Journal Issue

IT still key to U.S. productivity growth

International Monetary Fund. External Relations Dept.
Published Date:
March 2004
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Globalizing IT services, investing in human capital should generate high-skill U.S. jobs

In the 1990s, widespread investment in information technology (IT) boosted U.S. labor productivity growth and contributed to the country’s economic dynamism. At a March 11 discussion,”White-Collar Outsourcing,” hosted by the Institute for International Economics (IIE), Catherine Mann (Senior Fellow, IIE) argued that an even wider diffusion of IT throughout the U.S. economy, coupled with an upgrade of domestic IT skills, will spur a second wave of productivity growth. This, she said, can be achieved through a combination of the globalization of software and IT services, which will make the overall IT package affordable for more businesses, and domestic adjustment policies aimed at helping U.S. workers climb up the IT skills ladder, “as rungs on the bottom are moved elsewhere or eliminated entirely.”

The most important driver of IT price declines is technological change. But in the 1990s, globalized production and international trade also helped lower prices 10-30 percent more than they would otherwise have been. The lower prices, Mann said, were key to broad-based investment in IT capital throughout the U.S. economy, which was responsible for more than half of the acceleration in labor productivity and added at least $230 billion to GDP over 1995-2002.

Without a globalization of IT hardware production, GDP growth in the United States might have been 0.2 percentage point less a year in the second half of the 1990s, she added.

At the same time, globalization did not, on balance, undermine competitiveness as U.S. multinational firms maintained a net positive trade balance in IT hardware exports. By sourcing their components abroad, Mann said, these firms were able to build a competitive foundation for enhanced export competitiveness for IT hardware.

What about IT jobs?

The diffusion of IT investment throughout the U.S. economy is reflected in the fact that two-thirds of U.S. workers who use IT in their occupations—such as programmers, systems engineers, analysts, and database administrators—work in non-IT sectors. But has investment in IT equipment and software translated into job creation? They move in lockstep, said Mann, pointing to the rate of change in the number of jobs and investment in IT software processing equipment, both of which boomed beginning in 1991, peaked in 1997, and declined dramatically in 2001. In 2003, however, growth in IT investment picked up again, and the decline in IT job growth moderated.

Moreover, over the course of the 1990s, the demand for workers with the highest IT skills rose rapidly in conjunction with investment in IT. Mann compared IT employment numbers for 1999 with those for 2002. Over that period, she noted, about 241,000 people in the sector—data entry operators, computer operators, and computer programmers who earned between $23,000 and $64,000 a year—lost their jobs. Over the same period, however, the number of computer software engineers whose annual salary averaged nearly $75,000, grew by more than 115,000. The data do not differentiate, however, between jobs lost because they moved abroad and jobs made obsolete by new technology and possibly replaced by higher-paid positions. But this very rapid increase in the demand for more sophisticated IT skills is important for policymakers to keep in mind, Mann said.

Future sources of productivity gains

The sectors of the U.S. economy that had the greatest uptake of IT during the 1990s were wholesale trade, securities and commodities brokerages, depository institutions, and telecommunications. These sectors, which also contributed most to productivity gains, are intensive users of skilled IT workers and have managed to retain a positive financial balance in the trade accounts. In contrast, two other large sectors—health services and construction—stand out for not being IT-intensive and for having below average productivity growth. Small and medium-sized enterprises also generally invested less in productivity-enhancing IT. Mann emphasized that IT-based productivity gains could be achieved in these lagging sectors, particularly if globalization of software and services takes on the pattern of the price declines that have characterized the globalization of IT hardware production. Getting these sectors to improve their use of IT capital, she said, would enhance IT diffusion, leading to job creation and productivity gains.

A major obstacle facing the industries that did not participate in the productivity growth of the 1990s is the increasing share of software costs as part of the IT package. “What was globalized and globally sourced in the 1990s was IT hardware,” Mann said, but increasingly important on that hardware platform are software and service applications. As the platform price has fallen, the proportion of services and software in overall costs has increased, and now represents at least 50 percent of the total package of software services and hardware.

The second obstacle to meeting the needs of these lagging sectors is the difficulty and cost involved in writing software applications for these industries. The big players in the software and service application industries “have gone and picked up the $1,000 bills that are on the sidewalks,” explained Mann, adding “there are lots and lots of $100 bills down there, but it has not been worth their while, yet, to pick them up.” One thing that will increase the attention that software firms pay to these unexploited opportunities is the capacity to outsource production of IT products that are more routine and do not involve design, marketing, integration, or analysis of customer needs. Outsourcing these jobs will reduce the price of software and service applications and will generate increased investment in IT and, along with it, Mann indicated, more jobs for IT workers.

Investing in people

Mann conceded that the specter of losing white collar jobs looms large: the globalization of software and IT services means that some IT jobs will be performed abroad. The job categories that are projected to shrink, however, are at the low-wage, low-skill end of the IT job spectrum. Higher-paid jobs that demand IT skills are projected to grow very quickly in the United States, especially as more sectors of the economy and more businesses use IT packages.

For workers hurt by international competition, Mann supported extending unemployment benefits and wage insurance. More generally, she called for a strategy to ensure open markets abroad for internationally competitive services. But it will also be vital, Mann explained, to ensure that U.S. workers are prepared to fill higher-skill jobs. To be able to compete internationally and be domestically strong, “we need to invest in people,” she said. To this end, Mann recommended the introduction of a tax credit for investment in human capital, based on the same rationale as that for the tax credits for research and development and capital investment. Specifically, the tax credit for investments in human capital would mitigate the incentives that firms now have for not training workers because they fear losing them to rival firms. Firms could apply for a partial investment tax credit to cover the cost of training. Asked why the firm should receive the credit as opposed to the individual, she said that the firm plays a vital role in matching workers’ skills to specific jobs. And, in general, job training done through firms is significantly more successful than when done through other venues.

How likely are firms to take advantage of a tax credit for human capital? And, even if they do, how likely is it that workers truly in need of training will receive it? This selection problem applies to other tax credits, Mann said, but “if it’s good for capital and good for research and development, then why not apply it—with all the well-known warts—to people?” We ought to take this opportunity now, she said, “rather than wait for years.”

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