Chapter Five
The Faster-Accelerating Digital Economy
Economic Growth: The New
Perspectives for Theory and Policy
Tai-Yoo Kim (Seoul National University)
and
Almas Heshmati (Sogang University)
Springer 2014
Copyright © 2013 Tai-Yoo Kim and Almas Heshmati
CONTENTS
 5.1 Look at characteristics of Digital Economy
 5.2 Investigate the structure of the Digital
Economy’s faster growth
 5.3 Forecast future of Digital Economy by looking at
the real-life cases of the US, Finland, and Ireland
 5.4 Revisit the core of the IT paradox, so that the
potential of the digital economy can be
reaffirmed
 5.5. Summary
 5.6 References
5-1 Characteristics of the Digital Economy
What is Digital Economy?
 Digitization of information in every part of
the economy (Brynjolfsson and Kahin, 2000)
 Much faster economic growth than previous
societies accelerated by ICT innovation
(The US Department of Commerce, 1998)
 Considered as a step toward the knowledgebased society (Drucker, 1969 and Bell, 1973)
 Knowledge would be the basis of policy
decision, and knowledge workers who created
and used information would become more
important
5-1 Characteristics of the Digital Economy
Driving forces of the Digital Economy’s faster
economic growth:

ICT converges with and improves the efficiency of
traditional industries

Production function of the ICT industry shows
increasing returns to scale

Development of ICT stimulates not only demand
and supply but also the entire expansive
reproduction system (ERS)
5-1 Characteristics of the Digital Economy
1. Efficiency improvement in traditional industries
The technological advancement due to increasing
ICT use in traditional industries has resulted in:
 Raising the added value and improving the
productivity of traditional industries
 Influencing the entire production process,
introducing faster and more efficient
procedures
5-1 Characteristics of the Digital Economy
1. Efficiency improvement in traditional industries
Improving added values by developing new
convergence technologies into the existing systems
Table 5-1 Examples of technology convergence between
traditional industries and ICT
Industry:
Automobile industry
Mechanical industry
Shipbuilding industry
Textile industry
Construction industry
Health-care industry
*MEMS
Major convergence technologies:
Web-based automobile, Integrated modularization of components, Intelligent safety
system, Engine control, Gas emission control
MEMS*, Open PC-NC, Industrial robots, IMS*
Automatic sailing system, Automatic ship identification system, Integrated control
system, Super-luxury passenger ship (car ferry), Special vessel-building technology
High-performance industrial textile (conductivity textile, smart textile, intelligent
textile, etc.)
Intelligent construction system, Construction robots, Construction CALS/EC,
Contractor integrated technology and information system (CITIS)
Next-generation intelligent medical equipment, Sensory functions recovery devices
for the disabled, Speedy EMS, Operating robots, Micro autonomous endoscope
= micro-electronic-mechanical system, IMS = intelligent manufacturing system
5-1 Characteristics of the Digital Economy
2. IRS production function of the Digital Economy
Romer (1986), Ray et al.(2002)
 Production function of the Digital Economy has the
increasing-returns-to-scale(IRS) characteristic
whereas the traditional manufacturing industries of
industrial societies show decreasing-returns-toscale(DRS)
Characteristics of ICT:

Path-dependent economy (Arthur, 1994)

Network and tipping effect (Shy, 2001)

Unique characteristics of software products of
easy reproduction and network effects
5-1 Characteristics of the Digital Economy
2. IRS production function of the Digital Economy
The increasing-returns-to-scale (IRS) production
function: a certain trend in which the more the
units of the input factor, the greater the output per
unit of the input factor
 IRS appears due to the substitution of
material capital for knowledge capital
 and its self-reinforcing nature in the process
of knowledge accumulation as the driving
force
5-1 Characteristics of the Digital Economy
3. Social changes in the Digital Economy
Five social changes by the digital economy

Creates new demand generated by new
products, enabled by digital technology

Allows more flexible economic structures

Mitigates price fluctuation

Transforms the structure of firms and
employment type, and creates new
employment

Prompts the emergence of the digital
generation
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
The shift of DRS aggregate production functions
(APFs) at different time frames according to
technological changes as seen in agricultural
societies
Figure 5 - 1
Time-output
relationships with
DRS production
function and slow
technological change
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
The shift of APFs when technological innovation
happens in each time frames, e.g. in an
industrialized society
Figure 5 - 2
Time-output
relationships with
DRS production
function and fast
technological change
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
The shift of APFs from different DRS and IRS
production function
Figure 5 - 3
Time-output
relationships with IRS
production function;
the speed of
technological change
is the same as in
Figure 5.2.
Source: (a) Solow,
1957, p. 313, chart 1
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
The shift of APFs from different IRS production
function over time
Figure 5 - 4
Time-output
relationships in the
digital economy
The output curve from IRS production functions shows faster
accelerating growth than the line from DRS production
functions
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
Figure 5 - 5
Comparison of
shifting APF
patterns over time
among agricultural,
industrial, and
digital economies
5-2 Structure of the Digital Economy’s faster growth
The time-output relationship in the Digital Economy
Both Agricultural and Industrial societies have a DRS
production function in common.
The range and pace of technological changes in the long
run are different for the two societies.
This causes the economic growth path divergence:
decelerating vs. accelerating.
The economic growth of the Digital Economy is faster than
that of the industrial society.
This difference occurs because the acceleration
mechanism and the pace of the Digital Economy’s
economic growth are based on the IRS production function.
5-2 Structure of the Digital Economy’s faster growth
ERS of the faster-accelerating Digital Economy
Figure 5 - 6
Restructured ERS in
the digital economy
5-2 Structure of the Digital Economy’s faster growth
ICT’s impact on ERS
Efficient uses of traditional industries:
 Stimulates the development of new ICT
convergence products.
 Improves productivity and reduces the
production cost.
Creation of new ICT industries:
 Creates new industries that did not exist in
previous industrial societies.
 Stimulates the expansion of supply in the ERS
and creates new demands as well as new
industries.
5-2 Structure of the Digital Economy’s faster growth
ICT’s impact on ERS
Total reform of economic cycle:
 ICT developments generate positive effects on
the entire economy.
 Overall social change that occurs in the digital
economy causes the cycle of ERS to
accelerate faster.
 ICT developments exert mitigating influences
on the management cycle of macroeconomics
and improve its efficiency, leading to an
overall market equilibrium.
5-3 Case Studies: The Digital Economy in leading
industrialized countries
The US Case
The role of ICT increased rapidly between the early 1990s
and the late 1990s, a period considered to be part of the
New Economy phase.
Table 5-2 Rate of productivity increase and contributions
from ICT: the US and the EU
1990-1995
1990-2000
US
EU15*
US
EU15*
Total Economy
1.08
1.88
2.52
1.41
ICT Producing
0.51
0.33
0.75
0.47
ICT Using
Non ICT
0.43
0.23
0.42
1.10
1.42
0.36
0.42
0.48
Source: Van Ark et al., 2002
* EU 15 includes Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy,
Luxembourg, Netherlands, Portugal, Spain, Sweden, and the United Kingdom
5-3 Case Studies: The Digital Economy in leading
industrialized countries
The US Case
The New Economy left a large gap between the US
and the EU in terms of economic growth.
Figure 5 - 7
GDP per capita for
the US and OECDEurope (constant
2000 US$)
Source: World
Development
Indicators Database,
2008
5-3 Case Studies: The Digital Economy in leading
industrialized countries
The US Case
ICT is the main cause explaining the rapid
increase of labour productivity in the New
Economy (Stiroh, 1998, 2002; Jorgenson and
Stiroh, 1999; Jorgenson et al., 2003)
Figure 5 - 8
Labour productivity
of nonfarm business
in the US (1992 =
100)
Source: The Bureau
of Labor Statistics,
2010
5-3 Case Studies: The Digital Economy in leading
industrialized countries
The US Case
The accelerating growth trend of labour productivity
in the New Economy after 1995 comes from ICT
(Oliner and Sichel ,2003)
Table 5-3 Contributions to the growth of labour
productivity in the US
Growth of labour productivity*
Capital deepening
Contributions from
Labour quality
MFP
Total
Contribution from ICT ICT capital
ICT production
1974-1990
1991-1995
1996-2001
1.36
0.77
0.22
0.37
0.68
0.41
0.27
1.54
0.52
0.45
0.58
0.87
0.46
0.41
2.43
1.19
0.25
0.99
1.79
1.02
0.77
Source: Modified from Oliner and Sichel, 2003, table 1
* In the nonfarm business sector, measured as the average annual log difference for the years shown
multiplied by 100.
5-3 Case Studies: The Digital Economy in leading
industrialized countries
The US Case
The GDP of ICT-producing industries in the US
grew rapidly.
Although the size of ICT industries is relatively
small, they play a key role in economic growth as
its driving force.
Figure 5 - 9
GDP of ICTproducing industries
in the US (in billion $)
Source: The Bureau
of Economic Analysis,
2010
5-3 Case Studies: The digital economy in industrialized
following countries
Overtaking economy model
Process of a faster-accelerating economy
overtakes an accelerating industrial economy.
Figure 5 - 10
Overtaking model of
the digital economy
5-3 Case Studies: The digital economy in industrialized
following countries
Ireland Case
Ireland grew remarkably faster than other
economies, starting from the early 1990s.
Figure 5 - 11
GDP per capita of
Ireland, OECD Europe
(average), and other
European countries
Source: World
Development
Indicators Database,
2008
5-3 Case Studies: The digital economy in industrialized
following countries
Ireland Case
Economic growth of Ireland accelerated as ICT
industries matured, and the proportion of ICT capital’s
contribution to this growth continued to increase.
Table 5-4
Contributions to gross-value-added growth in Ireland
1990–1994
1995–1999
Gross-value-added growth
3.99
9.07
Contribution of capital input growth
1.37
3.51
(Contribution of ICT capital)
(0.25)
(0.71)
(Contribution of non-ICT capital)
(1.12)
(2.80)
Contribution of labour input growth
1.37
3.24
Contribution of multi-factor productivity growth
1.25
2.32
Source: EU KLEMS, 2009
5-3 Case Studies: The digital economy in industrialized
following countries
Ireland Case
The role of ICT industries, particularly the producers,
was crucial to the improvement of Ireland’s labour
productivity.
Table 5-5 ICT industries’ contributions to labour
productivity growth in Ireland
1990-1995
Total economy
ICT-producing industries
ICT-producing manufacturing
ICT-producing services
ICT-using industries
ICT-using manufacturing
ICT-using services
Non-ICT industries
Source: Van Ark et al., 2002
Labour
Contributions
productivity to productivity
growth
growth
3.0
11.2
0.89
17.1
0.82
2.2
0.07
1.4
0.42
6.1
0.37
0.2
0.05
2.6
1.48
1990-2000
Labour
productivity
growth
5.3
23.5
42.3
-0.2
2.9
8.7
1.4
2.7
Contributions
to productivity
growth
2.75
2.77
-0.02
0.89
0.56
0.33
1.65
5-3 Case Studies: The digital economy in industrialized
following countries
Ireland Case
The relatively high proportion of ICT industries in its
economy helped Ireland achieve a faster-accelerating
economic growth.
Figure 5 - 12
GDP share of ICTproducing industries
in Ireland
Source: The
Groningen Growth
and Development
Centre, 2005
5-3 Case Studies: The digital economy in industrialized
following countries
Finland Case
Fuelled by ICT, the economy of Finland has been
growing faster than OECD-Europe ever since (Part C).
Figure 5 - 13
GDP per capita in
Finland and OECD
Europe, at 1995
prices and purchasing
power parity (PPP)
exchange rates
Source: Carl et al.,
2006
5-3 Case Studies: The digital economy in industrialized
following countries
Finland Case
The contributions from ICT production and ICT capital to GDP
growth from 1990 to 2004 increased almost 2.5 times.
Table 5-6 Factor contributions to the output growth of the
Finnish non-residential market sector
Source: Source: Jalava and Pohjola, 2008, pp. 270–287, table 3
Notes: (a) Estimates based on non-hedonic ICT prices, (b) Estimates based on hedonic ICT prices
a: ln per cent, b: ln percentage points, c: In per cent
5-3 Case Studies: The digital economy in industrialized
following countries
Finland Case
The influence of ICT on the creation of new industries
has been substantial.
Table 5-7 Average growth of labour productivity and its
components in Finland, 1995–2005
Source: Jalava and Pohjola, 2007, pp. 463, Table 2
Notes: Numbers may not sum to totals due to rounding.
5-3 Case Studies: The digital economy in industrialized
following countries
Finland Case
The effects of the creation of new industries by ICT
was substantial
Figure 5 - 14
Changes in the GDP
shares of ICT sector
and forest industry in
Finland
Source: Pohjola, 2008
5-4 IT paradox of the digital economy revisited
IT productivity Paradox
‘You can see the computer age everywhere but in the
productivity statistics’ (Solow, 1987)
Two arguments
 The effects of IT investments on production are
not as apparent as we would expect because
statistical methodologies are not sufficiently
developed yet to calculate the relationship
exactly.
 ICT is simply not yet fully mature to be
effectively incorporated into every step of
production and its organizations. (Hilbert, 2001)
5-4 IT paradox of the digital economy revisited
IT productivity Paradox
Ongoing paradigm shift due to rapid technological
revolution
Figure 5 - 15
An ongoing
exponential sequence
made up of a cascade
of S-curves (linear
plot)
Source: Kurzweil,
2005, p. 43
5-4 IT paradox of the digital economy revisited
The theory of creative destruction of innovation
proposes that one technological innovation pulled
the next, the former becoming the foundation for
the latter in the process
Figure 5 - 16
The creative destruction of innovation. Source: Hilbert, 2001, p. 53
5-5 Summary
•
With an investigation into the definition, characteristics, and
mechanism of the Digital Economy, the Digital Economy is qualitatively
different from the industrial society.
•
The IRS short-term production function along with the rapid
technological progress of the Digital Economy, in the long term,
accelerates the growth curve of the Digital Economy faster than the
growth curve found in previous industrial societies.
•
The fundamental driving forces of the Digital Economy’s faster
economic growth are: First, ICT converges with and improves the
efficiency of traditional industries. Second, the production function of
the ICT industry shows increasing returns to scale. Third, the
development of ICT stimulates not only demand and supply but the
entire Expansive Reproduction System.
•
The ICT productivity paradox was based only on short-term and
temporary situations at the incipient stage of the digital economy. The
ICT productivity paradox arose from a contradiction when the effect of
ICT investments for economic growth fell short of expectations.
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