Why cutting back on IT and other capital spending is disastrous for U.S. business and the country.
Investment in new-capital machinery, equipment and software is the primary means through which innovation spreads throughout the economy.
As these innovations -- whether they are new PCs with touch screens and solid-state drives or new cotton harvesters with microwave sensors and wireless data communication capabilities -- diffuse through industries, they raise productivity, lower costs of production and improve the competitiveness of the American economy as a whole.
However, as the Information Technology and Innovation Foundation details in a new report, business investment in the U.S. has fallen significantly in the last decade. In the 1980s, businesses increased their fixed-capital investments in the U.S. by 2.7% per year on average, and in the 1990s by 5.2%. But since 2000, the rate has fallen to just 0.5% per year. In fact, as a share of gross domestic product, annual private capital investment has declined by more than three percentage points since the early 1980s. In addition, the capital stock of equipment and software used by business establishments has fallen 5%, relative to GDP, since 2000.
This decline isn't just in "old economy" machines. From 2000 to 2011, investment in IT assets as a share of GDP fell by 37%. That decline has particularly negative consequences because there's considerable evidence that IT capital investments have even larger benefits for companies and the economy than other kinds of capital investments.
Between 2006 and 2010, companies that invested heavily in IT assets increased productivity three times as fast as companies that didn't. In addition, from 2000 to 2009, service-sector companies that used IT intensively grew jobs at a rate of 5.1%, while non-IT-intensive service companies expanded jobs by only 1.5%. And a study by MIT’s Erik Brynjolfsson found that for every dollar a company invests in IT capital, it raises its market valuation by more than $10.
Unfortunately, the reverse is also true. Companies that fail to invest in new-capital equipment ultimately see productivity growth and competitiveness stagnate, while also lowering innovation diffusion throughout the economy. It isn't a coincidence that the decline in capital investment over the last decade has coincided with the decline in productivity growth rates and U.S. global competitiveness.
One reason for the decline in private-capital investment is the growing dominance of "short-termism." In recent decades, Wall Street pressure on public companies to hit short-term profit goals has all too often come at the expense of long-term investment. A 2013 study by three academics found that public companies made substantially lower capital investments than privately held companies for that reason.
Restoring robust capital investment rates is critical to our economic future. To encourage additional investment in machinery, equipment and software, Congress should restore the investment tax credit, which was abolished in 1986.
In addition, it's time to tackle the curse of corporate short-termism. It's not clear what the answer is, but the Obama administration can start addressing this issue by establishing a task force to recommend policies to ameliorate the problem.
Given the evidence of the paramount importance of investment to the growth and competitiveness of businesses, it's essential for governments and executives to take the long view and support policies that will spur increased capital investment. The long-term health of business -- and the country as a whole --depends on it.