The Substitution of Information Technology for Other Factors of Production: A Firm Level Analysis

Abstract

Fueled by its constant technological and price improvements, information technology (IT) is displacing other inputs in the production of goods and services. By 1994, IT accounts for over 15% of fixed investments by the U.S. private sector, and the ratio of new IT investments to labor costs is approaching 5% (1990 dollar basis). The ability to take advantage of improvements in IT is determined in part by the substitutability of IT for other factors of production. This paper builds on the empirical framework of Brynjolfsson and Hitt (Brynjolfsson, E., L. Hitt. 1995. Information technology as a factor of production the role of differences among firms. Econom. Innovations and New Tech. 3 183–199.) and extends it to jointly estimate output and substitution elasticities using the CES-translog production function. Our primary source of IT-related data is the IDG/Computerworld annual survey data on IS spending by large U.S. firms, for the period 1988 to 1992, previously analyzed by Brynjolfsson and Hitt ([Brynjolfsson, E., L. Hitt. 1995. Information technology as a factor of production the role of differences among firms. Econom. Innovations and New Tech. 3 183–199.], [Brynjolfsson, E., L. Hitt. 1996. Paradox lost? Firm-level evidence on the returns to information systems spending. Management Sci. 42(4) 541–558.]) and Lichtenberg (Lichtenberg, F. R. 1995. The output contributions of computer equipment and personnel a firm level analysis. Econom. Innovations and New Tech. 3 201–217.). A key result is that IT capital is a net substitute for both ordinary capital and labor, suggesting that the factor share of IT in production will grow to more significant levels over time. We confirm earlier findings of positive returns to IT investment for this data set. Further, we find excess returns on IT investment relative to labor input and some evidence of excess returns relative to ordinary capital. Taken together, these results shed new light on the productivity paradox of IT and on the growth of information intensity across the economy as firms take advantage of the continuing improvements in IT.