Everyone knows that the United States has been experiencing
an investment boom, driven by expenditures on information
technology equipment. Looking at real GDP (that is, removing
the effect of price changes), business investment in structures,
equipment, and software amounted to 14.1 percent of GDP
in 1999, up from 9.6 percent in 1990 and far above its share
throughout the 1970s and 1980s. § However, if one looks
at nominal expenditures — that is, not adjusting for
price changes — business investment amounted to 12.9
percent of GDP in 1999, up from 10.9 percent in 1990 but
no higher than the share of GDP that was devoted to business
investment from 1979 through 1982.
More generally, business investment in the 1990s looks
significantly more impressive when one adjusts for price
changes than when one does not.
What accounts for the difference? The primary explanation
is falling computer prices. Computer prices have been declining,
and declining rapidly. Computers are also much better than
they used to be; you probably could not buy what was available
ten years ago even if you wanted to do so. Consequently,
price changes for computers are based on estimates of the
prices of key attributes, namely speed and memory. As computers
get faster, the estimated price comes down, even if the
price of the physical machine does not. Thus, converting
the growth in nominal expenditures to real, by adjusting
for price changes — a process known as “deflation”
— results in a much higher rate of growth in real output.
While nominal investment in computers and peripherals rose
roughly 10 percent per year between 1995 and 1999, real
investment rose 45 percent per year.
Which is the better measure, real or nominal? If one is
looking for possible explanations for the recent pickup
in productivity growth in the United States, real investment
in computers is more informative. After all, businesses
investing in computers are enjoying huge increases in speed
and memory, even if they are not spending that much more.
REAL business investment
is spending on equipment, structures, and software measured
in constant dollars (usually 1996)
NOMINAL business investment is
measured in current dollars
However, if one is concerned about
businesses’ ability to finance their investments, nominal
expenditures is probably the more relevant measure. It is
the dollar outlays needed to acquire the rapidly growing
capability that determine whether firms can finance their
investment programs internally or must look to external
funds. Although capability, at least as represented by memory
and speed, has grown by leaps and bounds, spending has been
more in line with profits and cash flow.
Similarly, computers make up a
sizable fraction of U.S. exports and an even larger fraction
of U.S. imports. Thus, rapidly declining computer prices
boost real growth rates for both exports and imports as
compared to nominal growth — and raise real import
growth more. This is the right way to look at a number of
issues. But if one is concerned about financing the trade
deficit, it is nominal expenditures that matter. Between
1995 and 1999, the gap between imports and exports, in real
terms, grew from 1 percent of GDP to 3.6 percent; declining
prices for computers, peripherals, and parts accounted for
0.5 percentage points of this increase.
Real output figures can also give
a distorted sense of the health of the computer industry
and the impetus to aggregate demand that investment in computers
provides. Based on growth in real spending, one might assume
that computer firms have been doing well, with employment
growing vigorously. However, employment in the manufacture
of computers was only 5 percent higher in 1999 than in 1995.
Over the same period, employment in motor vehicles and parts
manufacturing also rose 5 percent, while real motor vehicle
output grew about 5 percent per year. Not a bad performance,
but only about one-tenth of the real growth rate in computers.
 |
Note: Information processing
equipment is included in equipment, structures, and
software
Source: U.S. Bureau of Economic Analysis |
Growth in real output
that is associated with rapidly declining prices should
be viewed somewhat differently from gains that result from
producing more units at a constant or rising price. While
rapid declines in computer prices reflect tremendous technological
strides, they also are indicative of intense competition
that results in these improvements being passed on to customers.
Ironically, an easing in competitive pressures could result
in a somewhat slower rate of price decline and, thus, somewhat
slower growth in estimates of computer output. Yet, workers
and shareholders in the industry might be better off, at
least in the short term.
As advances in computer technology
permit huge increases in speed and memory with much more
modest increases in dollar expenditures, it is important
that these increases in capability be captured in our measures
of output growth. But it is also important that we not look
at this “new economy” phenomenon with a mind-set
shaped by an old economy in which prices almost always increased.
Lynn
E. Browne is Senior Vice President and Director of Research
at the Boston Fed.
