(FORTUNE Magazine) – The Internet is changing more than our tastes and habits. It's transforming the economy too. We're now enjoying the longest economic expansion in history, partly because the Internet and related information technologies are powering unprecedented gains in productivity and efficiency. By making the Net faster and more pervasive, broadband promises to enhance economic performance even more.

The Internet has worked its economic magic by reducing the cost of getting information and increasing its availability, helping workers to produce more. This, in turn, boosts profits and stock prices. Today productivity is increasing at an annual rate of 5.7%, its quickest pace in 35 years and double the historical average of 2% to 3% a year. According to a joint study by Harvard and the Federal Reserve, information technology is responsible for almost half of the rapid gains of recent years. The economy can also expand much faster for much longer without triggering inflation. Historically, it could grow by 2.5% to 3% a year before inflation accelerated and the Fed had to slow things down. Now the speed limit is closer to 4%.

Broadband could help the economy in much the same way. By making information faster and easier to get than ever, it will reduce transaction costs and increase profit margins. "Companies will focus on what they do well and outsource everything else," says Mark Zandi, chief economist at Economy.com. "That lifts overall productivity growth."

The big question is how long broadband will take to percolate through the economy. According to Stanford economist Paul David, a penetration rate of 50% is the critical mass that a technology must achieve to bring productivity gains. But sometimes new technologies just ooze their way along. Take the electrification of U.S. industry. It took four decades after the first central power station opened before half of all U.S. factories were electrified. Not until the capital boom of the roaring '20s did firms find it profitable to switch from steam power, which was still functioning well.

No one expects broadband to take anywhere near that long. According to Vertical Systems Group of Dedham, Mass., more than half of all firms, and 15% of households, will have broadband connections by 2004. Hobbled by a strong dollar and high labor costs, U.S. companies must invest in new technology to boost efficiency. The money is there too, thanks to low interest rates and an influx of funds from foreigners. Investment in technology as a proportion of GDP is at its highest level ever--10.6%--and new orders of high-tech equipment grew by 29% in the second quarter.

For broadband to be truly transformational, though, service industries must embrace it. Over the past two decades, manufacturing companies, which employ less than 20% of the labor force, have been responsible for almost all of the gain in productivity. That may be starting to change. The service sector has made big investments in IT in recent years, and in the second quarter of 2000 service productivity finally took off, growing by about 6% over 1999.

The only fly in the ointment is the dire shortage of skilled workers. Early in the past century the car transformed the economy because automakers could draw on a ready pool of unskilled labor; the massive work force required to make cars then became the mass market needed for their widespread adoption. Now, though, says Stanford economist Paul Romer, "we aren't getting the flow of people with the skills firms need."

With the supply of skilled labor lagging behind demand, broadband may take longer to bear fruit than its enthusiasts project. But as was true with electricity, once broadband does take root its effects may well run deeper than anyone can imagine.

--Anna Bernasek