What's Holding Back Info Tech?

It's a surprisingly small share of the economy. But consumers could fix that

This is an Information Economy, right? Everyone knows that information technology is at the heart of America's productivity revolution. The Internet is transforming industries from retailing to media to education. And those poor souls without cell phones are getting scarcer.

Yet for all the signs of the information revolution, a look at economic statistics offers some surprising news: Info tech's share of the economy is barely higher than it was in 1997, when the productivity momentum really got going. After a boom and bust cycle, business investment in info tech hardware and software now totals 4.1% of domestic demand, up just a bit from its 3.8% share in 1997. And the consumer side never even saw a boom: American households barely opened their wallets for information-related products and services, such as telephone, Internet, cable television, video and audio, home computers, and consumer electronics. In 1997, such consumer purchases accounted for only 2.8% of domestic demand. That share rose a tad, to 3.0%, in 2000, before falling to 2.7% today. Not even Apple Computer Inc.'s (AAPL ) almighty iPod has been able to shake loose enough of consumers' cash to make a difference.

Instead, Americans have poured their money into housing and health care. With home sales powered by low interest rates and McMansions springing up everywhere, housing's share of the economy has exploded since 1997. It's now at a postwar high. Medical care is also absorbing a growing piece of the economic pie. No wonder info tech companies and workers feel as if they're scrambling for crumbs in the midst of plenty. Indeed, jobs in info tech related industries, such as telecom, software, and Net search firms, are only 3.5% of the workforce, down from 3.7% in 1997.

The big question is, what happens next? Some economists argue that info tech is a mature industry that cannot expect to grow much faster than the rest of the economy. Telecom companies, in particular, seem stuck in a spiral where rising cell-phone use doesn't compensate for falling prices.

Yet history offers an intriguing possibility. Since 1970 spending on information technology has followed a stop-and-go pattern rather than a steady rise. Periods of sluggish growth -- usually lasting seven years or so -- have been followed by tech booms ignited when companies learn how to apply a new technology, such as networking.


If the same pattern holds today, some of the technologies introduced in recent years would finally evolve into compelling products that attract higher levels of spending. The most likely candidate for a breakthrough is the consumer info tech sector, which is looking more and more like a glaring historical anomaly. It has been providing a steady stream of must-have, cutting-edge services and products, from cell phones to LCD televisions to MP3 players yet has not been able to expand its share of the economy.

That may be about to change. As advertising shifts online and people get more comfortable doing business on the Net, the companies that provide and distribute information may finally reap the benefits of the Information Economy. Orders for communications gear are up 11% over the past year, the biggest rise since 2000. Consumer prices for phone services, which plummeted because of intense competition, have leveled off in recent months, according to the Bureau of Labor Statistics. And revenues for telecom companies are starting to rise at a faster pace, though they're still lagging the overall economy.

Macro forces may also be acting in info tech's favor. In recent years low interest rates have lured consumers into buying bigger homes and more motor vehicles. But as the Federal Reserve keeps raising rates, such buys become less attractive. That frees up money for other purposes. Suppose spending on building new homes and renovating old ones, now a sky-high 5.5% of domestic demand, falls back to its historical 4.4% share. That would release about $140 billion for uses that are not sensitive to rising rates, such as consumer info tech spending.

It's worth looking back to see how previous stagnant periods of tech spending ended. From 1970 to 1977, spending on info tech barely kept pace with the overall economy, even though IBM (IBM ) was introducing model after model of mainframes. The drought ended when Corporate America finally figured out what do to with all that computing power. The late '70s and early '80s saw the creation of large-scale corporate databases, the rollout of automated teller machines, and the invention and spread of the personal computer. Oracle (ORCL ), Microsoft (MSFT ), and Apple were founded and became major powers. At home, Americans started tuning in to cable television (ESPN was launched in 1979, MTV in 1981), and color TV sets became essential in almost every household.

The next stagnant period ran from 1985 to 1992. This was the era of the "productivity paradox" -- a widespread disappointment with the impact of computers in the workplace. No matter how much money businesses devoted to info tech, companies didn't get the expected gains in productivity and profit. Not surprisingly, there was a reluctance to boost spending: Business investment in information technology, which was 3.1% of the economy in the first quarter of 1985, was still 3.1% in 1992. And computer industry jobs fell as a share of total employment, as IBM alone pared 100,000 workers.


What pumped life into the info tech sector was the spread of corporate networking -- linking individual desktops and minicomputers into something more powerful. A 1992 BusinessWeek cover story on the future of the computer industry barely alluded to networks and didn't even mention Cisco Systems Inc. (CSCO ) That changed as local-area networking and the Internet took center stage.

And since 1997? While clearly a boom-and-bust period for business tech spending, the past eight years have seen mostly stagnation on the consumer side. After a big runup in the first part of the 1990s, consumer info tech spending as a share of domestic demand has been effectively flat since 1997.

The catalyst for new spending may not be any single product or service but rather a variety -- everything from music-enabled cell phones to greater demand for broadband to an increased willingness to pay for downloading music and video online. As the technology evolves, each generation gets more powerful and easier to use.

Will today's new products and services be compelling enough to persuade Americans to fork over some of the cash they used to spend on housing and cars? Will Americans take that last dollar they would have spent on a bigger kitchen and put it into broadband instead? So far they haven't -- but if history is any sign, they just might.

By Michael J. Mandel

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