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The IT Productivity Paradox

Ethan Dreyfuss, Andrew Gadson, Tyler Riding, Arthur Wang

1995-2000: Before the Bubble Burst

The second half of the 1990's saw a reversal in the downward trends exhibited from decades earlier. Labor producivity grew at a rate of 2.5 percent, nearly double that of the 1.4 percent growth rate during the years from 1972-1995. During this same time period, IT investment nearly doubled. Observers were quick to notice the trend, concluding that the productivity paradox had reversed, and a that "New Economy" was being ushered in, riding on the waves of globalization and the revolutions being made in IT. Indeed, unemployment and inflation were at all time lows, and it seemed as if the economy would be able to avoid a recession indefinitely. However, there were opinions countering the unbridled enthusiasm of the New movement, attempting to discern whether the promises were real, whether such rapid growth was sustainable, and whether IT really deserved all of the credit.

How Important was IT?

A report compiled by the McKinsey Global Institute attributed virtually all of the growth during the late 1990s to six sectors: retail, wholesale, securities, semiconductors, computer manufacturing and mobile telecommunications. Within these sectors, IT was not found to have a particularly dramatic impact on productivity, but rather contributed to the growth to a degree similar to other factors of production.

Structural factors, including competition and industry-specific innovation were the primary contributors to productivity growth. For example, entering the from 1987 to the mid-1990's, Wal-Mart's market share in retail ballooned from 9 percent to 27 percent. Its already steep edge in productivity also surged, growing from being 40 to 48 percent more productive than its competitors. Wal-Mart saw increased productivity from IT, and its competitors inevitably followed its methods, but IT was merely a necessity in order to improve inventory methods and integrate new tech (i.e. electronic data interchange, wireless barcode scanning) into the company's core operations.

There were certain sectors where IT affected growth dramatically. In 1995 from virtually no securities trades were being brokered over the net; by 1999 the number was 40 percent. The internet allowed for the same number of employees to conduct ten times as many trades. The rapid growth of mobile-com also contributed greatly towards productivity acceleration. These were cases where IT really did function as a "magic bullet", because the services they provided required the digitization of "essentially intangible information". Both rates of growth were transitory, however, as demand for their new products and services invariably flattened.

Paradox Sectors

The MGI report also investigated certain sectors which invested heavily in IT, but experienced negative during the boom years. Hotels, and retail banking failed to reap IT's benefits because the labor utilized by these industries, i.e. room cleaning, front desk attendants, are not easily automated. These sectors also revealed evidence of lagging investments.


Further opposition to hype and exaggerated expectations came from considerations of cyclical or transitory factors affecting productivity growth, factors that were fundamentally unsustainable. Over half of the productivity growth was measured in retail and wholesale, reflecting a shift to higher-priced goods amongst consumers due to increased confidence, income, and wealth. Furthermore, irrational trading practices and buyer-seller overconfidence swelled the stock market to its peak tumescence, creating a bubble begging to be burst.

Lessons Learned

IT's contributions towards the half-decade of productivity growth were important, but not the "magic bullet" desired by the proponents of the New Economy. Despite the hype generated around IT, in all but a few exceptional cases, it served a necessary, but not excessive role, much like other more "traditional" forms of capital. Furthermore, the existence of paradox sectors was not an affirmation of the productivity paradox, but a demonstration that the effect IT had varied widely across industries.