Kerstin Hessius: The new economy seen from a central bank perspective
Speech by Ms Kerstin Hessius, Deputy Governor of the Sveriges Riksbank, at a seminar on the IT
revolution and the new economy, organised by Skandinaviska Enskilda Banken Institutionell
Förvaltning, at Moderna Museet Stockholm, on 12 October 2000.
* * *
I would like to begin by thanking the organisers for choosing such a stimulating and appropriate
environment for this seminar as Moderna Museet. If there is one place where you can see the effect of
structural change, it is in art.
A country's economy is constantly subjected to changes, which lead to new structures. However, this
is nothing new. Every time an economy has undergone significant structural changes, it has been
regarded as a new economy. In many ways today's "new economy" can be seen as one of many such
major structural changes. Nor is there any accepted definition of the "new economy" concept; what I
am referring to is primarily an increase in the growth potential of the economy.
"Multiplied intellectual capacity"
The new information technology and the internet have revolutionised the methods in which we work,
shop and communicate today. As someone once said, it is as though IT multiplies intellectual capacity
in the same way that the industrial revolution multiplied physical capacity. In addition, the costs of
using the new intellectual capacity have fallen drastically over a short period of time, which facilitates
a rapid dissemination.
However, from a historical point of view, it is only when technological advances have made a general
impact on the production process that productivity gains will arise. The steam engine moved
production from household to factory, the railway enabled wider markets to develop and electricity
brought the conveyer belt. Computers and the internet enable a more effective flow of information at
almost all stages; financing, projection, follow-up, stock management, procurement, negotiation,
auction, verification, invoicing, auditing, requisitioning and distribution. Furthermore, the improved
access to information contributes to a reduction in the risks when outsourcing parts of the company's
operations.
More efficient markets - the "naked economy"
Increased access to information means that the markets - the matching processes between buyers and
sellers - also become more efficient. Some people therefore call the new economy the "naked
economy". We can use the internet to search for products and compare prices, which brings down
transaction costs and new companies find it easier to get into the market.
A good example of this is how the matching process on the labour market is facilitated by information
technology. In the USA around 80% of personnel managers are said to use the internet and one of the
largest employment agencies on the internet advertises more than one million jobs.1 Four hundred of
the world's 500 largest companies use web sites in their recruitment process. These internet
employment agencies probably reduce the search costs and facilitate the matching process - reducing
what is known as friction unemployment.
This has a particularly strong impact when it occurs in conjunction with lower trade barriers and an
increased exchange of trade. A popular example of the new international business to business is the
joint electronic marketplace planned by the world's leading car manufacturers. This is estimated to
achieve a turnover of USD 250 billion and to cover 60,000 sub-contractors. Electronic trading in
components in the motor vehicle industry is estimated to be able to reduce the cost of producing a car
by almost 15%.2
The new internet markets will naturally lead to stiffer competition. Sub-contractors will experience
fewer barriers to entering markets and the price picture will become more transparent. This means that
strong suppliers will be able to push out weaker ones more quickly and sub-contractors' margins will
in general be put under pressure - the producer surplus will decline for the benefit of the consumers
and prices will fall. Suppliers will be forced to rationalise and to improve in order to maintain their
margins. The stiffer competition among those who remain will be the driving force behind continued
growth in productivity.
How IT will boost growth
The more efficient production process and markets are both examples of boosts to productivity that
will temporarily increase growth. A simple way of describing this is to imagine the new technologies
and more efficient markets causing the path of the long-term potential GDP to shift outwards. This is
done by growth strongly accelerating (see slide 1A). However, when the technological revolution has
subsided, the boost in growth will also subside.
However, it is not self-evident that there is some form of "natural" growth rate to return to. Over a
long-term perspective the growth rate has both varied and accelerated. I therefore intend to take up the
other possible angle of approach sometimes mentioned, that IT could raise growth permanently. This
could only be achieved by the technological innovations also creating the right conditions for a more
rapid development in technology in the future (see slide 1B). One example of this type of development
is what is known as Moore's Law. It is now 25 years ago that Gordon Moore, the founder of Intel,
predicted that the capacity of a microprocessor would double every 18 months. So far he has been
proved right and many believe that Moore's forecast may hold true far into the 2010s. However,
despite the fact that certain technological indicators, such as the number of patents granted, indicate an
increasingly rapid development in the USA and Sweden, it is difficult to believe in a perpetual
technological acceleration.
From a central bank perspective, we can probably keep our distance to this debate by reminding
everyone that our monetary policy goal horizon is one to two years. It suffices to imagine that the
adaptation periods between the first and second dotted-line curve (in slide 1A) will take perhaps five
to 10 years. From this perspective the question of whether IT developments will lead to a temporary or
permanent increase in the growth rate is of mainly academic interest.
The models can manage the "new economy"
1. Possible growth effects of IT
A. B.
Real GDP
Real GDP
time
time
In this context, it may be appropriate to dismiss some prejudices about macro-models. Many believe
that these models will become unusable and outdated in a "new economy", but that is not the case.
When structural changes take place, forecasts based on historical estimates naturally become more
uncertain. It is therefore reasonable to attach greater importance on these occasions to recent
need not
information and indicators. But the models be assessed on historical data. In actual fact the
models' parameters can be "calibrated" in such a way that their properties closely agree with the
conception of the way the economy functions. This conception can, of course, be based on historical
equally well be based on information not contained in historical
connections, but can data. The
models are in actual fact an important tool in testing whether historically assessed connections still
apply and play an important role in signalling significant structural changes.
What does the data in the USA say?
What information does factual data actually give us? Without doubt there is a clear break in the GDP
growth trend in the USA, which has been much higher during the second half of the 1990s than during
the 1970s and 1980s. The fact that this has occurred without any corresponding increase in inflationary
pressure indicates that there has been an increase in the economy's long-term production capacity. But
should this really be regarded as a "new" economy? In actual fact, the growth rate in recent years does
not appear unusually high when seen in a perspective of 40-50 years. On the contrary, it is the growth
rate during the 1970s and 1980s which appears to be unusually low.
What really makes the 1990s in the USA unique is the course of the economic upswing, its long
duration and especially the developments in productivity. Growth in productivity has largely increased
over time, instead of decreasing, as has been the case in previous periods of economic upswing
(slide 2).
There has been an intense debate among leading US economists over the past year as to whether this
increase in productivity merely reflects greater productivity in the manufacture of computers and other
IT equipment, or whether this IT capital also has a spread effect to other parts of the economy. No one
questions the fact that productivity in the actual manufacture of computers and IT equipment has
increased. There has been an increase of almost 25% a year in this field during the 1990s. The
dissension concerns the spread effects.
2. Productivity during different
economic expansions in the US
USA: Non-farm productivity growth
5
4,5
4
3,5
percent
3
in
2,5
2
increase
1,5
annual
1
0,5
0
1961-69 1982-90 1991-99
first 2 years year 3-4 year 5-6 year 7 and thereafter
Source: Federal Reserve, Board of Governors.
The background to this scepticism regarding the effects of IT on the rest of the economy lies in the
"Solow paradox". Nobel prizewinner Robert Solow stated in 1987 that "we see computers everywhere
but not in the productivity statistics". This was true until the mid-1990s.
3. Productivity by factor, USA
1980-99
3
2,5
2
percent
in
1,5
increase
annual
1
average
0,5
0
C apital deepening Labour quality TFP
Source: Federal Reserve, Board of Governors.
Now, however, the effects of computers are beginning to show in the statistics and this paradox could
be dismissed. Stephen Oliner and Daniel Sichel at the Federal Reserve in Washington3 have made an
in-depth analysis. This is based on the fact that the productivity trend has increased by just over
1 percentage point during the latter part of the 1990s and they conclude that IT actually accounts for
most of the growth in productivity. Just under half of the total increase results from investments in IT.
The remainder is the result of a more rapid increase in total factor productivity (TFP), that is to say,
the part considered to be due to factors such as technology and organisation (slide 3). Half of this part
can be attributed to the production of IT products, but the remainder - corresponding to one third of a
percentage point of the total increase - is attributable to a generally higher level of efficiency in the
economy as a whole. Other studies have produced similar results. However, the question of how
strong a relation this has to IT is still open. There are probably a number of factors working together in
this process, such as deregulation, increased competition, a higher average level of education, etc.
The new economy in Sweden
While many people are wondering whether what has happened in the USA can really reach Europe, it
cannot be denied that Sweden is showing many similarities. The good growth rate in recent years and
low prices provide food for thought.
Firstly, a few words on the conditions in Sweden compared with the USA. Here I am not merely
talking about the most fundamental factor, ie a broad base of well-educated labour. Price stability and
healthy public finances are also important conditions for providing a "new economy" with growing
power. In addition, strategically important markets, such as telecommunications and broadcasting
media have been opened up to competition.
It is especially important that Sweden had a broad base of users of various technical systems at an
early stage. A broad base is essential for users and producers to gain a real exchange from working in
the networks comprised by the new technology. Ericsson's successful broadening of its operations
from fixed to mobile telephony and Sweden's rapid licensing of first NMT and then GSM gave
Sweden one of the world's broadest bases of mobile phone users. The subsidised provision of personal
computers to employees also broadened the user base and gave Sweden the highest PC density in
Europe. This of course facilitated the use of the internet and thus the general e-mail revolution in
Swedish companies and homes. The combination of internet usage and the high density of mobile
phones means that mobile internet, despite its slow start, has already come further here than in the
USA. Slide 4 shows a summary of Sweden's position in various technological, network-based
systems. As the internet is still in a phase of development, these figures can primarily serve as
indicators of future growth.
4. Technology dissemination
users as a percentage of total population (unless indicated otherwise)
0 % 2 0 % 4 0 % 6 0 % 8 0 % 1 0 0 %
S w e d e n
1
P C -u s a g e U S A
s o u r c e s : N e t p r o f it, F T 2
G e rm a ny
3
4
S w e d e n
In te r n e
5
U S A
tu s a g e
6
s o u r c e s : N e ts iz e r, F T G e rm a ny
7
8
E -c o m m e r c e u s e rs S w e d e n
9
a s s h a re o f U S A
G e rm a ny
1 0
In te rn e t-u s e r s .
s o u r c e s : N e t p r of it, F T
1 1
1 2
S w e d e n
U s e r s o f in te r n e t
1 3
U S A
b a n k in g s e r v ic e s
1 4
s o u r c e s : S a lo m o n S m ith B a rn e y , FT G e rm a ny
1 5
1 6
S w e d e n
1 7
M o b ile u s e r s U S A
s o u r c e s : N e t Pr o f it, F T 1 8
G e rm a ny
1 9
2 0
U s e r s o f
S w e d e n 2 1
m o b ile in t e r n e t U S A
2 2
s o u r c e s : N e t Pr o f it, Ip s o s , FT
G e rm a ny
2 3
However, Sweden's relatively high growth rate and low inflation rate can at the same time be partly
explained by the fact that we are still absorbing spare resources and labour laid off in connection with
the crisis at the beginning of the 1990s. The gap between actual and potential growth does not appear
to be completely closed, while the Riksbank and others perceive that this gap is well and truly closed
in the USA.
There are thus a few pieces of the puzzle remaining before we can feel convinced that Sweden is
moving towards a US development: how large is the IT sector in the Swedish economy? How
important is the IT sector to the rest of the Swedish economy? What does IT mean to productivity in
Sweden? Unfortunately I have to say now that we know too little about this.
We know that productivity in Sweden has developed unevenly during the 1990s - a disjointed period
disturbed by a bank crisis, currency crisis and problems with public finances. Investment has
developed more weakly than in the USA, although it has picked up in recent years. Capital intensity
does not, therefore, explain the growth in productivity. What does become more evident, on the other
hand, is a break in trend in that part of productivity attributed to technology and more efficient
organisation, ie total factor productivity TFP (slide 5). This showed a weak and tentative development
up to the mid-1990s, but has really picked up over the last five years.
5. Productivity by factor,
Sweden 1976-2002
50%
Logaritmic scale
40%
Productivity
30%
TFP
20%
Capital deepening
10%
0%
-10%
76 78 80 82 84 86 88 90 92 94 96 98 00 02
Sources: SCB and Sveriges Riksbank.
This picture is also supported by studies from the OECD (slide 6). A comparison of the different
countries shows that Sweden, along with the USA, Finland and Australia, has had the highest
technology content (TFP) in growth, while other countries have grown through using more labour or
capital.
What we still do not know is how large and how important the IT sector actually is in Sweden. One
problem is that Statistics Sweden, which otherwise makes in-depth studies of many social phenomena,
cannot discern investments in IT - much less adjust the price of these investments against the rapid
qualitative development that constantly raises the performance of IT. It is necessary to obtain statistics
in this field in order to calculate where productivity is coming from and how it is spread on, as Oliner
and Sichel have calculated in the USA. The Riksbank therefore welcomes Statistics Sweden's
announcement of a report on IT-related statistics and hopes to see concrete results.
6. Output, Employment and
Productivity in the Business sector
Faster-Growing Advanced Economies, Percent
-2 -1 0 1 2 3 4 5 6
Finland
Australia
United States
Spain
Netherlands
Capital deepening
Canada
Total factor productivity growth
Employment growth
Norway
Sweden
Sources: OECD Analytical Data Bank and
IMF staff estimates
Meanwhile, there have been passable attempts from various quarters to bridge over the gap in the
statistics. The OECD has made a comparison of IT investments over one year between countries,
which clearly places Sweden at the top of the list, together with the USA (slide 7). In addition, there
are approximate calculations on expenditure on software which actually show a higher percentage in
relation to GDP in Sweden than in the USA.
7. Expenditure on Information and
Communication Technology
Advanced Economies 1997, Percent of GDP
0 2 4 6 8 10 12 14 16
Sweden
Australia
United States
United Kingdom
Canada
Japan
Netherlands
Denmark
France
Korea
Belgium
Finland
Norway
Ireland
Germany
Austria
Portugal
Italy
Sources: OECD Analytical Data Bank and
Spain
OECD Information Technology Outlook 2000
However, in the work on the Riksbank's Inflation Reports, there are factors that are easier to pick up.
One is of course the fall in computer prices. Prices have fallen by almost 35% a year since 1996. There
is even an element of "new economy" in the deregulation of the telecommunications and electricity
markets. Firstly, it would not have been so easy to implement the deregulation without the aid of the
new technology. Secondly, the deregulation might not have had the same impact without, for instance,
the information provided on the internet, which helped consumers in making a choice.
All in all, I can allow myself to make a qualified guess on some areas, without knowing for certain:
1. Productivity, total factor productivity, has risen considerably in Sweden during the latter half
of the 1990s. The emergence of information technology has probably been significant in this.
2. The effects will continue to be felt for a number of years, probably beyond the monetary
policy horizon, for which reason the Riksbank will continue to monitor the IT phenomenon
in future.
3. Deregulation and increased competition play a special role in Sweden, particularly as they
have run parallel to IT developments.
At the same time, there is reason to point out that the "new economy" does not constitute a guarantee
for a stable and positive development in asset prices, either in the USA or Sweden. On the contrary,
history shows that rapid technological changes often lead to speculative bubbles. This was the case
after the emergence of the railway at the end of the 19th century and the crash of 1929 followed on
from the breakthrough of electricity and the internal combustion engine at the beginning of the
20th century. I do not intend to make an in-depth analysis of the causes here, but to point out that even
very promising developments in the growth of productivity can live up to the profit expectations
created during speculative bubbles.
Monetary policy implications
It is evident that large, IT-driven and IT-supported structural changes are underway and that these
affect productivity and price levels in a way that needs to be taken into account when assessing
inflationary pressure in the economy. We do not know how long the technological changes will have
an effect, but I have every reason to believe that IT will affect developments in Sweden for the next
few years, which basically comprises the monetary policy target horizon. On the other hand, there is in
my opinion nothing to indicate that the "new economy" has invalidated any fundamental economic
connections.
At the same time, rapid changes such as those we are now experiencing involve greater uncertainty.
No one can say with any great precision how productivity will develop over the next few years and
how large a role IT will play in its development. This uncertainty is enhanced by the difficulty in
measuring the IT sector's significance as a result of shortcomings in Swedish statistics.
Uncertainty over the total effects of technological developments means that we must show greater
sensitivity when formulating monetary policy. Let me call it being more "reactive" than would
otherwise have been the case. By reactive, I mean that we must constantly reconsider our earlier
assessments in the light of developments in the economy and the way the various parts actually react. I
maintain that this has in many ways been a characteristic of our Inflation Reports over the past year.
These reflect clearly how the view of potential growth and the connection between inflation and
growth have changed as a result of the Riksbank's analyses and models taking account of structural
changes in their assessments.
The repo rate could not have remained at its current level if price levels had not been affected by
deregulation on several markets and the fact that we can see a positive development in productivity.
Then there are of course a number of other important factors that must be taken into account, labour
supply, wage formation, international price developments and, in particular, confidence in the
monetary policy. However, developments in productivity will continue to play a central role in the
assessments. The Riksbank monitors the various signs of the "new economy" and takes them very
seriously.