Miyakodayori 08

Are we measuring the impact of the IT revolution properly?

Dear readers,

This is a follow-up to Miyakodayori 2, which covered IT productivity. Please think of it as an installment in an occasional series on this theme.

Are we measuring the impact of the IT revolution properly?

Last month, we had the honor of having Professor Jorgenson of Harvard University speaking at a "Brown Bag Lunch" sponsored by METI RI. As you may well know, Professor Jorgenson is the leading authority in the analysis of productivity.
In his presentation, he showed how IT investment has contributed to the growth of the economy and the increase in the productivity of the U.S. economy. The contribution of IT investment did indeed appear to be very impressive. But the explanation that was most interesting to me was his reference to the Goldman Sachs analysis of the impact of the IT revolution which appeared in the October 18th, 2000 issue of the "Global Economics Weekly". The analysis showed that the impact of the IT revolution was significantly underestimated in some countries, especially in Japan. The cause was posited to be the price deflator not fully reflecting the improvement in quality.
According to the analysis, real GDP growth in Japan between 1996 and 1999 could more than double if the quality improvement was fully reflected. Real IT investment growth rate could also double if adjusted.

If this analysis is reasonable, then our economy may look better than what we tend to believe based on our national data. To be sure, the improvement in the growth rate after the adjustment is merely 1.08%, but the number is larger than the improvement in other countries. Furthermore, when the unadjusted growth rate was 0.82%, the possible addition of 1.08% per annum is significant.
We had noticed a similar potential underestimation a few months ago. We compared the computer prices of the U.S. and Japan. As you can see in the following graph 1, the computer price in the U.S. has been dropping rapidly, while the prices in Japan seems to be more or less flattening after 1997. If you can have a look at graph 2, which compares the changes in computer prices, the difference between the two countries is clearly very dramatic.

The Japanese price index for computers is supposed to be using the so-called "hedonic approach", which captures the improvement in quality. Considering the fact that new improvements in IT spread across the Pacific very fast, I have a hard time finding a convincing explanation for such a dramatic difference. It is difficult to tell which price index is closer to the truth at first glance. But I have to admit that the almost flat prices between 1997 and 2000 in Japan do not appear to be plausible considering the improvement in quality, especially the acceleration of Internet capability, of computers during this period.
If we use the U.S. price index, assuming that it is the more "correct" index, the capital investment and the growth of the economy in real terms should be larger than we have been led to believe based on the data supplied by the Japanese government. We ran a quick calculation and found out that the real growth in the Japanese economy can increase by 0.38% in 1998 and 0.47% in 1999.
The numbers might appear small, but for an economy growing at around 1% per annum, the potential increase is not insignificant. Furthermore, to fully reflect the impact of the IT revolution, the changes of prices of related IT items such as communication equipment and software must be added for adjustment as well. I would also have to point out that packaged software and software developed by users are not yet captured as capital investment in the Japanese GDP statistics. While we lack the necessary data for doing a complete calculation, it is conceivable that the real growth rate of our economy, fully adjusted for quality improvement in all IT items and including investment in the above mentioned software, in GDP statistics would look quite a bit better than we had thought. Although the improvement in the growth of the economy as a whole would not be substantial enough to turn the performance of the Japanese economy into a rosy picture, I believe that we should not be overly pessimistic about the Japanese economy based on the official data alone. IT investment in Japan in real terms, after adjustment, has been growing significantly. With the anticipated success of the Japanese corporations to fully utilize the IT related capital, the productivity of the Japanese economy can be expected to improve. The "learning" process may require some time, judging from the U.S. experience, but eventually the productivity of our economy should improve significantly. That is when we will truly have the IT revolution in Japan.
Isn't it about time to have little more "constructive optimism", using the phrase of the late prime minister Obuchi, for the prospects of the Japanese economy? It is true that we can not solely depend on IT for the revival of our economy. But if the U.S. economy has improved its performance thanks to IT, why not Japan?

Nobuo Tanaka
Executive Director, Research Institute of Economy, Trade and Industry, M.E.T.I.
e-mail: tanaka-nobuo@meti.go.jp
tel: 03-3501-1362 fax: 03-3501-8391

The opinions expressed or implied in this paper are solely those of the author, and do not necessarily represent the views of the Ministry of Economy, Trade and Industry (METI), or of the Research Institute of Economy, Trade and Industry (RIETI).

February 15, 2001