US Multinationals and the US Productivity Miracle

The hiccups in the international economic arena of the past year or two not withstanding, the US has experienced a sustained increase in productivity growth since the mid-1990s, particularly in sectors that intensively use information technologies (IT).

This has not occurred in Europe. If the US “productivity miracle” is due to a natural advantage of being located in the US then one would not expect to see any evidence of it for US establishments located abroad. A 2007 paper (NBER Working Paper Series, 13085*) shows in fact that US multinationals operating in the UK do have higher productivity than non-US multinationals in the UK, and this is primarily due to the higher productivity of their IT. Furthermore, establishments that are taken over by US multinationals increase the productivity of their IT, whereas observationally identical establishments taken over by non-US multinationals do not. One explanation for these patterns is that US firms are organized in a way that allows them to use new technologies more efficiently. It has taken a long time to confirm that computers boost productivity. The key seems to lie in management and internal organization. That’s why IT has helped US firms so much more than their European counterparts.

One of the most startling economic facts of the last decade has been the reversal in the longstanding catch-up of Europe’s productivity level with the United States. American labor productivity growth slowed after the early 1970s oil shocks but accelerated sharply after 1995.
Although European productivity growth experienced the same slowdown, it has not enjoyed the same rebound (see Chart 1 taken from the IMF). Decompositions of US productivity growth show that the great majority of this growth occurred in those sectors that either intensively use or produce IT (information technologies). Closer analysis has shown that European countries had a similar productivity acceleration as the US in IT producing sectors (such as semi-conductors and computers) but failed to achieve the spectacular levels of productivity growth in the sectors that used IT intensively (predominantly market service sectors, including retail, wholesale and financial services). Consistent with these trends, IT intensity has been shown to be substantially higher in the US than Europe and this gap has widened over time. Given the common availability of IT throughout the world at broadly similar prices, it is a major puzzle why these IT related productivity effects have not been more widespread.

There are at least two broad classes of explanation of this puzzle. First, there may be some “natural advantage” to being located in the US, enabling firms to make better use of the opportunity that comes from rapidly falling IT prices. These natural advantages could be tougher product market competition, lower regulation, better access to risk capital, more educated or younger workers, larger market size, greater geographical space, or a host of other factors. A second class of explanations stresses that it is not the US environment per se that matters but rather the way that US firms are organized or managed that enables better exploitation of IT.

These explanations are not mutually exclusive. In the final section of the NBER paper the researchers build a model that has elements of both (i.e. organizational practices in US-based firms are affected by the US regulatory environment and some of these practices are transplanted overseas through foreign affiliates of American multinationals). Nevertheless, one straightforward way to test whether the “US firm organization” hypothesis has any validity is to examine the IT performance of US owned organizations in a non-US environment. If US multinationals at least partially export their business models outside the US – and a walk into McDonald’s or Starbucks anywhere in Europe suggests that this is not an unreasonable assumption – then analyzing the IT performance of US multinational establishments in Europe should be informative. Finding a systematically better use of IT by American firms outside the US suggests that we should take the US firm organization model seriously. Such a test could not be performed easily only with data on plants located in the US because any findings of higher efficiency of plants owned by US multinationals might arise because of the advantage of operating on the multinational’s home turf (“home bias”).

In the NBER paper, the researchers examine the productivity of IT in a large panel of establishments located in the UK, examining the differences in IT-related productivity between establishments owned by US multinationals, establishments owned by non-US multinationals and domestic establishments. The UK is a useful testing ground for at least two reasons. First, it experiences extensive foreign ownership with frequent ownership change. Second, the UK Census Bureau has collected panel data on IT expenditure and productivity in both manufacturing and services since the mid-1990s.

The paper reports that the key fact in understanding productivity differences is the apparent ability of US multinationals to obtain higher productivity than non-US multinationals (and domestic UK establishments) from their IT capital. These findings are robust to a number of tests, including an examination of establishments before and after they are taken over by a US multinational versus a non-US multinational. Prior to takeover by a US firm the establishment’s IT performance is no different from that of other plants that are taken over by non-US firms. After takeover, the
American establishment’s productivity of IT capital increases substantially (while the productivity of non-IT capital, labor, and materials does not).

Overall, these findings suggest that the higher productivity of IT in the US has something to do with specific characteristics of US establishments, which the researchers define as their “internal organization”; (they discuss other possible explanations as well). They also show that US firms are organized differently to non-US firms and that they can change their organizational structure more quickly.

Finally, the researchers present a simple dynamic model that is consistent with the new micro and macro stylized facts outlined in the paper. The researchers first assume complementarity between organization and IT - i.e. IT has to be utilized in organization. Then, tailoring their model to the comparison between US and European firms, they assume that in adjusting their organizations, otherwise identical firms face country-specific costs arguably related to differences in labor market regulations. Firms optimally choose their organizational form and factor inputs (including IT) in response to the acceleration in the fall of quality-adjusted IT prices post-1995. The higher adjustment costs for firms in Europe imply that they take longer to make the organizational changes, so during the transition US labor productivity and IT rise more quickly.

Because multinationals find it costly to have different organization forms in their overseas plants, US firms in Europe will “transplant” their organizational practices, generating the results one can read in the data in the paper. The paper also presents some direct evidence supporting the model by using explicit indicators of institutions that could generate organizational inflexibility (i.e. measures of labor market regulation).

This NBER paper is related to several other areas of the economic literature. First, there is a large literature on the impact of IT on productivity at the aggregate or industry-level. Second, there is growing evidence that the returns to IT are linked to the internal organization of firms. On the econometric side several researchers find that internal organization and other complementary factors, such as human capital, are important in generating significant returns to IT.

On the case study side, there is a large range of evidence. For example - the radical change of the organization of US banks in the late 1980s. The introduction of ATMs substantially reduced the need for tellers. At the same time, PCs and credit-scoring software allowed staff to be located on the bank floor and to directly sell customers mortgages, loans and insurance, replacing bank managers as the primary sales channel for these products. Along with the IT enabled ability of regional managers to remotely monitor branches, this led to a huge reduction in branch-level management and much greater decentralized decision-making for the front-line staff. This reorganization of banks did not happen in much of Europe, however, until much later because of strong labor regulation and trade-union power. One of the unintended consequences of labor market regulation in researchers' model is that it slows down the ability of firms to re-organize. When faced by a radical technological shock (such as the big fall in IT prices), these adjustment costs can have serious consequences in terms of technological diffusion and productivity growth.

Summarizing...

Using a large and original establishment level panel dataset the NBER researchers find robust evidence that IT has a positive and significant correlation with productivity even after controlling for many factors, including establishment fixed effects. The most novel result, however, is that they can account for the US multinational advantage in productivity by the higher productivity of their IT capital.

Furthermore, the stronger association of IT with productivity for US firms is confined to the same
“IT using intensive” industries that largely accounted for the US “productivity miracle” since the mid 1990s. These results were robust to examining establishments that were taken over by other firms: US firms who took over establishments have significantly greater IT productivity relative to non-US multinationals who took over statistically similar establishments.

US firms appear to obtain significantly higher productivity from their IT capital than other multinational establishments (and domestic establishments), even in the context of a UK environment. This suggests that part of the IT-related productivity gains underlying the recent US “productivity miracle” may be related to US firm characteristics rather than simply the natural advantage (geographical, institutional or otherwise) of being located in the US environment. Firms in the US and Europe optimally choose their organization and factor inputs like IT with identical production functions and face the same rapid falls in IT prices. The lower adjustment costs for US firms (possibly due to more flexible labor regulations) allows them to re-organize more swiftly to take advantage of the new IT enabled innovations. Coupled with the idea that multinationals face costs of maintaining different organizational forms in different countries the model developed in the NBER paper delivers predictions consistent with results.

There are many outstanding issues and research questions. First, according to researchers' model, the US is not always superior. Rather, it is the flexibility of the US economy in adapting to major changes (such as the IT revolution) that gives it a temporary productivity advantage. The model predicts that Europe will start to realize enhanced IT-enabled productivity growth over the next few years and resume the catching up process with the US that was observed until the mid 1990s. There was some evidence of this occurring as Europe’s productivity growth in 2006 picked up as America’s slowed slightly. Once the dust of the financial crisis has settled some more productivity measures may shed some light on where we are now.

Of course, if the world economy has moved into a stage of development where technology-related turbulence is inherently greater, then the more flexible US will retain an edge over Europe for the foreseeable future.

* Bloom, N., R. Sadun and J.V. Reenen (2007) Americans do I.T. better: US multinationals and the productivity miracle.  NBER Working Paper Series, 13085