Investment in equipment: From processing materials to processing information Behind the Numbers, September 2015

Government statisticians divide business investment into three categories. Behind the Numbers has covered investment in structures and investment in intellectual property. When most people think of business investment, however, they think of machines: equipment used by businesses. To produce the goods and services people want to buy, businesses have to own or lease (or beg, borrow, or steal) a wide variety of things. This equipment can range from metal turning lathes to airplanes to the furnishings of a dentist’s office.

What’s on the business shopping list?

In 2014, the Bureau of Economic Analysis revealed that businesses spent approximately equal amounts on each of these four broad categories:

1. Information processing equipment (computers, communications equipment, medical equipment, instruments, and office equipment)
2. Industrial equipment (machine tools, engines and turbines, materials handling equipment, and electrical transmission equipment)
3. Transportation equipment (trucks, cars, aircraft, ships, railroad equipment): Cars and trucks make up about 80 percent of this category¹
4. Other equipment (office furniture, agricultural and construction machinery, service sector machinery, and various other miscellaneous types of equipment that can’t easily be classified)

The relatively even split among the four categories hides some significant differences in trend growth. Figure 1 compares the average annual growth rate over the past 20 years for real GDP, total real equipment investment, and real investment in each of the four categories. The fast growth of information processing equipment is not surprising, but it’s quite striking. In contrast, industrial machinery—“traditional” equipment investment—grew at about the same rate as GDP. Transportation equipment grew over twice as fast as GDP, with all types of transportation equipment contributing to the growth. Other equipment has seen fast growth in many categories offset by almost no growth in agricultural equipment and slow growth in furniture (perhaps reflecting the stagnation in office construction discussed in our previous post on nonresidential structures).

The (falling) cost of equipment

The biggest story in the sector has, of course, been the increasing importance of computers and computer equipment. This is partially because the price of information processing equipment has been falling rapidly. Figure 2 shows the price index for each of the different types of equipment investment relative to overall prices indexed to 100 in 1995. Prices of all types of equipment have been growing more slowly than overall prices, but the cost of information processing equipment has simply been annihilated. The chart shows that over about 20 years, relative prices have fallen to about one-quarter their initial level.²

As a result, growing real purchases of information processing equipment don’t necessarily translate into increasing spending in nominal terms. Between 1995 and 2014, average annual real purchases of information processing equipment of 9.3 percent have translated into an average growth of nominal purchases of just 3.1 percent. That’s created a brutal competitive environment for producers of information equipment, even as the sector has experienced explosive real growth. This trend, however, has slowed substantially in the past decade. Between 1995 and 2005, prices for information processing equipment fell 8.0 percent per year, but between 2006 and 2014, prices fell only 2.4 percent per year.

How equipment investment fared in the Great Recession—and after

Equipment investment tends to be very cyclical. It’s relatively easy for companies to cut back on purchases of new machines and equipment when they need to save money, and the spending stops (and starts) quickly. That’s very different from investments in structures, which require very long lead times, or intellectual property investment, which is not affected so strongly by the business cycle.

The most recent recession and recovery had some surprisingly different effects on the various types of equipment investment. Figure 3 shows each of the four broad categories indexed to 100 in Q2 2009.

Information processing equipment experienced the least impact from the cycle. From the time of peak spending in the category (which coincided with the business cycle peak) to the bottom in Q2 2009, which was also the bottom of the overall economy, real spending in the category fell 17 percent. That contrasts with both industrial equipment and other equipment. Spending for both of these categories was relatively flat for some time before the business cycle peak, and then fell almost 30 percent before starting to recover in late 2009 and early 2010.

Transportation equipment is a special case. The unusually large drop in transportation spending (which was down more than 75 percent from peak to trough) reflects a decline in spending for motor vehicles, specifically cars and light trucks. This very likely reflected consumer, not business, behavior. Spending for non-auto transportation equipment—categories including heavy trucks, aircraft, ships, and railroads—fell 35–40 percent. That’s certainly substantial, but nothing like the decline in spending for light motor vehicles.

Capital needs reflect changing business needs

While investment in nonresidential structures is stagnant, investment in equipment is growing faster than GDP. As a result, the US capital stock is changing. Buildings are less important, and equipment (and intellectual property) are more important in producing US goods and services. And “equipment” is increasingly less likely to refer to traditional metal fabrication machinery, and more likely to refer to computers and service sector equipment. And this equipment is cheap, especially compared to the capital needs of more traditional businesses.

All of this reflects the significant technological changes of the recent past. The substitution of knowledge and equipment for buildings, and the change from “metal bashing” to information make today’s business shopping lists look very different from their predecessors.