Productivity ; Venture capital ; Information technology

Mine K. Yücel

Thomas F. Siems

English

Research Papers in Economics

FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   JANUARY/FEBRUARY 2005 13
ince 1995, productivity in the
United States has surged, with
output per hour rising an aver-
age of more than 3 percent annually.
Information technology (IT) is getting
credit for much of this increase. But
should it?
IT has brought significant enhance-
ments. It has streamlined supply chains,
automated routine workflows and given
firms greater insight into customers.
Companies taking advantage of these
productivity enhancements have gotten
a leg up on the competition. But now,
with the dust beginning to settle, some
see IT as just another commodity,
another input necessary to compete but
insufficient to ensure competitive advan-
tage.
On September 10, 2004, the Federal
Reserve Bank of Dallas hosted a confer-
ence on technology and the economy,
cosponsored by the Technology Round-
table of the National Association for
Business Economics (NABE). This article
summarizes the ideas presented at the
conference on how to assess technology
and its potential impact on economic
growth and productivity.
Productivity and IT
U.S. productivity growth has taken
off in recent years to more than double
the growth rate experienced from 1973
to 1995 (Chart 1). Michael Cox, senior
vice president and chief economist of
the Dallas Fed, argued that technology
and globalization are providing the
nation with unusually strong productivity
growth.
1 The era of Solow’s paradox—
the observation that computers are
everywhere except in the productivity
statistics—appears to have ended.
2 The
United States has a dynamic, flexible and
open economy that continues to reorga-
nize work and expand markets through
technological innovation and change.
Cox emphasized the importance of up-
grading one’s skills and knowledge to
take advantage of the new and better
jobs created by these changes. He noted
that occupations using people skills, emo-
tional intelligence, creativity and imagi-
nation point the way to the jobs of the
future.
Hal Varian, professor in the School
of Information Management and Systems
at the University of California at Berke-
ley, brought the issue of productivity to
a more micro level. Varian described
combinatorial innovation as one of the
building blocks of productivity. Combi-
natorial innovation is where a set of
component technologies can be com-
bined and recombined to create new
products. Eli Whitney’s use of standard-
ized interchangeable parts in the early
1800s was one such example; the devel-
opment of the gasoline engine in the
early 1900s was another. 
Today, combinatorial innovation is
taking place with the Internet and
associated information technologies. The
component parts are bits of informa-
tion—digital strings of zeros and ones—
that have many productivity-enhancing
characteristics. With bits, there are no
time-to-manufacture, inventory or deliv-
ery problems. Varian noted that bits can
be shipped in seconds to many places in
the world, where innovators can work in
parallel.
Lacking physical constraints, the
Internet has provided a platform for
rapid innovation and change. Moreover,
relatively open technologies and low
barriers to entry have created an in-
tensely competitive environment, which
has led to overcapacity in some in-
stances. While this is good news for con-
sumers, it can be difficult for companies
to manage. 
Another caveat is that new ideas and
technologies created through combinato-
rial innovation can capture the public’s
imagination, leading to potential finan-
cial speculation and overinvestment.
This happened in the past with railroads
and automobiles and recently with the
high-tech boom in information technol-
ogy companies. Although it will take
some time to work through the excess
capacity created during the dot-com
investment boom of the late 1990s, Var-
ian is optimistic about the future. 
Varian said that businesses—particu-
larly small and medium-sized enter-
prises—are learning how to use IT cap-
Where IT’s @: Technology and the Economy
S
Productivity Growth Surges
(Output per hour, nonfarm business)
5-year annualized growth rate (percent)
Chart 1
SOURCE: Bureau of Labor Statistics.
0
.5
1
1.5
2
2.5
3
3.5
4
2005 2000 1995 1990 1985 1980 1975 1970ital effectively. The resulting effects on
aggregate productivity are clear, but the
impact on profitability is trickier due to
lack of entry barriers. The focus today is
on information management, that is,
how information flows through an orga-
nization and how it can be changed to
improve decisionmaking. Finally, busi-
ness survival depends on understanding
how the new network (or information)
economy differs from the past. Technol-
ogy changes, but economic laws do not.
3
Productivity growth results not only
from new technology, but also from new
business organization around that tech-
nology. Erik Brynjolfsson, professor of
management at Massachusetts Institute
of Technology, acknowledged that com-
puters are associated with greater pro-
ductivity and that IT is the catalyst
behind the recent productivity surge.
However, he suggested that modern
businesses need to be reorganized to
take advantage of IT and rethink the way
their work is done. On average, produc-
tivity improves as IT capital stock
increases. 
Not all firms with similar new tech-
nologies are equally productive, though.
In trying to understand the variation
across firms, Brynjolfsson analyzed
whether business productivity was
related to a firm’s corporate culture and
organizational practices or related more
to a firm’s investment in IT. His conclu-
sion was that business performance
depends on both IT and organizational
capital. Direct IT capital costs are often
only 10 to 20 percent of total IT project
costs. Far more important in the infor-
mation economy are intangible assets:
how the organization structures its peo-
ple and processes, how it manages risk
and how it integrates knowledge and
ideas.
Digital organizations, as termed by
Brynjolfsson, are heavy users of informa-
tion technology, with distinctly different
corporate cultures and organizational
practices formed into a coherent system.
He identified some key practices of dig-
ital organizations: moving from analog to
digital business processes, distributing
decision rights, fostering open informa-
tion access, linking incentives to perfor-
mance, maintaining focus, communicat-
ing goals, hiring the best people and
investing in human capital. 
Brynjolfsson illustrated that digital
organizations perform better and have
higher productivity and higher market
valuation than traditional organizations.
4
He stressed that market values rise dis-
proportionately for firms that follow the
digital organization practices and invest
heavily in IT capital.
Industry Applications
Entertainment is one example of an
industry in which new technology has
immeasurably increased productivity and
greatly lowered costs. Chris Anderson,
editor in chief of Wired magazine,
focused on the nearly unlimited supply
of music, books and films available
through online retailers.
5 Before the dig-
ital age, the entertainment industry was
limited by broadcasting technology. It
needed local audiences for movies and
was physically limited by the 24 hours in
a day and the radio and TV spectra. Sud-
denly, we are no longer as bound by the
shelf space, seating capacities and distri-
bution constraints of the physical world.
In the new digital economy, scarcity can
be replaced by abundance.
Anderson argued that the emerging
digital entertainment economy is going
to be radically different from today’s
mass market. The 20th century entertain-
ment industry was about hits; the 21st
century will be equally about misses.
Misses (80 percent of the market) are just
as profitable as hits (the other 20 per-
cent). That is, with no physical con-
straints to limit availability, profit margins
on hits and misses are roughly equal,
and the greatest profits will likely come
from the less familiar titles that fall in the
long tail of the demand distribution.
“Long-tail” businesses can treat cus-
tomers as individuals and offer mass cus-
tomization rather than mass-market fare.
Anderson pointed to the success of
online movie retailer Netflix and online
music retailers such as Rhapsody.  
The power of the long tail is that the
market is so much larger but just as prof-
itable on the margin. As a result, Ander-
son said, three new rules apply for the
new entertainment economy. First, be-
cause offering misses increases the mar-
ket’s potential size, online retailers
should not be selective in what they
offer, but should instead make every-
thing available. Second, online retailers
FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   JANUARY/FEBRUARY 2005 14
Productivity growth
results not only from
new technology, 
but also from new
business organization
around that
technology.
 FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   JANUARY/FEBRUARY 2005 15
should price items according to digital
costs, not physical ones. And finally,
online retailers should make recommen-
dations to customers and drive demand
down the long tail.
Many other industries have also ben-
efited from the effective implementation
of information technology. Jeff Donnel-
lan, chief information officer of Land-
mark Graphics, presented evidence that
new information technologies are being
used to help find drilling locations for oil
and gas exploration firms, thereby
reducing planning and production cycle
times. Rik Heller, president of FreshLoc
Technologies, noted the productivity
achievements gained in food distribution
and storage through the use of radio fre-
quency identification devices, or RFIDs.
In addition to providing real-time infor-
mation on inventory levels, these devices
can monitor temperatures to increase
shelf life and improve the safety of foods
being transported in truck trailers to
restaurants and grocery stores.
Does IT Matter?
In a seemingly divergent vein,
Nicholas G. Carr, former editor of the
Harvard Business Review, argued that
IT’s strategic importance has dissipated
as its core functions have become avail-
able and affordable to all.
6 Carr views IT
as an infrastructural technology, like rail-
roads and electric power, shared broadly
by all firms in an industry. He argued
that IT has moved from being a propri-
etary resource that helps firms generate
profits to being a commodity with van-
ishing advantages.
As such, Carr sees IT’s strategic
importance diminishing even as it has
become more powerful, more affordable
and more commoditized. While this
position at first seems contradictory, the
argument is that IT is necessary to com-
pete but is insufficient to ensure com-
petitive advantage. Thus, as IT becomes
less expensive, more accessible and bet-
ter understood, its beneficial and valu-
able uses can be easily replicated by
competing firms. The managerial impli-
cations of this shift in thinking can be
important.
Carr concluded by offering the fol-
lowing, somewhat controversial, guide-
lines for IT investment and management:
Spend less; follow, don’t lead; innovate
when risks are low; and focus more on
vulnerabilities than opportunities.  
IT and Financial and Human Capital
All new technologies require invest-
ments in venture and human capital. Ron
Harris, founder and general partner of
the venture capital firm Southwest Capi-
tal Partners, and Robert Helms, professor
and dean of the School of Engineering
and Computer Science at the University
of Texas at Dallas, provided perspectives
on the role of financial and human cap-
ital in today’s IT-enabled economy. 
Harris chronicled venture capital
investments in IT beginning with the
early 1980s, around the time the first per-
sonal computers were introduced. He
explained that the Internet emerged as a
viable business platform with the cre-
ation of the World Wide Web in the early
1990s, and an IT renaissance began as
capital spending on IT equipment and
software soared.
This incredible boom, however, was
followed by an almost equally incredible
bust and an IT recession that began in
early 2000 (Chart 2). IT investments
came to a halt as the century date
change (Y2K) passed almost without
notice and as business valuations of
Internet firms were scrutinized and
reevaluated. As global growth slowed,
firms realized the harsh realities of main-
taining a competitive web presence and
implementing and integrating business
process technologies into an efficient
and effective system.
In the aftermath, it became clear that
a different IT strategy was required: one
that made information available to those
who need it in real time. Harris con-
cluded by describing the “intelligent real-
time enterprise” as one that focuses its IT
efforts on security, business integration,
real-time monitoring, wireless connectiv-
ity, systems management and disaster
recovery. In his view, the winners will
be those firms that recognize and adapt
to the new realities created by informa-
tion technology.
Helms acknowledged the key role IT
has played in boosting productivity,
mainly by improving cycle times. New
technologies allow large quantities of
information to be moved rapidly to those
who need it anywhere in the world.
This, in turn, requires deeper and
broader strategic partnerships between
educational institutions and technology
firms to accelerate learning and speed
the flow of information.
Looking ahead, Helms is concerned
about how the United States’ competitive
advantages—knowledge, relationship
management and innovation—can be
maintained and nurtured. He asserted
that academic-engineering power drives
regional excellence and economic devel-
opment. Other nations are already out-
pacing the United States in graduating
engineers. In the United States only 1.8
U.S. Venture Capital Investment in Information Technology
Billions of dollars
Chart 2
NOTE: IT includes semiconductors, telecommunications, software, and computer and peripherals sectors.
SOURCE: MoneyTree Survey, PricewaterhouseCoopers.
0
2
4
6
8
10
12
14
2004 2003 2002 2001 2000 1999 1998 1997 1996 1995percent of 24-year-old graduating seniors
have engineering degrees, while the
share is 2.7 percent in Europe and 5.8
percent in Japan. Moreover, federally
funded research and development initia-
tives have been on the decline since the
mid-1960s. Helms stressed that a com-
mitment to education and the develop-
ment of human capital is required for the
United States to be able to keep its com-
petitive edge over the rest of the world.
Future Trends
The final panel of the conference
engaged in a lively discussion of future
trends in technology. What new tech-
nologies (or industries) might be on the
horizon that could impact business pro-
ductivity? What pitfalls and dangers lurk
in the shadows? What kinds of disrup-
tions to accepted societal norms might
result?
Douglas S. Rasor, vice president and
manager of worldwide strategic market-
ing at Texas Instruments, opened the dis-
cussion by sharing technology ideas for
the future. In a world that requires more
real-time monitoring and sharing of
information, Rasor stressed the impor-
tance of bandwidth for high-speed digi-
tal communications.
Dennis Wilson, chief technology
officer, chairman and founder of Nano-
technologies, explained the future im-
portance of nanotechnology to business.
Wilson defined nanotechnology as the
commercial development of materials,
tools, processes and devices that exploit
new properties occurring at dimensions
of only a few nanometers. Wilson argued
that nanotech is a disruptive technology
with the potential to significantly en-
hance business productivity by creating
powerful new materials with great
strength and less weight and size. 
But the benefits of new technologies
are not without potential problems and
concerns. John South, director of infor-
mation security at Alcatel North America,
warned that economic espionage is alive
and well—and thriving. South stressed
that security of information flows and
communication networks cannot be
overlooked or underestimated. In today’s
increasingly global economy, hackers
and computer viruses present a real and
present danger. 
Similarly, G. Anthony Gorry, profes-
sor of management and computer sci-
ence at Rice University, warned of tech-
nology’s impact on societal norms. For
example, technology has made intellec-
tual property theft easier and may be
changing the moral attitudes of the pub-
lic about such theft. The students he has
observed are more cavalier about down-
loading copyrighted material from the
Internet than they would be about steal-
ing a book or record from a retailer.  
Conclusion
Information technology is every-
where in today’s global economy. In the
past, IT helped firms become more pro-
ductive and competitive. However, future
gains will likely come through improved
information management and distinctly
different corporate cultures that focus on
improving organizational capital. IT re-
mains important, but the effective inte-
gration of IT into an organization’s cul-
ture and the reorganization of work are
what create competitive advantages.
— Thomas F. Siems
Mine K. Yücel
Siems is a senior economist and policy
advisor and Yücel is a senior economist and
vice president in the Research Department of
the Federal Reserve Bank of Dallas.
Notes
1 See “A Better Way: Productivity and Reorganization in the American
Economy,” by W. Michael Cox and Richard Alm, Federal Reserve Bank
of Dallas 2003 Annual Report, pp. 3–24.
2 See “We’d Better Watch Out,” by Robert M. Solow, New York Times,
July 12, 1987, p. BR36.
3 See Information Rules: A Strategic Guide to the Network Economy, by
Carl Shapiro and Hal R. Varian, Boston: Harvard Business School
Press, 1999.
4 See “Beyond Computation: Information Technology, Organizational
Transformation and Business Performance,” by Erik Brynjolfsson and
Lorin Hitt, Journal of Economic Perspectives, vol. 14, Fall 2000, 
pp. 23–48.
5 See “The Long Tail,” by Chris Anderson, Wired, vol. 12, October 2004,
pp. 170–77.
6 See Does IT Matter? Information Technology and the Corrosion of
Competitive Advantage, by Nicholas G. Carr, Boston: Harvard Busi-
ness School Press, 2004.
FEDERAL RESERVE BANK OF DALLAS   SOUTHWEST ECONOMY   JANUARY/FEBRUARY 2005 16
Information about the conference
and speakers and copies of most
presentations are available 
on the Dallas Fed web site, 
www.dallasfed.org, in the 
News & Events section.
The effective
integration of 
IT into an
organization’s
culture and the
reorganization of
work are what
create competitive
advantages.

Where IT's @: technology and the economy

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Where IT's @: technology and the economy

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