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The Dangerous Decline in Investment in Equipment and Software

Nov. 21, 2013
First, the failure of the U.S. federal government to put in place a robust national competitiveness strategy has led manufacturing firms to either look to other, more competitive countries when it comes to choosing locations or to lose market share to companies located in other nations.

One of the most important, if little publicized, intermediate economic indicators is business investment in new equipment and software. This type of investment drives productivity and competitiveness, not just in manufacturing firms, but in the economy as a whole.

It is therefore troubling, to say the least, that the trends in investment in capital equipment are down, not up.

In the 1980s, businesses in the United States increased their fixed capital investments by 2.7% per year on average, and in the 1990s, that figure rose to 5.2 % annually.

But, since the year 2000, capital investment grew a paltry 0.5% per year.  Even worse, as a share of GDP, investment in the 2000s was a full  30% lower than in the 1980s.

This is bad news for businesses, workers and consumers. Investment in new equipment and software is the primary means through which innovation spreads throughout the economy. Innovations are embedded in new capital, and investment in that new capital is what facilitates the adoption of those innovations.

Whether embedded in new personal computers with touch screens and solid state drives, or in new cotton harvesters with microwave sensors and wireless data communication capabilities, innovations—and in particular information technology (IT) innovations­—find their way into “new” and “old” industries alike. Therefore, failing to invest in new capital equipment leads to less innovation adoption causing productivity growth to stagnate and competitiveness to decline.

Missing Facts on Capital Investment Status

This situation is further worsened because of the lack of good data on capital investment.

This is due to the rapid quality change of IT assets, which massively skews the U.S. government’s data, and shows IT investment growing by an unbelievable 2,156% over the past three decades, while the next highest asset class, transportation equipment, grew by just sensible 69%.

In a new report, ITIF corrects this overstatement and finds that not only has investment trended downward over the past three decades, but also that investment that was once broadly distributed across industries is now much more concentrated in a few domestic service sectors, while industries that once powered U.S. competitiveness have seen sharp declines.

For example, investment in machines, equipment and software by manufacturers in the United States in 2011 was 13% below its 1998 peak, even as GDP was 71% higher, and while manufacturing was the highest investing sector in the 1980s and 1990s, in the 2000s it fell behind the real estate and financial sectors.

Moreover, investment in manufacturing structures in 2011 was at approximately the same level it was in 1959, having peaked in 1996 and then rapidly declining.

One response to this decline in manufacturing investment might be that this is to be expected, as “old” manufacturing industries such as textiles move offshore. However, investment has declined even in manufacturing industries where the United States is supposed to hold a competitive advantage.

In the chemical industry, for example, equipment and software investment is over 14% lower in 2011 than it was in 1998. The investment trends in the computer and electronic products industry are even worse with a 36% decline in equipment and software investment since 2000.

So why has investment declined? There are two likely suspects. First, the failure of the U.S. federal government to put in place a robust national competitiveness strategy has led manufacturing firms to either look to other, more competitive countries when it comes to choosing locations or to lose market share to companies located in other nations. 

This competitive decline over the past decade has been demonstrated in numerous studies. In 2010, the Boston Consulting Group ranked the United States just eighth in global innovation-based competitiveness. In 2011, ITIF ranked the United States fourth out of 40 nations in innovation-based competitiveness and found that the United States was second-to-last out of 44 countries in the rate of change in its competitive position between 1999 and 2011.

Second, the pressure on companies by Wall Street to achieve short-term profits has all too often meant cutting long-term investment. In a 2004 survey of more than four hundred U.S. executives, over 50% said they would delay new investment projects in order to meet short-term earnings targets, even if it meant sacrifices in value creation.

In addition, a 2013 study found that public firms invested substantially less than privately held firms and the authors surmised that the cause was the pressure on the management of public firms to achieve short-term profits.

There are a range of policies that can help restore robust capital investment rates, but there are two key ones. 

First, Congress should establish an investment tax credit to encourage additional investment in machinery, equipment and software.

Second, the Obama Administration should establish a task force on market short-termism to recommend policies to ameliorate the problem.

Investment in new equipment and software is an essential input to a healthy and competitive innovation ecosystem. It is therefore essential that policymakers and manufacturing executives make addressing this problem a top priority of our national growth and competitiveness agenda. 

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