EXECUTIVE SUMMARY

The U.S. economic expansion is now in its tenth year, showing no signs of
slowing down. The rate of labor productivity growth has doubled in recent
years, instead of falling as the expansion matured as in previous postwar
expansions. Moreover, core inflation remains low despite record employment and
the lowest jobless rates in a generation. Our sustained economic strength with
low inflation suggests that the U.S. economy may well have crossed into a new
era of greater economic prosperity and possibility, much as it did after the
development and spread of the electric dynamo and the internal combustion
engine.

The advent of this new era has coincided with dramatic cost reductions in
computers, computer components, and communications equipment. Declines in
computer prices, which were already rapid--roughly 12 percent per year on
average between 1987 and 1994--accelerated to 26 percent per year during
1995-1999. Between 1994 and 1998 (the last four years for which data are
available), the price of telecommunications equipment declined by 2 percent a
year.

Declining IT prices and years of sustained economic growth have spurred massive
investments not only in computer and communications equipment, but in new
software that harnesses and enhances the productive capacity of that equipment.
Real business investment in IT equipment and software more than doubled between
1995 and 1999, from $243 billion to $510 billion. The software component of
these totals increased over the period from $82 billion to $149 billion.

The new economy is being shaped not only by the development and diffusion of
computer hardware and software, but also by much cheaper and rapidly increasing
electronic connectivity. The Internet in particular is helping to level the
playing field among large and small firms in business-to-business e-commerce.
In the past, larger companies had increasingly used private networks to carry
out electronic commerce, but high costs kept the resulting efficiencies out of
reach for most small businesses. The Internet has altered this equation by
making it easier and cheaper for all businesses to transact business and
exchange information.

There is growing evidence that firms are moving their supply networks and sales
channels online, and participating in new online marketplaces. Firms are also
expanding their use of networked systems to improve internal business
processes--to coordinate product design, manage inventory, improve customer
service, and reduce administrative and managerial costs. Nonetheless, the
evolution of digital business is still in an early stage. A recent survey by
the National Association of Manufacturers, for example, found that more than
two-thirds of American manufacturers still do not conduct business
electronically.

Advances in information technologies and the spread of the Internet are also
providing significant benefits to individuals. In 2000, the number of people
with Internet access will reach an estimated 304 million people world-wide, up
almost 80 percent from 1999; and, for the first time, the United States and
Canada account for less than 50 percent of the global online population.
Further, according to Inktomi and the NEC Research Institute, the amount of
information available online has increased ten-fold over the last three years,
to more than a billion discrete pages.

As more people have moved online, so have many everyday activities. In March
2000, the Census Bureau released the first official measure of an important
subset of business-to-consumer e-commerce, "e-retail." Census found that in the
fourth quarter of 1999, online sales by retail establishments totaled $5.3
billion, or 0.64 percent of all retail sales. People increasingly use the
Internet not only to make purchases, but also to arrange financing, take
delivery of digital products, and get follow-up service.

The vitality of the digital economy is grounded in IT-producing industries--the
firms that supply the goods and services that support IT-enabled business
processes, the Internet and e-commerce. Analysis of growth and investment
patterns shows that the economic importance of these industries has increased
sharply since the mid-1990s. Although IT industries still account for a
relatively small share of the economy's total output--an estimated 8.3 percent
in 2000--they contributed nearly a third of real U.S. economic growth between
1995 and 1999.

In addition, the falling prices of IT goods and services have reduced overall
U.S. inflation--for the years 1994 to 1998, by an average of 0.5 percentage
points a year, or from 2.3 percent to 1.8 percent. The rates of decline in IT
prices accelerated through the 1990s--from about 1 percent in 1994, to nearly 5
percent in 1995, and an average of 8 percent for the years 1996 to 1998.

IT industries have also been a major source of new R&D investment. Between 1994
and 1999, U.S. R&D investment increased at an average annual (inflation
adjusted) rate of about 6 percent--up from roughly 0.3 percent during the
previous five-year period. The lion's share of this growth--37 percent between
1995 and 1998--occurred in IT industries. In 1998, IT industries invested $44.8
billion in R&D, or nearly one-third of all company-funded R&D.

New investments in IT are helping to generate higher rates of U.S. labor
productivity growth. Six major economic studies have recently concluded that
the production and use of IT contributed half or more of the acceleration in
U.S. productivity growth in the second half of the 1990s. This has occurred
despite the fact that IT capital accounts for only 6 percent of private
business income. Such remarkable leverage reflects in part the fact that
businesses must earn immediate rates of return on investments in IT hardware
high enough to compensate for the rapid obsolescence (i.e., depreciation) and
falling market value of these assets. In short, IT investments must be
extraordinarily productive during their short lives. Recent firm-level evidence
indicates that IT investments are most effective when coupled with
complementary investments in organizational change, and not very effective in
the absence of such investments.

Although the official data show declining productivity for a number of major
service industries that invest heavily in IT (e.g., health, business services),
this probably reflects the inadequacy of official output measures for those
industries. Until these measures are improved, the full effect of IT on service
industry productivity will remain clouded.

In 1998, the number of workers in IT-producing industries, together with
workers in IT occupations in other industries, totaled 7.4 million or 6.1
percent of all American workers. Growth in the IT workforce accelerated in the
mid-1990s, with the most rapid increases coming in industries and job
categories associated with the development and use of IT applications.
Employment in the software and computer services industries nearly doubled,
from 850,000 in 1992 to 1.6 million in 1998. Over the same period, employment
in those IT job categories that require the most education and offer the
highest compensation, such as computer scientists, computer engineers, systems
analysts and computer programmers, increased by nearly 1 million positions or
almost 80 percent.

At the same time, the rapid pace of technological change and increased
competition have added an element of uncertainty to IT employment. The number
of jobs has declined in some IT industries, such as computers and household
audio and video equipment. Moreover, while IT-producing industries as a whole
paid higher-than-average wages in 1998, some IT jobs remain low-skilled and
low-paid.

Paradoxically, although America's IT-producing companies are clearly
world-class, the United States regularly runs large trade deficits in IT
goods--an estimated $66 billion in 1999. One reason is that American IT firms
more often service foreign customers with sales from their overseas affiliates
than by exports from their U.S. operations. In 1997, foreign sales by overseas
affiliates of American IT companies totaled $196 billion, compared to U.S.
exports by firms in comparable industries of $121 billion. In the same year,
American affiliates of foreign-owned IT companies operating in the United
States reported sales here of $110 billion. Therefore, while the U.S. balance
of trade in IT products was negative, the "balance of sales" favored American
companies by $86 billion.

IT has not only propelled faster growth during this expansion, but it will have
a tendency to dampen the next business cycle downturn. Because IT investment is
driven by competitive pressures to innovate and cut costs more than to expand
capacity, it will be less affected by a slowdown in demand. In addition, by
creating supply chain efficiencies that reduce inventories, IT should dampen
the inventory effect that has worsened past recessions.

The strong performance of the U.S. economy since 1995 contrasts both with U.S.
performance from 1973 to 1995 and with the rest of the industrial world in
recent years. Historically, there have been long lags between fundamental
technological breakthroughs, such as electricity and electric motors, and large
economic effects from them. Although IT is generally available in world
markets, the U.S. economy to date has achieved greater gains from IT than other
countries at least partly because of favorable monetary and fiscal policies, a
pro-competitive regime of regulation, and a financial system and business
culture prepared to take risks.

Even in this country, however, the diffusion of IT has been uneven. Although
the number of homes with computers and Internet connections has been rising
rapidly, the majority of Americans do not have online connections at home.
Those on the wrong side of the digital divide--disproportionately people with
lower incomes, less education, and members of minority groups--are missing out
on increasingly valuable opportunities for education, job search, and
communication with their families and communities.

In conclusion, a growing body of evidence suggests that the U.S. economy has
crossed into a new period of higher, sustainable economic growth and higher,
sustainable productivity gains. These conditions are driven in part by a
powerful combination of rapid technological innovation, sharply falling IT
prices, and booming investment in IT goods and services across virtually all
American industries. Analysis of the computer and communications industries in
particular suggests that the pace of technological innovation and rapidly
falling prices should continue well into the future. Moreover, businesses
outside the IT sector almost daily announce IT-based organizational and
operating changes that reflect their solid confidence in the benefit of further
substantial investments in IT goods and services. The largest and clearest
recent examples come from the automobile, aircraft, energy and retail
industries, which all have announced new Internet-based forms of market
integration that should generate large continuing investments in IT
infrastructure. These examples mark only the beginning of the digital economy.