ICT, Corporate Restructuring and Productivity Laura Abramovsky Rachel Griffith IFS and UCL ZEW – November 2007 Workshop on Innovative Capabilities and the Role of Consultants in the Information Economy

US productivity growth has far outpaced the EU

Technology diffusion A lot of attention to knowledge production –but technology and knowledge diffusion probably more important for productivity Information and Communication Technology (ICT) has been one of largest technological advances

Investment in ICT in the US has continued to accelerate Gross fixed capital formation in software divided by GDP, both in 2000 prices Source: Timmer, Ypma and van Ark (2003), updated June 2005

US productivity growth driven by ICT using sectors USEU-15 ICT-producing sectors + 1.9%+ 1.6% ICT-using sectors + 3.5%- 0.1% other sectors- 0.5%- 1.1% Change in annual growth in output per hour from 1990–95 to 1995–2001

ICT and productivity - focus of literature Allows firms to restructuring internally –more optimal structure of the workplace –change decision authority –change workers’ tasks Improves organisational efficiency and productivity Adjustment process, requires complementary investments –in skills –in organisational capital

ICT adoption also facilitates corporate external restructuring Transactions previously conducted face-to-face can now be conducted at arms-length Feasible to outsource and off-shore activities that it was previously not possible to –optimal boundaries of the firm change –transactions can more cheaply be carried out over large distances

How can outsourcing affect productivity? Specialised providers of intermediate goods and services can exploit economies of scale/scope Improving suppliers incentives to innovate Purchasers of services can become more productive in core activities by outsourcing non-core activities if previously overloaded

Rapid growth in business service providers Consistent with one of the biggest recent changes to the US and UK economies - business services have been very fast growing –in 1980 business services very small sector –employment in UK business services grew by 92% or 1.9m jobs from 1984 to 2001 –accounted for over half of the total growth –from accounted for 1/3 of growth –in 2002, 4m people employed in this sector –accounting for around 1 in 7 jobs in the whole economy

Business services in the UK Source: ABI 2001

Is there evidence for this? Does ICT facilitate corporate external restructuring in the form of outsourcing of intermediate services Is this correlated with productivity growth? Econometric study –use large nationally representative data for the UK firms that use more ICT are more productive firms that outsource more services and use ICT are even more productivity

Empirical approach Estimate production function allow the way that ICT affects productivity to depend on amount of outsourcing of services measures the extent of complementarities between purchased services and ICT

Empirical approach Establishments face a production function of the form i: establishments j: industry Y: output L: employment K: total capital C: information and communication technologies S: purchased services G: purchased goods A: total factor productivity

Empirical approach Estimate in deviations from the industry mean, all variables take the form: allows us to control for unobserved industry specific factors (including price deflators) without imposing too many restrictions on the production technology

Empirical approach

Correlations, not causal relationship We estimate by ordinary least squares (OLS) –problem if firms anticipate future shocks Decline in price of ICT exogenous to the firm –leads to increased investment in ICT Increased levels of ICT mean that it is now feasible to outsource many more business processes –leads to further ICT investment Heterogeneity across firms arises due to adjustment costs; we use this to identify complementarity between ICT and outsourcing in production from cross-section data

Data UK Annual Census of Production (ARD-ABI) –Collected by the Office of National Statistics (ONS) –Establishment level (firm line of business) –Random stratified sample –Legal obligation to reply –Cross-section (few repeated observations) –Manufacturing and services industries –70,044 observations; median size 48 employees

Data Outsourcing of services (s) – intermediate expenditure on services (legal and accountancy, marketing, renting of machinery, telecommunication and transport, etc.) – on average 15% as a share of gross output ICT (c) –software capital stock (purchased and developed by own staff) –only partial measure of ICT investment –on average 1.25% as a share of gross output

How does ICT affect productivity? Notes: from Table 2 in paper; each column is a separate regression with 70,044 observations; ** significant at 1% Dep variable: ln (Gross output) i ln (L) i Labour(0.005)** ln (K) i Capital(0.005)** ln (S) i Purchased Services(0.005)** ln (G) i Purchased Goods(0.005)** ln (ICT) i ICT(0.001)**(0.002)** ln (ICT) i *ln (Services) i (0.000)**

Interpretation of results Positive coefficient on interaction of ICT with outsourced services –Firm that do both more ICT and more outsourcing (compared to their industry) are more productive Coefficient is elasticity of output with respect to ICT –an establishment that has 1% more ICT than the average in its 4-digit industry (and outsources services at its 4-digit industry average) is 0.02% more productive and if outsources services by 1% more than average has 0.025% higher productivity if outsources services by 1% less than average has 0.015% higher productivity

Interpretation of results level of outsourcing of services elasticity of output with respect to ICT 25 th percentile th percentile th percentile0.018 mean0.020

Alternative explanations? Multinational establishments Notes: from Table 2 in paper; each column is a separate regression with 70,044 observations; ** significant at 1% Dep variable: ln (Gross output) i ln (S) i Purchased Services (0.005)** ln (ICT) i ICT(0.001)**(0.002)** ln (ICT) i *ln (Services) i (0.000)** US i (0.016)**(0.017)** US i *ln(ICT) i (0.006)(0.006)* MNE i (0.009)** MNE i *ln(ICT) I (0.003)(0.004)**

Alternative explanations? Skills Dependant variable: ln (Gross output) i ln (S) i Purchased Services(0.006)** ln (ICT) i ICT(0.004)** ln (ICT) i *ln (Services) i (0.000)** ln(SK) j Skills(0.010)** ln(ICT) i * Ln(SK) j (0.002)** Notes: from Table 4 in paper; each column is a separate regression with 61,135 observations; ** significant at 1%

Alternative explanations? Allow ICT to interact with all other inputs Dependant variable: ln (Gross output) i ln (S) i Purchased Services (0.007)** ln (ICT) i ICT (0.002)** ln (ICT) i *ln (Services) i (0.002)** ln (ICT) i *ln (Labour) i (0.002)** ln (ICT) i *ln (Capital) i (0.002)** ln (ICT) i *ln (Goods) i (0.002) Notes: from Table 2 in paper; each column is a separate regression with 70,044 observations; ** significant at 1%

Consistent story across manufacturing and services Dependant variable: ln (Gross output) i ManufacturingServices ln (L) i Labour(0.008)**(0.006)** ln (K) i Capital(0.008)**(0.007)** ln (S) i Purchased Services(0.009)**(0.007)** ln (G) i Purchased Goods(0.010)**(0.005)** ln (ICT) i ICT(0.002)** ln (ICT) i *ln (Services) i (0.001)** Observations 20,785 44,539 Notes: from Table 3 in paper; ** significant at 1%

Consistent story across 2-digit industries Dependant variable: ln (Gross output) i Mean 2-digit industry ln (L) i Labour ln (K) i Capital ln (S) i Purchased Services ln (G) i Purchased Goods ln (ICT) i ICT ln (ICT) i *ln (Services) i Notes: from Table 3 in paper; ** significant at 1%

Composition effect? Split industries by mean labour productivity in business services –coefficient on ICT*services is: high labour productivity: (0.001)** low labour productivity: (0.000)** Also split by average wage, –coefficient on ICT*services is: high average wage:0.007 (0.001)** low average wage:0.005 (0.000)** Notes: from Table 3 in paper; ** significant at 1%

Conclusion Has ICT played an important role in productivity growth by facilitating corporate external restructuring, via outsourcing intermediate services? We find that ICT increases productivity (the elasticity of output with respect to ICT is higher) for firms that make greater use of outsourced services than other firms in their industry This is consistent with complementarities between ICT and outsourced services