Saturday, May 7, 2011

Creative Destruction and the IT Revolution

Timothy B. Lee presents a cogent review of Tyler Cowen’s Kindle book, The Great Stagnation.

Cowen makes the case that the American economy is in the midst of a decades-long period of mediocre economic growth. Since the mid-1970s, in fact. While previous generations of Americans enjoyed and abundance of “low-hanging fruits” – cheap land, technological breakthroughs like electricity and the internal combustion engine, rising levels of education, an end to racial and gender discrimination – that allowed rapidly increasing living standards with relatively little effort, now big innovations have been few and far between, and this explains – according to his analysis -- the comparatively slow rate of GDP growth in recent decades.

This story is rather surprising however in view of the striking information revolution of the last few decades. But Cowen claims that the “Internet revolution” is overrated: most people don’t spend enough time on the web for it to significantly improve their standard of living, and blogs, Facebook and Twitter don’t create jobs or produce revenue for the government.

Lee, however, points -- rightly in my opinion -- to the fact that “by focusing on “the Internet” … Cowen trivializes an industry whose economic effects extend far beyond a few overhyped websites.”

He then argues that although software innovations often make relatively small contribution to measured GDP, this is less a reflection of a “great stagnation” than a sign that official economic indicators are a bad way to measure our generation’s benefits from technology. This is because they change the quality of existing products without increasing their price. And without an increase in price the measured GDP is not increased either.

Moreover, there is at the same time a decrease of GDP because of the products and services that disappear, made obsolete by the new software:

“The digital revolution … is rapidly displacing a wide variety of “revenue-generating” products and services: typewriters, newspapers, magazines, books, maps, cameras, film development, camcorders, yellow pages, music players, VCRs and DVD players, encyclopedias, landline telephones, television and radio broadcasts, calendars, address books, clocks and watches, calculators, travel agents, travelers checks, and so forth.”

Thus the digital revolution’s increases in the standard of living are not correctly recorded in GDP statistics, while its destructions are. Hence the low aggregate growth rates recorded.

My comment:

This is typically a case of Schumpeterian creative destruction. I add to Lee’s remarks that it is generally the case, in an innovation phase, that the value of traditional, established, firms goes down while the new firms using the new technology aren’t yet fully developed, creating a sense of overall stagnation.

And in the present case, the digital revolution brings about a “general purpose technology”, i.e. one that affects all other industries. It follows that its two effects, the unrecorded improvement in products’ quality and the recorded destruction of older products and services by obsolescence, are general and widely diffused in the economy.

This is why, I believe, the aftermath of the bursting of the bubble (itself due to inflated expectations, rather normal given the uncertainties of the new products and processes, and of their prospective profits) is characterized by an hesitant and jobless recovery. It takes time to transform travel agents and watchmakers into software builders or vendors. Nevertheless the change is taking place and the measured prosperity growth will accelerate when it is completed. The “great stagnation” could then, surprisingly for many, give way to a “great acceleration”.

The Lee’s post is  here.

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