If the Economy Booms, Thank Software

Microsoft’s renaissance may herald a nascent boom in software-driven productivity and economic growth

Like-minded technological evangelists have long argued artificial intelligence, machine learning, big data and other technological advances were about to unleash a new boom. But the boom refused to show: growth in productivity—the best measure of how technology enhances worker output—remained mired near generational lows.

Recently, however, there have been intriguing signs a boom may be in the offing. In the first quarter, American companies for the first time invested more in software than in information-technology equipment. Indeed, outside of buildings and other structures, software surpassed every type of investment, including transportation equipment such as trucks and industrial equipment such as machine tools. Software spending is even higher if the cost of writing original software programs, now classified as research and development, is included.

Adjusted for inflation, software investment grew 11% from the first quarter of 2018 through the first quarter of 2019. By contrast, investment in equipment grew less than 4% and in structures, just 1%. (Revised data are due out Thursday.) The headwinds buffeting capital spending broadly, whether the waning tax cut, trade war or slumping commodity prices, have largely spared software. Meanwhile, productivity growth has picked up to 2.4% in the past year, the fastest since 2010.

Whether that can continue is debatable: business investment and productivity growth appear to have slowed in the current quarter. Nonetheless, a recent survey by Morgan Stanley & Co. found chief information officers planning to boost software budgets this year by 5%, and hardware budgets just 2%. Their main target is cloud computing, under which businesses pay external providers to host their data and supply tools to analyze that data.

After Chief Executive Satya Nadella took the company’s reins in 2014, Microsoft shifted focus to cloud-based services. Dubbed “Azure,” the services now account for half of the company’s revenue. Microsoft lacks the hipness factor of consumer-facing Amazon, Alphabet Inc.’s Google and Apple Inc. Yet it has achieved comparable growth by making itself a partner for businesses bent on “digital transformation,” a nebulous term that means using technology to remake processes or products.

What’s Missing From the Trump Economic Boom

Growth and productivity are up, but investment is a soft spot, and neither right nor left has good answers.

Yet if many workers still feel not entirely secure, there’s a reason: investment. Several policy improvements of the Trump era have buoyed business investment compared with the recent past. But America is nowhere near reversing long-run declines in business investment that continue to stress many households notwithstanding the good economic times.

A suggestive exploration of the problem emerges in a recent report released by Mr. Trump’s erstwhile rival Sen. Marco Rubio. It describes an American economy that somehow has forgotten how to invest.

Net private fixed investment (expenditures on equipment, machinery or property minus depreciation) averaged around 8% of gross domestic product between 1947 and 1990, with significant spikes during booms—it hit 10% of GDP under Ronald Reagan. It has lagged since then, however. As of late 2018, amid another burst of GDP growth, net investment was barely half the Reagan level.

The low net-investment baseline Mr. Trump inherited (from Republican and Democratic predecessors alike) doesn’t fully explain today’s shortfall. Despite faster growth, investment has not accelerated under Mr. Trump as much as during past periods of economic strength. Net investment grew by

  • 8% in 2006,
  • 10.9% in 1998 and
  • 16.7% in 1984

—the peaks of those business cycles. Mr. Trump managed investment growth of only 6.9% in 2018 and the rate is drifting downward again, not least thanks to Mr. Trump’s antitrade policies.

The cause of this is not a lack of cash in corporate America. Since 2000, nonfinancial firms have become net creditors in most years rather than net debtors. This is astounding. For most of our history the sole purpose of a nonbanking company was to receive capital from others so as to invest productively. Now on aggregate they distribute capital to others so that those guys can invest somewhere else. This phenomenon underlies the recent trend toward aggressive share buybacks.

This long-term downward trend in business investment raises a question about how well America will sustain its recent productivity gains. Absent sustained productivity growth, voters will be right to question the potential longevity of the current boom. Without parsing earnings press releases, employees can tell when their companies seem to have a plan to invest in long-term growth. A sense of directionless management can contribute to a gnawing unease about job security. This can produce unpredictable political consequences, whatever the GDP data say.

What to do about this is open to debate. The Rubio report’s ruminations about poor market incentives for longer-term investment are fine so far as they go, although its complaint about shareholder short-termism is partly belied by two of the corporate success stories it cites. Tesla and Amazon are conspicuous net debtors that continue to invest heavily back into their businesses. It can be done, and investors will tolerate it.

The 2017 tax reform and Mr. Trump’s mammoth deregulation drive are necessary conditions for an investment revival, as the recent investment uptick shows. But comparing recent trends with the historical norm, it’s clear these policies are not sufficient to restore the level of investment America needs. Can Mr. Trump figure out what is? Since he’s a longtime businessman you’d think so, except that his business experience lies exclusively in real estate and marketing—one of which features low productivity and the other low fixed-asset investment.

Nor do Democrats have any more of a clue. The common refrain from the left, with many melodic variations, is that if the private economy won’t invest in productivity enhancements, the government must.

Did these folks sleep through the past decade? With business not investing, government already has become the “investor of first resort” via its own deficit spending. The result has been a mix of social-welfare blowouts driven by political short-termism (indistinguishable, in productivity terms, from the worst charges laid against shareholders) and such crackerjack business plans as Solyndra.

Politicians continue casting about for productivity solutions. The danger is that 2020 becomes merely another contest to decide whom voters distrust the least to deliver one.

As Inflation Rises, It’s Even Harder to Get a Raise

Hourly earnings in June grew 2.7 percent from a year earlier. That’s more or less in line with the pace of the past two years. But now those modest wage gains are worth less in the real world. The reason: The prices of goods and services are picking up. In May, inflation hit 2.8 percent and grew faster than wages, which increased 2.75 percent.

.. The White House has contended that corporate tax cuts, like those enacted last year, will prompt companies to make investments that improve productivity and thus enable them to pay employees more. (Productivity measures output per worker.)

So far, that virtuous cycle does not seem to be taking hold. And some economists are skeptical that it will. Companies have had the ability to invest cheap capital for years, and wages have not risen strongly.

.. “A lower cost of capital may lead to more investment that may lead to more productivity growth, but to assume that will trickle down to middle-class wages flies in the face of everything we’ve seen for the last 20 years,” said Jared Bernstein

.. the effective personal tax rate had not changed much in the past year, edging down to 12.21 percent in May, from 12.25 percent a year earlier.

.. He noted that inflation-adjusted wages had in recent years grown more or less in line with productivity, which has itself been lackluster.

But wages could soon outpace productivity, Mr. Zandi predicted, because companies will have to pay higher wages to attract and retain workers.