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Monday, February 5, 2018

Apple Has Given Us an Early Sign of Tax Reform’s Long-Term Economic Boost

No doubt the digital industries will benefit from tax reform, too; but more than ever, the physical industries are poised to leverage information.

Last week, Apple generated headlines by announcing it would pay $38 billion in taxes to repatriate billions of dollars it was holding overseas, give bonuses to its employees, and contribute $350 billion and 20,000 new jobs to the US economy in the next five years — at least partially because of December’s tax reform law. While this announcement was met with much fanfare and hailed by the president, tax reform can also boost technology, productivity, and pay in other ways.

Productivity and Wages

Productivity and pay are still linked, although perhaps less tightly than before. For several years, we’ve debated whether new technologies can ignite a productivity resurgence or whether tech has lost its potency and whether increased productivity will benefit workers or eliminate jobs altogether.

The Economic Policy Institute (EPI) helped launch this debate back in 2012. In a blockbuster chart, EPI showed that for much of history, productivity and wages rose together, almost one to one, until the early 1970s. Then, in a clean break with the past, US productivity soared over the next 40 years, while wages hardly rose at all. It looked as if something had changed to rig the system against workers.

Several smart analysts, however, showed that the chart was highly misleading. Productivity and pay were still linked, although perhaps less tightly than before. Most recently, in a new, preliminary presentation, Harvard’s Larry Summers and Anna Stansbury find much the same. Holding other factors equal, “If productivity accelerates, the likely impact will be increased pay growth for middle-income workers,” they concluded.

So the case for tax reform is simple: boost productivity, boost wages. Looking at overall productivity growth, however, may miss a central point — the gigantic innovation differentials between firms and industries.

The “Information Gap”

In a recent paper, Michael Mandel and I found a yawning productivity gap between firms that use lots of information technology and those that don’t. Over the past 15 years, productivity in “digital industries” grew at a robust 2.7 percent annual rate, but productivity growth in “physical industries” was just 0.7 percent per year.

This “information gap” may also help explain the large pay divergence. We think a significant portion of this differential can be explained by the industries’ huge differential investments in — and creative use of — information technology. The physical industries account for around 70 percent of US output and 74 percent of employment but make just 30 percent of the investments in information technology.

This “information gap” may also help explain the large pay divergence. At the end of 2016, average total compensation for the 90.5 million workers in the physical industries was $55,600. But total compensation for the 32.6 million workers in the digital industries averaged $92,000.

Digital employees thus account for 26 percent of the private-sector workforce but earn 37 percent of total pay. And it’s not just because of a few high-paid executives in Silicon Valley and Wall Street.

In separate work, Mandel found that wage premiums for mid-skill occupations in digital versus physical industries range from 15 percent to 38 percent. For example, sales representatives in digital firms earn 15 percent more than non-digital sales reps.

Workers in advanced distribution centers, such as Amazon’s high-tech warehouses, earn 31 percent more than retail workers in the same geographic area. This tends to support the conclusions that productivity and pay are still linked, and technology differentials are a big part of the explanation.

Tax Reform Could End the Investment Drought

So how does all this fit into tax reform? The productivity and wage slowdowns have been concentrated in the physical industries, which have also suffered an investment drought.

The goal is to help traditional industries transform using a mix of physical capital and cutting-edge technology. Where many tech startups could rely on deep venture capital markets for growth financing and Silicon Valley giants for exit opportunities, physical economy firms enjoy no such advantages. Bank lending, public equity, and initial public-offering markets have been weak or nonexistent, especially for lower-margin businesses in the physical industries.

As foreign nations dramatically reduced their corporate tax rates, the 35 percent US rate soared on a relative basis and became yet another barrier to marginal investments in America.

The new 21 percent rate could help reverse this investment drought. The goal is not to bring back old industries and old jobs with old capital goods. The goal is to help traditional industries — manufacturing, transportation, retail, wholesale, health care, food, education, energy, etc. — transform and create new jobs, using a mix of physical capital and cutting-edge technology.

We’re beginning to see this with the coming of autonomous vehicles, drones, personalized digital health and genomic medicine, the shale petroleum boom, and robot-filled distribution centers.

No doubt the digital industries will benefit from tax reform, too; but more than ever, the physical industries are poised to leverage information.

Faster productivity growth in the physical industries doesn’t guarantee closure of the mean-median gap, but it almost certainly means better pay for millions of Americans who’ve yet to fully benefit from the information revolution.

This piece is based on the author’s December op-ed in The Hill.

Reprinted from American Enterprise Institute. 

  • Bret Swanson is a visiting fellow at AEI’s Center for Internet, Communications, and Technology Policy and president of Entropy Economics LLC, a strategic research firm specializing in technology, innovation, and the global economy.