The Resurgence of Growth in the Late 1990s:

Is Information Technology the Story?

Stephen D. Oliner*
Federal Reserve Board
Washington, DC 20551
[email protected]

Daniel E. Sichel*
Federal Reserve Board
Washington, DC 20551
[email protected]

February, 2000

* We thank Raven Saks for extraordinary research assistance. We received extremely helpful
comments and assistance from many colleagues at the Federal Reserve Board, and we wish to
particularly thank our colleagues Ana Aizcorbe, Michael Kiley, and Karl Whelan. We also
thank Robert Gordon for providing us with updated versions of the tables from Gordon (1999),
Michael Harper for valuable assistance with data from the Bureau of Labor Statistics, and Kevin
Stiroh for several useful conversations about the results in Jorgenson and Stiroh (2000). The
views expressed are those of the authors and should not be attributed to the Board of Governors
of the Federal Reserve System or its staff.

ABSTRACT
The performance of the U.S. economy over the past several years has been remarkable,
including a rebound in labor productivity growth after nearly a quarter century of sluggish gains.
To assess the role of information technology in the recent rebound, this paper re-examines the
growth contribution of computers and related inputs with the same neoclassical framework that
we have used in earlier work. Our results indicate that the contribution to productivity growth
from the use of information technology including computer hardware, software, and
communication equipment surged in the second half of the 1990s. In addition, technological
advance in the production of computers appears to have contributed importantly to the speed-up
in productivity growth. All in all, we estimate that the use of information technology and the
production of computers accounted for about two-thirds of the 1 percentage point step-up in
productivity growth between the first and second halves of the decade. Thus, to answer the
question posed in the title of this paper, information technology largely is the story.

1. INTRODUCTION1
The performance of the U.S. economy over the past several years has been nothing short
of remarkable. From the end of 1995 through the end of 1999, real gross domestic product rose
at an annual rate of more than 4 percent. This rapid advance was accompanied by a rebound in
the growth of labor productivity, with output per hour in nonfarm business rising at about a 2-
percent annual rate C nearly double the average pace over the preceding 25 years. Determining
the source of this resurgence ranks among the key issues now facing economists.
An obvious candidate is the Ahigh-tech@ revolution spreading through the U.S. business
sector. In an effort to reduce costs, to better coordinate large-scale operations, and to provide
new or enhanced services, American firms have been investing in information technology at a
furious pace. Indeed, business investment in computers and peripheral equipment, measured in
real terms, has jumped more than four-fold since 1995. Outlays have also risen briskly for
software and communication equipment, which are crucial components of computer networks.
We first examined the link between computers and growth in Oliner and Sichel (1994).
At that time, many observers were wondering why productivity growth had failed to revive
despite the billions of dollars that U.S. companies had poured into information technology over
the preceding decade. We concluded that, in fact, there was no puzzle

just unrealistic

expectations. Using a standard neoclassical growth-accounting framework, we showed that

computers should not have been expected to have contributed much to growth through the early

This paper draws heavily from Oliner and Sichel (1994) and Sichel (1997 and 1999), and
includes text taken directly from that earlier work. The first two studies were published by the
Brookings Institution and the last was published by the National Association for Business
Economics.
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1990s. The contribution was modest because computing equipment still represented a small
fraction of the total capital stock.
This paper updates our original analysis, using essentially the same framework as before.
Now, however, the results place information technology at center stage. The stocks of computer
hardware, software, and network infrastructure have ballooned and, by our estimates, are earning
greater returns than in the early 1990s. In addition, the producers of computers (and the
embedded semiconductors) appear to have achieved huge efficiency gains in their operations.
Focusing on the nonfarm business sector, we estimate that the growing use of information
technology equipment and the efficiency improvements in producing computers account for
about two-thirds of the acceleration in labor productivity between the first and second halves of
the 1990s. Thus, to answer the question we posed in the title, information technology largely is
the story.
The rest of the paper is organized as follows. The next section describes our analytical
framework and the data we employ. Section 3 presents our estimates of the growth contribution
from the use of computer hardware, software, and communication equipment; section 4 then
assesses the contribution from efficiency gains in producing computers and semiconductors. In
both sections, we compare our results with those from other recent studies. Section 5 takes a
quick look at the role of electronic commerce in the productivity speed-up, and section 6
concludes the paper.

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2. THE ANALYTICAL FRAMEWORK

The Neoclassical Growth-Accounting Expression
The framework used here was pioneered by Robert Solow (1957) and is similar to that
used in Oliner and Sichel (1994), Oliner and Wascher (1995), and Sichel (1997 and 1999). Our
earlier work focused on computer hardware and software. However, in recent years, the most
notable innovations have involved the convergence of computers and communication equipment.
The Internet, intranets, and other networks allow businesses, their employees, and consumers to
share or exchange vast amounts of information. Thus, to get a more complete picture of the role
of information technology in the economy, we now group communication equipment with
hardware and software.2 In the decomposition for this paper, we attribute growth in output ( Y)
in a given year to the contributions from computer hardware ( KC), computer software (KSW),
communication equipment (KM), other capital (KO), labor hours (L), labor quality (q), and
multifactor productivity (MFP):

0Y = " 0K

(1)

0 0

+ "SWKSW + "MKM + "OKO + "L( L + q ) + MF P,

where the dot over a variable indicates the rate of change expressed as a log difference. The
labor quality term captures changes in the composition of the workforce over time. The term for
multifactor productivity identifies the portion of output growth left after accounting for growth
in capital and labor. It is a catch-all for technological or organizational improvements that

Other researchers also have emphasized the importance of focusing on more than just
hardware to understand the role of information technology in the economy. For example,
Brynjolfsson and Yang (1999) use stock market valuations of firms to identify the value of
information technology assets broadly defined to include hardware, software, investments in
worker training, and firm-specific capital created from these inputs.
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increase output for a given amount of input. 3 Finally, the " terms are income shares; under
neoclassical assumptions these income shares equal the output elasticities for each input and they
sum to one. (Time subscripts on both the growth rates and the income shares have been
suppressed for notational simplicity.)
The key assumption underlying the neoclassical approach is that businesses always
maintain their capital stocks at or near their optimal long-run levels, which implies that all types
of capital earn the same competitive rate of return at the margin, net of depreciation and other
costs associated with owning each asset. If this were not the case, then a business could increase
its profits by reallocating its investment dollars toward the asset with the higher net returns. Of
course, such a model will not apply to every business all of the time, but it does provide a
baseline common to almost all prior growth-accounting research.
The contribution of information technology

including computer hardware, software,

and communication equipment C depends critically on the income shares, "C, "SW, and "M. To
illustrate how we calculate these income shares, consider the share for computing equipment, "C.
This share is not observable, but we estimate it for each year in accord with the methodology
used by the Bureau of Labor Statistics (BLS). In the BLS framework, the income share for
computing equipment in a given year is

"C = [r + *C - BC]pCKC/pY,

(2)

where r is a measure of the real net rate of return common to all capital, pY is total nominal
3

Because the capital stocks we use are constructed from quality-adjusted investment
flows, these stocks capture embodied technical improvements. If the quality adjustment were
perfect, the MFP term would pick up only disembodied improvements. However, the
investment data likely do not capture all quality improvement, with the unmeasured part being
subsumed into MFP.
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output (or income), and all other terms refer specifically to computing equipment; *C is the
depreciation rate, BC is the rate of capital gain (actually capital loss for computers), pC is the
price level, and KC is the real capital stock. 4 In this setup, it is the real net rate of return, r, that
the neoclassical model equates across different asset classes. The intuition behind equation 2 can
be easily explained. The term pCKC is the nominal stock of computer hardware. This stock
earns a gross rate of return equal to (r + *C - BC). The product of pCKC and the gross rate of
return equals the nominal income flow generated by computers, which is divided by total
nominal income (pY) to obtain the income share.
The exercise we perform with equations 1 and 2 has a few limitations. First, it captures
only the proximate sources of output growth

namely, the accumulation of capital and labor,

plus MFP. In particular, it does not model the underlying technical improvements that have
driven the accumulation of capital. In this sense, the neoclassical framework provides a
superficial explanation of growth. Second, this framework cannot satisfactorily explain why
growth slowed in the 1970s; it largely attributes this slowdown to a mysterious deceleration in
MFP. We make no attempt to address this puzzle, and instead pursue a less ambitious goal: To
assess how much of the recent resurgence of growth can be explained, under reasonable
assumptions, by factors related to the use of information technology and the production of

Although we include tax terms in our actual calculations, they are excluded in the

discussion for simplicity. Note also that

represents the rate of price change for hardware ( p C)

relative to inflation for overall output in the nonfarm business sector ( p ). Thus, it measures the
real change in hardware prices, consistent with the use of a real return (r) in equation 2.
Alternatively, r and C both could have been specified in nominal terms.
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computers and semiconductors.5

Capital Stocks
The capital stocks that we use throughout the analysis are Aproductive@ stocks, so named
because they measure the income-producing capacity of the existing stock during a given period.
This concept of capital stock differs from a wealth stock, which measures the current market
value of the assets in use. For growth accounting, the productive stock is the appropriate
measure because we are interested in how much computers and other assets produce each period,
not in tracking their market value.
The following example illustrates the difference between these two types of capital
stocks. Suppose that we had three PCs: A Pentium that was just purchased and two 486s that
were purchased three years ago. Assume, also, that the Pentium is twice as powerful as each 486
and that all units will be scrapped after four years of service. To calculate either a wealth or a
productive stock, these PCs must first be converted to a comparable-quality basis. Using the
Pentium as the numeraire, each 486 (when new) would count as one-half of a Pentium unit. 6 If
the 486s suffer no loss of efficiency while in use, the total productive stock of computers would

Others have attempted to explain the earlier slowdown in MFP growth. For example, see
Fischer (1988) and accompanying articles in a Journal of Economic Perspectives Symposium.
More recently, Greenwood and Yorukoglu (1997), Greenwood and Jovanovic (1998), and Kiley
(1999) argue that the adoption of information technology in the 1970s was itself responsible for
the slowdown because it took firms a long time to learn how to use the new equipment
effectively. This view is controversial. Kortum (1997) questions the empirical importance of
these adoption costs, while Hornstein (1999) shows that the theoretical results depend crucially
on the specification of the learning process.
6

BEAs hedonic price indexes for computers make just such an adjustment; that is,
nominal purchases of computers each year are quality-adjusted with BEAs deflator so that a
dollar of real investment in computers in a given year represents the same amount of computing
power as a dollar of real investment in another year.
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equal two units on a Pentium-equivalent basis (one unit for the Pentium and one unit for the two
486s). The wealth stock, however, would be less than two units. To see why, note that the 486s,
being three years old in our example, have only one more year of service before retirement; in
contrast, the currently-new Pentium has four years of service remaining. This means that the
future rental income to be earned by the two 486s together is only one-fourth that to be earned
by the Pentium. (The two 486s produce the same income as a Pentium in any given period, but
their remaining service life is only one-fourth as long.) Apart from the effects of discounting
these future income flows, the two 486s together would sell today for only one-fourth of the
Pentiums price, making the wealth stock equal to 1- Pentium-equivalent units. Thus, the
wealth stock would be smaller than the productive stock, illustrating the need to distinguish
between these two types of capital stock.
Although PCs experience little, if any, physical decay, they may still lose productive
efficiency as they age, in which case the 486s should be counted as less than one Pentiumequivalent unit in the productive stock. It may seem odd to argue that the 486s become less
efficient if they can still run all the same software as when new. However, the assumption of no
loss in efficiency actually imposes a strong condition C that the two 486s in our example remain
a perfect substitute for the Pentium throughout their entire useful life. This condition need not
hold. For example, if the two old 486s taken together can not run the latest software, a single
Pentium could be considerably more useful than two 486s. Thus, for the purposes of estimating
a productive stock of capital, it may be appropriate to downweight somewhat the productive
efficiency of older computers, even if there were no physical decay.
Exactly how much efficiency loss to build in for computers is a difficult question, for

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which there is little empirical guidance. BLS constructs productive stocks (for computers and all
other tangible capital) that assume some decline in productive efficiency with age. We follow
BLS and use their measures of productive capital stocks whenever possible. 7
Data for Estimating the Contribution of Computing Services to Growth 8
We rely heavily on data from the Bureau of Economic Analysis (BEA) and the BLS to
estimate the terms in equations 1 and 2. Our starting point is the dataset assembled by the BLS
for its estimates of multifactor productivity. These annual data cover the private nonfarm
business sector in the United States and provide superlative index measures of the growth of real
output, real capital input, and labor input. BLS measure of capital input is very broad,
encompassing producers durable equipment, nonresidential structures, residential rental
structures, inventories, and land.
At the time we were writing, the BLS dataset ran only through 1997. We extended all
necessary series through 1999, revised the output figures to be consistent with the October 1999
comprehensive revision of the National Income and Product Accounts (NIPAs), added in capital
stocks of software, and made a few other adjustments. 9 In making these modifications, our

In our earlier work, we used wealth stocks to calculate the income share of computers, as
in equation 2 above. If we had used productive stocks, the growth contribution of computers that
we reported in that earlier work would have been somewhat larger. Nonetheless, the basic
conclusion in our prior papers that computer use had not made a large contribution to growth
through the early 1990s would still hold.
8

This section provides a brief overview of our data. Additional detail can be found in a
data appendix available from the authors.
9

The most important adjustment accounts for changes in the methodology used for the
Consumer Price Index. Over time, the CPI has been improved to measure inflation more
accurately. Because the CPI is used to deflate parts of nonfarm business output, these changes
introduced discontinuities in the measurement of real output growth. In the BLS dataset that we
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intent was to anticipate the changes that BLS would incorporate in its next release of multifactor
productivity data.
Our estimate of the growth contribution from computer hardware is built up from very
detailed data. We start with BLS productive stocks for mainframes, personal computers,
terminals, printers, and three different types of storage devices. 10 Following the BLS
methodology, we calculate the growth contribution of each such asset (as the product of its
income share and the growth of the productive stock) and sum these growth contributions to
estimate the total contribution of computer hardware to output growth. For software, no
estimates of the productive stock have yet been published. However, in the comprehensive
NIPA revision, BEA did begin to publish data on aggregate investment in software. Based on
these aggregate investment data, and information from BEA about the service lives for software,
we constructed a productive stock of software capital in accord with the BLS methodology. We
use this stock to estimate the growth contribution from software. For communication
equipment, the estimated growth contribution is based on BLS published series for the
productive capital stock. Finally, to measure the contribution of other capital, we start with the
contribution from total capital (excluding software) and net out the contributions from computer

used, these CPI revisions had been carried back only to 1995. We adjusted the output data for
earlier years to make them methodologically consistent with the more recent data, using
information in BEAs comprehensive revision of the NIPAs and the Economic Report of the
President (1999, p. 94).
10

For personal computers, we recalculated the entire series for the productive stock. As
part of the recent comprehensive revision, BEA announced that it had boosted the depreciation
rate of personal computers, and we expect BLS in its next release of data to shorten the
service life used to estimate the productive stock of PCs. To be consistent with what we expect
BLS to do, we calculated a productive stock of personal computers with a shorter (five-year)
service life.
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hardware and communication equipment.

We estimate the income share for each type of capital from its analogue to equation 2.
With a couple of exceptions, the depreciation rate, *, for each type of equipment and structure
comes from BEA. 11 For the expected capital gain or loss, B, we use a three-year moving average
of the percent change in the price of each asset relative to the price of nonfarm business output.
The other critical piece is the net real rate of return, r. We calculate r by equating BLS estimate
of the income share for all nonresidential equipment and structures to the sum of the assetspecific income shares defined by equation 2. The resulting value of r, which represents the ex
post net return earned each year on the entire stock of nonresidential equipment and structures, is
then used to calculate the income share for each asset, including computer hardware, software,
and communication equipment. By so doing, the neoclassical assumption C that all types of
capital earn the same net return in a given year

is imposed by construction.

Consider the gross return to personal computers implied by this procedure. In 1997, r is
estimated to have been about 4 percent. Taking that figure, adding on a depreciation rate of
about 30 percent and a capital loss term of 34 percent, we obtain a gross return for personal
computers of 68 percent for 1997. Because computers become obsolete so rapidly, the gross
return must be quite large in order to cover the sharp decline in a personal computers market
value each year, while still providing a competitive return net of depreciation.

11

See the Survey of Current Business, July 1997. Because BEA does not publish
depreciation rates for the components of computers and peripheral equipment, we follow Whelan
(1999) and set the depreciation rates equal to a geometric approximation calculated from capital
stocks and investment flows, with the depreciation rate for PCs set equal to that for mainframes.
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3. GROWTH CONTRIBUTION FROM THE USE OF INFORMATION TECHNOLOGY

Contribution to Output Growth
Key results are shown in table 1. The first two columns, which cover 1974-90 and
1991-95, tell a similar story to that in our earlier work. In these periods, real nonfarm business
output rose at an average pace of around 3 percent per year. And, in these periods, computer
hardware accounted for about percentage point per year of that growth, as shown on line 3.
Computer software contributed 0.1 percentage point per year during 1974-90, with its
contribution rising to almost percentage point per year during 1991-95. 12 Communication
equipment contributed about 0.1 percentage point per year in both periods. 13 Adding up these
pieces, information technology capital accounted for about percentage point of output growth
per year during both 1974-90 and 1991-95.
Calculations such as this were the basis for our earlier conclusion that the growth
contribution from information technology had been relatively small through the early 1990s,
especially if one focused on computer hardware alone. During the first half of the 1990s, the
stock of computer hardware increased at an average rate of about 17 percent per year, but its
income share averaged just 1.4 percent (see lines 10 and 13 of the table). Hence, the

12

The contribution of software is a little bigger than in our earlier work. Previously, we
counted only pre-packaged software, while BEAs new software figures include custom and ownaccount software as well. Custom software is produced when businesses hire outside consultants
to write programs, while own-account software is produced in-house by a business employees.
13

BEA uses hedonic price measures only for selected components of communication
equipment. Thus, it seems probable that the data on investment and capital stock do not fully
capture the quality improvements in communication equipment. If that is the case, the true
stock of communication equipment would grow more rapidly than that shown in the published
numbers, and the contribution of communication equipment to output growth would be larger
than that shown above.
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contribution of computer hardware to output growth, computed as the product of these figures,
was only percentage point in this period.
However, the contribution of information technology capital to output growth surged in
the second half of the 1990s. As shown in the last column, we estimate that the contribution of
computer hardware to output growth during 1996-99 was about 0.6 percentage point per year,
while the contribution of overall information processing capital to output growth was about 1.1
percentage points, a considerable step-up from the pace earlier in the decade. 14 This step-up is
even more evident in figure 1, which plots the contributions year by year.
Contribution to Productivity Growth
Table 1 showed a decomposition of output growth. A closely related decomposition
focuses on growth in labor productivity. In particular, equation 1 can be transformed into an
equation for labor productivity (output per hour) by subtracting the growth rate of total hours
from both sides of the equation, yielding:

0Y - 0L = [" (0K - 0L ) + " (K0 - 0L ) + " (0K - 0L ) + " (0K - 0L )] + " 0q + M0F P.

(3)

SW

SW

In this decomposition, growth in labor productivity reflects increases in the amount of capital per

14

Note that the results in table 1 are based on BLS published series for nonfarm business
output. This series is a product-side measure of output, which reflects spending on goods and
services produced by nonfarm businesses. Alternatively, output could be measured from the
income side as the sum of payments to capital and labor employed in that sector. Although the
two measures of output differ only slightly on average through the mid-1990s, a sizable gap has
emerged in recent years. By our estimates, the income-side measure has grown about
percentage point faster (at an average annual rate) since 1995. We employ the published productside data because no one knows the appropriate adjustment (if any) to this series; using the
published data also allows us to maintain consistency with other studies. Nonetheless, the true
pickup in output growth after 1995 could be somewhat larger than that shown in table 1.
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hour worked C referred to as capital deepening and captured by the terms within square brackets
C

and growth in labor quality and MFP. In equation 3, the capital deepening portion is further

divided into the contribution of computer hardware, software, communication equipment, and
other capital.
Table 2 presents this decomposition of productivity growth. As can be seen in the first
line of the table, growth in labor productivity picked up from about 1.6 percent per year in the
first half of the 1990s to nearly 2.7 percent in the second half. The rapid capital deepening
related to information technology capital accounted for nearly half of this increase (line 3).
Other types of capital (line 7) made almost no contribution to the step-up in labor productivity
growth, while the contribution from labor quality actually fell across the two periods. This
leaves MFP to account for more than half of the recent improvement in labor productivity
growth.
So far, we have focused on the contribution from the use of information technology
capital. Later in the paper, we will discuss the separate contribution from the production of
computers and semiconductors, which is embedded in the MFP term.
The Growth Contribution from Computer Hardware: Comparison to Other Studies
Recently, several other researchers have estimated the growth contribution from the use of
computer hardware. Two of our colleagues at the Federal Reserve Board, Michael Kiley and Karl
Whelan, have taken sharply different approaches to address this question. In addition, Dale
Jorgenson and Kevin Stiroh have produced estimates within the well-known framework that

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Jorgenson and various collaborators developed to measure the sources of economic growth.15
Table 3 compares the results from the various studies. For each one, we show the contribution to
output growth from computer hardware for the latest period covered by that study and for the
immediately preceding period. As can be seen, the estimates vary widely. At the top end, Whelan
(1999) estimates that the use of computer hardware contributed more than 0.8 percentage point,
on average, to output growth during the latest period (1996-98) somewhat above our own
estimate. In contrast, Kiley (1999) estimates that computer hardware has consistently made a
negative contribution to growth since the mid-1970s. Jorgenson and Stiroh (1999) are close to
the middle of this wide range. We briefly explain why these estimates differ from ours.
Whelan (1999) analyzes the growth contribution within a vintage model of production.
Quite apart from his empirical results, Whelans paper provides a nice micro-foundation for the
growth accounting framework that we implement. Whelan derives an expression for the optimal
service life of computers (and, thus, for the depreciation rate) that depends on the rate of quality
improvement in new vintages, the cost of maintaining existing vintages, and the rate of physical
decay as vintages age. These structural parameters appear in his expression for the gross return
on computer capital, making it look different from our expression (r + c - c). However, his
numerical estimate of the gross return closely resembles ours because the depreciation rate ( c) is,
in effect, a summary statistic for these parameters.
Whelans estimate of the growth contribution exceeds ours because of a difference in
measurement, not concept. His measure of the productive stock of computers is roughly one-

15

See Jorgenson, Gollop, and Fraumeni (1987) for a detailed description of this
framework; Ho, Jorgenson, and Stiroh (1999) provide a more abbreviated account.
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third larger than ours, which boosts his estimate of the income share (and, in turn, the growth
contribution) by the same proportion. As described above, we use BLS productive stocks, which
allow for some loss of efficiency before retirement; this allowance reflects, however crudely, the
view that older vintages of computers become less productive with age, even if they remain in
perfect physical condition. Whelan assumes instead that each quality-adjusted dollar of
investment in PCs, mainframes, and most other types of computing equipment remains fully
productive until retirement. Although we believe Whelans measure of the productive stock is on
the high side, our estimate could be too low. One cannot rule out that we have underestimated
the growth contribution from computer hardware by a tenth or two.
Jorgenson and Stirohs (2000) estimate of the growth contribution is smaller than ours.
During 1996-98, the latest period covered by their estimates, they figure that computer hardware
contributed 0.36 percentage point annually to growth, about double their contribution for 197495. In the 1996-98 period, their estimate is roughly three-fifths the size of ours, reflecting their
smaller income share for computer hardware 1.12 percent during 1996-98 compared to our
estimate of 1.65 percent and their slower growth rate for capital services from computer
hardware.
Two factors largely explain these differences. First, they employ a broader concept of
output than we do. Jorgenson and Stiroh include imputed service flows from owner-occupied
housing and consumer durables, which are excluded from the BLS output series we use. With
these additions to output, the income share attributed to business computers falls, all else equal.
Business-owned computers are simply a smaller part of the economy that they choose to measure.
Second, Jorgenson and Stiroh assume that capital put in place only becomes productive with a
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lag, and therefore their capital stock numbers are lagged one year relative to ours; that is, for the
1998 contribution to growth, we use an estimate of computer capital and its growth rate for 1998
while they use figures for 1997. This convention causes their estimate of the current-dollar
computer stock, and hence the income share, to be smaller than ours. In addition, because the
growth of the real stock of computer hardware has picked up in recent years, their estimate of

0K

for 1996-98 actually reflects the slower growth recorded over 1995-97.
In contrast to the other studies, Kiley (1999) estimates that the contribution of computers
to growth has been negative since the mid-1970s. Kiley obtains this result by modifying the
growth accounting framework in one important way. He assumes that investment in new
computers entails adjustment costs, a catch-all phrase meant to capture any disruption to the
firms normal activities. As a result, his growth-accounting equation includes a term for the rate
of computer investment, which has a negative coefficient. Because computer investment has been
very strong, Kileys model generates large adjustment costs so large that they swamp the
output from the existing stock of computers. The adjustment costs in Kileys model will diminish
only when the boom in computer investment comes to an end. When this happens (at some point
in the future), he estimates that the growth contribution from computers will become positive,
reaching about percentage point annually in the steady state.
As Kiley notes, there certainly are some start-up costs associated with the transition to
new types of hardware or software. However, in our view, Kileys adjustment cost framework
overstates their importance. His framework implies that the costs associated with software, user
training and support, and system upkeep would all drop notably once the transition period of

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heavy computer investment is over. This implication seems at odds with the high level of care
and feeding required by computer systems, including mature ones.

4. GROWTH CONTRIBUTION FROM THE PRODUCTION OF COMPUTERS

So far, we have focused on the contribution from the use of information technology
capital. However, this is only part of the story. An additional growth contribution can come
through the efficiency improvement in the production of computing equipment. As we will show,
this second channel works through the MFP residual. In this section, we will identify the part of
MFP growth that can be attributed to improvements in computer production, using a framework
that draws on Hulten (1978), Triplett (1996), Stiroh (1998), and Whelan (1999).
For our analysis, computer production encompasses not only the assembly of computers
but also the production of the semiconductor chips that form the heart of computers. Including
semiconductors is important because advances in chip technology ultimately account for a large
share of computer-sector productivity gains.16 We model the nonfarm business economy as
having three sectors. One produces semiconductors, another manufactures computers, and a third
represents all other industries; these sectors are indexed by the superscripts s, c, and o,
respectively. Each sector has its own production function, with output growth depending on the
accumulation of inputs and growth in sectoral MFP. In a multi-sector model, one must specify
the input-output connections among the sectors. We focus on the one connection that really
matters for our analysis the use of semiconductors as an input by the other two sectors and

16

See Triplett (1996) for estimates of the extraordinary pace of MFP growth in the
semiconductor industry.
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abstract from all others. Our companion working paper, Oliner and Sichel (2000), fully describes
this three-sector model; here, we discuss the main results.
The key expression relates MFP growth for nonfarm business as a whole to that in each
c

sector. Let denote computer output as a share of total nonfarm business output, in current
o

dollars, and let denotes the corresponding share for the rest of nonfarm business (excluding
c

semiconductors). Because these two sectors produce all final output in our model, + = 1,
o

so that = 1 - . Also, let denote the value of semiconductors used as inputs by the other
two sectors, scaled by nonfarm business output, again in current dollars. With this notation, our
companion working paper shows that

(4)

MF P = MF P + (1- )MF P + MF P .

Aggregate MFP growth is a weighted average of MFP growth in the two sectors that produce
final goods, plus a term for the semiconductor sector. To see why this additional term is needed,
assume that there were no MFP growth in the other two sectors and that the aggregate stocks of
capital and labor were fixed. Growth in semiconductor MFP would either allow capital and labor
to be reallocated to the other sectors (with no change in semiconductor production) or it would
increase the volume of semiconductors supplied to those sectors (with no reallocation of capital
and labor). Either way, total nonfarm business output would rise with no change in aggregate
capital and labor. The final term in equation 4 identifies the source of this increase in aggregate
MFP.
To decompose aggregate MFP growth in accord with equation 4, we need estimates of

- 18 -

the current-dollar output shares and the sectoral MFP growth rates. Using BEA data, we
approximate current-dollar computer output with the sum of computer spending by U.S.
businesses, households, and all levels of government, plus net exports of computers. For currentdollar semiconductor output, we use internal Federal Reserve Board estimates developed to
support the Feds published data on U.S. industrial production. We divide both series by currents

dollar nonfarm business output to obtain estimates of and .

To estimate sectoral MFP growth, we employ the so-called dual method used by
Triplett (1996) and Whelan (1999). This method uses data on the prices of output and inputs,
rather than their quantities, to calculate sectoral MFP growth. We opted for the dual method
because it can be implemented with relatively little data. To see why prices contain information
about sectoral MFP growth, consider an example involving the semiconductor sector, where
output prices have trended sharply lower over time. Also, assume that input prices for the
semiconductor industry have been stable. Given the steep decline in the relative price of
semiconductors, MFP growth in semiconductor production must be rapid compared to that
elsewhere. Were it not, semiconductor producers would be driven out of business by the ever
lower prices for their output in the face of stable input costs. This example illustrates the link
between movements in relative output prices and relative growth rates of sectoral MFP. More
formally, our companion working paper shows that

0s 0o

0c 0o

(5)

MF P = MF P - ( p - p ) + terms for relative growth in sectoral input costs

(6)

MF P = MF P - ( p - p ) + terms for relative growth in sectoral input costs,

- 19 -

where the p terms denote growth in the sectoral output prices. If input costs grew at the same
rate in all three sectors, the change in relative output prices would fully characterize the
differences in sectoral MFP growth. However, because semiconductors loom large in the cost
structure for computer producers, we know that input costs for that sector are falling relative to
those for the other sectors. The final terms in equations 5 and 6 (see the companion paper for
details) take account of these differences in sectoral input costs. Equations 4 through 6 form a
system of three equations, which we solve for the three sectoral MFP growth rates; all other
terms can be calculated using the data described above and are treated as known in these
equations.
Table 4 presents our estimates of the sectoral contributions to growth in MFP. As shown
on lines 2 and 3, the contributions from computer and semiconductor producers moved up sharply
during 1996-99, reaching 0.22 and 0.41 percentage point per year, respectively. The increases
largely reflect the faster decline in the relative prices of computers and semiconductors during this
period, which this framework interprets as signaling a pick-up in MFP growth (lines 9 and 10).17
Note that our estimate of MFP growth for semiconductors covers the output that feeds into
computer production and that used elsewhere in the economy. Only the first piece is relevant for

17

Alternatively, one might argue that the sharp price declines merely reflect weak
worldwide demand rather than a rise in MFP growth. The economic problems during 1997-98 in
in Asia and Latin America likely did depress semiconductor demand for a while. However, if
weak demand rather than faster MFP growth were the main story, we might expect profit
margins for semiconductor producers to have narrowed. In fact, data for Intel, the worlds
largest semiconductor producer do not show that pattern. Intels profit margin, defined as net
income divided by net sales, averaged 25 percent during 1996-99, up from 20 percent during
1990-95. This evidence, while far from definitive, does suggest that the sharp decline in
semiconductor prices since 1995 has been accompanied by rapid efficiency gains in production.
- 20 -

measuring the MFP contribution of the computer sector, broadly defined to include the
production of the embedded semiconductors. Line 5 presents an estimate of the MFP
contribution from this vertically-integrated computer sector. This estimate includes the MFP
contribution from computer manufacturing (line 2), plus 60 percent of the MFP contribution from
semiconductor production (line 3).18 As can be seen by comparing lines 1 and 5, this verticallyintegrated computer sector accounted for nearly two-fifths of the growth in nonfarm business
MFP during the second half of the 1990s a remarkable percentage given its tiny share of total
current-dollar output.
Growth Contributions: The Full Story
We pull together the strands of our story in table 5, which decomposes the roughly 1
percentage point acceleration in labor productivity between the first half and the second half of
the 1990s. As shown on line 2, we attribute almost percentage point of the pick-up to the
growing use of information technology capital throughout the nonfarm business sector. In
addition, as noted above, the rapidly improving technology for producing computers (and the
embedded semiconductors) has contributed another percentage point to the acceleration (line
3). Taken together, these factors account for about two-thirds of the speed-up in labor
productivity growth since 1995. The growth in other capital services per hour (line 4) explains
less than 0.05 percentage point of the acceleration, while MFP growth elsewhere in nonfarm
business (lines 6 and 7) accounts for the remainder. These results suggest that information
18

The 60 percent share is based on the following data from the Semiconductor Industry
Association (SIA). During 1990-94, U.S. computer producers accounted for almost 60 percent
of total U.S. consumption of semiconductors. For 1995-98, the SIA data cover a broader region
that includes all of North and South America; the share of semiconductors consumed by computer
producers in this broader region remained around 60 percent.
- 21 -

technology has been the primary force behind the sharp gains in productivity growth, especially if
one includes MFP growth for the entire semiconductor sector, not just the part that feeds into the
computer industry.19
A Different View of the Recent Experience
In a widely cited paper, Robert Gordon (1999) also emphasized the role of information
technology, but with an important twist from our explanation. He argued that improvements in
the production of computer hardware accounted for the entire acceleration in labor productivity
in nonfarm business (after adjusting for the cyclical component of productivity and for changes in
the methodology of price measurement). Elsewhere in nonfarm business, Gordon argued there
has been no rise in trend productivity growth. Based on this decomposition, Gordon inferred that
the increasing use of computers across the nonfarm business sector had contributed nothing to the
recent acceleration of trend productivity. We will briefly explain why Gordon reaches a
conclusion so different from ours.
Gordon wrote his paper before the comprehensive revision of the national accounts in
October 1999; he has since recalculated his numbers using the new data, and we shall refer to his
new numbers unless noted otherwise. As for the contribution from producers of computer
hardware, Gordons results are actually quite consistent with our own. He calculates that this
sector accounts for about 0.3 percentage point of the acceleration in labor productivity for

19

As we noted above, the post-1995 pickup in the growth of output (and, hence, in output
per hour) could be larger than is indicated by the published product-side data. If so, the share of
the pickup attributed to information technology likely would be smaller than in table 5, though it
would still be quite sizable. The extent of any adjustment in this share would depend on both the
size of the upward revision to output growth and on the fraction of the extra output that takes the
form of investment in information technology capital.
- 22 -

nonfarm business after 1995.20 We estimate that the increase in MFP growth for producers of
computer hardware and the embedded semiconductors accounts for 0.26 percentage point of this
pickup (see table 5, line 3). Capital deepening in this sector, not shown separately in the table,
would boost this contribution a bit leaving our estimate of the sectors total contribution to
labor-productivity growth very close to Gordons.
In his paper, Gordon estimated that trend productivity growth for nonfarm business as a
whole increased about 0.3 percentage point, the size of the step-up he attributed to the production
of computers. This left no room for any other factor such as the use of computers or MFP
growth in other industries to have contributed to the pickup. Using the new data through
1999:Q3, Gordon now estimates that the post-1995 acceleration in trend productivity for nonfarm
business was about 0.5 percentage point, 0.2 percentage point more than his estimate of the
contribution from computer producers. Thus, Gordons original conclusion that the
production of computer hardware accounted for the entire pickup in trend labor-productivity
growth no longer stands.
Whether he uses the new or the old data, Gordon attributes much of the recent
acceleration in productivity to cyclical factors. Unlike Gordon, we have made no attempt to
distinguish trend from cycle. Rather, we have tried to explain the speed-up of actual productivity

20

Specifically, using the new data, Gordon estimates that labor productivity for computer
manufacturers grew at a 35.1 percent annual rate from 1995:Q4 to 1999:Q3 and that the nominal
share of computers in nonfarm business output averaged about 1.5 percent. Over 1972:Q21995:Q4, Gordon estimates that labor productivity for computer manufacturers increased at a
25.1 percent annual rate and that the share of computers in output averaged 0.9 percent. These
numbers imply a pickup in the contribution of computer producers to overall productivity growth
of 0.3 percentage point (=0.015x35.1 - 0.009x25.1). The comprehensive revision had little effect
on this estimate.
- 23 -

growth during the late 1990s. Separating cycle from trend is difficult, particularly in the midst of
an expansion. In Gordons framework, as in ours, the production of computer hardware does not
come close to accounting for the entire rise in actual productivity growth, leaving plenty of room
for the use of computers to have boosted this growth in recent years. Indeed, as our results show,
the use of computers and other information technology makes an important contribution to the
acceleration in productivity after 1995.

5. THE INTERNET AND E-COMMERCE

In the past few years, the Internet has spread rapidly, e-commerce appears to have
exploded, and telecommunications links connecting computer networks have become ever more
extensive. And, according to the anecdotes, these developments have led to some spectacular
increases in productivity, as transaction and information costs have plummeted. Thus far, we
have not explicitly considered these developments. In principle, however, our results already
incorporate their impact to a large extent.
To see why, reconsider equation 1, which decomposed the growth of output into
contributions from different types of capital, labor, and MFP. Our output measure should largely
capture the effects of e-commerce. Most business-to-consumer e-commerce would be included in
the usual surveys of retail sales and consumer prices that underlie the NIPAs. Business-tobusiness e-commerce mainly represents transactions in intermediate inputs. These transactions
would not create new difficulties for estimating real GDP because the current system measures
final demand, not the underlying intermediate sales. Also, the indirect effects of business-tobusiness e-commerce on real GDP would be picked up without any change in current
- 24 -

procedures.21 Moving to the right-hand side of equation 1, the computer and communication
infrastructure needed to support the Internet and e-commerce is included in our measure of
capital stocks for those assets. Indeed, the rapid growth of activity over the Internet surely helps
explain the surging investment in these categories in recent years. Similarly, our measure of labor
input should cover workers involved in e-commerce.
To the extent that output, capital input, and labor input are properly measured, MFP
the residual in equation 1 would include the effect of e-commerce on business efficiency. If ecommerce enables goods and services to be produced and delivered using fewer total resources, it
could be one factor that has pushed up MFP growth in recent years. However, as described
below, a back-of-the-envelope calculation suggests that, to date, any such efficiency effects have
been small.
There are many different estimates of the volume of e-commerce transactions using widely
differing definitions of what should be included in such a measure. An article by Kim Cross in a
recent issue of Business 2.0 surveyed estimates of e-commerce and provided aggressive and
conservative estimates for 1999. Taking the aggressive estimates to get an upper bound, the
business-to-business figure is $112 billion and the estimate for the business-to-consumer segment
is $23 billion. Of this $135 billion in e-commerce, how much could represent a gain in efficiency
and therefore in MFP? To the extent that these transactions only represent a shift in distribution
channels without any cost savings, they would have no effect on MFP. Of course, sales activity is
21

For example, if an automaker purchased steel via the Internet, the GDP measure in the
national accounts would include the value of the car produced the final good but would not
separately count the value of the steel the intermediate input in order to avoid double
counting. Any additional efficiencies in the distribution of intermediate inputs would, in a
competitive equilibrium, show up in the price or quantity of the final good produced.
- 25 -

shifting to these electronic channels precisely because costs are perceived to be lower than
through traditional channels.
To get a very rough gauge of the possible size of these efficiency gains, we turn to a
recent study that compared prices on the Internet to those at bricks-and-mortar outlets.
Brynjolfsson and Smith (1999) examined prices for books and CDs in 1998 and 1999 and found
that Internet prices were about 9 to 16 percent lower than those in conventional stores. Of
course, this range could well over-estimate the efficiency gains in the retail sector because much
of the current price differential between on-line and bricks-and-mortar outlets likely represents a
short-term effort by on-line retailers to gain customers. Indeed, very few of the on-line retailers
have turned a profit at the discounted prices they are offering to the public.22 Thus, we use a
round figure of 10 percent, near the lower end of Brynjolfsson and Smiths range, as an estimate
of the true resource saving associated with e-commerce, and for lack of other information
we assume that this figure also represents the true resource saving in the business-to-business
segment. Putting together the pieces, a 10 percent resource reduction implicit in $135 billion of
sales implies $15 billion in cost savings [=(135/.9)x.10]. With total output in the nonfarm
business economy amounting to about $7 trillion, these cost savings represent only 0.2 percent of
output. And, assuming that these savings accrued during 1996-99, the impact of e-commerce on
MFP growth would be considerably less than 0.1 percentage point per year. This back-of-theenvelope calculation suggests that gains in efficiency related to the spread of e-commerce have
22

Also, one recent study actually found that prices are higher on the Internet. For
example, Bailey (1998) compares prices of books, compact discs, and software sold on the
Internet and through conventional channels. He found that in 1996 and 1997 prices were higher
on the Internet. This result seems counterintuitive, and Bailey argues that it reflected the
immaturity of the electronic marketplace.
- 26 -

had, to date, only a small impact on productivity. Nevertheless, all indications are that the volume
of e-commerce (including both business-to-business and business-to-consumer) will continue to
grow rapidly in coming years, raising the possibility of more substantial efficiency gains in the
future.23

6. CONCLUSION
The growth of labor productivity rebounded in the second half of the 1990s, drawing
attention to the role that information technology may have played. This paper examined that role
with the same neoclassical framework we used in earlier work. Once again, we find that the use
of information technology including computer hardware, software, and communication
equipment made a relatively small contribution to output and productivity growth through the
early 1990s. However, our results indicate that this contribution surged in the second half of the
decade. In addition, technological advance in the production of computers (including the
production of the embedded semiconductors) appears to have contributed importantly to the
speed-up in productivity growth. All in all, we estimate that the use of information technology
and the production of computers accounted for about two-thirds of the 1 percentage point stepup in productivity growth between the first and second halves of the decade. Thus, we conclude
that information technology has been the key factor behind the improved productivity
performance of the U.S. economy in recent years.

23

In a recent study, Brookes and Wahhaj (2000) used input-output analysis to argue that
business-to-business e-commerce will make a considerable contribution to economic growth over
the next ten years. However, like our analysis, their numbers suggest that the effect to date has
been small.
- 27 -

How much of the boost to productivity growth from information technology can be
expected to persist for the next several years? This crucial question cannot be answered with any
certainty, but we suspect that a sizable portion will. The recent surge in the growth contribution
likely reflects the interaction of a strong economy and investment opportunities created by the
convergence of communication and computer technology. Assuming that business cycles will
remain a feature of the economic landscape, the growth contribution will vary over time.
However, against that cyclical backdrop, the continued expansion of the Internet and e-commerce
likely will support the contribution of information technology to growth for some time to come.

- 28 -

Table 1
Contributions to Growth of Real Nonfarm Business Output, 1974-1999

1974-90
a

1. Growth rate of output:

1991-95

1996-99

3.13

2.82

4.90

.51
.28
.11
.12

.54
.24
.23
.07

1.08
.62
.31
.15

.85
1.15
.22
.40

.44
.82
.44
.57

.76
1.51
.31
1.25

Contributions from:
2.
3.
4.
5.

Information technology capital

Hardware
Software
Communication equipment

6.
7.
8.
9.

Other capital
Labor hours
Labor quality
Multifactor productivity

Memo:
Income shares:

10. Hardware
11. Software
12. Communication equipment
Growth rate of inputs:

1.0
.9
1.6

1.4
1.9
2.0

1.8
2.4
2.1

31.4
13.2
7.7

17.5
12.8
3.6

36.0
13.1
7.1

13. Hardware
14. Software
15. Communication equipment

a
Average annual log difference for years shown multiplied by 100.
b
Percentage points per year.
c

Percent.

Note: In lines 1 to 9, detail may not sum to totals due to rounding. Also, the product of growth
rates of inputs (lines 13 to 15) and income shares (lines 10 to 12) differ slightly from the value of
growth contributions (lines 3 to 5), which are calculated on the basis of year-by-year data, not
period averages.
Source: Authors calculations based on BEA and BLS data.
- 29 -

Table 2
Conbtributions to Labor Productivity Growth in the Nonfarm Business Sector, 1974-1999

1974-90
a

1. Growth rate of labor productivity:

1991-95

1996-99

1.43

1.61

2.66

Contributions from:
2.
3.
4.
5.
6.
7.

Capital deepening
Information technology capital
Hardware
Software
Communication equipment
Other capital

.81
.45
.26
.10
.09
.36

.60
.48
.22
.21
.05
.12

1.09
.94
.58
.26
.10
.16

8.

Labor quality

.22

.44

.31

9.

Multifactor productivity

.40

.57

1.25

a
Average annual log difference for years shown multiplied by 100.
b

Percentage points per year.

Note: Detail may not sum to totals due to rounding.

Source: Authors calculations based on BEA and BLS data.

- 30 -

Table 3
Contribution from Computer Hardware to Output Growth: Comparison to Other Studies

Previous Period
Contributiona

Current Period

Years Covered

1. This paper

1974-95

.27

1996-99
1996-98

.62
.58

2. Whelan (1999)

1980-95

.37

1996-98

.82

3. Jorgenson-Stiroh (2000)

1974-95

.17

1996-98

.36

4. Kiley (1999)

1974-84

-.34

1985-98

-.27

Years Covered

Contributiona

Study

Percentage points per year.

Sources:
This paper: Authors calculations based on BEA and BLS data.
Whelan (1999): Table 4 (Column labeled Obsolescence Model), p. 35. The figure shown for
1980-95 is a weighted average of figures presented by Whelan for 1980-89 and 1990-95.
Jorgenson-Stiroh (2000): Table 5 (Line labeled Computers (Kc)).
Kiley (1999): Table 3 (Line labeled Computers). These figures refer to the version of his model
with moderate adjustment costs.

- 31 -

Table 4
Sectoral Contributions to Growth in Nonfarm Business MFP

1. Growth rate of nonfarm business MFP

Contribution from each sector:

1974-90

1991-95

1996-99

.40

.57

1.25

2.
3.
4.

Computer sector
Semiconductor sector
Other nonfarm business

.12
.08
.20

.13
.13
.30

.22
.41
.62

5.

Computer sector plus computer-related

semiconductor sector

.17

.21

.47

1.0
.3
99.0

1.1
.6
98.9

1.3
.9
98.7

11.6
30.9
.21

11.6
22.7
.31

16.3
45.0
.63

Memo:
Output shares:
6.
7.
8.

Computer sector
Semiconductor sector
Other nonfarm business

Growth of MFP:

9. Computer sector
10. Semiconductor sector
11. Other nonfarm business

a
Percent per year.
b
Percentage points per year.
c

Percent. Note that the shares sum to more than 100. See the text for details.

Note: In lines 1 to 4, detail may not sum to totals due to rounding. Also, the product of sectoral
output shares (lines 6 to 8) and sectoral MFP growth (lines 9 to 11) differ slightly from the value
of growth contributions (lines 2 to 4), which are calculated on the basis of year-by-year data, not
period averages.
Source: Authors calculations based on data from BEA, BLS, and the Semiconductor Industry
- 32 -

Association, and on internal Federal Reserve estimates for semiconductor output and prices.

- 33 -

Table 5
Acceleration in Labor Productivity from 1991-95 to 1996-99

1. Labor productivity

1.05

Contributions from:
2.
3.

Information technology capital services per hour

MFP in computer production and computer-related
semiconductor production

4.
5.
6.
7.

Other capital services per hour

Labor quality
MFP in other semiconductor production
MFP in other nonfarm business

Percentage points per year.

Note: Detail may not sum to totals due to rounding.

Source: Results shown in tables 2 and 4.

- 34 -

.46
.26

.04
-.13
.11
.32

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- 37 -

APPENDIX A: MODEL OF SECTORAL PRODUCTIVITY

This appendix presents the model used in Section 4 to calculate the contributions of
computer and semiconductor producers to the growth of MFP in the nonfarm business sector.
The model divides nonfarm business into three sectors: Semiconductor producers, computer
producers, and all other industries, which are indexed by s, c, and o, respectively. All
semiconductor output is assumed to be consumed as an intermediate input by the other two
sectors, both of which produce only final products. To avoid cluttering the model with
unessential details, we abstract from the use of materials or purchased services in all three sectors.

Details of the Model

i

Let Q (i = s,c,o) denote the total output of sector i, and let Y denote the output that is
c

sold as final product. Given the assumptions of our model, Y = Q and Y = Q , while Y = 0.
i

Also, let K and L denote capital and labor inputs in sector i, and let S (i = c,o) denote the
semiconductors used as an input in sector i. The sectoral production functions then can be
written as:
s

(1)

Q = S +S

= F (K , L , t)

(2)

Q = Y = F (K , L , S , t)

(3)

Q = Y = F (K , L , S , t),

where t enters each production function as a proxy for the level of MFP. The capital and labor
used across all three sectors must exhaust the aggregate amount of capital and labor employed in
nonfarm business:
(4)

K =K +K +K

- 38 -

(5)

L =L +L +L .

Note that equation 4 directly aggregates the capital used in each sector, and equation 5 does the
same for labor. By so doing, we have implicitly assumed that each sector employs the same mix
of capital goods and the same mix of workers (otherwise, we would have to aggregate each input
across sectors with superlative indexes).1 As we discuss below, ignoring sectoral differences in
capital and labor use likely has no material effect on our results. This assumption of identical
capital and labor use implies a common rental rate (r) for capital in each sector and a common
wage rate (w) for labor:
s

(6)

r =r =r =r

(7)

w=w =w =w .

Finally, let p , p , and p denote the price of output in the three sectors. This completes the setup of the sectoral aspects of the model.
The aggregate production relation in our model is entirely standard. We assume that
output is a function of capital input, labor input, and the level of MFP. Under the usual
assumptions of perfect competition in input and output markets, this implies the standard growthaccounting identity for nonfarm business as a whole:

 wL  C  rK  C
C
'
&
L & K,
MFP Y
 pY 
 pY 
C

(8)

This assumption does not imply that all workers are the same, only that each sector
employs the same mix of heterogeneous workers. The measure of labor input in each sector (Li)
should be viewed as embedding both labor hours and labor quality.
- 39 -

where the dot signifies a growth rate, i.e., X = (MX/Mt)/X for any variable X. We measure the
growth in aggregate final output as a superlative index of growth in sectoral final output:

 p cY c  C
 p oY o  C
'


c %
o
Y
 pY  Y
 pY  Y ,
C

(9)

i i

where pY is aggregate final output in current dollars, p Y (i = c,o) is sectoral final output in
c c

o o

current dollars, and pY = p Y + p Y . The following proposition derives the relationship

between aggregate and sectoral MFP growth.

Proposition 1: Given the model specified in equations 1-9,

 C cY cp cYC c C C  p cY c pCcYC c  C  pCsQ sp sQC s  C

C p
'
' ' MFP
c c %
c 1c&% c1& o o % s o % s
s MFPs
MFP
MFPMFP
%
(1&pY
) MFP
%
MFP
MFP MFP
MFP
MFP
MFP
pY
pY
pY
pY
pY


 
 
 


C

c c

s s

where = (p Y )/pY and = (p Q )/pY.

Proof. To begin, totally differentiate equations 1-3, imposing the standard condition that the
i

marginal revenue product of each input equals its one-period cost, i.e., that p (MF /MK ) = r and
i

p (MF /ML ) = w for i = s,c,o, and p (MF /MS ) = p for i = c,o. This generates:

(10)

s
Q
C

 s c
 s o
 sC
 wL s  C
C
' p s S s SC c % p s S s SC o ' rK

s %
s % MFP
s
s s K
s s L
p
Q
p
Q
p
Q
p
Q








 cC
 wL c  C
 p sS c  C
C
' YC c ' rK

c %

c %

c %
c
MFP
 p cY c  K
 p cY c  L
 p cY c  S

(11)

c
Q

(12)

 rK o  C
 wL o  C
 p sS o  C
C
o' o'
o % o o Lo % o o So % MFP
o
Q
Y
o o K
.
p Y 
p Y 
p Y 
C

- 40 -

Next, totally differentiate equations 4 and 5, yielding:

 rK i  C
Ki
i's,c,o  rK 

(13)

'
K

(14)

 wL i  C
'
Li .
L
i's,c,o  wL 

Now, substitute equation 9 into equation 8, and then substitute equations 11-14 into the resulting
equation, which produces:

(15)



'
MFP

i'c,o


 rK i  C
 wL i  C
 p sS i  C
 p iY i  C 
Si %
MFPi
Ki % Li %

 pY 
 pY 
 pY 
 pY 


 
 wL i  C 

rK i C
&
Ki %  pY  Li .
i's,c,o  pY 


After cancelling and rearranging terms, equation 15 becomes:

(16)




i i
s s  s i 
p Y C i % p Q p S C i &
C
'
MFP

MFP
 pY  p sQ s  S 
i'c,o   pY 



i i
p Y C i %
'

MFP
i'c,o   pY 


 rK s  C
 s
Ks & wL LC s
 pY 
 pY 

 p sQ s  C
 rK s  C
 wL s  C 

Qs & s s Ks & s s Ls
 pY 
p Q 
 p Q  ,

where the final equality follows from the first part of equation 10. Applying the second part of
equation 10 yields

- 41 -


 C 

p iY i
'


i %
MFP i'c,o pY MFP




C

(17)

 p sQ s  C

s

 pY  MFP

 c c C
 p cY c  C
 s s C
' p Y MFP
c % 1&
MFPo % p Q MFP
s
,
pY
pY
pY






o o

c c

where the second equality follows from p Y = pY - p Y . This completes the proof.

Measuring Sectoral MFP

Proposition 1 shows the relationship between the growth of aggregate and sectoral MFP
in our model. To make use of Proposition 1 we need to measure MFP growth in each sector.
This can be done either from the sectoral production functions, as in equations 10-12, or from the
sectoral cost functions the so-called dual approach. We opt for the dual approach because
the required data are more readily available. The dual counterparts to equations 10-12 are:

(18)

 rK s  C  wL s  C
C
s s r % s s w & MFP
'
s
p
p
Q
p
Q





(19)

 rK c  C  wL c  C  p sS c  C
C
'


%


%


s &
c
p
MFP
 p cY c  r  p cY c  w  p cY c  p

(20)

 rK o  C  wL o  C  p sS o  C
C

%


%


s &
o
o'
p
r
w
p
MFP
.
 p oY o 
 p oY o 
 p oY o 

These equations state that the growth in each sectors output price equals the growth in the
(share) weighted average of its input costs, minus the growth in MFP. MFP growth enters with a
negative sign because efficiency gains hold down a sectors output price given its input costs.

- 42 -

To simplify matters, we impose the following assumption on equations 18-20. Let Z

denote the growth in the share-weighted cost of capital and labor input for the nonfarm business
sector as a whole; that is,

 rK  C  wL  C
'
r % w.
Z
 pY 
 pY 
C

(21)

We assume that the share-weighted growth of capital and labor costs for semiconductor

producers equals Z . Equation 18 then becomes:

(22)

' Z & MFPs .

We also impose this assumption on the other two sectors, so that equations 19 and 20 become:
C

(23)

' (1&

c
S) Z

' (1&

o
S) Z

p
C

(24)

c
S

o
S

p
C

& MFPc
C

& MFPo ,

s i i i

where s = p S /p Y is the cost share for semiconductors in sector i (i = c,o). Z is scaled by

i

(1- s) because capital and labor, taken together, account for (1- s) percent of total input costs in
each sector.
Our simplifying assumption that capital and labor costs rise at the same rate in each
sector likely introduces only a slight approximation error into the estimates of MFP growth for

- 43 -

computer and semiconductor producers. Consider equation 22 for semiconductor producers.

This equation can be rearranged to show that growth in semiconductor MFP equals Z minus the
percent change in semiconductor prices. These prices have trended sharply lower since the mid-

1970s, falling at an average annual rate of more than 25 percent. Even if Z misstated the true
growth in capital and labor costs for semiconductor producers by a couple percentage points per
year, this error would be insignificant compared to the decline in semiconductor prices. The same
argument applied to equation 23 suggests that the approximation error for computer-sector MFP
growth would be relatively small as well.
We now use the dual equations to derive expressions for sectoral MFP growth that, when
aggregated in accord with Proposition 1, add up exactly to our independent measure of aggregate
MFP growth from the Bureau of Labor Statistics.

Proposition 2: Given the dual equations 22-24 and Proposition 1,

C

C
' MFPo & s &

C
C
C
' MFPo & c % ( cs & os)( ps & Z )

s
MFP
c
MFP
C

o
MFP

where

s
o
s(p

&Z )

 1  C

C
C
c c
s s
c c o
s o s




'  1%S MFP %
%
&  ( s & s ) & s ( p & Z ) 

0c 0o

= p - p and

0s 0o

=p -p .

Proof. The result is nearly immediate. Subtract equation 24 from 22 and then subtract equation

- 44 -

24 from 23, obtaining:

s
MFP

(25)

c
MFP

(26)

'
'

o
MFP
C

o
MFP

&

&

&

%( &

s
o
s(p
c
s

&Z )
C

s
o
s )( p

&Z ) .

This establishes the expressions for MF P and MF P in the proposition. The final step is to

measure MF P such that the relationship in Proposition 1 holds for a pre-specified estimate of
MFP growth for nonfarm business as a whole. To do this, substitute equations 25 and 26 into
the expression for MFP growth in Proposition 1:

(27)

MFP

' 

o
MFP

&

o
MFP

% 

&


C
% ( cs & os)( p & Z )  % (1& c ) MFPo
C

&

o
s(



p &Z ) .

C

Solving equation 27 for MF P completes the proof.

- 45 -

Figure 1

Contributions of Computer Hardware, Software and Communications Equipment

to Growth of Real Nonfarm Business Output, 1974-1999
Percentage points
1.6
Hardware
Software

1.4

Communications equipment
1.2

0.8

0.6

0.4

0.2

0
1974

1979

1984

1989

1994

1999