why the economy is so good

3
T he US economy has rarely been as prosperous as it is today, and many businesspeople and econ- omists are pressed to explain why. Compared with the past, the recent rise in the wealth of the nation doesn’t make sense. How can the United States go on enjoying full employment and prosperity without the threat of inflation? The answer: rocketing pro- ductivity. Increased productivity has more than compensated for a slowly ris- ing wage rate amid unbridled con- sumerism. The late 1990s has the best of both worlds—low inflation and rising prosperity—because, unlike the 1980s, productivity has kept pace. Many economists don’t like the data: more jobs, less inflation, more supply, less spending, and so forth. The data pre- dicts a crash—or what economists politely call a “correction.” But disaster never arrives. Indeed, the economy seems to defy common sense, especially as the rosy economic picture gets even rosier. Will this prosperity never end? Not for another 10 years or so, and here is why. MEASURING PRODUCTIVITY Classical economists have sold us on the misguided idea of a “productivity paradox” that raises its head whenever cocktail chatter turns to the subject of IT (information technology). The produc- tivity paradox of the 1990s asks why productivity has remained constant even though captains of industry have spent billions on computers and networks over the past two or three decades. If IT is so good, why hasn’t it improved productiv- ity? Were these billions squandered? The measure of productivity may itself be outdated, because it simply tallies the value of products produced by factory workers and divides by average hourly wage. Thus, productivity is measured in how many dollars are produced in rela- tion to how many dollars are spent. Perhaps a better measure for a company is the amount of revenue generated per employee. But such a measurement doesn’t account for expenses. Another metric is what I call the MegaGates. One MegaGate is equal to the market capitalization of Microsoft— currently around $200 billion and rising. The beauty of this measure is that mar- ket cap seems to go up and down with perceived productivity. Still, whatever the metric, most people would agree that current measures do a poor job of gauging true productivity. There is a little publicized fact of life about the infamous paradox that should get more attention: The productivity paradox isn’t anything new. It has hap- pened before. In fact, we can gain a much better understanding of why the econ- omy is so good by dissecting previous productivity paradoxes. In short, the economy is so good because we are enjoying the bumper crop of a third productivity paradox. What were the previous two and how does today’s version account for the current state of prosperity? THE FIRST TWO PRODUCTIVITY PARADOXES Everything is going according to plan if you believe in the previous two para- doxes. Figure 1 on page 110 shows ad- option rates for three infrastructure tech- nologies: electrification of factories from 1899 to 1939, electrification of city dwellers’ homes from 1907 to 1929, and the Webification of American homes from 1993 to the present and beyond. Each of these technologies corresponds to a productivity paradox. The first two happened so long ago that we’ve over- looked them. The latest one, Webifi- cation, is partly responsible for the good times ahead. The similarity among adoption curves shown in Figure 1 is clear: Changes in infrastructure diffuse through society today in much the same way as yesterday, only faster. Technological change— whether it is due to electric motors or desk- top computers—sends waves of change throughout society. It happened with elec- tricity, telephony, air travel, and broad- casting, and now it is happening all over again with the adoption of IT. Between 1914 and 1929, industrial- power use increased by 68 percent per year, but productivity barely increased at all. Just like the computer revolution that took place between 1975 and 1990, elec- trical power transformed manufacturing from a centralized or “mainframe” era to a decentralized network system of per- sonal devices in the form of electric motors that could be distributed to every worker’s workbench. And like the decentralization of computing power that characterized the 1980s, electric motors decentralized power, which caused radical changes in the structure of organizations. In another analog with today’s diffu- Why the Economy Is So Good Ted Lewis, Technology Assessment Group 112 Computer Binary Critic Modern business is exploiting the 25-year investment in information technology that is now fueling the economy. Resident Critic: Ted Lewis, Technology Assessment Group, 13260 Corte Lindo, Salinas, CA 93908; tedglewis@friction- free-economy.com; http://www.friction- free-economy.com Continued on page 110 .

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Page 1: Why the economy is so good

The US economy has rarely beenas prosperous as it is today, andmany businesspeople and econ-omists are pressed to explainwhy. Compared with the past,

the recent rise in the wealth of the nationdoesn’t make sense. How can the UnitedStates go on enjoying full employmentand prosperity without the threat ofinflation? The answer: rocketing pro-ductivity. Increased productivity hasmore than compensated for a slowly ris-ing wage rate amid unbridled con-sumerism. The late 1990s has the best ofboth worlds—low inflation and risingprosperity—because, unlike the 1980s,productivity has kept pace.

Many economists don’t like the data:more jobs, less inflation, more supply,less spending, and so forth. The data pre-dicts a crash—or what economistspolitely call a “correction.” But disasternever arrives. Indeed, the economy seemsto defy common sense, especially as therosy economic picture gets even rosier.

Will this prosperity never end? Not foranother 10 years or so, and here is why.

MEASURING PRODUCTIVITYClassical economists have sold us on

the misguided idea of a “productivityparadox” that raises its head whenevercocktail chatter turns to the subject of IT(information technology). The produc-tivity paradox of the 1990s asks whyproductivity has remained constant eventhough captains of industry have spentbillions on computers and networks over

the past two or three decades. If IT is sogood, why hasn’t it improved productiv-ity? Were these billions squandered?

The measure of productivity may itselfbe outdated, because it simply tallies thevalue of products produced by factoryworkers and divides by average hourlywage. Thus, productivity is measured inhow many dollars are produced in rela-tion to how many dollars are spent.Perhaps a better measure for a companyis the amount of revenue generated per employee. But such a measurementdoesn’t account for expenses.

Another metric is what I call theMegaGates. One MegaGate is equal tothe market capitalization of Microsoft—currently around $200 billion and rising.The beauty of this measure is that mar-ket cap seems to go up and down withperceived productivity.

Still, whatever the metric, most peoplewould agree that current measures do apoor job of gauging true productivity.There is a little publicized fact of lifeabout the infamous paradox that shouldget more attention: The productivityparadox isn’t anything new. It has hap-

pened before. In fact, we can gain a muchbetter understanding of why the econ-omy is so good by dissecting previousproductivity paradoxes.

In short, the economy is so goodbecause we are enjoying the bumper cropof a third productivity paradox. Whatwere the previous two and how doestoday’s version account for the currentstate of prosperity?

THE FIRST TWO PRODUCTIVITY PARADOXES

Everything is going according to planif you believe in the previous two para-doxes. Figure 1 on page 110 shows ad-option rates for three infrastructure tech-nologies: electrification of factories from1899 to 1939, electrification of citydwellers’ homes from 1907 to 1929, andthe Webification of American homesfrom 1993 to the present and beyond.Each of these technologies correspondsto a productivity paradox. The first twohappened so long ago that we’ve over-looked them. The latest one, Webifi-cation, is partly responsible for the goodtimes ahead.

The similarity among adoption curvesshown in Figure 1 is clear: Changes ininfrastructure diffuse through societytoday in much the same way as yesterday,only faster. Technological change—whether it is due to electric motors or desk-top computers—sends waves of changethroughout society. It happened with elec-tricity, telephony, air travel, and broad-casting, and now it is happening all overagain with the adoption of IT.

Between 1914 and 1929, industrial-power use increased by 68 percent peryear, but productivity barely increased atall. Just like the computer revolution thattook place between 1975 and 1990, elec-trical power transformed manufacturingfrom a centralized or “mainframe” era toa decentralized network system of per-sonal devices in the form of electric motorsthat could be distributed to every worker’sworkbench. And like the decentralizationof computing power that characterized the1980s, electric motors decentralizedpower, which caused radical changes in thestructure of organizations.

In another analog with today’s diffu-

Why the EconomyIs So Good

Ted Lewis, Technology Assessment Group

112 Computer

Bina

ry C

ritic

Modern business isexploiting the 25-year

investment in informationtechnology that is nowfueling the economy.

Resident Critic: Ted Lewis, TechnologyAssessment Group, 13260 Corte Lindo,Salinas, CA 93908; [email protected]; http://www.friction-free-economy.com

Continued on page 110

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Page 2: Why the economy is so good

110 Computer

Binary CriticContinued from page 112

sion of IT throughout society, the electricmotor found its way into home appli-ances just like the microprocessor is find-ing its way into network appliances.Figure 1 shows the growth of Web infra-structure in homes, which is really a pre-cursor to the widespread acceptance ofnetwork appliances in the years to come.

Electrification of the factory led to thestudy of the first paradox by economistPaul David of Stanford University. Whathe discovered applies to today’s scene:Power systems evolved over a period of 25 years and gave power to small energyusers without a large investment. Cheappower permitted efficient reengineering ofindustrial processes, but the productivitygains were not realized until much laterduring the 1920s. Productivity gainslagged behind the investment in infra-structure by two decades.

We can observe a similar phenomenain homes: Electrification did not increaseproductivity. Rather, it shifted the bur-den of work to women, who replacedservants with washing machines andrefrigerators, took up machine-assistedstrenuous work previously done by menand boys, and increased the amount oftime they spent on housework from 51to 60 hours per week to 60 to 81 hours.Modern labor-saving devices eliminateddrudgery, not labor. Thus, the second

productivity paradox was observed inthe home. Not until 20 to 25 years alongthe adoption curve did automation beginto show benefits to homemakers.

INFORMATION TECHNOLOGY: THE THIRD PARADOX

Now we are nearing the end of a two-decade time period of investment in ITthat has consumed more money andeffort than it has produced. But this thirdproductivity paradox is starting toreverse itself. We are entering a goldenage similar to the 1920s, when the 20-year investment in infrastructure and reengineering of processes around thecomputer is beginning to pay off.

As you can see in Figure 1, the periodof payoff doesn’t begin until adoptionexceeds 50 percent. If we use the adop-tion rate of Web access in homes as ourstarting point, Figure 1 suggests the gold-en era of the information age will beginaround the year 2002. But if we comparethis model to adoption of business IT, werealize that the US economy is currently inthe midst of the payoff. Indeed, dramaticincreases in productivity made possibleby large investments in IT is the forceunderlying today’s prosperity.

The industrial revolution was built ontop of networks of water, power, tele-phony, and transportation. These net-

works required 20 to 25 years of invest-ment before they boosted productivityand led to greater economic prosperity.Similarly, the information revolution isbuilt on top of networks of computersand information processes that took 20to 25 years of investment to build. Thisinvestment has been made and now theUS economy is reaping its rewards.

THE FOUR PILLARS OF ITThe introduction of electric motors into

factories and homes led to reengineer-ing—a step that is taking place againtoday. But today, four megatrends are reengineering factories and homes: disin-termediation, integration, flexing, andone-on-one narrowcasting. These are thepillars of the new economic architecture.

DisintermediationDisintermediation is the process of

flattening organizations. In many cases,disintermediation eliminates the middleparty. It permits consumers to buydirectly, not through intermediaries butdirectly from the manufacturer orwholesaler. For example, Amazon.comdrop-ships books directly to yourdoorstep, bypassing the Barnes & Nobleretail outlet. Amazon. com grows where-as Barnes & Noble scrambles to open abookstore in cyberspace.

Disintermediation diffuses throughoutan organization in subtle ways. E-mailreplaces memos, but it also flattens theorganization because e-mail can godirectly to the top. Automated workflowsystems bypass middle management.Databases and online services replacepeople managers with process owners.Taken all together, these disintermediatedprocesses accelerate the modern organi-zation by shortening decision loops. Andshort loops mean greater productivity.

IntegrationThe other side of the disintermedia-

tion coin is integration, which is theprocess of putting the organization backtogether again. Today’s integration spansmultiple organizations, with supply-chain integration being the most dra-matic example. Using the Internet,companies can tie together all of the pro-curement processes needed to managebuying, negotiating, and distributing

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Web access at home (1993-2025)Electric power in manufacturing (1899-1939)Electric power in city homes (1907-1929)

Figure 1. Changes in infrastructure diffuse through society today in much the same way as yes-terday, only faster.

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Page 3: Why the economy is so good

materials used for products or services.Wal-Mart integrates its database with

the databases of its suppliers, and resul-tantly cuts costs because there are fewerintermediaries and even less spoilage. Just-in-time inventory becomes extreme—turning mass production assembly linesinto mass customization build-to-ordercells for companies like Dell Computer.Value-chain partners such as Sony,WebTV, and various ISPs share the risks aswell as the rewards of bringing a productto market. Once again, integrationreduces costs, accelerates organizations,and increases productivity.

FlexingIntegration paves the way for flexing,

which is the business ecosystem equiva-lent of natural selection in nature. Flexingpermits organizations to adapt to changeand turn on a dime. IT enables flexing.

Top-down organization charts giveway to workgroup charts that change ona project-by-project basis. Sometimes aworkgroup organization reorganizesthree to four times per year. Some work-groups thrive and grow, while otherswither and die. All live for a certain time,eventually fading as their reason for beingrises and falls. Flexing organizations aremore flexible than matrix organizations.

A flexing design team can span severalcompanies. Beckton-Dickinson & Com-pany combined 110 people from its IToperation with 50 SAP and Deloitte &Touche consultants during a rollout ofthe company’s new information system.No one had a title or an office; everyonein the workgroup worked as peers. Afterabout a year of working together, theworkgroup splintered into smallergroups and infiltrated branch officesthroughout the world.

Instead of top-down managers, flexcompanies have product champions;instead of pursuing efficiency, flex orga-nizations pursue opportunities; insteadof tolerating slow decision loops, theyrun through extremely fast decisionloops; and instead of building consensus,flexible organizations evolve accordingto Darwinian principles.

A flexible organization is driven fromthe bottom up, exploiting emergingbehaviors as soon as they are identified.They get the ultimate productivity boost

when a billion dollar idea, product, or ser-vice emerges from the bottom. Withoutflexing, top-down managers often nevereven see such breakthroughs.

One-on-one narrowcastingFinally, heightened productivity has

propelled us into abundance. The econ-omy of abundance puts the consumer inthe driver’s seat. Thus, the fourth pillaris the power of the Market of One.

The fact that there is plenty of every-thing makes one-on-one narrowcastingnecessary; that technology can deliverproducts to a single individual at nearlythe same cost as if mass-produced makesone-on-one narrowcasting possible.

Dell Computer dramatically illustratesthe BYO (build your own) transforma-tion sweeping the computer industry. Butthere are many other examples in the friction-free economy. For example, theWeb’s cookie controversy pits personal-ization against privacy as software watch-dogs track consumers electronically.

The Safeway and Lucky grocery storeshave a reward system that works thesame way. Every time you buy groceries,you swipe your reward card. The storetracks your behavior and tailors theirincentives to you. If you buy enough tofu,sooner or later you will be rewarded with

a special price on tofu. You could be theonly shopper in the store to receive thisreward. After a while, you find yourselfgoing back for more—at the same store.

M odern business is simply exploit-ing the 20- to 25-year investmentin information technology that is

now fueling the friction-free economy.The total information technology indus-try surpassed the automobile industry inits dollar impact on the US economy in1997. The $5 trillion retail business is upfor grabs as the Web makes buying andselling friction free.

This burst of productivity will con-tinue until baby boomers start to dieoff—somewhere around the year 2008.Consumers reach their buying peak atthe age of 46, and the number of 46-year-olds in the US will reach its pinnacle in2008. But be careful. When 2008 rollsaround, the US economy will need to findanother engine of prosperity. ❖

Ted Lewis is author of The Friction-FreeEconomy (Harper Collins, 1997) and co-author with Hesham El-Rewini of Distrib-uted and Parallel Computing (Prentice Hall,1998). Contact him at tedglewis@ friction-free-economy.com.

May 1998 111

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