Economic Growth in the Information Age: From Physical Capital to Weightless Economy.

• Author: Cameron, Gavin

The defining feature of economic growth in the Information Age is the increasing weightlessness of output. Production and consumption are shifting away from objects toward information and services. Good examples of weightless goods are computer software, financial products, telecommunications, the Internet, entertainment and even management consulting. These goods accounted for about 23 percent of U.S. gross domestic product between 1987 and 1994. Their key characteristic is that they are often infinitely expansible; that is, they can be used by many people at the same time. Another way to think of this is that once the good has been produced, it can be replicated at very low cost.(1)

It is currently fashionable for some economic pundits to prophesy that the Information Age is dramatically changing the structure of the world economy, reducing the power of governments to raise taxes or to undertake independent economic policies. Furthermore, it is argued, new technologies will lead to an inexorable rise in unemployment in the West. This view is also often linked to a belief in the death of inflation. As stated, these views are nonsensical. There is little evidence that unemployment, at the aggregate level at least, is caused by technological change.(2)

This paper argues that while globalized and weightless activities have become increasingly important, they do not pose insuperable threats to the world economy. The overall message of this essay is an optimistic one: inequality and unemployment need not rise in the face of competition from the developing world or in response to technological change. However, government policy can play a major role in promoting adjustment to change, especially in terms of adjustment to the growing importance of weightless technologies.

In fact, three economic phenomena are at work. First, production has become increasingly globalized and foreign competition, especially from the newly industrializing economies (NIEs), has become more intense. Second, deregulation and liberalization of domestic and world markets have reduced the power of trade unions and increased levels of competition. Third, the pace of technological change has accelerated, and it has become increasingly biased towards skilled workers and weightless goods. To some extent these phenomena are not independent, since it is easy to see why they might cause each other in turn. In particular, this essay concentrates on the implications of globalization and weightlessness.

The paper is structured as follows. Section one describes the neoclassical view of economic growth, trade and inequality, and contrasts them with the theoretical developments of the past decade. These theoretical developments make an important contribution to our understanding of the economic effects of increasing globalization and weightlessness. Section two addresses two particular aspects of the Information Age: the collapse in demand for the unskilled and the rise of foreign direct investment (FDI). Section three looks at the East Asian growth miracle, a major recent economic development that has potential implications for how other emerging nations should manage their development. Section four examines the experience of the United Kingdom, an open economy which has experienced deindustrialization and has increasingly switched toward services and other weightless goods. The paper concludes by reviewing the implications of the Information Age for government policy in both developing and industrialized countries.

THE ECONOMICS OF THE INFORMATION AGE

A Neoclassical View

The measurement of economic growth raises a number of interesting and difficult problems. One obvious way to measure the material progress made by any economy is to measure labor productivity; that is, output per worker. However, to compare different industries or countries on such a basis is more contentious, since differences in the quantities of other inputs, such as capital or materials, will also affect output per worker. Consequently, economists prefer to look at measures of total factor productivity (TFP), which is usually thought to measure technological progress.

Total factor productivity growth is the rate at which output would increase if all inputs were held the same. It is calculated as the difference between the rate of growth of output and the rate of growth of total inputs. The rate of growth of total inputs is a weighted average of the rates of growth of individual inputs. It is common practice to weight inputs according to their shares in output, a practice that makes certain assumptions, notably that product and factor markets are competitive.

Although economic growth had been an important interest of earlier economists, it is to the work of Robert Solow that we owe the foundations of its modern stud.(3) The startling conclusion of his 1957 paper was that technological change was responsible for the majority of economic growth in the United States between 1909 and 1949. Later work by researchers in the growth accounting tradition, such as Zvi Griliches, who adjusted for changes in labor quality and for various measurement errors, reduced the residual effect of TFP to around one-third of economic growth.(4) An important drawback with this early literature was that it considered technological progress (TFP growth) to be generated exogenously.

To a traditional economist raised in the neoclassical tradition, technological change is not at all worrying. Even if different countries grow at different rates, the theories of international trade of Ricardo and Hecksher-Ohlin suggest that countries will tend to specialize in the goods in which they have a comparative advantage and that all countries gain from trade.(5) The standard view of international trade, however, has trouble explaining the fact that the majority of trade is between nations with similar resource and factor endowments rather than between the world's most dissimilar countries.

Even within the neoclassical theory of trade, there are reasons why specific factors of production may not gain from trade even when the country as a whole does gain. For example, the Stolper-Samuelson theory predicts that the move to free trade will result in decreased real returns to the factor used intensively in the import-competing industry. This is often taken to mean that scarce unskilled labor in the North will lose in the face of competition from plentiful unskilled labor in the South.(6)

ENDOGENOUS GROWTH THEORY AND OTHER DEVELOPMENTS

A new theory of economic growth has developed in the past 10 years, after the pathbreaking work of Paul Romer.(7) Romer showed that it was possible to produce consistent economic models that did not rely upon exogenous technological progress to generate increases in living standards. Instead, he argued that investments in capital produce externalities through learning by doing, raising the productivity of other firms. A larger capital stock in the whole economy thereby provides an external benefit and improves the technology level for all producers. While this sounds reasonable, learning by doing is not the only possible source of endogenous growth. Other researchers have suggested other factors such as human capital, research and development, infrastructure and fertility.(8)

Endogenous growth theory has many applications. First, let us consider the implications for the distribution of income within a country New inventions increase the return to skills and ability, but as the technology matures and becomes more familiar, the return to skills falls. In this view, the early stages of an invention would be accompanied by increases in the skills gap (i.e. the wage differential between the skilled and the unskilled), followed later by a convergence in wages. Taken a little further, this argument would suggest that the highest technology sectors of the economy should have the highest wage differentials between skilled and unskilled labor.(9) Furthermore, faster growth may increase the ratio of skilled workers, since it can only be supported by a high stock of human capital, and thus requires a high degree of wage inequality. However, a low wage ratio does not provide a large enough incentive for education and, as a result, too few people become educated. The economy thus remains in a poverty trap.(10)

This discussion leads naturally into the so-called superstar economy On the supply side, Sherwin Rosen has argued that imperfect substitution between people means that earnings distributions should be skewed to the right, with a small number receiving much greater rewards than the average.(11) This is possibly due to the winner-takes-all nature of their business. For example, if a baseball player scores 10 percent more home runs than his peers, he will receive more than 10 percent higher wages.

On the demand side, high-quality sellers have a competitive advantage. For example, it would be very costly for one person to have a private concert from Pavarotti, but not so costly when the audience numbers hundreds, thousands or even millions. Alfred Marshall wrote that as long as the number of people who can be reached by a human voice is strictly limited, there must be a limit to how much any one performer could command.(12) The advances in communications embodied in radios, cable television, mobile telephones, home computers and the Internet have certainly raised this ceiling.

It should be clear that the question of why some individuals or families remain poor over time is related to the question of why some countries stay poor over time. Turning to the distribution of income between countries, in the neoclassical growth model, poor countries should grow more rapidly than rich ones due to capital deepening, conditional on their having the same determinants of steady states, such as preferences and the same levels of technology. Levels and growth rates of income per capita should therefore...