Ed Yardeni and Chinese “Takeout” Jude Wanniski July 18, 2000

To: Website Browsers, Fans, Clients
From: Jude Wanniski
Re: “The Productivity Revolution”

One of my favorite Wall Street economists, Ed Yardeni, sent me his July “Global Column,” as he calls it, this one on “The Productivity Revolution.” It’s easy reading and, like Chinese food, soon after you finish, you have a craving for more.

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My wife and I commute together by car to our Wall Street jobs from our Long Island home. At least once a week, either my wife or I have to stay at work later than usual. On the way home, we call ahead and take out dinner from a great Chinese restaurant on Third Avenue and 81st. In my view, this widely practiced ritual is one of the sources of our productivity and it can help us understand how the Internet specifically and Information Technology (IT) in general is working to boost productivity.

"Takeout" is just another way of saying outsource. We all outsource virtually everything we need as consumers or businesses every single day. Self-reliance may be a virtuous concept to some, but it is very impractical. We are all better off by spending our working day on tasks that we are skilled and qualified to accomplish. The income we earn from this activity will necessarily be greater if we aren't distracted by having to do additional chores to support ourselves.

Adam Smith was the first to understand and explain this simple concept. He didn't call it "outsourcing," but rather the division of labor. In The Wealth of Nations (1776), he explained that the division of labor means we can all specialize in what we do best and exchange our products in the market for other goods and services that are more efficiently produced by others. In other words, outsourcing is the main source of productivity.

Why do we care about productivity? More productive workers tend to earn more than less productive ones. So they have a higher standard of living because they have the purchasing power to buy more. In addition, productivity growth moderates inflationary pressures.

The Internet is a revolutionary new technology. Yet, at the same time, it's greatest contribution is to promote the ongoing evolution in outsourcing, thus boosting productivity. More specifically, e-commerce markets will increasingly allow businesses to focus on their most profitable activities and outsource everything else from human resources to legal services. Undoubtedly, many firms will outsource to e-commerce market vendors their IT, which is essential to function in our increasingly wired world, but is too costly for most to support in-house.

Metcalfe's Law helps explain how the Internet reduces costs, by increasing efficiency of communication: The value of a network is proportional to the square of the number of participants. If there are 30 buyers and sellers, the number of possible buyer-seller contact points is 30² or 900. But if an e-hub is introduced, the number of contact points is just 60. Obviously, e-commerce hubs over the Internet can create significant savings.

British Telecom claims that procuring goods and services online will reduce the average cost of processing a transaction by 90% and reduce the direct costs of goods and services it purchases by 11%. Promoters of e-commerce in many other industries including autos, aerospace, and computers project similar savings. I recently partnered with CIO magazine to survey 42 chief information officers from some of the largest companies in the world. In our June "CIO E-conomy Poll," exactly half of the panelists said that the Internet cut their costs of doing business, while one-third report higher costs. On average, the panelists said they expect to purchase about 23% of their materials, supplies, and parts over the Internet during the coming 12 months, up significantly from 15% over the previous 12 months. (For more, see my www.peoplepolls.com.)

Of course, there are many other information-based technologies in addition to the Internet that are likely to boost productivity. A comprehensive list of the ones with the greatest potential would be too long for this column. Two of my favorites are 1) software recently developed by RealNetworks and Intel to boost the quality of Internet video and, 2) International Paper and Motorola will soon put microchips in the packaging boxes, a big step toward eliminating bar codes and ultimately bringing the entire manufacturing supply chain online.

Personally, I can hardly wait to check out of Costco or Wal-Mart at the speed of light. Imagine a scanner that can simultaneously and instantaneously detect and add up the prices of all the goods in your shopping cart, deduct the sum from your checking account, and post all your transactions on your personal web site. Imagine less business travel as you use Internet video for more of your meetings. It won't be long.

It may take a bit longer, but the impact of the bio-tech revolution on our lives is also in sight. The 10-year effort to map the human genome was recently completed. Of course, there are now many predictions that this amazing achievement will lead to better and faster ways to develop new drugs. Maybe so, but there is no doubt that the goal was achieved years ahead of schedule thanks to the IT revolution. Pfizer recently acquired Warner-Lambert, which owns a biotech outfit that has emerged as a leader in computer-aided drug design. Instead of randomly screening thousands of chemical agents, 3-D computer models are used to engineer molecules that precisely block disease-causing proteins.

Of course, measuring the impact of the biotech revolution on productivity is going to be difficult. Our statistical methods are already quite inadequate for measuring productivity, especially in such industries as banking and software. In the United States, there has been a big debate about productivity between two camps. The optimists see a technology-based secular rebound in the productivity growth data since 1995. Some skeptics say the efficiency gains are mostly occurring in the technology industry -- computers are creating productivity only in the computer industry. Other skeptics think that the data are wrong because people are working longer hours than measured.

I am in the optimists' camp -- the digital crowd. I think the analog (business cycle) thinkers are wrong. Of course, what matters most is what they think at the Federal Reserve. I believe that Fed Chairman Alan Greenspan is becoming increasingly convinced that the rebound in productivity is sustainable allowing the U.S. economy to grow at a faster pace with less risk of inflation. On June 13, he delivered one of his most bullish New Economy speeches ever, endorsing several important New Economy ideas about the upbeat outlook for productivity. This explains why the Fed did not raise interest rates again at the June 28 policy meeting, and may leave interest rates unchanged through the end of the year.

How can investors profit from the productivity revolution? The market's answer has been loud and clear: Buy technology. Despite the crash in dot-coms and other technology stocks from March through May, technology still accounts for one-third the value of the S&P 500. The rebound in this sector during June was impressive. I think that half of the S&P 500 market capitalization could be technology by the second half of the decade.

So what does Chinese takeout food have to do with productivity? Maybe not much, but next time you bring it home, tell the kids why it makes more economic sense to outsource it, then to cut up all the vegetables and stir fry them in a wok on your stove.