Why Did Semiconductor Price Indexes Fall So Fast in the 1990s? A Decomposition

I. INTRODUCTION By any measure, price deflators for semiconductors fell at a staggering pace over much of the last decade. As shown in the top part of Table 1, Fisher price indexes for integrated circuits (ICs)--a broad class of semiconductor devices that includes logic and memory chips--fell an average of 36% per year from 1993 to 1999. As shown in the bottom part, those price declines were generated primarily by sharp declines in the price index for microprocessors (MPUs), the logic chips that serve as the central processing unit in personal computers (PCs). The price deflator for ICs fell even faster in the second half of the decade, pushed down by faster declines in the MPU price index. Jorgenson (2001) noted the acceleration and hypothesized that the development and deployment of semiconductors could have been a key driver in the economy-wide resurgence in economic growth that began in the mid-1990s. Empirical work based on macroeconomic growth models supported his hypothesis by showing that the semiconductor industry accounted for nearly three-fourths of the acceleration in multifactor productivity that occurred over the 1990s (see, for example, Gordon 2001; Jorgenson 2001; Jorgenson and Stiroh 2000; McKinsey Global Institute 2001; Oliner and Sichel 2000; Triplett 1999). These sharp declines are typically attributed to the rapid rate of product innovation that characterizes this sector; a recent example may be found in Triplett (2004). Informal measures of quality change--as in Aizcorbe et al. (2003)--suggest that product innovation is the primary driver behind the price declines typically seen for these devices. Indeed, the industry is credited with one of the fastest rates of product innovation and technical change within manufacturing, as chipmakers generate wave after wave of ever more powerful chips for prices not much higher than those of existing chips. At the same time that the quality of MPUs is increasing, manufacturers are also getting better at producing them, and the attendant reductions in the manufacturing cost per chip could also have contributed to the observed declines in the price index. As is well known, the semiconductor production process is subject to important learning economies along several dimensions (see, for example, Gruber 1994; Hatch and Mowery 1998). Most of the empirical literature on learning by doing in the semiconductor industry has focused on memory chips--a homogenous commodity good sold in fairly competitive markets. For MPUs, Intel's dominance of the market has generated large margins so that cost savings from learning by doing may not necessarily be passed along to consumers in the form of lower prices. The presence of large margins in and of itself has potential implications for price measurement: Although quality increases and reductions in cost per chip are associated with increases in productivity, changes in margins are not. Over the 1990s, Intel's margins shrank as increased competition from its rivals and weaker than expected demand for PCs in 1995 and beyond put downward pressure on prices. This decline in Intel's margins could have potentially distorted standard price indexes because those indexes implicitly assume perfect competition. (1) So, for example, falling margins could lead one to incorrectly interpret the resulting price decline as a productivity improvement. (2) Although it is unlikely that Intel's margins fell sufficiently fast to explain much of the absolute price declines over the decade, those declines may nonetheless have had a nontrivial effect on the acceleration that began in 1995. To better understand the trend and inflection point in semiconductor prices, this article decomposes movements in the constant-quality price index into changes in the index associated with productivity growth and those associated with margins. A further decomposition of the productivity-related component into quality change--owing to rapid rates of product innovation--versus changes in cost per chip--perhaps related to learning by doing--is also done. …