impact will be good or bad, depending mainly on the
question: Will to be 'online' be a privilege or a right? If only a favored
segment of the population gets a chance to enjoy the advantages . . . the
network may exaggerate the discontinuity in the spectrum of intellectual
opportunity.
(119)

In more affluent and better educated communities, Internet access has reached
a critical mass. Students are assigned to do their research on the Web, at home
and not just in the library. Increasingly, job-seekers find job openings on the
Web. Sign-up lists passed around at the PTA or other local organizations include
a column for e-mail addresses, along with name and telephone number. In each
instance, the Internet provides the means for communicating information critical
for students, job-seekers, and members of organizations, that could not occur as
effectively in other ways.

In 1998, 42 percent of all American households had computers at home, and 22
percent had Internet connections at home. Some groups, however, are better
networked. Among the 5.5 million White, Asian, and Pacific Islander families
with incomes of at least $75,000, living in a metropolitan area, headed by
someone with at least a college education and age 30 to 55, 87 percent had
computers at home, and 68 percent had Internet connections. Among households
with these levels of income, education, age and living in a metropolitan area,
Black and Hispanic households were just as likely to have home computers - but
roughly 14 percent less likely to have Internet access at home - as White,
Asian, and Pacific Islander households in the same income, education and age
group. (120)

At the other extreme, the 1.2 million Black and Hispanic urban households
with incomes below $15,000, in which all adults lack a high school diploma or
GED, and headed by someone age 30 to 55, only 7 percent had computers at home
and only 2 percent had Internet service. Among Whites, Asians, and Pacific
Islanders with similar low income, lack of education, and age, 14 percent had
computers at home, and 5 percent had home Internet connections. (121)

Since 1998, more households have obtained computers and Internet access and
alternative points of access, such as state employment commission offices,
public libraries, and community centers and clubs, have expanded. When the
results from a new Census Bureau August survey of households become available
this Fall, we will learn the extent to which different groups have improved
their access to the Web and capacity to create networks on the Internet.

Nonetheless, many Americans - particularly those with less income and
education - are still missing out on the network benefits of the Internet age.
And as more and more everyday activities migrate to the Internet, the gap in
opportunities available to those on either side of the digital divide increases.

CONCLUSION

The dynamism of the New Economy presents opportunities and challenges for
almost everyone. IT can offer cost savings, expanded markets, and more intense
competition for private businesses in almost every industry. As employers are
less readily finding workers with appropriate skills, they have had to provide
more training for current employees and to modify technology to match the skills
of available workers. Workers are more readily finding better paid jobs, but to
do so they must often adapt to new technologies. Because many of the jobs
potentially displaced by IT investments now require average or better education
and skills, those displaced may well find new jobs quickly, possibly with the
same employer. The New Economy is expanding the revenues for government, even as
it presents many new and difficult policy issues. Finally, economists and
statistical agencies are now able to obtain better information, more quickly,
but they also have to redesign their frameworks to capture this fast-changing
economy.

ACKNOWLEDGMENTS

The authors would like to express their appreciation to the many people who
contributed substantially to the production of this report. These include at the
Department of Commerce: Elliot Maxwell, Special Advisor to the Secretary for
E-Commerce; Carol A. Meares, Technology Administration; Barbara Fraumeni, Ralph
Kozlow, Christopher Bach, Michael Mann, John Rutter, Mai-Chi Hoang, Obie
Whichard and Ray Mataloni, Bureau of Economic Analysis; Thomas Mesenbourg,
Harvey Monk, Donna Wade and Minh Nguyen, Bureau of the Census; Carl Cox, John
Tschetter and George McKittrick, Office of Chief Economist, Economics and
Statistics Administration; Roger Pomeroy and Marjorie Pavliscak, International
Trade Administration; and James McConnaughey, National Telecommunications and
Information Administration. The authors would also like to thank Daniel Hecker
and James Franklin, Bureau of Labor Statistics, U.S. Department of Labor; Scott
Ki, International Trade Commission; Raymond Wolfe and John Jankowski, National
Science Foundation; and Daniel E. Sichel and Stephen D. Oliner, Board of
Governors of the Federal Reserve System.

1. If productivity
growth had remained at 1.4 percent for the last four years, nonfarm output would
have been $300 billion lower in 1999, the equivalent of about $1,100 in lost
output for every person in the country.

2. Doubling every 18 months is
closely equivalent to increasing by a factor of 10 every 5 years and by a factor
of 100 every 10 years. This phenomenon is know as "Moore's Law" and was first
noted by Gordon Moore, co-founder of Intel, in 1965. Intel. "What is Moore's
Law" Intel Museum Home Page. (http://intel.com/intel/museum/
25anniv/hof/moore.htm)

3. Jon William Toigo,
"Avoiding a Data Crunch." Scientific American. May 2000.
(http://www.scientificamerican.com/ 2000/0500issue/0500toig.html)

4. David Clark, senior
research scientist at MIT's Laboratory for Computer Science, cited in Jeff
Hecht, "Wavelength Division Multiplexing." MIT's Technology Review.
March/April 1999. (http://www.techreview.com/articles/ma99/ hecht.htm)

5. Skeptics argue that
software upgrades do not represent increases in performance, but only the
addition of bells and whistles that offset improvements in processing speed.
However, that view ignores the directions taken in the business uses of their
software investments. Businesses are deploying software to combine cheaper
computer power with more reliable communications to create extraordinary
efficiencies and improve decision making within their own operations and supply
networks. For example, over a three-year period, Wal-Mart achieved a 47 percent
increase in sales on only a 7 percent increase in inventories by using a
relational database system running on massively parallel computers. The system
allows vendors to access almost realtime information on sales and customer
transactions and handles 120,000 queries each week from 7,000 suppliers.
Businesses are also investing in software to integrate information and reduce
staffing in other activities, such as production operations, human resource
management, payroll, and sales force activities. "High-tech Complements Human
Touch." Discount Store News. October 1999.

6. The number of possible
connections is technically n(n-1). This contrast between the change in cost and
value of a network as it grows is sometimes labeled "Metcalfe's Law." Shapiro,
Carl and Varian, Hal. Information Rules: A Strategic Guide to the
Network Economy, Boston: Harvard Business School Press. 1998. p. 184.

7. Robert X.
Cringely, Accidental Empires, New York: Harper Business. 1992. P.
83.

8. This chapter was written by
Patricia Buckley, Senior Policy Advisor, and Sabrina Montes, Economist, in the
Office of Policy Development.

9. Specific estimates from
private sources and company-specific examples are included in this report to be
illustrative of developing trends and their inclusion does not signify
Department of Commerce validation or approval. Disparities among private
estimates can result from differences in definitions, methods, data, model and
sampling error, and product coverage. Variations also reflect the research needs
of customers. While data used for estimates and forecasts are based on a
combination of surveys and interviews, the survey questions and answers are not
made public, sample sizes vary considerably across surveys, and little
information is available on the respondents.

10. Inktomi, "Inktomi
WebMap," Press Release, January 2000 (http:/www.inktomi.com/webmap). Although
over one billion unique pages exist, it should be noted that even the most
sophisticated search engines cover only a relatively small proportion of the
total number of existing Web sites.

11. David Peterschmidt,
President of Inktomi, quoted by Yahoo, "Internet Volume is Doubling Every 90
Days," October 3, 1997 (http://www.nua.ie).

12. This analysis follows the draft definition of electronic
commerce developed by the U.S. Bureau of the Census. According to this
definition, electronic commerce is a specific type of e-business processes--one
that involves a transaction, the transfer of ownership. See Thomas L.
Mesenbourg, "Measuring Electronic Business: Definitions, Underlying Concepts,
and Measurement Plans," U.S. Bureau of the Census, 1999
(http://www.census.gov/epcd/ www/ebusines.htm).

13. The Census retail
e-commerce estimate was obtained by surveying goods retailers. The survey panel
included not only the traditional bricks and mortar retailers, but also Internet
"pure plays," online versions of traditional retailers, and manufacturers that
have set up a retail establishments (real or virtual) to sell directly to the
public. The Census retail e-commerce estimate does not include
business-to-consumer sales of services, such as travel, entertainment, or stock
transactions. Ongoing Census surveys will provide information on 1998 and 1999
transactions in other areas of the business-to-consumer e-commerce market space
(including services and food service and accommodations businesses).

14. Forrester Research,
Forrester Findings (http://www.forrester.com/ER/Press/0,1772,0,FF.html).

15. See for example, Jupiter
Communications, "Online Holiday Sales Hit $7 Billion, Consumer Satisfaction
Rising," Press Release, January 13, 2000 (http://www.jup.com) and PC Data
Online, "Web Retailers Score High In Customer Satisfaction Study," Press
Release, January 11, 2000 (http://www.pcdataonline.com).

16. Jonathan Weber, "The Last
Mile," The Industry Standard, March 27, 2000 (www.thestandard.com).

17. Erik Brynjolfsson and
Michael D. Smith, "Frictionless Commerce? A Comparison of Internet and
Conventional Retailers," Management Science, April 2000
(http://ecommerce.mit.edu/papers/friction).

18. Karen Clay, Ramayya
Krishnan, Eric Wolff, and Danny Fernandes, "Retail Strategies on the Web: Price
and Non-price Competition in the Online Book Industry," Working Paper, December
1, 1999. Differentiating factors include site brand name awareness, ease of
navigation while on the site, and a reputation for reliability.
(http://dnet.heinz.cmu.edu/dcsrg/books/papers/paper1.pdf). In addition, a recent
Activmedia Research report found that competing on price alone is not enough for
an e-commerce site to sustain competitive advantage. See Nua Internet
Surveys, "Activmedia: Competitive Advantage is Not About Price," March 2,
2000 (http://www.nua.ie. Another survey, this one by Cyber Dialogue, found that
price was a decisive factor in online purchases. See Nua Internet
Surveys, "Cyber Dialogue: Price Still Drives Choice of Shopping
Site," March 1, 2000 (http://www.nua.ie).

19. J.D. Powers and
Associates, "More Than Five Million New-Vehicle Shoppers Nationwide Use the
Internet to Shop for New Vehicles," Press Release, August 23, 1999
(http://www.jdpower.com).

20. Janlori Goldman, Zoe
Hudson, and Richard Smith, "Privacy: Report on the Privacy Policies and
Practices of Health Web Sites," sponsored by California HealthCare Foundation,
January 2000. Executive Summary, pp. 4-5 (http://ehealth.chcf.org).

21. Jupiter Communications,
"Internet Health Commerce to Soar to $10 Billion, But Current Offerings Don't
Deliver on Consumer Convenience," Press Release, January 26, 2000
(http://www.jup.com).

22. Recruitsoft.com and
iLogos Research, Global 500 Web Site Recruiting 2000 Survey, An Internet
Intelligence Report (http://www.recruitsoft.com/iLogosSurvey/doc.html). The
Global 500 is a list of the largest companies in the world, by gross revenue,
according to Fortune Magazine.

23. Forrester Research,
"Forrester Predicts Career Networks Will Capture Majority of Online Recruitment
Market in 2005," Press Release, February 14, 2000 (http://www.forrester.com).

24. Glenn R. Simpson, "The
Web's Final Frontier: City Hall--Two Internet Start-Ups Find Bureaucrats a
Harder Sell Than Venture Capitalists," The Wall Street Journal, May 17,
2000, p. B1.

25. Emily Wax, "Immigrants
Use Internet As a Link With Past," The Washington Post, February 3, 2000.

26. Although The Census
Bureau has developed a measurement program to capture B2B e-commerce and the
broader category of activities generally termed e-business processes, no
government estimates are currently available. For a discussion of the surveys
currently scheduled see http://www.census.gov/epcd/www/ebusines.htm.

27. Stacy Lawrence, "Behind
the Numbers: The Mystery of B2B Forecasts Revealed," The Industry
Standard, February 21, 2000 (http://www.thestandard.com).

28. National Association of
Manufacturers, "New NAM Poll Shows that Despite Tech Advances, Most Manufactures
Still Not Using E-commerce." Press Release. February 22, 2000
(http://www.nam.org/News/Releases/Feb00/ pr0222.htm).

29. Mark A. Brunelli, "What
Buyers Want From Web Sites," Purchasing Online, Special Internet
Report, December 16, 1999
(http://www.manufacturing.net/magazine/purchasing).

30. "Seller Beware," The
Economist, March 4, 2000, p. 61-2.

31. General Motors
Corporation, Ford Motor Company, and DaimlerChrysler, "Ford, General Motors and
DaimlerChrysler Create World's Largest Internet-Based Virtual Market Place,"
Press Releases, February 25, 2000.

32. Keith Bradsher,
"Carmakers to Buy Parts on Internet," The New York Times, February
25, 2000, p.1.

33. Oracle, "Sears,
Carrefour, Oracle to Form Retail's First Worldwide Online Marketplace," Press
Release, February 28, 2000 (http://www.globalnetxchange.com).

34. Sandra Guy, "Sears,
French Giant in Online Venture," Chicago Sun-Times. February 29,
2000.

35. Boeing, "Boeing, Lockheed
Martin, BAE Systems and Raytheon to Create B2B Exchange for the Aerospace and
Defense Industry," Press Release, March 28, 2000 (http://www.boeing.com).

36. National Association of
Manufacturers, "New NAM Poll Shows that Despite Tech Advances, Most Manufactures
Still Not Using E-commerce," Press Release, February 22, 2000
(http://www.nam.org/News/Releases/Feb00/ pr0222.htm).

37.  Boston Consulting Group, "New BCG Study
Re-Evaluates Size, Growth and Importance of Business-to-Business E-Commerce,"
Press Release, December 21, 1999
(http://www.bcg.com/media_center/media_press_release_ archive2.asp).

38. Clinton Wilder, "Unload
your Surplus on the Web," Informationweek, August 30, 1999.

39.  Ibid.

40. Pat Reynolds, "Corrugated
Comes Over the Internet," Packaging World Interactive. April 2000.

41. BOC Gases, "Electronic
Commerce as BOC Gases in the United States," Web site viewed February 23, 2000
(http://www.boc.com/ecom/success.html).

42. John Deere, "Deere
Announces Internet-Based Customer Support Program," News Release, December 9,
1999 (http://www.deere.com).

43. David Kleinbard, "Web
Puts a Charge into Electronics," InformationWeek, September 27,
1999.

44. "Shaw Industries
Optimizes Employee Compensation and Retention using Hyperion's Analytic
Application Software," Business Wire, Feb 23, 2000.

45. "Symbol Partners With BPA
Systems To Provide Cablevision With Wireless ERP Warehouse
Solution," Business Wire, February 23, 2000.

46. Richard W. Oliver,
"Killer Keiretsu," Management Review, September 1999, p.11.

47. Ford Motor Company Web
site, Viewed on May 9, 2000 (http://www.ford.com).

48. Edward Cone, "Building a
Stronger Economy," Zdnet, January 24, 2000
(http://www.zdnet.com/intweek/stories/ news/0,4164,2425874-1,00.html).

49. Forrester Research,
"Spectacular Growth for Digital Delivery," February 7, 2000 reported by Nua
Internet Surveys, (http://www.nua.ie). The ability to download material
raises concerns about intellectual property protection. For example, Napster,
creator of a software program that allows users to swap music stored in the MP3
format, is facing multiple lawsuits, charging that it facilitates the pirating
of digitized music.

50. See
(http://www.havi.org).

51. Emily Thornton, "Digital
Wheels", BusinessWeek Online (International Edition), April 10, 2000
(http://www.businessweek.com/2000/00_15/b3676012.htm ). For example, Toyota
equips some high-end models with its Monet system that offers a online
navigational system as well as audio e-mail, weather, news, and real-time video
pictures of traffic at major intersections.

52. This chapter was written
by David Henry, Senior Industry Analyst, and Donald Dalton, Economist, in the
Office of Business and Industrial Analysis. See the Appendix for data sources
and the methodologies underlying the findings.

53. Estimates of GPO in this
analysis are derived from BEA measures prior to the October 1999 benchmark
revisions, but include the conceptual change made at that time in the treatment
of prepackaged software and software services in the National Income and Product
Accounts. Prior to this change, software purchases were treated as an
intermediate input with no lasting effect. Such purchases are now classified as
fixed investments for both business and government sectors.

54.
IT-producing industries' share of the economy is calculated from its Gross
Product Originating (GPO) as a percent of the economy, as measured by Gross
Domestic Income (GDI). Theoretically, the nominal dollar value of GDI, the
income associated with the output of all industries, should equal that of Gross
Domestic Product (GDP); i.e., final demand or the market value of the goods and
services produced by labor and property in the United States. In practice,
growth in GDI and GDP have differed by half a percent in recent years.

55. Estimate of percent
of output based on industry spending estimates in the The Economics of
Y2K and the Impact on the United States, Economics and Statistics
Administration, U.S. Department of Commerce, November 17, 1999.

56. These estimates are based
on inflation adjusted "income side" data; i.e., income attributable to IT
industries compared to growth in Gross Domestic Income (GDI). Income side data
were used here because "product side" data--the data used to estimate GDP--are
not sufficiently disaggregated to describe the economic performance of all
IT-producing industries. However, for a large segment of IT output--i.e.,
computers, software, and telecommunications--product side data can be used to
test the robustness of income side estimates. In fact, for this segment of
output, estimates of IT industries' contribution to economic growth based on
product side data coincide quite closely with growth estimates based on income
side data. Since 1995, based on product-side data, computers and software and
communications services have contributed about 23 percent to economic growth;
the comparable estimate using income-side data is about 22 percent.

57. Prior to the inclusion
of software as an investment good, industry spending on IT equipment
consistently accounted for about one-third of all capital equipment spending in
the 1990s.

58. Over the 20 year period
since 1980, spending on IT equipment has grown at a steady annual rate of 10-11
percent. In contrast, growth in spending in other categories of capital
equipment, including industrial equipment, averaged about 5-6 percent over the
same period. Spending for transportation equipment grew by an average 5 percent
per year in the 1980s, but accelerated to 11 percent in the 1990s.

59. Total R&D spending
includes industry, federal government, universities and nonprofit institutions.

60. R&D data are
available for most, but not all, of the IT-producing industries identified in
Table 3.1. Analysis in this section is based on data for the following 3-digit
SIC categories: computers and office equipment, communications equipment,
electronic components, communications services, and computer services and
software.

61. See the Appendix for the
National Science Foundation data on R&D spending.

62. This chapter was written
by Gurmukh Gill, Director of the Office of Business and Industrial Analysis
(OBIA), Jesus Dumagan, Economist, OBIA and Susan LaPorte, Economist, OBIA.

63. "Capital deepening"
occurs when the amount of capital rises relative to the amount of labor hours.

64. The rates of capital
deepening in Figure 4.2 are obtained for each period by subtracting the labor
hours growth rate from the growth rates of each type of capital, where the labor
hours growth rate is equal to the growth rate of output minus the growth rate of
labor productivity. All growth rates used in the figure can be obtained from
Stephen D. Oliner and Daniel E. Sichel, "The Resurgence of Growth in the Late
1990s: Is Information Technology the Story?," Washington, DC: Federal Reserve
Board, May 2000, Tables 1 and 2, pp. 24-25.

65. Computing speed has been
doubling every 18 months. This phenomenon
is commonly called "Moore's Law." A number that doubles every 18 months grows
exponentially 46.2 percent per year. Thus, by Moore's Law, computer speed
increases roughly ten-fold every 5 years.

66. Daniel E. Sichel,
"Computers and Aggregate Economic Growth: An Update," Business
Economics, April 1999, pp. 18-24, Table 1, p. 19.

67. The contribution of
capital deepening to labor productivity growth for each type of capital equals
the rate of growth of the ratio of the capital type to labor hours multiplied by
the income share of the same type of capital. For example, Oliner and
Sichel, op. cit., Tables 1 and 2, pp. 24-25, estimated that the rate
of growth of computer hardware/labor-hour was 33.65 percent during 1996-99 and
the corresponding income share of computer hardware was 1.8 percent. Thus, they
estimated that the contribution of capital deepening in computer hardware to
labor productivity growth was (33.65) x (0.018) = 0.606 percentage points when
average labor productivity growth was 2.57 percent, yielding a contribution of
0.606/2.57 or 23.6 percent.

68. U.S. Department of
Commerce, The Emerging Digital Economy, April 1998 and The Emerging
Digital Economy II, June 1999.

69. Oliner and Sichel, op.
cit., Table 5, p. 28; Congressional Budget Office, The Budget and
Economic Outlook: Fiscal Years 2001-2010, January 2000, Appendix A;
Economic Report of the President, February 2000, Table 2-3, p. 83; Dale
W. Jorgenson and Kevin J. Stiroh, "Raising the Speed Limit: U. S. Economic
Growth in the Information Age," May 1, 2000, available from
[email-masked]; Karl Whelan, "Computers, Obsolescence, and
Productivity," February 2000, Table 4, p. 34, available from [email-masked];
and Macroeconomic Advisers, LLC, "Productivity and Potential GDP in the 'New' US
Economy," September 1999, pp. 2-3. Table 4.1 excludes, however, results from
Macroeconomic Advisers, LLC because they pertain to
acceleration in potential productivity defined as the "level of
productivity consistent with sustainable utilization rates of capital and
labor," which is different from measured or actual productivity in the other
studies.

70. Macroeconomic
Advisers, op. cit., p. 6.

71. Emerging Digital
Economy II, Table 3.2, p. 29.

72. Kevin Stiroh,
"Computers, Productivity, and Input Substitution," Economic Inquiry,
1998, v. 36, pp. 175-191.

73. This finding was
reported originally in The Emerging Digital Economy II, p. 35. More
recent BLS data also support the finding.

74. See Jorgenson and
Stiroh, op. cit.

75. Ibid., pp. 43-44.

76. See Jack E. Triplett and
Barry P. Bosworth, "Productivity in the Services Sector," Washington, DC:
Brookings Institution, January 2000, paper prepared for the American Economic
Association Meetings, Boston, MA, January 7-9, 2000, Table 3, p. 24.

77. See citation in footnote
8.

78. In Figure 4.5, the ten
excluded industries are water transportation, transportation services,
depository institutions, nondepository institutions, holding and investment
offices, business services, insurance agents, legal services, motion pictures,
and health services. Based on the classification established in Emerging
Digital Economy II, the first two are non-IT intensive and the remaining
eight are IT-using. BEA estimates the real GPO of the first five industries by
"extrapolation" based on "BEA persons engaged in production" and the GPO of the
sixth industry based on "BLS employment weighted by Census Bureau receipts." BEA
uses separate deflators for outputs and inputs ("double deflation") for the
remaining four industries. See Robert E. Yuskavage, "Improved Estimates of Gross
Product by Industry, 1959-94," Survey of Current Business, August 1996,
p. 145.

79. However, there will
still be many industries awaiting similar improvements in the future. A
comprehensive review of the problems and prospects for their resolution is
available in Triplett and Bosworth, op. cit.

80. Erik Brynjolfsson
and Lorin M. Hitt, "Beyond the Productivity Paradox: Computers are the Catalyst
for Bigger Changes," Communications of the ACM, August 1998.

81. Erik Brynjolfsson and
Lorin M. Hitt, "Computing Productivity: Are Computers Pulling Their Weight?,"
MIT Sloan School of Management, January 2000.

82. Erik Brynjolfsson and
Shinkyu Yang, "The Intangible Costs and Benefits of Computer Investments:
Evidence from the Financial Markets," MIT Sloan School of Management (December
1999 revised draft). See also Erik Brynjolfsson, Lorin M. Hitt, and Shinkyu
Yang, "Intangible Assets: How the Interaction of Computers and Organizational
Structure Affects Stock Market Valuations," (http://ccs.mit.edu/erik). A
related study by Timothy F. Bresnahan, Erik Brynjolfsson and Lorin M. Hitt,
"Information Technology, Workplace Organization and the Demand for Skilled
Labor: Firm-level Evidence," January 2000 draft, finds that "IT use is
complementary to a new workplace organization which includes broader job
responsibilities for line workers, more decentralized decision-making, and more
self-managing teams. In turn, both IT and that new organization are complements
with worker skill, measured in a variety of ways. ...Taken together, the results
highlight the roles of both IT and IT-enabled organizational change as important
components of the skill-biased technical change."

83. As interpreted by Robert
E. Hall, "The Stock Market and Capital Accumulation," NBER Working Paper 7180,
Cambridge, MA: National Bureau of Economic Research, June 1999, p. 28
(http://www.nber.org/papers/w7180).

84. This chapter was written
by Sandra D. Cooke, Economist, in the Office of Business and Industrial
Analysis.

85. IT-producing
industries produce IT infrastructure and provide services that enable electronic
commerce and the Internet. See Chapter 3 for a list of IT-producing
industries. Note: the focus of this analysis is on the IT workforce only
and not the effects of technology on the general workforce.

86. Software and computer
services include computer services management, rental and leasing, computer
programming services and prepackaged software, all of which have grown at well
above average rates for the past decade.

87. Carol A. Meares and John
Sergeant, "The Digital Workforce: Building Infotech Skills at the Speed of
Innovation," Office of Technology Policy, U.S. Department of Commerce, 1999.

88. Don Tapscott, "Strategy
in the New Economy," Strategy and Leadership, November/December, 1997.

89. Saroja Girishankar, "In
Focus: E-Commerce Outsourcing - Internet Time Forces Anxious Enterprises to Seek
Outside Help," Internetweek, June 28, 1999.

90. Aaron Bernstein, "Down
and Out in Silicon Valley," Business Week, March 27, 2000, reports the
fact that the success of IT-producing industries in Silicon Valley has rapidly
raised the cost of living, but the earnings of workers in low-end jobs have not
kept pace.

91. Bob Weistein,
"E-commerce Puts Techies Front and Center," Chicago Sun Times, July 18, 1999.

92. Cole Gomolski, "IT Job
Market, Now and Later," Computerworld, October 28, 1999.

93. RHI Consulting press
release, December 2, 1999 and 2000 Salary Guide. RHI Consulting collects and
reports starting salaries for IT workers. Starting salaries, unlike occupational
averages, exclude bonuses and other factors that could influence pay, such as
seniority and past job performance.

94. Computerworld's
13th Annual Salary Survey, September 6, 1999
(www.computerworld.com).

95. Carolyn Veneri, "Can
Occupational Labor Shortages be Identified Using Available Data?" Monthly
Labor Review, March 1999.

96. The BLS analysis
concluded that there is no single empirical measure of labor market tightness,
nor does it appear that one can be easily developed. Labor market data such as
employment and wage trends and unemployment rates for a specific occupation
should be examined in addition to supply information including demographic
characteristics, employer requirements for education and training and education
by field of study. For IT occupations in particular, analysis should be done on
a case by case basis and should focus on one or a group of closely related
occupations.

97. Peter Freeman and
William Aspray, The Supply of Information Technology Workers, Computing
Research Association, Washington, DC: 1999.

98. The National Research
Council, in response to a Congressional mandate, will deliver two reports to
Congress by October 1, 2000 on 1) older workers in the information technology
field and 2) high technology labor market needs.

The U.S. Department
of Commerce's Technology Administration (TA) in July 1999 released The
Digital Workforce: Building Infotech Skills at the Speed of Innovation which
demonstrates the complexities of trying to define and measure the IT workforce.
The TA will continue to be heavily involved in monitoring the needs of the IT
workforce and making policy recommendations.

The Bureau of Labor
Statistics' recently revised Standard Occupational Classification (SOC) provides
more IT occupational detail than in previous years. The revised SOC
classification was used in the 1999 Occupational Employment Statistics Survey
and will be reflected in the 2000-2010 employment projections and in the 2002-03
edition of the Occupational Outlook Handbook. Both will be released in late
2001. (http://stats.bls.gov/soc/soc_home.htm)

99. INS statistics reported
in Wall Street Journal article. See Marjorie Valbrun,"Immigration Foe's Reversal
Bodes Well for Silicon Valley," Wall Street Journal, May 2, 2000.

100. U.S. Immigration and
Naturalization Service, "Characteristics of Specialty Occupations Workers
(H-1B)", February 2000. Preliminary survey results are for the May 1998 to July
1999 period.

101. This chapter was
written by Dennis Pastore, Economist, in the Office of Business and Industrial
Analysis.

102. Sales by affiliates are
reported on an industry basis while U.S. trade data are organized by type of
product. For this reason, the comparison between sales (by IT firms) and exports
(of IT products) is intended only as an indication of the relative magnitude of
the difference. Furthermore, estimates of sales by U.S.- and foreign-owned
affiliates involve only a subset of the IT industries, since aggregate data on
sales by instrument manufacturing affiliates are too broad to be included, and
data on sales by affiliates of producers of magnetic and optical recording media
are unavailable. The affiliate total also includes sales by firms in the
industries that manufacture prerecorded records and tapes (SIC 3652) and
communications equipment, n.e.c. (SIC 3669). (Table 6.2) The total for IT
exports has been adjusted accordingly. Altogether in 1997, the United States
exported $0.8 billion of prerecorded records and tapes and communications
equipment, n.e.c.

103. The various classes of
IT products include: computers and peripherals, prepackaged software, electronic
components including semiconductors, several classes of scientific instruments,
household audio and video devices, and telecommunications equipment, primarily
telephones and broadcasting equipment.

104. Exports of all goods
from the United States to U.S. Majority-owned IT affiliates in Table 6.2 totaled
$35.6 billion in 1997.

105. This chapter was
written by Lee Price, the Chief Economist of the Economics and Statistics
Administration.

106. Contrary to much of the
media's discussion, economists do not consider the strong rise in equity prices
year after year to be an essential component of the "New Economy." Indeed, at a
recent White House Conference on the New Economy, William Nordhaus concluded
that the IT revolution has generated a new economy in productivity terms, but
worried that unrealistically high stock prices were damaging on several fronts:
national saving, management decisions, compensation structures, and job choices.
William Nordhaus, "What Is the Shape of the New Economy?", White House
Conference on the New Economy, April 5, 2000
(http://www.econ.yale.edu/~nordhaus/homepage/
white%20house%20remarks%20040400%20final.htm).

107. Philip Evans and Thomas
S. Wurster, Blown to Bits: How the New Economics of Information Transforms
Strategy, Boston: Harvard Business School Press, 1999, pp. 24-25.

108. Actual forecasts were
2.1 or 2.2 percent. For purposes of comparison, we have added 0.2 percentage
points to account for definitional changes (e.g., treatment of software as
investment and revision to the measure of banking) that BEA initiated in October
1999 and applied to prior years.

109. The more optimistic
outlook does not come from expectations of faster growth in hours worked. If
anything, the continued reduction in unemployment leads many economists to
anticipate slower hours growth in the medium term.

110. Quote contained in
Louis Uchitelle, "Productivity Finally Shows the Impact of Computers," New
York Times, New York, March 12, 2000.

111. At some point, U.S.
demand growth will slow from its 5+ percent pace of recent years back to a level
consistent with the growth of labor productivity plus growth of the labor force.
In recent years, falling unemployment and a rising trade deficit have allowed
demand growth to exceed trend growth in potential output. Neither of the first
two trends can continue indefinitely.

112. P.A. David and G.
Wright, "Early Twentieth Century Growth Dynamics: An Inquiry into the Economic
History of 'Our Ignorance'," Stanford: SIEPR Discussion Paper No. 98-3, 1999.

113. Hal Varian, "The Theory
of Recombinant Growth," The Industry Standard, February 23, 2000.

114. Edison's "invention
factory" did not invent the first or the best light bulb, electric wiring, power
generator, or switch. But, recognizing the need for thin copper wire to compete
with gas lighting, Edison and his team did create the first "lighting system"
designed to optimize the interplay of all parts in a price competitive system.
Using venture capital, he was the first to go beyond the "tinkering inventor" to
create the first "invention factory" with teams assigned to develop specific
related innovations, first in lighting, then in batteries, recording, and movie
cameras.

115. Alan Greenspan,
"Remarks," Survey of Current Business," January 2000, p. 12.

116. The growth accounting
framework, discussed in Chapter IV, makes an estimate of the contributions of
capital and labor to growth, with the residual part of growth not accounted for
by capital or labor often called multi- or total factor productivity. Although
this residual is often viewed as an indicator of technical change, others have
called it a "measure of our ignorance" of all the factors contributing to
growth.

117. Dale W. Jorgenson and
Kevin J. Stiroh, "Raising the Speed Limit: U.S. Economic Growth in the
Information Age," May 1, 2000, forthcoming in Brookings Papers in Economic
Activity, p. 37 (http://www.economics.harvard.edu/
faculty/jorgenson/papers/dj_ks5.pdf).

118. National
Telecommunications and Information Administration, (NTIA) U.S. Department of
Commerce, "Falling Through the Net: Defining the Digital Divide," July 1999
(http://www.ntia.doc.gov/ntiahome/digitaldivide/).

119. Robert W. Taylor and
J.C.R. Licklider quoted in David Plotnikoff, "A Father of the Net Looks back and
asks, 'What took so long?'", San Jose Mercury News, March 12, 2000
(http://www.mercurycenter.com/svtech/columns /modemdriver/docs/dp031200.htm).

120. Calculations by the
Office of the Chief Economist, U.S. Department of Commerce based on data from
the Bureau of the Census' Current Population Survey Internet and Computer Use
Supplement, 1998 (http://www.bls.census.gov/ cps/computer/computer.htm) and
published in NTIA's "Falling Through the Net: Defining the Digital Divide."

121. Ibid.