Companies Choose Profits Over Productivity
When the U.S. economy emerged from the recession in June 2009, productivity was rising at a fast clip. Companies had spent the downturn cutting jobs and were lean and efficient. Productivity—output per hour worked—jumped 5.5 percent in the fourth quarter from a year earlier as workers did more with less. But as the recovery has chugged on, productivity growth has stalled, averaging less than 1 percent a year since 2011. Workers were actually less efficient in the first quarter of 2014, producing fewer goods and services per hour than they had during the previous quarter.
Although there are many reasons for the productivity rut, one of the primary ones is that businesses aren’t investing in their workers. Business investment fell almost 25 percent during the recession and hasn’t come back the way many economists had expected, especially given that low interest rates make borrowing less expensive. Growth of capital spending during this recovery is about 30 percent below the average of the prior five recoveries, according to Bank of America Merrill Lynch. That’s left many workers without the equipment, software, and structures—which economists call “capital”—that they need to be more productive. Whether it’s a computer or a forklift, workers are stuck using outdated machines. The average age of equipment in the U.S. is 7.4 years, the highest in 20 years, according to the Bureau of Economic Analysis.
After growing only 0.5 percent in 2010, the amount of capital per hour worked fell 1.1 percent in 2011 and 0.8 percent in 2012. According to the Bureau of Labor Statistics, that’s the first time capital per worker has declined since the agency began tracking the measure in 1987. Considering that business investment remained weak in 2013 and early 2014, “we are likely in an unprecedented fifth year of no growth in capital per worker,” Ted Wieseman, an economist at Morgan Stanley, wrote in a May 7 note to clients.
Equipment and software appear to be boosting output less than they once did. The government measures labor’s contribution to economic output in terms of hours worked. It measures the corresponding contribution of capital (equipment and software) to the economy in terms of “capital services.” Over the past 30 years, no form of capital has made workers more efficient than the computer. From 1995 to 2000 the capital services of computers grew at an annual rate of 40 percent. From 2007 to 2012 the rate slowed to 6.8 percent, and for 2012 it grew at no more than a 1 percent pace.
Just as higher productivity creates wealth that’s shared by both workers and business owners, low levels of productivity make businesses less efficient and lower wages. Over time that can increase income inequality. “The only times since World War II that income inequality improved were during periods where the amount of capital per labor rose,” says James Paulsen, chief investment strategist at Wells Capital Management. Prolonged periods of low productivity and investment eventually eat into growth. “By our estimates that’s already coming true,” says Wieseman, who lowered his potential gross domestic product growth rate to 2 percent.
It’s not as if companies don’t have money to spend. Cash on corporate balance sheets has increased almost 70 percent over the past four years to more than $2 trillion, the size of Russia’s economy. Profits are high, and employee compensation as a percentage of GDP fell to a 65-year low last year, according to the BEA. Companies that are spending their cash have largely chosen to increase dividends and buy back stock. Low growth and high levels of uncertainty have kept companies from investing in their own operations. Throughout the recovery, economic growth has consistently been below expectations, and executives remain wary of Washington after the government shutdown and the battles over the debt ceiling and fiscal cliff. “We’re just seeing an abundance of caution,” says Sandy Cockrell, who runs Deloitte’s quarterly survey of chief financial officers. “We keep thinking business investment is going to pick up, but it just keeps disappointing.”
A key tax break has also been downsized. Since 1983 businesses have been able to record as an expense new machinery and equipment. The result was a reduction in taxable profits. From 2010 to 2013 that amount was $500,000. But the deduction expired at the end of 2013; now companies can write off only $25,000, the lowest since 2002. “That’s a big reason why my clients aren’t buying new equipment,” says Grafton Willey, former chairman of the National Small Business Association and a managing director at the Boston accounting and consulting firm CBIZ Tofias.
There may be an even bigger reason businesses aren’t investing: Wall Street has rewarded those that don’t. According to Morgan Stanley, companies that haven’t spent on new equipment have outperformed those that have spent for most of the recovery. The situation could be set to change: For the last four months, companies with high levels of capital spending have outperformed those with low levels. Savita Subramanian, head of equity and quantitative strategies at Bank of America, thinks this could mark a turning point. Buying the stock of “companies with the largest share buybacks was the best performing strategy from 2012 through most of 2013, but is one of this year’s worst,” she wrote in a May 9 research note. This change in investor preferences could lay the groundwork for higher productivity growth. Workers may finally get those new computers.