The historians Alfred Chandler and James Cortada make the point in a 2000 essay that the software industry is unlike any other, and represents a sharp break from anything that came before. Its combination of low barriers to entry and huge growth potential make it a unique segment of the economy. To take just one representative example, Chandler and Cortada relate how IBM in 1981 “publicly encouraged ‘the industry’ [which at that time meant anybody in the economy who could program] to write software that would work on a PC, thereby driving up sales of IBM’s desktop machines… Thousands of little start-ups began… By the end of the 1990s, these companies were generating over $100 billion in sales.”

I’ve been looking over US government data on the investments made over time by American companies, and I’ve come to the conclusion that computer hardware, in addition to software, also displays some weird, wonderful, and unique economics. In particular, computers improve so quickly and consistently over time that they are fundamentally unlike anything else that companies spend money on.

In data series that go back in some cases to the early years of the 20th century, the US Bureau of Economic Analysis (BEA) has been keeping track of all the different types of equipment, or ‘fixed asset,’ bought by American companies. Fixed asset categories include construction machinery; trucks, buses, and truck trailers; photocopy and related equipment; and so on. The Bureau tracks how much each US industry spends on each category annually in both nominal and real terms.

To do this, the BEA has to estimate how much prices change over time for each type of fixed asset, holding quality roughly constant. For almost all categories of equipment, these price indexes increase over time. This is simply inflation at work, and is to be expected.

Here’s a graph of the price indexes since 1946 for the aggregate categories of Industrial Equipment, Transportation Equipment, and Other Equipment. In this graph 1995 is chosen as the reference year; all values are set to 100 for this year, and values for other years are calculated in relation to it. This doesn’t mean, of course, that the three types of equipment cost the same in 1995. The point of normalizing on a particular year is to ignore absolute price differences, allowing the viewer to concentrate instead on trends over time.

The graph shows that each of the three types of gear gets more expensive over time along roughly the same trajectory. There are no exceptions to this rule within these categories; all types of Industrial, Transportation, and Other equipment have gotten steadily more costly over time.

Computer hardware and software prices have moved in exactly the opposite direction, and the trend for hardware is especially striking. To show it, in fact, we have to move away from a linear scale on the Y axis (where each tick mark represents an additional 20 units) and adopt a logarithmic one (where each tick mark represents a factor of 10 increase). Here’s the logarithmic graph with computer hardware added:

This chart shows that since the end of WWII, prices for virtually all other types of corporate equipment have increased by about one order of magnitude (that is, one factor of 10). Over a substantially shorter time, meanwhile, computer hardware prices have decreased by about four orders of magnitude. Nothing else in the history of the industrial US economy has ever behaved like this. I’d wager, in fact, that nothing anywhere ever has.

What explains this astonishing downward trajectory in computer prices? I see four main factors at work:

The first is continued technical innovation in computer hardware, which is most famously summarized by Moore’s Law.

The second is that most of the raw materials that make up a computer are dirt cheap. Hardware is basically made from sand (for glass and chips), rust (for disk drives), plastic, and a few metals, most of them cheap.

The third factor driving prices down is high volume production. Large and growing product markets call for ever-larger factories, which can turn out goods with amazing efficiency.

The last factor, of course, is intense competition among hardware suppliers. A computer monopolist would have little incentive to reduce prices over time, even if the three factors above were all in place. Luckily for us, there have been relatively few long-lived hardware monopolies.

So what have been the consequences of this sustained freefall in hardware prices? How has it affected investment patterns over time? We’ll take up that question in later posts. In this one, I simply want to illustrate that computers are unique pieces of gear.

I’ll close with one last chart that emphasizes this point. As I was looking over the table BEA data, I noticed that in addition to hardware and software there was one other line that showed a downward price trend over some timespan. This was “Communication equipment,” (telephone and networking gear) which had a very interesting pattern. For most of its history it looked like Transportation or Industrial equipment, with price increases every year. This continued until the mid 1980s, at which time the trend line leveled off. Then it started to actually decline, a pattern that’s continued steadily until the present.

My explanation for this is straightforward: for about the last thirty years, communications equipment has been turning into computer hardware. As this happened all four of the factors listed above started to kick in, and the category’s price economics also became more computer-like — deflationary rather than inflationary — and the graph below took shape.

In the next post I’ll show a couple interesting consequences of this massive price decline. In the meantime, leave a comment and tell me what you think are the most interesting aspects of the arrival of the hardware and software industries and the digitization of our economies. I’d love to hear from you.