'Boom is IT-driven' say US economists

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...

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.

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