Unformatted text preview: 2007 developing new skills. When the rewards to gaining skills increase, workers
have increased incentive to acquire additional skills. For example, over the
past 30 years, there has been a substantial widening in the difference between
pay for workers with a bachelor’s degree and pay for those with only a high
school diploma. For men, this difference grew from 50 percent in 1975 to
87 percent in 2004.
If this widening in pay differences represents an increase in the amount a
worker gains by getting a college education, then it gives individuals a greater
incentive to make such an investment in education. Over the last 10 years,
there has been an increase in the percentage of people who choose to go to
college rather than enter the workforce directly out of high school. In 1992,
the size of the workforce with some college education was roughly the same
as the size of the workforce with a high school diploma or less. By 2006, the
workforce with at least some college had become 50 percent larger than the
workforce with no college. Other levels of education, such as master’s and
doctoral degrees, have shown similar increases in the rewards for obtaining
such a degree and in the number of people choosing to make that investment.
From 1987 to 2003, wages for those with an advanced degree increased faster
than for those of any other education group, and since the mid-1990s, the
share of people age 30–39 with an advanced degree has increased by
38 percent. Thus increased demand for skilled workers has been followed by
an increase in supply, which raises the average skill level in the economy and
leads to higher average productivity. Understanding the Acceleration in
U.S. Productivity: Industry Analysis
Understanding why productivity growth in the United States has increased
requires knowing what factors in the economy have changed. Chart 2-1
demonstrated that most of the recent increase came about through greater
capital deepening and efficiency gains. What the chart did not tell us is why
businesses increased their rates of capital investment to bring about capital
deepening and why efficiency gains have been higher in the past decade than
they were for much of the previous two decades.
Productivity growth for the economy as a whole comes from investment
and innovation in a wide variety of businesses. A lot can be learned about the
sources of growth by looking at which kinds of investments have grown most
quickly, as well as which industries have had the fastest productivity growth.
The average rate of productivity growth hides substantial differences across
industries. In particular, the surge in productivity in the late 1990s appears to
be a story of growth in industries making and using IT capital. Chart 2-3
54 | Economic Report of the President 2007 illustrates that efficiency growth since 2000 has been particularly strong in the
high-tech sector, but that it has also been strong in the distribution sector,
which includes retail and wholesale trade, transportation, and warehousing.
Finance and business services also showed strong efficiency growth and hence
strong productivity growth. Manufacturing, which has made small investments in IT capital compared to the other sectors shown, has had the slowest
recent growth in efficiency.
The strong productivity growth in the distribution and financial services
sectors highlights one of the most striking differences between the pre- and
post-1995 periods. From the 1970s through 1995, productivity growth in
goods-producing industries was generally greater than that in service-providing
industries. However, since 1995, productivity growth in service-providing
industries has exceeded the growth in goods-producing industries (such as
Given this difference, one of the most important insights into the recent
period of productivity growth comes from understanding why service-sector
productivity growth accelerated after a long period of slow growth. As
discussed above, capital deepening and efficiency growth accounted for most
of the acceleration of productivity growth for the U.S. economy as a whole
over the last decade. Chapter 2 | 55 2007 In examining productivity growth rates over the recent period, researchers
have found it useful to characterize investments by whether they involve a
purchase of IT equipment, which is usually defined as computer hardware,
software, and telecommunications equipment. Box 2-1 discusses some of the
potential mechanisms, such as intangible capital accumulation, through
which IT capital leads to productivity improvements. Box 2-1: Intangible Capital and IT Investment
While information technology clearly accounts for a sizable share of
productivity growth since 2000, the mechanisms through which it
induced this growth are not as clear. The assumption has been that
since efficiency growth has been the largest contributor to productivity
in this recent period, IT gains are embedded in this growing efficiency.
However, hidden within these increases in efficiency may also be
capital growth not captured in official measures.
Standard measures of capital primarily count physical capital, but
businesses expend resources on many other activities that aim to increase
the value of future output. Some examples are research and development
spending, revamping a business’s organization, advertising aimed at
improving consumers’ perceptions of a business’s brand, or developing a
secret recipe. These kinds of activities are often called intangible investment because they build up assets that are valuable to firms but are not
Conceptually, these activities qualify as capital investment, but they
are not currently included in official capital measures because they are
hard to measure. Why does this matter when discussing productivity?
Expanding the definition of capital by including intangibles would
change the shares of the factors contributing to labor productivity
growth, increasing the share attributed to capital deepening and
reducing the share attributed to efficiency gains. This shift would not
only call into question the finding that IT investment contributed to
productivity mainly through efficiency gains, but would also help
explain why productivity did not accelerate with early waves of IT
investments. Indeed, it is consistent with the hypothesis that for businesses to take full advantage of their IT investments, they needed to
develop innovative business practices. Only when they made intangible investments to complement their IT investments did productivity
growth really take off. 56 | Economic Report of the President 2007 The industries that produce IT equipment had particularly rapid efficiency
growth, resulting in falling prices accompanied by rapid increases in the speed
and power of IT equipment. These industries directly brought up the average
rate of productivity growth for the economy, but their advances also had
significant indirect effects by driving a surge in IT equipment investment in
other industries. The increase in capital deepening in the 1990s was led by
large investments in IT equipment, but productivity gains from these investments did not immediately emerge.
In the 1995 to 2000 period, industries with above-average investment in IT
equipment had significantly larger increases in their productivity growth rates
than did other industries. For example, the retail trade and financial services
industries had much higher productivity growth over the 1995 to 2000
period than in the preceding period, and had well-above-average investment
in IT equipment. Box 2-2 indicates that much of the retail trade productivity
gains occurred because of supply chain improvements made possible by information technology. Research estimating the contribution of IT-related
forces—including both productivity growth in IT-producing industries and
the share of productivity growth accounted for by IT investment in other
industries—shows that information technology accounted for more than half
of productivity growth from 1995 to 2000. Box 2-2: Information Technology, the Supply Chain,
and Productivity Growth in Retail Trade
The retail trade sector shows how IT investment, innovation,
competition, and flexible markets interact to affect productivity growth.
Retailers have made heavy investments in information technology and
have had rapid productivity growth, but changes in the way that
retailers use information technology—both in their stores and with their
suppliers—were necessary to generate this surge in productivity
growth. The focus here is on two types of innovations: changes in the
organization of the supply chain of consumer goods and changes in the
way retailers organize store operations.
Manufacturers and retailers of consumer goods have increased their
use of electronic data interchange, allowing manufacturers to help
retailers manage inventories and avoid stockpiling and shortfalls.
Electronic data interchange also allows for automatic ordering, billing,
and payment. Retailers benefit from lower costs of carrying inventory
and reduced resources spent managing it, and manufacturers benefit
continued on the next page Chapter 2 | 57 2007 Box 2-2 — continued
from being able to smooth out production. Because these changes have
enabled retailers to more reliably stock a wide variety of goods,
consumers have benefited from increased product variety. Making
these changes required an investment in IT equipment by manufacturers and retailers, and required them to change the way they
exchanged information and interacted.
Large retailers also made internal changes that significantly increased
productivity. One change was an increase in the scale of stores. Other
important changes involved the use of information technology and
improved management practices. Examples include an increased use of
software to manage the flow of goods and staffing levels in stores, and
more cross-training of employees to make better use of store labor.
Rapid expansion of the largest firm put competitive pressure on other
retailers, leading them to cut costs and, in many cases, to emulate the
process improvements introduced by the industry leader. Why Has Productivity Growth Accelerated in
the U.S. While Slowing in Other Countries?
The United States has experienced the fastest acceleration of productivity
growth among major industrialized countries since the early 1990s. Chart 2-4
shows that, after lagging behind most of the countries in the G7 between
1990 and 1995, the United States has been the country with the fastest
growth in GDP per hour worked in the G7 between 2000 and 2005. Only
the United States and Japan had faster productivity growth in the most recent
period than they did in the early 1990s, and only the United States has shown
consistent acceleration over this time period.
Since all of these countries have, in principle, approximately the same
access to information and global markets, why have the other major industrialized countries not been able to post productivity gains as large as those in
the United States and Japan? The major advances in this period appear to
have come from opportunities that developed from the rapid advancement in
information technology. While all developed countries had access to IT
capital, the existing economic environment in the United States put it in position to quickly make the most of these opportunities. International openness
to investment and trade combined with highly flexible and lightly regulated
markets and an environment that fosters innovation appear to be at least part
of the answer.
58 | Economic Report of the President ...
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