Overall knowledge-related business investment continued to grow in 3Q 2021

But the semiconductor shortage may be creating problems for investment in information processing equipment

As BEA’s data released yesterday showed, GDP growth in the 3rd quarter of 2021 came in at a disappointing 2% annual rate. This was well below the 6.5% growth rate of the previous quarter and below general expectations. However, business (non-residential fixed) investment in knowledge-related areas grew by 5.7%. This grow was due to healthy increases in investment software (up by almost 15%) and R&D spending (up by over 9%). Investment in information processing equipment unfortunately declined by 6%. Total business investment in all other areas declined by 3.5%.

The decline in investment in information processing equipment is especially worrisome. This marks the second quarter in a row of declines following four earlier quarters of growth. This may be a reflection of the ongoing semiconductor shortage.

Another casualty of the computer chip shortage is the auto industry. Both expenditure on motor vehicles and parts and investment in transportation equipment dropped dramatically in the 3rd quarter. That decline accounts for much of the overall slow growth in GDP. If motor vehicle expenditures had simply stayed at the 2Q level, the overall GDP growth rate would have been double, at a respectable 4%.  

Knowledge related business investments did not suffer as great a cutback as other business investments in the COVID-19 slowdown and have been growing since 2Q20. They now account for 58% of total business investment (up from 50% in 3Q19). Looking at only the two digital-related investments of information processing equipment and software, this subcategory makes up 40% of business investments.

[Note: I define knowledge-related investment as the combination of investment in Information Processing Equipment, R&D, and Software. The first of these three categories is reported in the GDP data as a subcategory of Non-residential Fixed Investment: Equipment. The latter two are reported as subcategories of Non-residential Fixed Investment: Intellectual Property Products.]

Lessons from agriculture on going beyond technological innovation

One does not normally think of technological innovation and agriculture. But I recently came across an article in PwC’s Strategy & Business on “The fourth industrial revolution in agriculture” from a couple of years ago. The authors, Sebastiaan Nijhuis and Iris Herrmann, describe how technologically sophisticated agriculture has become and how agribusiness is going about implementing new technologies. These technologies range from AI to track and better manage cows for more efficient milk production to the use of drones and IoT sensors to improve crop yields.

https://www.strategy-business.com/article/The-fourth-industrial-revolution-in-agriculture

However, what really struck me about the article was not the new technologies. Rather it was their argument on the need for organizational and strategic change to better utilize the technologies. And, in turn on how the development of these technologies will force those changes in ways we might not expect. For example:

“One firm is developing a swarm of miniature autonomous robots that can plant seeds. Controlled by a farmer’s handheld tablet, which is operated with the help of satellites and cloud-based software, the swarm will be able to put each seed in the right place with greater precision than current approaches can. Not incidentally, the technology will eliminate the need for planter bars, tractors, and tractor operators.”

They go on to note that:

“The most common response of companies has been to plug new technology into old business models, with the hope of enhancing those models with smarter tools and more data. But that tactic is flawed. Making old models work better isn’t enough — not when technologies are enabling all-new models that can render the old ones obsolete.

Many pesticide and fertilizer companies, for example, are using 4IR [4th Industrial Revolution] technologies to provide better products and roll them out faster than before. That might sound like a success story, but precision farming — which uses IoT sensors, high-resolution 3D aerial imagery from drones, and AI-powered analytics to analyze the characteristics of soil and the behavior of crops down to the square inch — may soon significantly reduce the need for fertilizers and pesticides altogether.

A better approach for those manufacturing companies is to discover and develop these new business models, creating new markets along the way. Instead of looking for a better product, companies should look for better solutions for the problems that their customers face, whether those customers are farmers, agricultural suppliers, or end consumers. Many successful solutions will bring together products and services from multiple companies, rather than just using products manufactured by the solution provider.”

Good advice in general – not just for agribusiness.

More on disclosure of human capital data

One of the most important policy steps the US could take to heighten awareness of intangible assets is to require companies to include them in companies’ financial statements (see earlier postings). In a speech given earlier this summer, SEC Chairman Gary Gensler reiterated his support for enhanced disclosure by companies of their human capital:

Further, investors have said that they want to better understand one of the most critical assets of a company: its people. To that end, I’ve asked staff to propose recommendations for the Commission’s consideration on human capital disclosure.

This builds on past agency work and could include a number of metrics, such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.

Disclosure helps companies raise money. It helps the efficient allocation of capital across the market. And it helps investors place their money in the companies that fit their investing needs.

As the SEC works through its process, it is important to understand what companies are already doing. A new study out from the analytics organization JUST Capital (The Current State of Human Capital Disclosure in Corporate America: Assessing What Data Large U.S. Employers Share) provides some helpful insights.

The report identifies 35 human capital metrics (28 of which they were able to collect data). The metrics cover six themes: employment and labor type; job stability; wages, compensation, and benefits; workforce diversity, equity, and inclusion; occupational health and safety; and, training and education. The specific metrics are very detailed. For example, the employment and labor type theme includes not only the number of employees but the number of on-site contractors and on-site temporary or seasonal workers. The job stability theme includes the amount of voluntary turnover by gender and race/ethnicity. The wages theme includes the minimum wage to local minimum wage ratio.

Their analysis of the data collect from 100 of the largest U.S. companies shows why SEC action is needed. To start with, disclosure of human capital data is low. The disclosure rate is below 20% for the majority of metrics. The most commonly disclosed metric was the number of full time employees; even there the disclosure rate was below 40%.

And even then when the data is disclosed, it is likely to be included in a Corporate Social Responsibility Report, Sustainability Report or other Impact Report rather than in the company’s financial report (10-K). As important as these reports are, the study points out that they are optional publications with no set standards for reporting and no auditing requirements. Thus, they are difficult to use to make comparisons across companies and may lack accountability.

The report explains why this lack of data standardization matters: “Without the ability to compare how companies are performing on various human capital metrics, investors can’t make well-informed decisions about where to direct their holdings, potential hires can’t factor a company’s treatment of workers into their employment choices, and customers can’t shift their purchasing practices to support companies leading the way.”

Likewise, the same need for comparability is the reason for why such data disclosure must be mandatory. I understand that some object to increased mandatory reporting, arguing that it gives away important information to competitors. Remember that there was a time when the disclosure of even basic financial data such as revenues, expenses and profits was opposed on the grounds it was proprietary. But as I noted back in 2005 in our paper on Reporting Intangibles, without such information investors and others are flying blind.

Managers also need better data. The JUST Capital study l0oked at public disclosure of human capital metrics. I wonder how many companies don’t even collect such data. Mandatory disclosure may force companies to do what they should be doing anyway: collecting data to better understand and manage their intangible assets including human capital.

So, the sooner the SEC moves to requiring more disclosure of data on human capital, the better. And thanks to JUST Capital for continuing to push on this topic.