If the US was one big company its IT director would be the most
popular person on earth. As the US government's latest report on
the digital economy reveals, IT investment has been crucial to
America's long-term economic boom period
Last week yet another analyst report came out about the
IT-driven "new economy". But when the analyst is the US government,
you'd better sit up and listen.
The report, called Digital Economy 2000 and released by the US
Department of Commerce, says the Internet, business reorganisation
and falling IT prices have combined to deliver a massive return on
investment since 1995, for companies that can make it work.
While hype-merchants have been banging away at the "new economy"
theory for years, the DoC itself remained uncommitted in its first
two annual reports. So this is the first time the US Government has
unequivocally acknowledged the existence of an "IT effect" on
productivity and the economic cycle.
The report reveals that IT investment is powering US economic
growth, and creating productivity gains far beyond those normally
achieved at this stage of an economic recovery. It demonstrates a
sharp upturn in the rate of productivity growth since 1995,
coinciding with the accelerated decline in the price of software,
hardware and communications equipment.
But while the figures show an economic gear-change since 1995,
they do not translate evenly into all sectors.
Beyond the IT industry itself, the "IT effect" on productivity
is only measurable in the goods-producing industries, and where
increased IT spend is combined with business reorganisation. Heavy
IT investment in service industries, for example, has actually
produced a small decline (0.3%) in labour productivity.
The lessons for IT directors in the UK are clouded by the fact
that many of the factors contributing to productivity gains are
specific to the US. The existence of a large IT supply industry
focused on high-value business - as well as economies of scale and
a flexible investment environment - mean that US firms are better
placed to take advantage of the new technologies.
The report reveals:
- Despite contributing just 8% of gross domestic product (GDP),
the US IT supply industry contributed nearly one-third of its
economic growth from 1995 to 1999.
- US businesses' real spending on IT grew from $243bn to $510bn
(at 1996 values) - almost double. That occurred despite prices for
all IT products falling on average by 8% a year between 1995 and
1998. Without the fall in IT prices, says the Department of
Commerce, inflation would have been 2.3% - not the actual 1.8%
achieved.
- In the US, the proportion of spending on hardware has
decreased, while software and services take up an ever larger
proportion of the aggregate IT budget. That is a trend UK directors
will recognise - but the speed of change in the US is probably
greater than in this country.
IT innovation and spending in the past five years have
contributed to an increase in productivity not seen at this stage
of any economic cycle since the war. From 1997 - seven years into
the economic cycle - US output per hour surged forward 3.2% per
year. In every previous recovery it tailed off to less than half of
that at the same stage.
US federal economists put this down to "the rapid growth in the
real net stock of IT capital per labour hour, especially computer
hardware". The report continues, "Rapidly growing IT investments
have been unusually productive."
However, when the economists tried to trace productivity effects
of IT into different sectors of the economy, they found mixed
results.
The IT supply industry itself experienced phenomenal
productivity growth. Goods-producing industries investing heavily
in IT registered stronger growth than those that did not invest
heavily in IT - 2.4% growth compared with 1.3%.
In the services sector, IT-intensive industries did not register
productivity gains but declines, the report reveals. IT-heavy
service sectors saw productivity decline by 0.3% between 1990 and
1997 whereas non-IT-heavy service sectors experienced gains of
1.3%.
At the level of individual firms, the report found no automatic
correlation between IT investment and productivity growth. Only
where major organisational changes accompanied IT spending did
productivity increase. Decentralisation is a key factor in linking
IT spending with productivity gains.
Returns on investment
The report authors see high returns on investment in IT as a
double-edged sword. Returns must be high because the kit
depreciates fast. "Investment in computer hardware must produce
gross rates of return of about 68% in order to cover an estimated
depreciation rate of 30% and capital loss of 34% per year, plus a
competitive net return of 4% per year."
The authors estimate that the payback period for computer
hardware investment in the US is less than two years.
For UK IT directors, the report confirms what they already know:
when it comes to IT investment returns, it is business
reorganisation that matters - not pure IT spend.