1. Short Paper:
Does the “New Economy” Measure up
to the Great Inventions of the Past?
Robert J. Gordon, 2000
Melika Liporace
December 5, 2014
1 Summary
Does the “New Economy” Measure up to the Great Inventions of the Past? No, it does not,
at least according to Gordon’s article from 2000. The author reaches this skeptical conclusion
after a detailed analysis of the question. He first draws some stylized facts on U.S. economical
productivity throughout time, from the first industrial revolution in 1870 until the Internet era
at the end of the 20th
century 1
. In a second step, the author describes the austere living condi-
tions of the pre-industrial era, and the notable improvements in its lifestyle caused by the great
Inventions of the first industrial revolution. The author then discusses the modern inventions,
that is, computer and computer-related technologies, and its downsides. In a final approach,
Gordon focuses its attention on Internet specifically, to descriptively qualify its positive and
negative effects on productivity.
The necessity of this whole analysis is brought by the impressive productivity revival since
1995, which leads to a broad enthusiasm across U.S. media and economic scholars. At first
glance, one could attribute this increase in productivity to technology. Although the nomi-
nal share of computer-related investments stagnated since 1987, the sharp decline in computer
prices (holding performance levels equal) implies an increase in ”real” investment, that is indeed
strongly correlated to the rise in productivity. The multifactor productivity (hereafter MFP,
see section 2 for further discussion) growth was higher between 1995 and 1999 than it had ever
been since 1870.
This apparent proof of a ”New Economy” defined as ”the post-1995 acceleration in the rate
of technical change in information technology together with the development of the Internet”,
is questioned by two elements: first, this increase in MFP is mainly driven by the computer-
related sector of economy, which represents about 12% of the whole economic activity only;
second, as the analyzed timespan is much shorter than the previous eras, and may not be rep-
resentative, the MFP growth could be cyclical rather than a long-run trend. Disentangling this
two contributions, Gordon finds no indication of positive effects of technology on MFP in the
non computer economy, and that considering several sets of goods to include in his definition
of the economy. It thus indicates an almost zero rate of return of computer investment outside
of durable manufacturing, which represents about three-quarters of the aforesaid investments.
1
The paper was published in 2000
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2. This paradoxical result, best summarized by Solow in 1987 when he declared ”we can see the
computer age everywhere but in the productivity statistics”, can be, if not completely solved,
better explained by picturing the qualitative differences between the two first industrial revo-
lutions and the modern era of technology.
From a historical perspective, the first industrial revolution, mainly located in Britain be-
tween 1760 and 1830, gave rise to many innovations such as steam engine or the power loom, but
the real phenomenal MFP expansion occurred during the second industrial revolution, which
happened in both Europe and United States between 1913 and 1972, and saw the inventions of
e.g. electricity or internal combustion engine. To account for the major changes caused by these
revolutions, Gordon depicts a vivid scenery of the pre-industrial era. In cities, the streets were
filthy, putrid and contaminated because of the horses, the pigs, the smog or still the dumped
rotting merchandise; in brief, they were a ”chaotic jungle”. In the country-side, the danger of
traveling made life isolated; the absence of other form of power made ”muscle-power(ed)” hard
work necessary.
This lifestyle is turned upside down by the inventions of the industrial revolution, that can be
grouped in five categories: first, electricity - creating a less exhausting lifestyle and making the
air breathable again by avoidance of rotten food (refrigerator) and invention of air conditioning
-; second, internal combustion engine - helping transportation and hence diminishing manures
and isolation -; third , chemistry - suppressing coal air pollution and improving medicine and
treatments to prolong life expectancy-; fourth, communicational and informational inventions
- making the world smaller-; fifth and final, running water - including indoor plumbing and
overall increasing urban sanitation infrastructure. All these inventions created a whole new
environment, that would improve the living standards, not only in the mentioned areas, but
also, for instance, in the availability of bigger and better housing conditions. The undeniable
convenience of modern technology still appears pale in comparison to these radical changes:
who would chose an internet connexion over running water? However, more than this intuitive
difference, deeper arguments from economic theory can explain Gordon’s skepticism.
A first major difference between past inventions and modern technological improvements is
the singular rate of decrease in price of computer-related goods. To examine this issue further,
the author sketches the relationship between prices and computers purchased (both in natural
logarithm, so that variations represent rates). The resulting curve is a decreasing function that
resemble a demand curve; as the marginal cost of producing more computer characteristics -
such as speed or memory - at a given level are likely to be constant, the supply surge is likely
to be flat; hence, the observed curve is argued to be indeed the demand curve, ”mapped out”
by successive shifts in supply curves. Its slope indicated then the rate of technological improve-
ments (shifting the supply curve) rather than a change in the relationship between supply and
demand. Interestingly, the slope of the sketched relationship between prices and quantities,
which represents the inverse of price-elasticity, has become steeper since 1987, which indicates
a decline in price elasticity. Coupling this observation with the fact that, although sharply ris-
ing before 1987, the share of nominal computer investment in the total economy has stagnated
since 1987, Gordon concludes that ”the most important uses of computers were developed more
than a decade into the past, not currently”.
The second main element that motivates Gordon’s skeptical point of view is the theoretically
well-known diminishing returns of computer investments. As the time dedicated to computer
use is constrained, additional computer performances become exceptionally quickly useless to
increase productivity; As an illustration, the author consider the word processing activity: al-
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3. though going from typewriter to the first computer was a considerable gain of productivity,
the last word processing software update is unlikely to help the user save more than a few
seconds. The extreme pace at which the returns for computers diminish argues against other
competing more optimistic theory about technology, such as a delay hypothesis, which assumes
that the productivity gains from computers could require some time to appear; the main gains
in productivity due to computer have probably already occurred. A further and final argument
in favor of diminishing returns in a macro perspective is that some human works cannot be
replaced by computers.
Gordon then draws critics regarding Internet specifically. Internet era is considered to ap-
pear with the broader use of web browser. Although most of the ”New Economy” optimism
is motivated by the spread of this new tool, the facts seem to point towards a small influence
of Internet on productivity. The author analyzes such facts through four ”Internet Economy”
categories: infrastructure (hardware), applications (software), intermediary and commerce. If
the dynamism of the first sector is consensually accepted, the main issue arise from the second
sector, for which the price deflator could be argued to be misrepresenting the actual software
improvements; citing Jorgenson and Stiroh (2000), the author settles the question stating: the
outcome of the debate over the software deflators has almost no impact on the question of how
this sector of the Internet economy affects productivity in the rest of the economy. Concerning
the third category, business-to-business e-commerce is arguably out of the debate as well, since
an increase in the linking efficiency in the supply chain would lead to a decrease in costs and
labor requirements, that would imply a faster productivity growth, that should show in the non
computer economy; actually ”this payoff has appeared in other parts of durable manufacturing,
but not in rest of the economy. The relevant analysis hence concerns e-commerce of final goods.
The benefits of Internet for the consumers are numerous: convenience, informational gains,
lower shipping costs, higher market efficiency. However, some of them can be discussed. For
instance, if e-commerce creates a downward pressure on prices, helping consumer surplus to rise
and inflation risk to drop, it creates an additional pressure on producers that could actually
encounter financial losses. Furthermore, certain new advantages of internet are not actually
that new and can be compared to past inventions: notably, the telegraph did improve the com-
munication speed and, in growth rates, this change is greater than the one induced by Internet.
Another interesting paradox is the apparent discordance between micro- and macro- data:
although the figures regarding internet investments are impressive - which should be motivated
by its higher returns - the overall productive performance is unconvincing. Four elements can
contribute to solve this seeming conflict. First, IT investments can be seen necessary to hold
or gain market shares against other competitors, which makes it extremely profitable at a
micro-level but a zero-sum game at a macro-level. Second, most of the new features offered
by Internet are actually a reinvention of old activities made more convenient or cheap. Third,
most of the activities have not been revolutionized by the Internet; in that sense, Internet has
a duplicative aspect. Fourth, the constant access to Internet has a mean of distraction can
actually impair the productivity while working.
In a final response to New Economy optimists, who argue that computer do have benefits
on the productivity but are not taken into account in the standard measuring tools, Gordon
emphasizes that, if present, a major part of the benefits should be measured, or at least bring
positive spillovers in the whole economy, which is not observed. Furthermore, the same issue
could be raised concerning the great inventions of the past, as it is probable that some of their
benefits remained hollow in the macro-figures.
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4. Hence, the conclusions of the author are unambiguous: although Internet and computer-
related technology has its advantage and improves everyday life, it remained of incomparable
magnitude when considering the great inventions of the past that literally revolutionized the
standard of living.
2 Technical considerations
Multifactor productivity is the central concept used to infer the influence of Internet on pro-
ductivity. However, measuring it is not straightforward. What can be easily measured is the
overall growth of output, as well as the inputs used in such a production process. From there,
it is possible to infer the productivity, that can be defined as the ratio of output with respect
to inputs. As it is hard to disentangle the contribution of each input to the final production
due to their complementarity - i.e. one unit of isolated labor plus one unit of isolated capital
will produce less than one unit of labor and capital together, or ∂2f(K,L)
∂K∂L
= 0 - the productivity
of each input cannot be computed separately. For this reason, the standard approach is to con-
sider the overall productivity of all inputs taken together, which is the multifactor productivity
(MFP).
If the theoretical notion is simple, the technical calculation is less straightforward. How
can the MFP be computed from raw data? The first step is to assume a production function
in order to properly separate the role of productivity from the contribution of inputs. The
neoclassical properties are usually assumed, and Gordon implicitly follows this path. In his
paper, he indeed considers the following production function:
y = m + bh + (1 − b)k
where y is the growth rate of output, m is the growth rate of MFP growth, b is a measure of the
importance of the contribution of labor to the output - i.e. the elasticity of output with respect to
labor input, and (1-b) being its counterpart for capital - and k the growth rate of capital input.
To establish this result, one could consider the well-known neoclassical production function
that is the Cobb-Douglas specification. Hence, we define:
Y = AKb
L1−b
Now, we are interested in the growth rate; by considering the logarithmic transformation of
such a function, we can apply the useful trick for growth rates, that is ∂ ln X
∂t
= gx, where gx is
the growth rate of X. Here, we thus examine:
ln Y = ln A + b ln K + (1 − b) ln L
By differentiating with respect to time, we get:
∂ ln Y
∂t
=
∂ ln A
∂t
+ b
∂ ln K
∂t
+ (1 − b)
∂ ln L
∂t
which is the decomposition of growth considered by Gordon, as mentioned above. From
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5. there, we rearrange and find:
y − h = m + bh + (1 − b)k − (1 − b + b)h
y − h = m + bh + (1 − b)k − (1 − b)h − bh
y − h = m + (1 − b)(k − h)
From our raw data, we know y, h and k, that are the growth rates of output, labor hours
and capital. The elasticity of output with respect to each input is inferred from the ratio of
income from capital on the overall income. Implicitly, perfect competition is assumed, so that
the return on capital does equal the marginal productivity of capital. Obviously, this ratio
variates through time, but turns around one-third. This coefficient is the standard value used
in the growth accounting literature and is naturally the one chosen by Gordon.
Finally, the MFP can be computed from the data, as:
m = (y − h) − 2
3
(k − h)
Let us finally note that this measure of MFP, often called Solow residual2
, is intrinsically
flawed as it is actually a measure of ignorance, the part of the growth that cannot be explained.
Obviously, in theory, it corresponds to the growth in productivity, but the theoretical assump-
tions to attain such a result are somewhat bold, and macro-data are by their essence subject to
major measurement errors. However, for want of anything better, this method stays the most
broadly implemented in such literature.
3 Insights on ICT
Because of its general considerations, the conclusions of Gordon’s article, although concerning
technology at the beginning of the 21st
century only, could be directly applied to bright new
technology opportunities. Although figures are obviously not available yet and that the first
step towards Gordon’s conclusion was to empirically analyze in more depth the macro data,
the profound theoretically-rooted arguments against utopian optimism towards technological
endless possibilities to increase living standards and productivity still stand. Indeed, one of
the central argument is the diminishing returns of new technology: if the introduction of IT
did somewhat boost productivity, it did not throughly changed the economic system, such that
the human limitations prevent technology from exponentially increasing MFP in the long-run.
By human limitations, one can understand limited amount of time, of cognitive power or still
requirements for human work. Thus, the argument could still be valid for new information and
communication technology.
A interesting illustration of this insight could be voice recognition: if its introduction could
temporarily boost productivity growth rate by avoiding word processing and allowing faster
work, this increase cannot be of long run, as the new device will not improve the quality or the
speed of worker’s thought. In that sense, a technology as voice recognition can be compared to
2
from Robert Solow due to his famous contributions:
- ”A Contribution to the Theory of Economic Growth”, Quaterly Journal of Economics, February 1956,
70(1), pp.65-94
- ”Technical Change and the Aggregate Production Function”, Review of Economics and Statistics, August
1957, 39(3), pp.312-20
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6. word-processing softwares: its introduction can bring a large increase in marginal productivity,
but its improvements should rapidly lead to near-zero productivity increment. Indeed, at first,
switching from word-processing to voice recognition will increase productivity by eliminating
the slow typing activity, and the first improvements should allow to avoid wasting time in
correcting or repeating words misidentified; yet, successive improvements will slowly become
almost superfluous, as the technology will be able to seize words at the speed of thought, and
will not improve worker’s cognitive capacities.
Nevertheless, this argument can be modulated regarding other aspects of ICT’s. Indeed,
new organizational systems such as industry 4.0 or impressive capacity of robots to imitate hu-
man labor and process information could slacken the human labor requirement constraint, and
hence, actually revolutionize the economy. It is interesting to note that the connotation behind
the term ”industry 4.0” is actually the exact idea of a fourth revolution, the first three being
the two industrial revolutions discussed above and the digital era. Such an industry would
require virtually no human implication in the process of production - one could argue about
maintenance need, but such labor requirement is minor, and capital would not then present
returns of scale as diminishing as in the case of production. Hence, the argument of extreme
diminishing returns of capital because of human labor limitation would be discarded.
Another interesting argument against the apparent innovation of Internet was its duplica-
tive aspect: the main activities of production are not necessarily made better, more efficient
or cheaper, but they simply slightly change. The example evoked by Gordon was e-commerce:
if the order is made easier through computer than by phone or post, the rest of the process of
production and delivery stays fundamentally the same: the labor required to produce and stock
warehouses, compose the order, pack it and ship it, is essentially the same as during the pre-
internet era. Once more, this argument does not stand when confronted to the idea of industry
4.0. Indeed, the revolutionary idea of such an organizational system is the automatization of
the tasks previously requiring human action. Even if an overall human supervision could be
necessary, the amount of labor required for one shipping would be extremely reduced. In that
sense, industry 4.0 would be far more similar to the second industrial revolution, than to the
digital revolution: if the first one replaced muscle power by machine power, the latter revolu-
tionized the treatment and spread of information; hence, industry 4.0 could actually measure
up to the industrial revolution as it would virtually eliminate requirements for human labor,
and hence, increase productivity in the long run - a few specialized workers supervising a great
amount of machines, who need a reduced amount of labor to be built and operational for a larger
quantity of production. Such an industry however requires Internet to transmit information. In
that sense, one could argue that industry 4.0 is actually the logical continuation of the digital
revolution, and that the delay hypothesis may actually stand, even against Gordon’s arguments.
The same argument can be applied to robots when considering the, maybe utopian, artificial
intelligence. If the idea of cognitive limitation is valid concerning the use of softwares like
spreadsheets and word-processing, such cannot be said regarding the impressive increase in
calculation and problem solving capacities of technology. When Gordon wrote his article, the
computer would simple execute what it was explicitly asked to. If it is still theoretically the
case, the advance in computer programming allows to solve problems that would be inaccessible
to the human mind. If the speed and performance of the computer was useless, at the margin,
in 2000, since Gordon argued that the pace of the human mind would not be improved by
it, the increasing apparition of robots is the proof that the technology could actually enhance
cognitive capacities.
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