Glimpse of Recovery Spotted Amid Equipment Sales: Peter Orszag
It’s been a hard slog for the U.S. economy since the financial crisis of 2008. Yet the type of investment most closely correlated with productivity growth has been booming.
That’s right: Despite widespread concern about weak business investment, companies have been pouring money into equipment and software -- everything from tools and tractors to word-processing programs.
In the third quarter of 2011, private-sector investment in equipment and software accounted for more than 60 percent of total growth in gross domestic product. Since the official end of the recession in the spring of 2009, the share of GDP devoted to such investment has risen more rapidly than in any recovery in the post-World War II era.
The boom is occurring only in equipment and software, which have a relatively short shelf life. Investment in nonresidential structures, which have a longer lifespan, plummeted in the downturn and has not come back as strongly. That’s why, even with the boom in equipment and software, total private, fixed nonresidential investment has remained below its pre-recession peak.
Within equipment and software investment, however, all categories have risen rapidly. Transportation equipment, in particular, has more than doubled in inflation-adjusted terms from the trough of the recession in the second quarter of 2009 to the third quarter of 2011 (the most recent data available). Information-processing equipment and software, along with industrial equipment, are up more than 20 percent. Overall, equipment and software investment has risen more than 30 percent, after adjusting for inflation.
Investment Boosts Growth
Some studies suggest equipment and software investment is particularly beneficial for economic growth. In the early 1990s, for example, economists Brad DeLong of the University of California, Berkeley, and Larry Summers of Harvard examined the strong cross-country connections between this type of investment and economic growth. They concluded that “a high rate of equipment investment is a key cause of rapid growth.” (Other economists have challenged that strong conclusion, but the debate is about magnitudes; no one disagrees that investment helps boost economic growth.)
So what’s driving the equipment- and software-investment boom?
Part of it is simply a bounce back from the depths of the recession. Investment of all kinds is highly cyclical. As the economy weakens, companies cut back drastically on their capital expenditures. Then, as the economy reaches bottom, investment tends to grow more rapidly than other components of GDP. But given all the discussion today about how and why the investment cycle in general is not occurring, the rebound in equipment and software investment is striking.
Tax policy has also played a role in the boom, though perhaps only a modest one. Congress has allowed more rapid write-offs of investments, but generally only for those with a depreciation period of 20 years or less. These tax breaks have effectively allowed companies to write off immediately -- rather than depreciate over time -- 50 percent of equipment and software investments made from 2008 to the summer of 2010, and 100 percent of those made from September 2010 through the end of 2011. This year, bonus depreciation returns to 50 percent, then expires at the end of the year.
Evidence suggests that earlier rounds of bonus depreciation boosted investment a bit, so it’s reasonable to assume some effect from these recent provisions also. Temporary provisions are particularly effective at creating an incentive to invest now, in order to capture the tax benefit. But a company’s savings --and therefore the tax’s impact on investment -- depend on interest rates: When interest rates are high, the tax savings from immediate write-offs are large, whereas when rates are low, as they are today, the tax savings are more modest. One would therefore expect the effect on investment to be more modest also.
Those low interest rates spur investment all by themselves, however. Given sluggish growth in demand and substantial uncertainty about the economy over the next few years, companies appear to be tilting away from long-term investments in favor of spending on equipment and software.
What is the future for this bright spot in the U.S. economy? Most forecasters expect its growth to remain strong, but nonetheless to be lower this year than it was in 2010 or 2011. A recent report from Bridgewater Associates suggests that significant slowing already occurred in the fourth quarter of 2011.
My discussions with chief executives at major U.S. companies suggest they will exercise restraint in their 2012 capital budgets. Uncertainty about policy in 2012 could depress investment; for example, farmers may postpone spending on agricultural equipment until Congress is done wrangling over the farm bill, which is up for reauthorization this year. And the reduction in the bonus depreciation this month from 100 percent to 50 percent can be expected to slow investment somewhat.
Because of these forces, a recent report from the Equipment Leasing and Finance Foundation predicted that growth in equipment and software investment will be two to three percentage points lower this year than in 2011. If that’s correct, equipment and software investment will still be a source of support for the economy, but will contribute about 0.2 percentage points less to growth this year than last.
Even if it slows a little, equipment and software investment will probably remain one of the bright spots for 2012. Growth in exports is likely to remain subdued, as is government spending. Although consumption looks to have grown strongly during the fourth quarter of 2011, that partly reflected a decline in the saving rate, which is unlikely to be sustained throughout 2012.
So, to monitor how strong the economy will be in 2012, keep a close eye on equipment and software investment.
(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)
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