Declining business investment isn’t the whole story: Shift your focus to IP

While much of the northern hemisphere was on vacation in late August, U.S. second-quarter gross domestic product (GDP) growth was revised down to 2.0%, encouraging the media to lament the decline in business investment and the risk of recessionary forces reaching a point of no return. At first blush, the weakness in capital spending does appear to be challenging; private business investment declined 0.6% in the second quarter, its first contraction since the first quarter of 2016, powered by a 10% decline in capex spending on structures (per CSIMarket 2Q19). Even looking forward, S&P Global estimates growth in business investment will decrease from 11% in 2018 to 3% this year, while Morgan Stanley’s index of planned capex dropped to its lowest level in two years this June.

Coming against the backdrop of a global economic slowdown, market gyrations, escalating trade tensions and yield-curve inversions, the sharp decline in business investment has many worried. Their fear – which can of course become a self-fulfilling prophecy – is that the current sputtering of business investment amid the trade war and the global slowdown is an early indicator of growing recessionary forces.

However, the capital spending story in the U.S. is more nuanced and more positive than reported by the media pundits. According to Federal Reserve Economic Data, investment in intellectual property (IP) – including software, R&D, patents and proprietary data – continues to outpace overall investment, growing at nearly 11% in Q1 2019 and around 4% in Q2 2019. This trend is not new; software investments, for instance, have grown at twice the rate of investment in industrial equipment for more than a decade. Leading companies continue to see the value of IP investment, with private sector IP spending remarkably resilient through the last two economic downturns. Furthermore, Bureau of Economic Analysis data shows that IP is gaining importance: its share of total private investment has grown steadily from 22% in 1990 to almost 34% in 2018.

Moreover, investment in IP and technology is not solely the bastion of trendy start-ups. Even traditional industries – such as oil and gas extraction, brick-and-mortar retail, and logistics – can be re-energized by outsized productivity gains from IP utilization. The bigger picture emerging is a dual-speed world for business investment: IP-driven investing is growing and traditional physical capex is sputtering. This has some important implications:

1.    Softening business investment in “traditional” capex – such as factories, machinery and equipment – will likely continue to be a drag on economic growth this year.

2.    IP investment is not likely to waver and will continue to drive real productivity gains going forward – but only in those sectors and among those firms that have embraced the current wave of new technologies.

3.    Today’s business investment, of course, has implications for tomorrow’s productivity. The productivity gap will continue to widen between sectors and firms that embrace IP and those that do not, with the latter facing increasing obsolescence risk as IP-driven disruption extends its reach into their industry.