Production of IT capital goods linked to productivity

According to a study by the Citizens for Tax Justice, four industries receive more than half of the tax breaks granted by the federal government. The IT industry collected only 2.7 percent of the tax subsidies, yet hardware suppliers are, on average, enjoying twice the productivity growth as others in the manufacturing sector. “The IT industry should be appreciated more by regulators, legislators, policymakers and everyday folks,” says Associate Professor Benjamin Shao.

Here in the U.S., we subsidize high-fructose corn syrup even though many think it makes us fat. Oil and gas companies are subsidized as well, despite their prodigious profits, and the financial sector, creator of those high-risk, derivative investments that made our national economy implode in 2007, continues to benefit from government largesse.

In fact, four industries receive more than half of federal tax breaks, according to a study conducted by the Citizens for Tax Justice (CTJ), a non-profit research group. Those were the findings last year when CTJ looked at 280 Fortune 500 companies, their performance and tax subsidies between 2008 and 2010. The financial sector received 16.8 percent of tax subsidies, gas and electric utilities reaped a 14.0 percent share, telecommunications companies garnered 13.8 percent and oil and gas pipeline giants pocketed 10.9 percent of the savings.

All of the 280 companies studied were profitable during the three years reviewed. Their pre-tax profits topped $1.4 trillion for the study period.

Are these the main industries government should be supporting with tax subsidies? If you ask Benjamin Shao, an associate professor of Information Systems at the W. P. Carey School of Business, we might want to add information technology hardware suppliers to the tax-advantaged crowd. Among the 280 companies studied by CTJ, those involved in producing computers and related technology collected only 2.7 percent of tax subsidies. “The IT industry should be appreciated more by regulators, legislators, policymakers and every day folks,” Shao says.

He should know. He has spent the past several years looking at productivity improvements and return on IT investments. Shao’s earlier studies examined ROI from a corporate standpoint but, recently, he turned his attention to IT value creation for national economies with a focus on providers of IT capital goods and services. His recent findings reveal that IT hardware suppliers are, on average, enjoying twice the productivity growth as others in the manufacturing sector.

That productivity growth, Shao argues, means that IT hardware suppliers do double duty as contributors to national productivity and economic well-being. As a result, policymakers should consider offering them more incentives. After all, Shao notes, IT is an industry that adds to national output and produces goods and services that support greater efficiency and productivity for other business sectors, too.

Why IT matters

To conduct his study of the IT capital goods, Shao teamed with two colleagues: Yen-Chun Chou, an information systems doctoral student at the W. P. Carey School and Winston Lin, a professor from the State University of New York at Buffalo. The scholars focused their research on countries that belong to the Organization of Economic Cooperation and Development (OECD) because the 34 member nations have, in recent years, accounted for 84 percent of global spending on information and communications technology (ICT) and 52 percent of global ICT trade.

According to the OECD, some 8 percent of the business sector’s value in 28 nations came from ICT during 2008. IT capital goods — the hardware end of the ICT industry — make up 25 percent of the total ICT market. Global spending on IT hardware was estimated at $525 billion in 2008 and $447 billion during 2009.

Despite the size of the industry, Shao and his colleagues noted that few researchers had looked at IT capital goods as value creators for an economy as a whole. To that end, the researchers examined data related to IT hardware output in 19 OECD countries for the years of 2000 through 2009.

“The period of the data is inherently insightful,” the team wrote in a paper covering their study. “It allows us to evaluate the performance of IT production during and after dramatic changes of economic conditions.” That is, the study period followed the industry through the bursting of the dot.com bubble, the recession that followed in March 2001 and this most recent downturn – December 2007 to June 2009 — all of which led to “pullback in IT investment.”

Innovation vs. efficiency

For their empirical study, the team used the Malmquist total factor productivity index to measure productivity gains in those 19 countries under review. “Often, when researchers look at productivity, the most common thing they look at is labor,” Shao notes. “But labor is just one input in the production process,” he adds, which is one reason his team looked at total factor productivity, a measure that theoretically includes multiple factors of production, such as raw materials, equipment, facilities and even energy.

Another reason they chose this metric is its depth. It can be deconstructed into two components -- technological change and efficiency change — which allowed the researchers to see what really drove productivity gains. Technological change relates to innovation, such as that found in new products or new ways of doing things, Shao explains. “Efficiency change is getting better at what you do.” Or, put another way, it’s how closely your processes mimic or catch up with those of productivity leaders in your industry.

Using a statistical process that accounted for measurement errors and random events that showed up in the data, the team discovered that, overall, the 19 countries saw an average annual productivity increase of 10.7 percent among IT capital goods suppliers. Of that average, 10.5 percent was due to technical change. Only 0.2 percent was due to efficiency change. Among other manufacturing industries, an annual productivity gain of 4 percent to 5 percent is more common, Shao Says.

Why are IT equipment manufacturers so good at improving their productivity than most other manufacturing sectors? One reason, Shao says, is because these companies produce the very technology that enables other companies in other sectors to improve, giving them the earliest opportunities to employ such technology in the first place. Then, too, there is necessity at play. “If every other industry is using your products — buying computers, monitors, printers and servers to carry out their day-to-day business — the products you’re putting on the market are in very high demand,” he says. “You have to be more productive to meet that demand.”

Delivering the goods

Not only is the IT sector more than twice as productively enhancing as most other sectors, it’s also what the researches called “a general-purpose technology” that can spur innovations for other, IT-using organizations. As an example, Shao points to the type of integrated supply chain systems Wal-Mart uses.

“Wal-Mart links their systems to those of their suppliers so they can check the suppliers’ delivery schedules and the suppliers can check store inventory to see if it’s time to ship another truckload of products,” he notes. “That’s why Walmart can be so efficient and good at meeting demand without holding a lot of inventory. They can meet inventory needs without much human intervention.”

The Wal-Mart system is proprietary, but that doesn’t mean other companies shouldn’t have one, too. “In order to be competitive, Walmart’s competitors need to develop these capabilities,” Shao says.

That competition spurs more business for the IT capital goods suppliers, as well as the IT services companies, which will be called in to do things like the systems integration and business analytics that power supply chain applications. And, speaking of IT services companies, these have higher productivity than most others in the services sector, according to preliminary findings from research Shao is currently conducting. That makes the service end of IT a strong economic contributor, too, although not as much of a powerhouse as the manufacturing side of IT’s house.

In their paper, the researchers note that “two-thirds of the total factor productivity growth in the U.S. after 1995 was due to the industries that produce IT capital goods.”

This is something Shao thinks politicians and regulators should keep in mind, especially since both Obama and Romney want to lower corporate tax rates. Both want to spur industry so, while they’re at it, adding incentives for IT companies might also be a smart move, Shao notes. “IT provision, because it is so productive, raises the average productivity for the whole economy.”

Bottom line

• IT capital goods manufacturers — the companies that make computers and peripherals – are more than twice as productively enhancing as other manufacturing sector companies.
• In a review of 19 countries during 2000 through 2009, IT goods manufacturers demonstrated an average annual productivity gain of 10.7 percent. Other manufacturing industries saw gains in the 4 percent to 5 percent range during that time.
• While many industries enjoy hefty government subsidies, IT isn’t one of them. One study showed that while the financial sector got nearly 17 percent of tax breaks, IT capital goods manufacturing only got 2.7 percent between 2008 and 2010.
• Benjamin Shao, an associate professor at the W. P. Carey School of Business, thinks legislators and regulators might want to show more appreciation for the IT sector. Adding more incentives and tax breaks would be a way to do it.