Diane Coyle: Forget productivity obsession, count the customers

The list of new high technology products is long indeed and the demand for them is far from satiated

When every day seems to bring news of more large-scale lay-offs by one of the titans of the New Economy, and America shed nearly a quarter of a million jobs last month, it is hard to remember last year's euphoria about the growth potential of new technologies.

When every day seems to bring news of more large-scale lay-offs by one of the titans of the New Economy, and America shed nearly a quarter of a million jobs last month, it is hard to remember last year's euphoria about the growth potential of new technologies. But the pendulum of opinion is now swinging too far the other way because of the downturn in the business cycle.

There are two things it's worth remembering about technology and growth. One is that in the very long run, although investment in physical and human capital matter, it is advances in technology that mostly account for economic growth.

The other is that economists do not actually understand how technology generates growth, which is why there is such heated controversy about whether or not the internet and other aspects of information and communication technologies have boosted the trend rate of productivity growth in the US, and if so by how much. The links between technical advance and increases in productivity are certainly long and variable. But are we unhealthily obsessed with the role of technology in production? Should we consider instead its role in consumption? If you put it like this, it is obvious that there has been no retreat in the New Economy. It might not be clear exactly which types of mobile phones or online music services are going to win in the various competitive races taking place, but there is no doubt that people have a still insatiable demand for mobile telephony, for the distribution of services ranging from e-mail and music all the way to pornography over the internet, for digital photography and film, for game handsets, for next-day delivery using modern logistical systems of items ordered online or by phone, or looking a bit into the future for genetic information. The list of new high technology products and services is long indeed and the demand for them is far from satiated.

One economist who argues the demand side is more important than the supply side in the New Economy is Danny Quah, a professor at the London School of Economics. He gives the example of late 14th century China, which was technologically much further advanced than Europe yet lost its lead. For example, China produced more iron per capita in the 14th century than Europe did in the 18th, and appeared to be on the verge of the Industrial Revolution, which in the event did not occur for another 400 years and then in a different country. Professor Quah suggests the reason was lack of demand for the new products. Scholars and bureaucrats prevented the dissemination of the new technologies, keeping them secret in order to protect the existing imperial power. Innovation came to a halt in the absence of a customer base.

While 21st century America is certainly at the forefront of technology production, thanks to its superb scientific establishment, large and flexible workforce and other supply side strengths, it also imports huge quantities of high technology products. And Japan has many similar or superior supply-side strengths but has not experienced a growth surge in the past decade ­ far from it. So the idea that US superiority in consumption matters more has an immediate appeal. Looking across countries, Finland, Ireland, Sweden, and to some extent Korea and Japan have seen more dramatic advances than the US in the production of new technologies. Yet we do not think of them as having been at the forefront of the New Economy in quite the same way. Perhaps that is because they are all so much smaller, but that is another way of saying they are smaller markets with less demand.

This is not to say the US productivity gains of the 1990s were illusory. Even several quarters of slow GDP growth, even a recession, would not necessarily overturn the finding that there has been an improvement in trend productivity growth. In fact, the pace of job cuts in the past couple of months suggests companies are acting swiftly to maintain high levels of labour productivity, or output per worker. Productivity is always cyclical, and a cyclical downturn does not therefore mean the underlying trend cannot have improved. There is a growing body of case study evidence suggesting firms are continuing to use new technologies to reshape the way they do business.

However, if Professor Quah is right, long-term economic dynamism will depend on consumers. In the case of many weightless 'knowledge products' such as internet-based services, software or biotechnology, demand will be unusually important in determining the size of the market because these products have unusual supply characteristics. Often all the cost of production lies in developing the first item, and the marginal cost of making copies is almost zero. Software is a good example. It is easy and almost free to copy and distribute a programme once it is written and working. With such products, the extent of demand alone will determine the size of the market, and profits are likely to depend on how successfully the company manages to operate as a monopoly through patents or other restrictions.

So, not for the first time, the health of the world economy looks as though it depends on the willingness of US consumers to shop, not for cars and refrigerators this time, but for software, games, MP3 players, and other hi-tech products. And if past experience is anything to go by, its consumers will keep America securely at the economic frontier.

Technology Dissemination and Economic Growth by Danny Quah

http://econ.lse.ac.uk/staff/dquah/currmnu1.html#hku