TOPIC 1: Innovation and productivity

Discuss the possible ways in which the adoption of information and communication technologies (ICT) in production processes has an impact on productivity, and some of the possible explanations for why these positive effects on productivity have taken a long time to appear in productivity statistics, presenting some examples. Will the impact of ICT on productivity continue in the future?
Adoption of information and communication technologies (ICT) Production processes has an impact on productivity Explanations for why these positive effect on productivity statistics Will the impact of ICT on productivity continue in the future

1. INTRODUCTION Productivity is a key measure in macro and micro economics. It is defined as the Relationship between input and output which can be applied to individual factors of production or collectively (Economics A-Z terms, 2013). As pointed out by Brynjolfsson et al, productivity growth is important because It determines our living standards and the wealth of nations (Brynjolffson & Hitt, 1998). Productivity growth, is measured for various purposes, including tracing technology change, efficiency, real cost savings, benchmarking and living standards. (OECD, 2001), but is also a function of changes in output, although there are several models for its calculation. The most popular measures deal with types of output (gross or value added) and types of input (single factor i.e. labour or capital) or multi-factor (labour and capital) for multi-factor productivity measures. The impact of productivity on firms is key to their, profitability and therefore their success. Hence it has a knock on effect on a countries economic fortunes, indicated by the amount and rate of economic growth. Due to this long held, fundamental economic principle, institutions factor productivity into the performance equation, using it as a key indicator by which institutions are governed. ICT is significant in the economics and Governance of institutions, primarily because of the role it has played in fulfilling business objectives, which are primarily measured in financial terms revenue and profit (Increase revenue and profit through increased productivity).

2.HOW ICT HAS IMPACTED PRODUCTION PROCESSES AND PRODUCTIVITY As defined by the NACE classification, the ICT sector is composed of manufacturing and service industries. These encompass office, accounting and computer, communication equipment and machinery on one hand and telecommunication, computer hardware, computer software, data-processing and repair services on the other. 2.1 The impact on inputs Firstly we can see that ICT has impacted production strategy of firms. One such strategy is the Just-in-Time production which started in Japan in the 1970 as a way of reducing inventory. After becoming widespread in Japan it was later adopted by the USA and globally. One study found that in the USA, JIT resulted in 70% reduction in inventory and 50% reduction in labour. (The Economist: idea, Just in Time, 2009) The impact of ICT on labour as an input to production has been marked due to the automation of production processes. This meant the unskilled labour required per unit was reduced as computer control machines were able to handle processes more efficiently. At the same time, the need for skilled computer engineering services increased. According to a study by Tripplet (2001), manufacturing has applied ICT less intensively than service industries such as banking but with more growth. (Bosworth & Triplett, Spring 2001) We can summarize the impact of ICT on inputs as the reduction of the cost of inputs, most of all labour per unit of output. Solow noted this phenomena in the period of organisation reengineering of the 1990s.

2.2 The Impact of ICT as a General Purpose Technology What has been widely observed is the increases in output at the firm level due to automation of processing allowed by ICT. But the major contribution of ICT in the last 20 years has been the creation of the internet, which gave rise to the virtual or e-economy. It has given power to the biggest companies in the world, Apple and Google , while restructuring many industries such as the music and the airlines industries. More generally ICT has transformed the work in organisations. This is both physical and mental work (Hughes & Morton, 2005).This includes the use of robots in the production process to computer software programmes used for controlling and monitoring the production line.

3. Productivity Paradox Possible Explanations Robert Solow, an important figure in the development of productivity measurements questioned the impact on ICT on productivity growth, stating that Computers can be seen everywhere but in the productivity statistics (Solow, 1987) The evidence to support this view was firstly that the growth in ICT was not matched by growth in productivity in the period between 1960s -and 1990s. Secondly, the sectors that used ICT more intensively were those in which productivity growth was lower. (Bosworth, B & Trippett, J : 2001) Appendix 1, and 2

This observation lead to what has been termed the productivity paradox and to extensive research into the impact of ICT on productivity to understand the reasons for this.

3.1) Measurement Problems The work of Anderson and Chorley studied the impact of traditional perspectives of the service sector and how the misjudgement of the contribution to productivity measures has lead to miscalculations. This view of services was purported based on the following findings: - The traditional view did not give services an explicit distinct treatment - Any error in calculation in the measurement of output was bound to corrupt the national measures as services represent an overwhelming chunk of output in most industrialized countries. - Differing view of the classification of industries into sectors and the defining of boundaries in the Fiscer -Clarks model - Enterprises being classified according to their primary product whereas enterprises normally have more than one primary output which may span several categories - The increasing sophistication of service sector activities. - The transformation element of services is not considered, as they involve changes of state i.e. physical, biological, social and abstract.

3.2) Technological interdependencies The relationship between manufacturing and service output can be intertwined making it arduous

task to accurately measure the contribution of either to the productivity statistics.

3.3) Complementary organisational innovations

The 4R of David Gordon is one framework for understanding the impact of ICT on productivity at the micro level and its relationship to macro-economic productivity measures. David Gordon (2012), proposed that the impact of the ICT on industry can be viewed in terms of the third of three industrial revolutions. The first being steam and railroad, while the second is considered to include electricity, internal combustion engine, running water, communication. According to Gordon (2012) the third industrial revolution took place from 1960 to present and includes computers, the web, and mobile phones. The significance of Gordon(2012) contribution is that he notes a time lag between the capital investment in ICT and the productivity growth between 1996 to he also 2004, from 1.4% to 2.5%, which he notes was slower than for the previous two industrial revolutions and of a shorter duration. An opposing view to this is that there were substantial increase in productivity due to ICT investment. This is supported by the work of Dewan, S. et al, which revealed that IT investments are contributing to output and productivity at a rate that is disproportionate to their factor share in production. For example, 1% increase in IT capital is associated with 0.041% increase in output. Also calculating that the gross return for the US of IT investment of 58.6%. Additionally there research concluded that IT investment contributed more to productivity growth than non-IT related capital investment and it is therefore not to blame for the late growth in productivity or its slowdown. (Dewan & Kraemar, 1998) Jorgenson and Bresnaham; Martin, B; Sichel, D also investigated the productivity paradox and concluded that growth of IT was real and sustainable through economic downturn. While Gordon argued that these gains were cyclical and concentrated in certain sectors related to manufacture of durable goods, but most of the gains in productivity are due to IT itself.

(Kraemer & Dedrick, 2001)

The reason for the Solow Paradox which observed that ICT productivity did not lead to a significant increase in productivity growth statistics as with previous industrial revolutions, was

As ICT capital investment has impacted on the way business is organised, through its processes and practices and its initial impact was simple to observe and to measure at the firm or even industry level. The work of management theorist such as Taylor and Feyol, whose work fuel the growth of industrialisation. The corresponding productivity growth of developed economies was largely accepted as a by-product of this increased ICT capital investment. The work of important theorist such as Schumpeter, Usher and Fishlow laid the foundation for understanding the impact of ICT on output and input and hence productivity. For example, the reduction in labour cost, and increase in capacity.

Possible ways

Adoption of ICT in the production process

Impact on Productivity Paradox Erik Brynjolfsson / Lorin M Hitt The product At the macro level innovation drives productivity which drives growth

Explanations for why these positive effects on productivity have taken so long In productivity statistics David Ricardo /The Harrod-Domar model / Theory The Solow Model / The new growth theory Barro-Lee

Nesta Thomas Malthus (1798)

In the future