We're beginning to understand what fueled growth in the late 1990s, but there is much remaining to be explored.
The resurgence of the U.S. economy from 1995 to 1999 outran all but the most optimistic expectations. It is not surprising that the unusual combination of more rapid growth and slower inflation touched off a strenuous debate among economists about whether improvements in U.S. economic performance can be sustained. This debate has been intensified by the recent growth slowdown, and the focus has shifted to how best to maintain economic momentum.
A consensus is building that the remarkable decline in information technology (IT) prices provides the key to the surge in U.S. economic growth. The IT price decline is rooted in developments in semiconductor technology that are widely understood by technologists and economists. This technology has found its broadest applications in computing and communications equipment, but has reduced the cost and improved the performance of aircraft, automobiles, scientific instruments, and a host of other products.
Although prices have declined and product performance has improved in many sectors of the U.S. economy, our picture of these developments is still incomplete. The problem faced by economists is that prices are difficult to track when performance is advancing so rapidly. This year's computer, cell phone, and design software is different from last year's. Fortunately, statistical agencies are now focusing intensive efforts on filling in the gaps in our information.
Price indexes for IT that hold performance constant are necessary to separate the change in performance of IT equipment from the change in price for a given level of performance. Accurate and timely computer prices have been part of the U.S. National Income and Product Accounts (NIPA) since 1985. Software investment was added to the NIPA in 1999. Unfortunately, important information gaps remain, especially regarding price trends for investments in software and communications equipment.
Knowing how much the nation spends on IT is only the first step. We must also consider the dynamics of investment in IT and its impact on our national output. The national accounting framework treats IT equipment as part of the output of investment goods, and capital services from this equipment as a component of capital input. A measure of capital services is essential for capturing the effects of rapidly growing stocks of computers, communications equipment, and software on the output of the U.S. economy.
A substantial acceleration in the IT price decline occurred in 1995, triggered by a much sharper acceleration in the price decline of semiconductors. This can be traced to a shift in the product cycle for semiconductors in 1995 from three years to two years as the consequence of intensifying competition. Although the fall in semiconductor prices has been projected to continue for at least another decade, the recent acceleration may be temporary.
The investment boom of the later 1990s was not sustainable, because it depended on growth in hours worked that was substantially in excess of growth in the labor force. Nonetheless, growth prospects for the U.S. economy have improved considerably, due to enhanced productivity growth in IT production and rapid substitution of IT assets for non-IT assets in response to falling IT prices. An understanding of the role of IT is crucial to the design of policies to revive economic growth and exploit the opportunities created by our improved economic performance.
Faster, better, cheaper
A mantra of the "new economy"--"faster, better, cheaper"--captures the speed of technological change and product improvement in semiconductors and the precipitous and continuing fall in semiconductor prices. Modem IT begins with the invention of the transistor, a semiconductor device that acts as an electrical switch and encodes information in binary form. The first transistor, made of the semiconductor germanium, was constructed at Bell Labs in 1947.
The next major milestone in IT was the co-invention of the integrated circuit by Jack Kilby of Texas Instruments in 1958 and Robert Noyce of Fairchild Semiconductor in 1959. An integrated circuit consists of many, even millions, of transistors that store and manipulate data in binary form. Integrated circuits were originally developed for data storage, and these semiconductor devices became known as memory chips.
In 1965, Gordon E. Moore, then research director at Fairchild Semiconductor, made a prescient observation, later known as Moore's Law. Plotting data on memory chips, he observed that each new chip contained roughly twice as many transistors as the previous chip and was released within 18 to 24 months of its predecessor. This implied exponential growth of chip capacity at 35 to 45 percent per year.
In 1968, Moore and Noyce founded Intel Corporation to speed the commercialization of memory chips, and Moore became a key participant in the realization of Moore's Law. Integrated circuits gave rise to microprocessors, or logic chips, with functions that can be programmed. Intel's first general-purpose microprocessor was developed for a calculator produced by Busicom, a Japanese firm. Intel retained the intellectual property rights and released the device commercially in 1971.
The rapidly rising capacities of microprocessors and storage devices illustrate the exponential growth predicted by Moore's Law. The first logic chip in 1971 had 2,300 transistors; the Pentium 4, released by Intel on November 20, 2000, had 42 million. Over this 29-year period, the number of transistors increased by 34 percent per year, tracking Moore's Law with astonishing accuracy.
Semiconductor prices. Moore's Law captures the fact that successive generations of semiconductors are faster and better. The economics of semiconductors begins with the closely related observation that memory and logic chips have become cheaper at a truly staggering rate. Figure 1 gives semiconductor price indexes used in the U.S. national …