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Beyond Computation: Information Technology, Organizational Transformation and Business Performance

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To understand the economic value of computers, one must broaden the traditional definition of both the technology and its effects. Case studies and firm-level econometric evidence suggest that: 1) organizational "investments" have a large influence on the value of IT investments; and 2) the benefits of IT investment are often intangible and disproportionately difficult to measure. Our analysis suggests that the link between IT and increased productivity emerged well before the recent surge in the aggregate productivity statistics and that the current macroeconomic productivity revival may in part reflect the contributions of intangible capital accumulated in the past. Erik Brynjolfsson is Associate Professor of Management, Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts and Co-director of the Center for eBusiness at MIT. Lorin M. Hitt is Assistant Professor of Operations and Information Management, Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania. Their e-mail addresses are <erikb@mit.edu> and <lhitt@wharton.upenn.edu> and their websites are <http://ebusiness.mit.edu/erik> and <http://grace.wharton.upenn.edu/~lhitt>, respectively. 2 Computers and Economic Growth How do computers contribute to business performance and economic growth? Even today, most people who are asked to identify the strengths of computers tend to think of computational tasks like rapidly multiplying large numbers. Computers have excelled at computation since the Mark I (1939), the first modern computer, and the ENIAC (1943), the first electronic computer without moving parts. During World War II, the U.S. government generously funded research into tools for calculating the trajectories of artillery shells. The result was the develo...
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Beyond Computation: Information
Technology, Organizational
Transformation and Business
Performance
Erik Brynjolfsson and Lorin M. Hitt
H
ow do computers contribute to business performance and economic
growth? Even today, most people who are asked to identify the
strengths of computers tend to think of computational tasks like
rapidly multiplying large numbers. Computers have excelled at computation
since the Mark I (1939), the first modern computer, and the ENIAC (1943), the
first electronic computer without moving parts. During World War II, the U.S.
government generously funded research into tools for calculating the trajecto-
ries of artillery shells. The result was the development of some of the first digital
computers with remarkable capabilities for calculation—the dawn of the com-
puter age.
However, computers are not fundamentally number crunchers. They are
symbol processors. The same basic technologies can be used to store, retrieve,
organize, transmit, and algorithmically transform any type of information that
can be digitized—numbers, text, video, music, speech, programs, and engineer-
ing drawings, to name a few. This is fortunate because most problems are not
numerical problems. Ballistics, code breaking, parts of accounting, and bits and
pieces of other tasks involve lots of calculation. But the everyday activities of
most managers, professionals, and information workers involve other types of
y
Erik Brynjolfsson is Associate Professor of Information Technology and Management, Sloan
School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts
and Co-director of the Center for eBusiness at MIT. Lorin M. Hitt is Assistant Professor
of Operations and Information Management, Wharton School, University of Pennsylva-
nia, Philadelphia, Pennsylvania. Their e-mail addresses are erikb@mit.edu and
lhitt@wharton.upenn.edu and their websites are http://ebusiness.mit.edu/erik and
http://grace.wharton.upenn.edu/lhitt, respectively.
Journal of Economic Perspectives—Volume 14, Number 4 —Fall 2000—Pages 23–48
thinking. As computers become cheaper and more powerful, the business value
of computers is limited less by computational capability and more by the ability
of managers to invent new processes, procedures and organizational structures
that leverage this capability. As complementary innovations continue to de-
velop, the applications of computers will expand well beyond computation for
the foreseeable future.
The fundamental economic role of computers becomes clearer if one thinks
about organizations and markets as information processors (Galbraith, 1977; Si-
mon, 1976; Hayek, 1945). Most of our economic institutions and intuitions
emerged in an era of relatively high communications cost and limited computa-
tional capability. Information technology, defined as computers as well as related
digital communication technology, has the broad power to reduce the costs of
coordination, communications, and information processing. Thus, it is not surpris-
ing that the massive reduction in computing and communications costs has engen-
dered a substantial restructuring of the economy. The majority of modern indus-
tries are being significantly affected by computerization.
As a result, information technology is best described not as a traditional capital
investment, but as a “general purpose technology” (Bresnahan and Trajtenberg,
1995). In most cases, the economic contributions of general purpose technologies
are substantially larger than would be predicted by simply multiplying the quantity
of capital investment devoted to them by a normal rate of return. Instead, such
technologies are economically beneficial mostly because they facilitate complemen-
tary innovations.
Earlier general purpose technologies, such as the telegraph, the steam engine
and the electric motor, illustrate a pattern of complementary innovations that
eventually lead to dramatic productivity improvements. Some of the complemen-
tary innovations were purely technological, such as Marconi’s “wireless” version of
telegraphy. However, some of the most interesting and productive developments
were organizational innovations. For example, the telegraph facilitated the forma-
tion of geographically dispersed enterprises (Milgrom and Roberts, 1992); while
the electric motor provided industrial engineers more flexibility in the placement
of machinery in factories, dramatically improving manufacturing productivity by
enabling workflow redesign (David, 1990). The steam engine was at the root of a
broad cluster of technological and organizational changes that helped ignite the
first industrial revolution.
In this paper, we review the evidence on how investments in information
technology are linked to higher productivity and organizational transformation,
with emphasis on studies conducted at the firm level. Our central argument is
twofold: first, that a significant component of the value of information technology
is its ability to enable complementary organizational investments such as business
processes and work practices; second, these investments, in turn, lead to produc-
tivity increases by reducing costs and, more importantly, by enabling firms to
increase output quality in the form of new products or in improvements in
intangible aspects of existing products like convenience, timeliness, quality, and
24 Journal of Economic Perspectives
variety.
1
There is substantial evidence in both the case literature on individual firms
and multi-firm econometric analyses supporting both these points, which we review
and discuss in the first half of this paper. This emphasis on firm-level evidence
stems in part from our own research focus but also because firm-level analysis has
significant measurement advantages for examining intangible organizational in-
vestments and product and service innovation associated with computers.
Moreover, as we argue in the latter half of the paper, these factors are not well
captured by traditional macroeconomic measurement approaches. As a result, the
economic contributions of computers are likely to be understated in aggregate level
analyses. Placing a precise number on this bias is difficult, primarily because of
issues about how private, firm-level returns aggregate to the social, economy-wide
benefits and assumptions required to incorporate complementary organizational
factors into a growth accounting framework. However, our analysis suggests that the
returns to computer investment may be substantially higher than what is assumed
in traditional growth accounting exercises. Furthermore, total capital stock (includ-
ing intangible assets) associated with the computerization of the economy may be
understated by a factor of ten. Taken together, these considerations suggest the
bias is on the same order of magnitude as the currently measured benefits of
computers.
Thus, while the recent macroeconomic evidence about computer contribu-
tions is encouraging, our views are more strongly influenced by the microeconomic
data. The micro data suggest that the surge in productivity that we now see in the
macro statistics has its roots in over a decade of computer-enabled organizational
investments. The recent productivity boom can in part be explained as a return on
this large, but intangible form of capital.
Case Examples
Companies using information technology to change the way they conduct
business often say that their investment in information technology complements
changes in other aspects of the organization. These complementarities have a
number of implications for understanding the value of computer investment. To be
successful, firms typically need to adopt computers as part of a “system” or “cluster”
of mutually reinforcing organizational changes (Milgrom and Roberts, 1990).
Changing incrementally, either by making computer investments without organi-
zational change, or only partially implementing some organizational changes, can
create significant productivity losses as any benefits of computerization are more
than outweighed by negative interactions with existing organizational practices
(Brynjolfsson, Renshaw and Van Alstyne, 1997). The need for “all or nothing”
1
For a more general treatment of the literature on information technology value, see reviews by
Brynjolfsson (1993); Wilson (1995); and Brynjolfsson and Yang (1996). For a discussion of the problems
in economic measurement of computers contributions at the macroeconomic level, see Baily and
Gordon (1988), Siegel (1997), and Gullickson and Harper (1999).
Erik Brynjolfsson and Lorin M. Hitt 25
changes between complementary systems was part of the logic behind the organi-
zational reengineering wave of the 1990s and the slogan “Don’t Automate, Oblit-
erate” (Hammer, 1990). It can also explain why many large scale information
technology projects fail (Kemerer and Sosa, 1991), while successful information
technology adopters earn significant rents.
Many of the past century’s most successful and popular organizational prac-
tices reflect the historically high cost of information processing. For example,
hierarchical organizational structures can reduce communications costs because
they minimize the number of communications links required to connect multiple
economic actors, as compared with more decentralized structures (Malone, 1987;
Radner, 1993). Similarly, producing simple, standardized products is an efficient
way to utilize inflexible, scale-intensive manufacturing technology. However, as the
cost of automated information processing has fallen by over 99.9 percent since the
1960s, it is unlikely that the work practices of the previous era will also be the same
ones that best leverage the value of cheap information and flexible production. In
this spirit, Milgrom and Roberts (1990) construct a model in which firms’ transition
from “mass production” to flexible, computer-enabled, “modern manufacturing” is
driven by exogenous changes in the price of information technology. Similarly,
Bresnahan (1999) and Bresnahan, Brynjolfsson and Hitt (2000) show how changes
in information technology costs and capabilities lead to a cluster of changes in work
organization and firm strategy that increase the demand for skilled labor.
In this section we will discuss case evidence on three aspects of how firms have
transformed themselves by combining information technology with changes in
work practices, strategy, and products and services; they have transformed the firm,
supplier relations, and the customer relationship. These examples provide quali-
tative insights into the nature of the changes, making it easier to interpret the more
quantitative econometric evidence that follows.
Transforming the Firm
The need to match organizational structure to technology capabilities and the
challenges of making the transition to an information technology-intensive pro-
duction process is concisely illustrated by a case study of “MacroMed” (a pseud-
onym), a large medical products manufacturer (Brynjolfsson, Renshaw and Van
Alstyne, 1997). In a desire to provide greater product customization and variety,
MacroMed made a large investment in computer integrated manufacturing. This
investment also coincided with an enumerated list of other major changes includ-
ing: the elimination of piece rates, giving workers authority for scheduling ma-
chines, changes in decision rights, process and workflow innovation, more frequent
and richer interactions with customers and suppliers, increased lateral communi-
cation and teamwork, and other changes in skills, processes, culture, and structure
(see Table 1).
However, the new system initially fell well short of management expectations
for greater flexibility and responsiveness. Investigation revealed that line workers
still retained many elements of the now-obsolete old work practices, not necessarily
from any conscious effort to undermine the change effort, but simply as an
26 Journal of Economic Perspectives
inherited pattern. For example, one earnest and well-intentioned worker explained
that “the key to productivity is to avoid stopping the machine for product
changeovers.” While this heuristic was valuable with the old equipment, it negated
the flexibility of the new machines and created large work-in-process inventories.
Ironically, the new equipment was sufficiently flexible that the workers were able to
get it to work much like the old machines! The strong complementarities within the
old cluster of work practices and within the new cluster greatly hindered the
transition from one to the other.
Eventually, management concluded that the best approach was to introduce
the new equipment in a “greenfield” site with a handpicked set of young employees
who were relatively unencumbered by knowledge of the old practices. The resulting
productivity improvements were significant enough that management ordered all
the factory windows painted black to prevent potential competitors from seeing the
new system in action. While other firms could readily buy similar computer-
controlled equipment, they would still have to make the much larger investments
in organizational learning before fully benefiting from them and the exact recipe
for achieving these benefits was not trivial to invent (see Brynjolfsson, Renshaw, and
Van Alstyne, 1997 for details). Similarly, large changes in work practices have been
documented in case studies of information technology adoption in a variety of
settings (Hunter, Bernhardt, Hughes and Skuratowicz, 2000; Levy, Beamish, Mur-
nane and Autor, 2000; Malone and Rockart, 1991; Murnane, Levy and Autor, 1999;
Orlikowski, 1992).
Changing Interactions with Suppliers
Due to problems coordinating with external suppliers, large firms often pro-
duce many of their required inputs in-house. General Motors is the classic example
Table 1
Work Practices at MacroMed as Described in the Corporate Vision Statement
(introduction of computer-based equipment was accompanied by a large set of
complementary changes)
Principles of the “old” factory Principles of the “new” factory
Designated equipment Flexible computer-based equipment
Large inventories Low inventories
Pay tied to amount produced All operators paid same flat rate
Keep line running no matter what Stop line if not running at speed
Thorough final inspection by quality assurance Operators responsible for quality
Raw materials made in-house All materials outsourced
Narrow job functions Flexible job responsibilities
Areas separated by machine type Areas organized in work cells
Salaried employees make decisions All employees contribute ideas
Hourly workers carry them out Supervisors can fill in on line
Functional groups work independently Concurrent engineering
Vertical communication flow Line rationalization
Several management layers (6) Few management layers (3–4)
Beyond Computation: Information Technology and Organizational Transformation 27
of a company whose success was facilitated by high levels of vertical integration.
However, technologies such as electronic data interchange, Internet-based pro-
curement systems, and other interorganizational information systems have signifi-
cantly reduced the cost, time and other difficulties of interacting with suppliers. For
example, firms can place orders with suppliers and receive confirmations electron-
ically, eliminating paperwork and the delays and errors associated with manual
processing of purchase orders (Johnston and Vitale, 1988). However, even greater
benefits can be realized when interorganizational systems are combined with new
methods of working with suppliers.
An early successful interorganizational system is the Baxter ASAP system, which
lets hospitals electronically order supplies directly from wholesalers (Vitale and
Konsynski, 1988; Short and Venkatraman, 1992). The system was originally de-
signed to reduce the costs of data entry—a large hospital could generate 50,000
purchase orders annually which had to be written out by hand by Baxter’s field sales
representatives at an estimated cost of $25-35 each. However, once Baxter comput-
erized its ordering and had data available on levels of hospital stock, it took
increasing responsibility for the entire supply operation: designing stockroom
space, setting up computer-based inventory systems, and providing automated
inventory replenishment. The combination of the technology and the new supply
chain organization substantially improved efficiency for both Baxter (no paper
invoices, predictable order flow) and the hospitals (elimination of stockroom
management tasks, lower inventories, and less chance of running out of items).
Later versions of the ASAP system let users order from other suppliers, creating an
electronic marketplace in hospital supplies.
ASAP was directly associated with costs savings on the order of $10 to $15
million per year, which allowed them to recover rapidly the $30 million up front
investment and approximately $3 million annual operating costs. However, man-
agement at Baxter believed that even greater benefits were being realized through
incremental product sales at the 5500 hospitals that had installed the ASAP system,
not to mention the possibility of a reduction of logistics costs borne by the hospitals
themselves, an expense which consumes as much as 30 percent of a hospital’s
budget.
Computer-based supply chain integration has been especially sophisticated in
the consumer packaged goods industries. Traditionally, manufacturers promoted
products such as soap and laundry detergent by offering discounts, rebates, or even
cash payments to retailers to stock and sell their products. Because many consumer
products have long shelf lives, retailers tended to buy massive amounts during
promotional periods, which increased volatility in manufacturing schedules and
distorted manufacturers’ view of their market. In response, manufacturers sped up
their packaging changes to discourage stockpiling of products and developed
internal audit departments to monitor retailers’ purchasing behavior for contrac-
tual violations (Clemons, 1993).
To eliminate these inefficiencies, Procter and Gamble pioneered a program
called “efficient consumer response” (McKenney and Clark, 1995). In this ap-
proach, each retailer’s checkout scanner data goes directly to the manufacturer;
28 Journal of Economic Perspectives
ordering, payments, and invoicing are fully automated through electronic data
interchange; products are continuously replenished on a daily basis; and promo-
tional efforts are replaced by an emphasis on “everyday low pricing.” Manufacturers
also involved themselves more in inventory decisions and moved toward “category
management,” where a lead manufacturer would take responsibility for an entire
retail category (say, laundry products), determining stocking levels for their own
and other manufacturers’ products, as well as complementary items.
These changes, in combination, greatly improved efficiency. Consumers ben-
efited from lower prices and increased product variety, convenience, and innova-
tion. Without the direct computer-computer links to scanner data and the elec-
tronic transfer of payments and invoices, they could not have attained the levels of
speed and accuracy needed to implement such a system.
Technological innovations related to the commercialization of the Internet
have dramatically decreased the cost of building electronic supply chain links.
Computer-enabled procurement and on-line markets enable a reduction in input
costs through a combination of reduced procurement time and more predictable
deliveries, which reduces the need for buffer inventories and reduces spoilage for
perishable products, reduced price due to increasing price transparency and the
ease of price shopping, and reduced direct costs of purchase order and invoice
processing. Where they can be implemented, these innovations are estimated to
lower the costs of purchased inputs by 10 to 40 percent, depending on the industry
(Goldman Sachs, 1999).
Some of these savings clearly represent a redistribution of rents from suppliers
to buyers, with little effect on overall economic output. However, many of the other
changes represent direct improvements in productivity through greater production
efficiency and indirectly by enabling an increase in output quality or variety without
excessive cost. To respond to these opportunities, firms are restructuring their
supply arrangements and placing greater reliance on outside contractors. Even
General Motors, once the exemplar of vertical integration, has reversed course and
divested its large internal suppliers. As one industry analyst recently stated, “What
was once the greatest source of strength at General Motors—its strategy of making
parts in-house—has become its greatest weakness” (Schnapp, 1998). To get some
sense of the magnitude of this change, the spinoff in 1999 of Delphi Automotive
Systems, only one of GM’s many internal supply divisions, created a separate
company that by itself has $28 billion in sales.
Changing Customer Relationships
The Internet has opened up a new range of possibilities for enriching inter-
actions with customers. Dell Computer has succeeded in attracting customer orders
and improving service by placing configuration, ordering, and technical support
capabilities on the web (Rangan and Bell, 1999). It coupled this change with
systems and work practice changes that emphasize just-in-time inventory manage-
ment, build-to-order production systems, and tight integration between sales and
production planning. Dell has implemented a consumer-driven build-to-order
business model, rather than using the traditional build-to-stock model of selling
Erik Brynjolfsson and Lorin M. Hitt 29
computers through retail stores, which gives Dell as much as a 10 percent advantage
over its rivals in production cost. Some of these savings represent the elimination
of wholesale distribution and retailing costs. Others reflect substantially lower levels
of inventory throughout the distribution channel. However, a subtle but important
by-product of these changes in production and distribution is that Dell can be more
responsive to customers. When Intel releases a new microprocessor, as it does
several times each year, Dell can sell it to customers within seven days compared to
eight weeks or more for some less Internet-enabled competitors. This is a nontrivial
difference in an industry where adoption of new technology and obsolescence of
old technology is rapid, margins are thin, and many component prices drop by 3 to
4 percent each month.
Other firms have also built closer relations with their customer via the web and
related technologies. For instance, web retailers like Amazon.com provide person-
alized recommendations to visitors and allow them to customize numerous aspects
of their shopping experience. As described by Denise Caruso (1998), “Amazon’s
on-line account maintenance system provides its customers with secure access to
everything about their account at any time. [S]uch information flow to and from
customers would paralyze most old-line companies.” Merely providing Internet
access to a traditional bookstore would have had a relatively minimal impact
without the cluster of other changes implemented by firms like Amazon.
An increasingly ubiquitous example is using the web for handling basic cus-
tomer inquiries. For instance, UPS now handles a total of 700,000 package tracking
requests via the Internet every day. It costs UPS 10¢ per piece to serve that
information via the Web vs. $2 to provide it over the phone (Seybold and Marshak,
1998). Consumers benefit, too. Because customers find it easier to track packages
over the web than via the phone, UPS estimates that two-thirds of the web users
would not have bothered to check on their packages if they did not have web access.
Large-Sample Empirical Evidence on Information Technology,
Organization and Productivity
The case study literature offers many examples of strong links between infor-
mation technology and investments in complementary organizational practices.
However, to reveal general trends and to quantify the overall impact, we must
examine these effects across a wide range of firms and industries. In this section we
explore the results from large-sample statistical analyses. First, we examine studies
on the direct relationship between information technology investment and busi-
ness value. We then consider studies that measured organizational factors and their
correlation with information technology use, as well as the few initial studies that
have linked this relationship to productivity increases.
Information Technology and Productivity
Much of the early research on the relationship between technology and
productivity used economy-level or sector-level data and found little evidence of a
30 Journal of Economic Perspectives
relationship. For example, Roach (1987) found that while computer investment
per white-collar worker in the service sector rose several hundred percent from
1977 to 1989, output per worker, as conventionally measured, did not increase
discernibly. In several papers, Morrison and Berndt examined Bureau of Economic
Analysis data for manufacturing industries at the two-digit SIC level and found that
the gross marginal product of “high-tech capital” (including computers) was less
than its cost and that in many industries these supposedly labor-saving investments
were associated with an increase in labor demand (Berndt and Morrison, 1995;
Morrison, 1996). Robert Solow (1987) summarized this kind of pattern in his
well-known remark: “[Y]ou can see the computer age everywhere except in the
productivity statistics.”
However, by the early 1990s, analyses at the firm-level were beginning to find
evidence that computers had a substantial effect on firms’ productivity levels. Using
data from over 300 large firms over the period 1988-92, Brynjolfsson and Hitt
(1995, 1996) and Lichtenberg (1995) estimated production functions that use
the firm’s output (or value-added) as the dependent variable and include ordinary
capital, information technology capital, ordinary labor, information technology
labor, and a variety of dummy variables for time, industry, and firm.
2
The pattern
of these relationships is summarized in Figure 1, which compares firm-level infor-
mation technology investment with multifactor productivity (excluding computers)
for the firms in the Brynjolfsson and Hitt (1995) dataset. There is a clear positive
relationship, but also a great deal of individual variation in firms’ success with
information technology.
Estimates of the average annual contribution of computer capital to total
output generally exceed $.60 per dollar of capital stock often by a substantial
margin, depending on the analysis and specification (Brynjolfsson and Hitt, 1995,
1996; Lichtenberg, 1995; Dewan and Min, 1997). These estimates are statistically
different from zero, and in most cases significantly exceed the expected rate of
return of about $.42 (the Jorgensonian rental price of computers—see Brynjolfsson
and Hitt, 2000). This suggests either abnormally high returns to investors or the
existence of unmeasured costs or barriers to investment. Similarly, most estimates
of the contribution of information systems labor to output exceed $1 for every $1
of labor costs.
Several researchers have also examined the returns to information technology
using data on the use of various technologies rather than the size of the investment.
Greenan and Mairesse (1996) matched data on French firms and workers to
measure the relationship between a firm’s productivity and the fraction of its
employees who report using a personal computer at work. Their estimates of
computers’ contribution to output are consistent with earlier estimates of the
computer’s output elasticity.
Other micro-level studies have focused on the use of computerized manufac-
2
These studies assumed a standard form (Cobb-Douglas) for the production function, and measured
the variables in logarithms. Later work using different functional forms, such as the transcendental
logarithmic (translog) production function, has little effect on the measurement of output elasticities.
Beyond Computation: Information Technology and Organizational Transformation 31
turing technologies. Kelley (1994) found that the most productive metal-working
plants use computer-controlled machinery. Black and Lynch (1996) found that
plants where a larger percentage of employees use computers are more productive
in a sample containing multiple industries. Computerization has also been found to
increase productivity in government activities both at the process level, such as
package sorting at the post office or toll collection (Muhkopadhyay, Rajiv and
Srinivasan, 1997) and at higher levels of aggregation (Lehr and Lichtenberg, 1998).
Taken collectively, these studies suggest that information technology is associated
with substantial increases in output and productivity. Questions remain about the
mechanisms and direction of causality in these studies. Perhaps instead of information
technology causing greater output, “good firms” or average firms with unexpectedly
high sales disproportionately spend their windfall on computers. For example, while
Doms, Dunne and Troske (1997) found that plants using more advanced manufactur-
ing technologies had higher productivity and wages, they also found that this was
commonly the case even before the technologies were introduced.
Efforts to disentangle causality have been limited by the lack of good instru-
mental variables for factor investment at the firm-level. However, attempts to
correct for this bias using available instrumental variables typically increase the
estimated coefficients on information technology even further (for example, Bry-
njolfsson and Hitt, 1996; 2000). Thus, it appears that reverse causality is not driving
the results: firms with an unexpected increase in free cash flow invest in other
factors, such as labor, before they change their spending on information technol-
Figure 1
Productivity Versus Information Technology Stock (Capital plus Capitalized La-
bor) for Large Firms (1988 –1992), Adjusted for Industry
32 Journal of Economic Perspectives
ogy. Nonetheless, as the case studies underscore, there appears to be a fair amount
of causality in both directions—certain organizational characteristics make infor-
mation technology adoption more likely and vice versa.
The firm-level productivity studies can shed some light on the relationship
between information technology and organizational restructuring. For example,
productivity studies consistently find that the output elasticities of computers
exceed their (measured) input shares. One explanation for this finding is that the
output elasticities for information technology are about right, but the productivity
studies are underestimating the input quantities because they neglect the role of
unmeasured complementary investments. Dividing the output of the whole set of
complements by only the factor share of information technology will imply dispro-
portionately high rates of return for information technology.
3
A variety of other evidence suggests that hidden assets play an important role
in the relationship between information technology and productivity. Brynjolfsson
and Hitt (1995) estimated a firm fixed effects productivity model. This method can
be interpreted as dividing firm-level information technology benefits into two parts;
one part is due to variation in firms’ information technology investments over time,
the other to fixed firm characteristics. Brynjolfsson and Hitt found that in the firm
effects model, the coefficient on information technology was about 50 percent
lower, compared to the results of an ordinary least squares regression, while the
coefficients on the other factors, capital and labor, changed only slightly. This
change suggests that unmeasured and slowly changing organizational practices
(the “fixed effect”) significantly affect the returns to information technology in-
vestment.
Another indirect implication from the productivity studies comes from evi-
dence that effects of information technology are substantially larger when mea-
sured over longer time periods. Brynjolfsson and Hitt (2000) examined the effects
of information technology on productivity growth rather than productivity levels,
which had been the emphasis in most previous work, using data that included more
than 600 firms over the period 1987 to 1994. When one-year differences in
information technology are compared to one-year differences in firm productivity,
the measured benefits of computers are approximately equal to their measured
costs. However, the measured benefits rise by a factor of two to eight as longer time
periods are considered, depending on the econometric specification used. One
interpretation of these results is that short-term returns represent the direct effects
of information technology investment, while the longer-term returns represent the
effects of information technology when combined with related investments in
organizational change. Further analysis, based on earlier results by Schankerman
(1981) in the R&D context, suggested that these omitted factors were not simply
information technology investments and complements that were erroneously mis-
classified as capital or labor. Instead, to be consistent with the econometric results,
the omitted factors had to have been accumulated in ways that would not appear on
3
Hitt (1996) and Brynjolfsson and Hitt (2000) present a formal analysis of this issue.
Erik Brynjolfsson and Lorin M. Hitt 33
the current balance sheet. Firm-specific human capital and “organizational capital”
are two examples of omitted inputs that would fit this description.
4
A final perspective on the value of these organizational complements to
information technology can be found using financial market data, drawing on the
literature on Tobin’s q. This approach measures the rate of return of an asset
indirectly, based on comparing the stock market value of the firm to the replace-
ment value of the various capital assets it owns. Typically, Tobin’s q has been
employed to measure the relative value of observable assets such as R&D or physical
plant. However, as suggested by Hall (1999a, b), Tobin’s q can also be viewed as
providing a measure of the total quantity of capital, including the value of “tech-
nology, organization, business practices, and other produced elements of successful
modern corporation.” Using an approach along these lines, Brynjolfsson and Yang
(1997) found that while one dollar of ordinary capital is valued at approximately
one dollar by the financial markets, one dollar of information technology capital
appears to be correlated with on the order of $10 of additional stock market value
for Fortune 1000 firms using data spanning 1987 to 1994. Since these results, for
the most part, apply to large, established firms rather than new high-tech start-ups,
and since they predate most of the massive increase in market valuations for
technology stocks in the late 1990s, these results are not likely to be sensitive to the
possibility of a recent “high-tech stock bubble.”
A more likely explanation for these results is that information technology
capital is disproportionately associated with intangible assets like the costs of
developing new software, populating a database, implementing a new business
process, acquiring a more highly skilled staff, or undergoing a major organizational
transformation, all of which go uncounted on a firm’s balance sheet. In this
interpretation, for every dollar of information technology capital, the typical firm
has also accumulated about $9 in additional intangible assets. A related explanation
is that firms must occur substantial “adjustment costs” before information technol-
ogy is effective. These adjustment costs drive a wedge between the value of a
computer resting on the loading dock and one that is fully integrated into the
organization.
The evidence from both the productivity and Tobin’s q analyses provides some
insights into the properties of information technology-related intangible assets,
even if we cannot measure these assets directly. Such assets are large, potentially
several multiples of the measured information technology investment. They are
unmeasured in the sense that they do not appear as a capital asset or as other
components of firm input, although they do appear to be unique characteristics of
particular firms as opposed to industry effects. Finally, they have more effect in the
long term than the short term, suggesting that multiple years of adaptation and
investment is required before their influence is maximized.
4
Part of the difference in coefficients between short and long difference specifications could also be
explained by measurement error (which tends to average out over longer time periods). Such errors-
in-variables can bias down coefficients based on short differences, but the size of the change is too large
to be attributed solely to this effect (Brynjolfsson and Hitt, 2000).
34 Journal of Economic Perspectives
Direct Measurement of the Interrelationship between Information Technology
and Organization
Some studies have attempted to measure organizational complements directly,
and to determine whether they are correlated with information technology invest-
ment, or whether firms that combine complementary factors have better economic
performance. Finding correlations between information technology and organiza-
tional change, or between these factors and measures of economic performance, is
not sufficient to prove that these practices are complements, unless a full structural
model specifies the production relationships and demand drivers for each factor.
Athey and Stern (1997) discuss issues in the empirical assessment of complemen-
tarity relationships. However, after empirically evaluating possible alternative ex-
planations and combining correlations with performance analyses, complementa-
rities are often the most plausible explanation for observed relationships between
information technology, organizational factors, and economic performance.
The first set of studies in this area focuses on correlations between use of
information technology and extent of organizational change. An important finding
is that information technology investment is greater in organizations that are
decentralized and have a greater investment in human capital. For example,
Bresnahan, Brynjolfsson and Hitt (2000) surveyed approximately 400 large firms to
obtain information on aspects of organizational structure like allocation of decision
rights, workforce composition, and investments in human capital. They found that
greater levels of information technology are associated with increased delegation of
authority to individuals and teams, greater levels of skill and education in the
workforce, and greater emphasis on pre-employment screening for education and
training. In addition, they find that these work practices are correlated with each
other, suggesting that they are part of a complementary work system. Kelley (1994)
found that the use of programmable manufacturing equipment is correlated with
several aspects of human resource practices.
Research on jobs within specific industries has begun to explore the mecha-
nisms within organizations that create these complementarities. Drawing on a case
study on the automobile repair industry, Levy, Beamish, Murnane and Autor
(2000) argue that computers are most likely to substitute for jobs that rely on rule-
based decision-making while complementing nonprocedural cognitive tasks. In
banking, researchers have found that many of the skill, wage and other organiza-
tional effects of computers depend on the extent to which firms couple computer
investment with organizational redesign and other managerial decisions (Hunter,
Bernhardt, Hughes and Skuratowicz, 2000; Murnane, Levy and Autor, 1999).
Researchers focusing at the establishment level have also found complementarities
between existing technology infrastructure and firm work practices to be a key
determinant of the firm’s ability to incorporate new technologies (Bresnahan and
Greenstein, 1997); this also suggests a pattern of mutual causation between com-
puter investment and organization.
A variety of industry-level studies also show a strong connection between
investment in high technology equipment and the demand for skilled, educated
workers (Berndt, Morrison and Rosenblum, 1992; Berman, Bound and Griliches,
Beyond Computation: Information Technology and Organizational Transformation 35
1994; Autor, Katz and Krueger, 1998). Again, these findings are consistent with the
idea that increasing use of computers is associated with a greater demand for
human capital.
Several researchers have also considered the effect of information technology
on macro-organizational structures. They have typically found that greater levels of
investment in information technology are associated with smaller firms and less
vertical integration. Brynjolfsson, Malone, Gurbaxani and Kambil (1994) found
that increases in the level of information technology capital in an economic sector
were associated with a decline in average firm size in that sector, consistent with
information technology leading to a reduction in vertical integration. Hitt (1999),
examining the relationship between a firm’s information technology capital stock
and direct measures of its vertical integration, arrived at similar conclusions. These
results corroborate earlier case analyses and theoretical arguments that suggested
that information technology would be associated with a decrease in vertical inte-
gration because it lowers the costs of coordinating externally with suppliers (Ma-
lone, Yates and Benjamin, 1987; Gurbaxani and Whang, 1991; Clemons and Row,
1992).
One difficulty in interpreting the literature on correlations between informa-
tion technology and organizational change is that some managers may be predis-
posed to try every new idea and some managers may be averse to trying anything
new at all. In such a world, information technology and a “modern” work organi-
zation might be correlated in firms because of the temperament of management,
not because they are economic complements. To rule out this sort of spurious
correlation, it is useful to bring measures of productivity and economic perfor-
mance into the analysis. If combining information technology and organizational
restructuring is economically justified, then firms that adopt these practices as a
system should outperform those that fail to combine information technology
investment with appropriate organizational structures.
In fact, firms that adopt decentralized organizational structures and work
structures do appear to have a higher contribution of information technology to
productivity (Bresnahan, Brynjolfsson and Hitt, 2000). For example, firms that are
more decentralized than the median firm (as measured by individual organiza-
tional practices and by an index of such practices), have, on average, a 13 percent
greater information technology elasticity and a 10 percent greater investment in
information technology than the median firm. Firms that are in the top half of both
information technology investment and decentralization are on average 5 percent
more productive than firms that are above average only in information technology
investment or only in decentralization.
Similar results also appear when economic performance is measured as stock
market valuation. Firms in the top third of decentralization have a 6 percent higher
market value after controlling for all other measured assets; this is consistent with
the theory that organizational decentralization behaves like an intangible asset.
Moreover, the stock market value of a dollar of information technology capital is
between $2 and $5 greater in decentralized firms than in centralized firms (per
standard deviation of the decentralization measure), and as shown in Figure 2 this
36 Journal of Economic Perspectives
relationship is particularly striking for firms that are simultaneously extensive users
of information technology and highly decentralized (Brynjolfsson, Hitt and Yang,
2000).
The weight of the firm-level evidence shows that a combination of investment
in technology and changes in organizations and work practices facilitated by these
technologies contributes to firms’ productivity growth and market value. However,
much work remains to be done in categorizing and measuring the relevant changes
in organizations and work practices, and relating them to information technology
and productivity.
The Divergence of Firm-level and Aggregate Studies on
Information Technology and Productivity
While the evidence indicates that information technology has created substan-
tial value for firms that have invested in it, it has sometimes been a challenge to link
these benefits to macroeconomic performance. A major reason for the gap in
interpretation is that traditional growth accounting techniques focus on the (rel-
atively) observable aspects of output, like price and quantity, while neglecting the
Figure 2
Market Value as a Function of Information Technology and Work Organization
Source: This graph was produced by nonparametric local regression models using data from
Brynjolfsson, Hitt and Yang (2000).
Erik Brynjolfsson and Lorin M. Hitt 37
intangible benefits of improved quality, new products, customer service and speed.
Similarly, traditional techniques focus on the relatively observable aspects of invest-
ment, such as the price and quantity of computer hardware in the economy, and
neglect the much larger intangible investments in developing complementary new
products, services, markets, business processes, and worker skills. Paradoxically,
while computers have vastly improved the ability to collect and analyze data on
almost any aspect of the economy, the current computer-enabled economy has
become increasingly difficult to measure using conventional methods. Nonetheless,
standard growth accounting techniques provide a useful starting point for any
assessment or for the contribution of information technology to economic growth.
Several studies of the contribution of information technology concluded that
technical progress in computers contributed roughly 0.3 percentage points per
year to real output growth when data from the 1970s and 1980s were used
(Jorgenson and Stiroh, 1995; Oliner and Sichel, 1994; Brynjolfsson, 1996).
Much of the estimated growth contribution comes directly from the large
quality-adjusted price declines in the computer producing industries. The nominal
value of purchases of information technology hardware in the United States in 1997
was about 1.4 percent of GDP. Since the quality-adjusted prices of computers
decline by about 25 percent per year, simply spending the same nominal share of
GDP as in previous years represents an annual productivity increase for the real
GDP of 0.3 percentage points (that is, 1.4 .25 .35). A related approach is to
look at the effect of information technology on the GDP deflator. Reductions in
inflation, for a given amount of growth in output, imply proportionately higher real
growth and, when divided by a measure of inputs, higher productivity growth as
well. Gordon (1998, p. 4) calculates that “computer hardware is currently contrib-
uting to a reduction of U.S. inflation at an annual rate of almost 0.5 percent per
year, and this number would climb toward one percent per year if a broader
definition of information technology, including telecommunications equipment,
were used.”
More recent growth accounting analyses by the same authors have linked the
recent surge in measured productivity in the U.S. to increased investments in
information technology. Using similar methods as in their earlier studies, Oliner
and Sichel (this issue) and Jorgenson and Stiroh (1999) find that the annual
contribution of computers to output growth in the second half of the 1990s is closer
to 1.0 or 1.1 percentage points per year. Gordon (this issue) makes a similar
estimate. This is a large contribution for any single technology, although research-
ers have raised concerns that computers are primarily an intermediate input and
that the productivity gains are disproportionately visible in computer-producing
industries as opposed to computer-using industries. For instance, Gordon notes
that after he makes adjustments for the business cycle, capital deepening and other
effects, there has been virtually no change in the rate of productivity growth outside
of the durable goods sector. Jorgenson and Stiroh ascribe a larger contribution to
computer-using industries, but still not as great as in the computer-producing
industries.
38 Journal of Economic Perspectives
Should we be disappointed by the productivity performance of the down-
stream firms?
Not necessarily. Two points are worth bearing in mind when comparing
upstream and downstream sectors. First, the allocation of productivity depends on
the quality-adjusted transfer prices used. If a high deflator is applied, the upstream
sectors get credited with more output and productivity in the national accounts, but
the downstream firms get charged with using more inputs and thus have less
productivity. Conversely, a low deflator allocates more of the gains to the down-
stream sector. In both cases, the increases in the total productivity of the economy
are, by definition, identical. Since it is difficult to compute accurate deflators for
complex, rapidly changing intermediate goods like computers, one must be careful
in interpreting the allocation of productivity across producers and users.
5
The second point is more semantic. Arguably, downstream sectors are deliv-
ering on the information technology revolution by simply maintaining levels of
measured total factor productivity growth in the presence of dramatic changes in
the costs, nature and mix of intermediate computer goods. This reflects a success
in costlessly converting technological innovations into real output that benefits end
consumers. If a firm maintains a constant nominal information technology budget
in the face of 50 percent information technology price declines over two years, it is
treated in the national accounts as using 100 percent more real information
technology input for production. A commensurate increase in real output is
required merely to maintain the same measured productivity level as before. Such
an output increase is not necessarily automatic since it requires a significant change
in the input mix and organization of production. In the presence of adjustment
costs and imperfect output measures, one might reasonably have expected mea-
sured productivity to decline initially in downstream sectors as they absorb a rapidly
changing set of inputs and introduce new products and services.
Regardless of how the productivity benefits are allocated, these studies show
that a substantial part of the upturn in measured productivity of the economy as a
whole can be linked to increased real investments in computer hardware and
declines in their quality-adjusted prices. However, there are several key assumptions
implicit in economy- or industry-wide growth accounting approaches which can
have a substantial influence on their results, especially if one seeks to know whether
investment in computers are increasing productivity as much as alternate possible
investments. The standard growth accounting approach begins by assuming that all
inputs earn “normal” rates of return. Unexpected windfalls, whether the discovery
of a single new oil field, or the invention of a new process which makes oil fields
obsolete, show up not in the growth contribution of inputs but as changes in the
5
It is worth noting that if the exact quality change of an intermediate good is mismeasured, then the
total productivity of the economy is not affected, only the allocation between sectors. However, if
computer-using industries take advantage of the radical change in input in their quality to introduce
new quality levels output (or entirely new goods) and these changes are not fully reflected in final output
deflators, then total productivity will be underestimated. In periods of rapid technological change, both
phenomena can be expected.
Beyond Computation: Information Technology and Organizational Transformation 39
multifactor productivity residual. By construction, an input can contribute more to
output in these analyses only by growing rapidly, not by having an unusually high
net rate of return.
Changes in multifactor productivity growth, in turn, depend on accurate
measures of final output. However, nominal output is affected by whether firm
expenditures are expensed, and therefore deducted from value-added, or capital-
ized and treated as investment. As emphasized throughout this paper, information
technology is only a small fraction of a much larger complementary system of
tangible and intangible assets. However, current statistics typically treat the accu-
mulation of intangible capital assets, such as new business processes, new produc-
tion systems and new skills, as expenses rather than as investments. This leads to a
lower level of measured output in periods of net capital accumulation. Second,
current output statistics disproportionately miss many of the gains that information
technology has brought to consumers such as variety, speed, and convenience. We
will consider these issues in turn.
The magnitude of investment in intangible assets associated with computer-
ization may be large. Analyses of 800 large firms by Brynjolfsson and Yang (1997)
suggest that the ratio of intangible assets to information technology assets may be
10 to 1. Thus, the $167 billion in computer capital recorded in the U.S. national
accounts in 1996 may have actually been only the tip of an iceberg of $1.67 trillion
of information technology-related complementary assets in the United States.
Examination of individual information technology projects indicates that the
10:1 ratio may even be an underestimate in many cases. For example, a survey of a
common category of software projects—namely, “enterprise resource planning”—
found that the average spending on computer hardware accounted for less than
4 percent of the typical start-up cost of $20.5 million, while software licenses and
development were another 16 percent of total costs (Gormely et al., 1998). The
remaining costs included hiring outside and internal consultants to help design
new business processes and to train workers in the use of the system. The time of
existing employees, including top managers, that went into the overall implemen-
tation were not included, although it too is typically quite substantial.
The up-front costs were almost all treated as current expenses by the compa-
nies undertaking the implementation projects. However, insofar as the managers
who made these expenditures expected them to pay for themselves only over
several years, the nonrecurring costs are properly thought of as investments, not
expenses, when considering the impact on economic growth. In essence, the
managers were adding to the nation’s capital stock not only of easily visible
computers, but also of less visible business processes and worker skills.
How might these measurement problems affect economic growth and produc-
tivity calculations? In a steady state, it makes little difference, because the amount
of new organizational investment in any given year is offset by the “depreciation” of
organizational investments in previous years. The net change in capital stock is
zero. Thus, in a steady state, classifying organizational investments as expenses does
not bias overall output growth as long as it is done consistently from year to year.
However, the economy has hardly been in a steady state with respect to comput-
40 Journal of Economic Perspectives
ers and their complements. Instead, the U.S. economy has been rapidly adding
to its stock of both types of capital. To the extent that this net capital accumulation
has not been counted as part of output, output and output growth have been
underestimated.
The software industry offers a useful example of the impact of classifying a
category of spending as expense or investment. Historically, efforts on software
development have been treated as expenses, but recently the government has
begun recognizing that software is an intangible capital asset. Software investment
by U.S. businesses and governments grew from $10 billion in 1979 to $159 billion
in 1998 (Parker and Grimm, 2000). Properly accounting for this investment has
added 0.15 to 0.20 percentage points to the average annual growth rate of real GDP
in the 1990s. While capitalizing software is an important improvement in our
national accounts, software is far from the only, or even most important, comple-
ment to computers.
If the wide array of intangible capital costs associated with computers were
treated as investments rather than expenses, the results would be striking. Accord-
ing to some preliminary estimates from Yang (2000), building on estimates of the
intangible asset stock derived from stock market valuations of computers, the true
growth rate of U.S. GDP, after accounting for the intangible complements to
information technology hardware, has been increasingly underestimated by an
average of over 1 percent per year since the early 1980s, with the underestimate
getting worse over time as net information technology investment has grown.
Productivity growth has been underestimated by a similar amount. This reflects the
large net increase in intangible assets of the U.S. economy associated with the
computerization that was discussed earlier. Over time, the economy earns returns
on past investment, converting it back into consumption. This has the effect of
raising GDP growth as conventionally measured by a commensurate amount even
if the “true” GDP growth remains unchanged.
While the quantity of intangible assets associated with information technology
is difficult to estimate precisely, the central lesson is that these complementary
changes are very large and cannot be ignored in any realistic attempt to estimate
the overall economic contributions of information technology.
The productivity gains from investments in new information technology are
underestimated in a second major way: failure to account fully for quality change
in consumable outputs. It is typically much easier to count the number of units
produced than to assess intrinsic quality—especially if the desired quality may vary
across customers. A significant fraction of value of quality improvements due to
investments in information technology—like greater timeliness, customization, and
customer service—is not directly reflected as increased industry sales, and thus is
implicitly treated as nonexistent in official economic statistics.
These issues have always been a concern in the estimation of the true rate of
inflation and the real output of the U.S. economy (Boskin et al., 1997). If output
mismeasurement for computers was similar to output mismeasurement for previous
technologies, estimates of long-term productivity trends would be unaffected (Baily
and Gordon, 1988). However, there is evidence that in several specific ways,
Erik Brynjolfsson and Lorin M. Hitt 41
computers are associated with an increasing degree of mismeasurement that is
likely to lead to increasing underestimates of productivity and economic growth.
The production of intangible outputs is an important consideration for infor-
mation technology investments whether in the form of new products or improve-
ments in existing products. Based on a series of surveys of information services
managers conducted in 1993, 1995 and 1996, Brynjolfsson and Hitt (1997) found
that customer service and sometimes other aspects of intangible output (specifically
quality, convenience, and timeliness) ranked higher than cost savings as the moti-
vation for investments in information services. Brooke (1992) found that informa-
tion technology was also associated with increases in product variety.
Indeed, government data show many inexplicable changes in productivity,
especially in the sectors where output is measured poorly and where changes in
quality may be especially important (Griliches, 1994). Moreover, simply removing
anomalous industries from the aggregate productivity growth calculation can
change the estimate of U.S. productivity growth by 0.5 percent or more (Corrado
and Slifman, 1999). The problems with measuring quality change and true output
growth are illustrated by selected industry-level productivity growth data over
different time periods, shown in Table 2. According to official government statis-
tics, a bank today is only about 80 percent as productive as a bank in 1977; a health
care facility is only 70 percent as productive and a lawyer only 65 percent as
productive as they were 1977.
These statistics seem out of touch with reality. In 1977, virtually all banking was
conducted via the teller windows; today, customers can access a network of 139,000
automatic teller machines (ATMs) 24 hours a day, seven days a week (Osterberg
and Sterk, 1997), as well as a vastly expanded array of banking services via the
Internet. The more than tripling of cash availability via ATMs required an incre-
mental investment on the order of $10 billion compared with over $70 billion
invested in physical bank branches. Computer controlled medical equipment has
facilitated more successful and less invasive medical treatment. Many procedures
that previously required extensive hospital stays can now be performed on an
outpatient basis; instead of surgical procedures, many medical tests now use non-
invasive imaging devices such as x-rays, MRI, or CT scanners. Information technol-
ogy has supported the research and analysis that has led to these advances plus a
wide array of improvements in medication and outpatient therapies. A lawyer today
can access a much wider range of information through on-line databases and
manage many more legal documents. In addition, some basic legal services, such as
drafting a simple will, can now be performed without a lawyer using inexpensive
software packages such as Willmaker.
One of the most important types of unmeasured benefits arises from new
goods. Sales of new goods are measured in the GDP statistics as part of nominal
output, although this does not capture the new consumer surplus generated by
such goods, which causes them to be preferred over old goods. Moreover, the
Bureau of Labor Statistics has often failed to incorporate new goods into price
indices until many years after their introduction; for example, it did not incorpo-
rate the VCR into the consumer price index until 1987, about a decade after they
42 Journal of Economic Perspectives
began selling in volume. This leads the price index to miss the rapid decline in
price that many new goods experience early in their product cycle. In a related
example, in 1990, sales of the printed multi-volume Encyclopedia Britannica were
$650 million and the production cost for each set was over $250, plus up to $500
for the salesperson’s commission (Evans and Wurster, 2000). Producing a CD-ROM
with the same information now costs less than $1, and presenting it via a website like
www.britannica.com, costs but a fraction of that. Sales of the printed version of all
encyclopedias, including Britannica, collapsed by over 80 percent in the 1990s, as
the content was bundled for “free” with office software or delivered on the web. The
GDP statistics captured this collapse in sales, but not the value of the content that
is now free or nearly free. As a result, the inflation statistics overstate the true rise
in the cost of living, and when the nominal GDP figures are adjusted using that
price index, the real rate of output growth is understated (Boskin et al., 1997). The
problem extends beyond new high-tech products, like personal digital assistants
and web browsers. Computers enable more new goods to be developed, produced,
and managed in all industries. For instance, the number of new products intro-
duced in supermarkets has grown from 1281 in 1964, to 1831 in 1975, and then to
16,790 in 1992 (Nakamura, 1997); the data management requirements to handle so
many products would have overwhelmed the computerless supermarket of earlier
decades. Consumers have voted with their pocketbooks for the stores with greater
product variety.
This collection of results suggests that information technology may be associ-
ated with increases in the intangible component of output, including variety,
customer convenience, and service. Because it appears that the amount of unmea-
sured output value is increasing with computerization, this measurement problem
not only creates an underestimate of output level, but also errors in measurement
of output and productivity growth when compared with earlier time periods which
had a smaller bias due to intangible outputs.
Just as the Bureau of Economic Analysis successfully reclassified many software
expenses as investments and is making quality adjustments, perhaps we will also
find ways to measure the investment component of spending on intangible orga-
nizational capital and to make appropriate adjustments for the value of all gains
attributable to improved quality, variety, convenience and service. Unfortunately,
Table 2
Annual (Measured) Productivity Growth for Selected Industries (based on dividing
BEA gross output by industry figures by BLS hours worked by industry for comparable
sectors)
Industry 1948–1967 1967–1977 1977–1996
Depository Institutions .03% .21% 1.19%
Health Services .99% .04% 1.81%
Legal Services .23% 2.01% 2.13%
Source: Partial reproduction from Gordon (1998, Table 3).
Beyond Computation: Information Technology and Organizational Transformation 43
addressing these problems can be difficult even for single firms and products, and
the complexity and number of judgments required to address them at the macro-
economic level is extremely high. Moreover, because of the increasing service
component of all industries (even basic manufacturing), which entails product and
service innovation and intangible investments, these problems cannot be easily
solved by focusing on a limited number of “hard to measure” industries—they are
pervasive throughout the economy.
Meanwhile, however, firm-level studies can overcome some of the difficulties in
assessing the productivity gains from information technology. For example, it is
considerably easier at the firm level to make reasonable estimates of the invest-
ments in intangible organizational capital and to observe changes in organizations,
while it is harder to formulate useful rules for measuring such investment at the
macroeconomic level.
Firm-level studies may be less subject to aggregation error when firms make
different levels of investments in computers and thus could have different
capabilities for producing higher value products (Brynjolfsson and Hitt, 1996,
2000). Suppose a firm invests in information technology to improve product
quality and consumers recognize and value these benefits. If other firms do not
make similar investments, any difference in quality will lead to differences in the
equilibrium product prices that each firm can charge. When an analysis is
conducted across firms, variation in quality will contribute to differences in
output and productivity and thus, will be measured as increases in the output
elasticity of computers. However, when firms with high quality products and
firms with low quality products are combined together in industry data (and
subjected to the same quality-adjusted deflator for the industry), both the
information technology investment and the difference in revenue will average
out, and a lower correlation between information technology and (measured)
output will be detected. Interestingly, Siegel (1997) found that the measured
effect of computers on productivity was substantially increased when he used a
structural equation framework to directly model the errors in production input
measurement in industry-level data.
However, firm-level data can be an unreliable way to capture the social gains
from improved product quality. For example, not all price differences reflect
differences in product or service quality. When price differences are due to
differences in market power that are not related to consumer preferences, then
firm-level data will lead to inaccurate estimates of the productivity effects of
information technology. Similarly, increases in quality or variety (like new product
introductions in supermarkets) can be a by-product of anticompetitive product
differentiation strategies, which may or may not increase total welfare. Moreover,
firm-level data will not fully capture the value of quality improvements or other
intangible benefits if these benefits are ubiquitous across an industry, because then
there will not be any interfirm variation in quality and prices. Instead, competition
will pass the gains on to consumers. In this case, firm-level data will also understate
the contribution of information technology investment to social welfare.
44 Journal of Economic Perspectives
Conclusion
Concerns about an information technology “productivity paradox” were raised
in the late 1980s. Over a decade of research since then has substantially improved
our understanding of the relationship between information technology and eco-
nomic performance. The firm-level studies in particular suggest that, rather than
being paradoxically unproductive, computers have had an impact on economic
growth that is disproportionately large compared to their share of capital stock or
investment, and this impact is likely to grow further in coming years.
In particular, both case studies and econometric work point to organizational
complements such as new business processes, new skills and new organizational and
industry structures as a major driver of the contribution of information technology.
These complementary investments, and the resulting assets, may be as much as an
order of magnitude larger than the investments in the computer technology itself.
However, they go largely uncounted in our national accounts, suggesting that
computers have made a much larger real contribution to the economy than
previously believed.
The use of firm-level data has cast a brighter light on the black box of
production in the increasingly information technology-based economy. The out-
come has been a better understanding of the key inputs, including complementary
organizational assets, as well as the key outputs including the growing roles of new
products, new services, quality, variety, timeliness and convenience. Measuring the
intangible components of complementary systems will never be easy. But if re-
searchers and business managers recognize the importance of the intangible costs
and benefits of computers and undertake to evaluate them, a more precise assess-
ment of these assets needn’t be beyond computation.
y
Portions of this manuscript are to appear in MIS Review and in an edited volume, The
Puzzling Relations Between Computer and the Economy, Nathalie Greenan, Yannick
Lhorty and Jacques Mairesse, eds., MIT Press, 2001.
The authors thank David Autor, Brad De Long, Robert Gordon, Shane Greenstein, Dale
Jorgenson, Alan Krueger, Dan Sichel, Robert Solow, Kevin Stiroh and Timothy Taylor for
valuable comments on (portions of) earlier drafts. This work is funded in part by NSF Grant
IIS-9733877.
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