G:\TRC\AW\EAS\ICCP SOFTWARE.DOC

Better Understanding the Role of Software in the Information Economy:

A Preliminary Overview of Research, Policy and Measurement Challenges

Andrew W. Wyckoff and Nadim Ahmad

Organisation for Economic Co-operation and Development

Paris, France[1]

Abstract

As our power to measure and analyse the impact of information and communication technologies (ICT) on economic performance has increased, it is clear that our current tools are blunt and crude and do not allow us to differentiate between driving determinants, necessary compliments and extraneous factors. A necessary first step in this work is to move beyond broad aggregates such as IT or ICT and begin to focus on components such as computer equipment, communications equipment, computer services, communication services and software. Each of these elements has evolved from a distinctly different technological, economic and policy environment, necessitating a distinct treatment. This entails a need for significant improvements in their measurement and analysis. This paper examines this need using software as a case study both from the perspective of its development as well as its use.

Presented to “Transforming Enterprise and Beyond:

Connecting Research and Policy in the Digital Economy”

Post Conference Workshop at the National Science Foundation

29 January 2003

Washington, DC

Preliminary working draft. Please do not quote or cite without permission of the authors. Comments are welcomed and should be sent to or .

The Changing Nature of Growth in the 1990s

Now that the hype associated with the new economy has dissipated as the dotcom and telecom bubbles have burst and a series of accounting scandals have cast doubt on the true performance of some of the fast growing firms, a more critical assessment of the determinants of economic growth during the 1990s can occur with the aid of hindsight. While the fundamentals of a stable macro policy, competitive product markets, flexible labour markets and a well functioning financial system will be reasserted, it is clear that the role of science and technology policy, especially the technology of the 1990s -- information and communication technologies (ICT) -- was a key differentiating determinant of growth performance across countries. While the United States has been the laboratory for much of this analysis, in fact the importance of ICT to growth, both in terms of production and use, has been confirmed for several other countries as well (OECD, 2002).

. Among the findings from this work are (see Table 1):

·  Despite different timing of countries’ expansions and recessions in the 1990s, all the eight OECD countries analysed have witnessed a rapid increase, ranging from 10 to 25 percent, in constant price investment in information and communication equipment and software. In the US, Australia and Finland, ICT investment accounted for over 50 per cent of constant price growth of non-residential investment in the most recent years (1995-99);

·  Over the past twenty years (1980-99) the contribution of ICT equipment and software to output growth of the business sector has been between 0.2 and 0.5 of a percentage point a year depending on the country. Over the past 4 years (95-99) the contribution of ICT and software has raised risen to annual values that range from 0.3 to 0.9 per cent. The United States is not alone in experiencing the “growth” effects of ICT, . ICT equipment and software have also played are playing a major role in driving output growth also in the case of Australia and Finland. In the case of Canada software investment series are not available but the contribution of ICT equipment is fairly strong and growing. However, Tthe impact of ICT in the other countries in the sample, instead, has shown little change in seems not to have increased in the latest years;

·  Software has been the most dynamic component of ICT investment and, in the 1995-99 period, accounted for 25 to 40 per cent of the ICT contribution to overall investment growth across the eight countries; [Figure ?]

·  Software capital accumulation accounted for a third of the overall contribution of ICT capital to output growth between 1995 and 1999. What is remarkable is that this result holds across all OECD countries in the sample, with the exception of Japan and the UK[2]. The United States is the most striking in that respect since the average percentage contribution of software to output growth in 1995-99 is four times up from its 1980-85 value.

. The estimates obtained in this study are in the range of those obtained with similar methods and official statistics for the United States, France and the United Kingdom (see tTable 2). A point that fails to get much recognition is the important role played by software.

. Although comparable international data is not yet available for updating this work and taking into account the downturn associated with the bursting of the “dotcom” and telecommunications investment bubbles, these results have been reaffirmed for the US. While the downturn in 2001 trimmed the increase in the average annual labour productivity growth achieved in the latter half of the 1990s as compared to 1973 to 1995 from about three-quarters of a percentage point to a little more than two-thirds, the contribution from IT to these productivity gains has not changed (Jorgenson, Ho and Stiroh, forthcoming).

. Updating previous work, the Federal Reserve Board (Oliner and Sichel, 2002) shows a similar downward tick in the growth of labour productivity as new, more up-to-date data is included which contains the US downturn, but confirms the importance of ICT (Table 32). This study differentiates between computer hardware, software and communications equipment, revealing that while software made a contribution to labour productivity growth that was the same as that made by communications equipment between 1974 and 1990 (0.13 percentage points), and only about 40 percent of what computer equipment made during this period, its contribution from 1996 to 2001 had more than tripled, where it was accountable for more than four-tenths of a percentage point to labour productivity growth. This contribution was more than double twhat made by communications equipment made during this period and nearly two-thirds (63 percent) of that madeof by what computer hardware contributed. By 2001, US investment in software was more than double that or computers or communications equipment (US Department of Commerce, 2003).

. It appears that many of the OECD economies have evolved from a “gold rush” period as regards ICT, fuelled by fears of a Y2K catastrophe and the excitement associated with the invention of the WWW, to a reflective period where organisations are learning how best to use this technology. In this sense, the economic impact of ICT may be just beginning and may be better analysed and understood in a more subdued economic period. It also gives the researchers and statistical agencies some time to consolidate the work done to date and consider thoughtfully the next steps that need to be taken to improve our understanding of this phenomenon.

Unanswered Questions

. Inherent in any exercise that attempts to understand a new phenomenon, is that it generates more questions than it answers and is unable to analyse some factors simply because we lack the data and the proper conceptual framework. One of these unanswered questions is: “Why the sudden increase in productivity starting in the second-half of the 1990s?” The OECD recommendations suggest that “getting the economic fundamentals right,” “public investment in innovation”, “investing in up-skilling” or “injecting more competition into markets” are useful for creating economic frameworks conducive to innovation characterised by ICT in the 1990s, but these policies have a long gestation period. In this sense, they do not provide a completely satisfying explanation as to why a country like the US suddenly saw its productivity rate double in the late-1990s compared to a trend that had prevailed over the previous two-decades. Analytically, given the jump, one might expect to see would look for an “event” such as an oil shock, a dramatic change in exchange rates or a technological breakthrough that is quickly and widely diffused.

. There is no shortage of plausible explanations. Some have suggested that it was the budget agreement that President Clinton made with Congress in 1993 that provided the foundation for an economic environment conducive to investment (Baily and Lawrence, 2001), others suggest that it was the cumulative effect of increased labour participation (Bosworth and Triplett, 2000). Many suspect that information and communication technologies played a significant role, but without much explanation as to why ICTs would have a more pronounced impact in the late-1990s than in the 1970s or the 1980s when their newness would have been expected to have a more visible impact. Some suggest that it was due to an acceleration of Moore’s Law at this time (Jorgenson, 2001). While others point to the analogy put forward by Paul David (David, 1990) that as in the case of electric dynamos it takes time for organisations to adapt their structure to fully exploit the potential of a new technology (Brynjolfsson and Hitt, 2002). Others suggest that the accumulation of falling costs led to capital deepening so that whereby 1995 the stock of ICT was of sufficient size to have an observable impact (capital deepening) (Oliner and Sichel, 2002). And some suggest that it was a combination of one-time events such as the Y2K bug, the invention of the Internet and a very favourable financial environment for investment as well as organisational innovations by “big box” US retailers (Gordon, 2003). Lastly, in a reversal from the circumstance of the early 1980s, the growth of the 1990s was due to a fortuitous confluence of good luck (favourable supply side shocks) (Bosworth and Triplett, 2000). In practiceactuality, it is likely that all of these explanations played a role. In this sense, it is insufficientwrong to look at the impact of ICT in isolation but rather how it interacts with a broader constellation of conditions and factors.

. Upon closer examination of many of these studies, an important “red thread” running through many of the findings is the explicit and implicit role of software as an enabling technology. While the Internet is popularly thought of as servers, optic fibre cables and routers, it can and did work without any of this hardware. In fact, the Internet is probably more accurately thought of as software thanks to three separate software innovations: the transport control protocol / Internet protocoal (TCP / IP) that allows messages to be broken down into packets; hypertext mark up language (HTML) that allowed documents to be linked, creating the World-wide web (WWW) and the web browser that provided an easy-to-use form of access to the WWW. SMTP (simple mail transfer protocol), the standard for the exchange of e-mail can be credited with enabling the “killer application” that continues to fuel the demand for consumer Internet access[3]. This cluster of developments and their adherence to non-proprietary, open standards coalesced in 1994/95 and created a network that at a very low cost could tie together the existing computing stock through use of easy-to-use graphical software that was platform independent, non-proprietary and linked the existing communication systems (satellite, cable, telephone, etc.). This development vastly increased the functionality of the existing ICT capital, lowered the switching costs of moving from one IT technology to another and enabled new business practices that led to growth and increases in productivity[4].

. All of these developments were undoubtedly contributing factors as to why ICT started to have an economic impact during the middle-of-the-1990s, although it is difficult to establish causality and it is clear that no one factor can be isolated as the key factor. This underscores the need to improve our analytical tools, especially the measurement of these different factors so that the role of ICT and the constellation of factors that surround it are better understood. A necessary first step in this work is to move beyond broad aggregates such as IT or ICT and begin to focus on components such as computer equipment, communications equipment, computer services, communication services and software. In an effort to sketch out the nature of this work, one element, software, is used as a case study. The policy issues posed by software are briefly explored from the perspective of its use as it becomes an integral part of the economic infrastructure as well as its development since this sector may be offer “strategic” advantages in maintaining technological competitiveness. The measurement issues are then outlined with a focus on the treatment of software in the national accounts given the importance of this source for economic analysis.

The Use of Software

. As demonstrated by the Microsoft antitrust case, the Y2K scare, the widespread copying of music, the large-scale inconvenience associated with SPAM or the various viruses that take advantage of holes in popular applications, the use of software and its importance to the economy is already recognised. But it appears that these events are treated in an ad hoc, piecemeal basis and an overall appreciation for the role software plays as an enabling economic infrastructure, akin to ports and highways for transport, is lacking. This is probably because its role is largely invisible – the rocket blows up, the plane crashes or telephone service is disrupted (NAS, 2000; Huckle, 2002) -- but the role of software is only recognised as the critical factor later. Because of its increasing complexity both separately, and as applications begin to interact with each other, the role of software is difficult to comprehend, especially to policy makers. Sadly, heightened concerns about terrorism may be changing this view.