Are Capital Incentives Slowing the Diffusion of Cloud, Big Data, and AI?

The views expressed in this blog are solely those of the authors.

We live in a world overflowing with data, yet turning this abundance into economic growth and job creation remains a significant challenge. Cloud computing has emerged as a powerful tool for this transformation, especially in developing economies. Traditionally, firms in these countries have faced barriers to accessing computing power, largely due to the high upfront costs of purchasing servers and establishing IT infrastructure. Cloud services are changing this dynamic by allowing firms to rent scalable computing resources on-demand. In addition, cloud computing serves as the foundation for next-generation technologies such as big data analytics and artificial intelligence (AI), which have the potential to boost productivity, enable innovative business models, and drive economic growth.

However, there is a policy challenge. Many government initiatives designed to promote technology adoption—particularly tax allowances and grants for capital investments—were created in an era dominated by physical IT assets like PCs and servers. Today, a large number of countries offer some form of capital incentive (see Figure 1 below), many of which specifically target IT investments. These incentives are structured to encourage firms to purchase equipment. But what happens when the technological frontier shifts from owning hardware to renting it via the cloud?

Figure 1:  Capital investment allowances use in developing countries

_{Notes: Reflects the share of countries using a capital investment allowance, defined as the availability in at least one sector of investment tax allowances or credits that grant investors the right to deduct investment expenses from taxable income or credit them against payable taxes.  Data comprises 106 low- and middle-income countries in 2015.}

_{Source: World Bank Developing Countries Tax Incentives Database, see World Bank (2018), "Global Investment Competitiveness Report 2017/2018".}

Capital Incentives, Traditional Investments, and the Cloud Conundrum

Recent evidence shows how capital incentive policies can affect IT investments and the adoption of cloud, AI, and big data analytics. While these policies have a strong track record of stimulating investment in tangible assets such as machinery and IT equipment, they may not be as effective in the current digital landscape. Capital incentives can help address market imperfections that make it difficult for firms—especially startups and small businesses—to secure financing. For example, firms eligible for capital incentives have been found to increase their investments in hardware and software significantly compared to those that are not eligible (see Figure 2).

However, these incentives typically subsidize investments in IT hardware, not expenditures on cloud services. When cloud and IT investments serve as partial substitutes, capital incentives may unintentionally steer firms toward purchasing hardware and away from adopting cloud solutions. Evidence suggests that while capital incentives boost IT investment, they can slow cloud adoption by a notable margin (see Figure 3). The effect is even more pronounced for small and medium-sized enterprises, which are often the firms that stand to benefit most from the flexibility and scalability of cloud computing.

Figure 2: The capital incentive policy increased firm investment in hardware and software

_{Note: The chart presents the coefficients for the effects of Annual Investment Allowance (AIA) policy eligibility on hardware and software investments estimated via Callaway and Sant’Anna (2021). All regressions include year and firm fixed effects and control for lagged employment, multi-establishment status, foreign ownership and age.}

_{Source: Authors’ calculations.}

Ripple Effects on AI, Big Data, and the Workforce

The slowdown in cloud adoption has broader implications. Since cloud services provide the computational foundation for big data analytics and AI, any delay in cloud diffusion can hinder the uptake of these advanced technologies. Evidence suggests that capital incentives can slow the adoption of big data analytics and AI, delaying their diffusion by over a year on average.

There are also labor market effects. The policy dampens demand for data-analytics professionals: evidence suggests that workers in data analytics roles can experience a decline in wages in firms eligible for the incentive, relative to their counterparts in ineligible firms. Notably, there is no significant impact on other types of workers, such as those who input rather than analyze data. Thus, while the policy does not appear to affect overall labor demand, it does slow the demand for data-analytics occupations.

Figure 3: The capital incentive policy decreased firm adoption of cloud computing, big data and AI

_{Note: The chart presents the coefficients for the effects of Annual Investment Allowance (AIA) policy eligibility on hardware and software investments estimated via Callaway and Sant’Anna (2021). All regressions include year and firm fixed effects and control for lagged employment, multi-establishment status, foreign ownership and age.}

_{Source: Authors’ calculations.}

Looking Ahead: Rethinking Incentives for a Digital Economy

As governments strive to accelerate digital transformation, these findings highlight a crucial point: incentives designed for a world of physical capital may inadvertently impede the diffusion of newer, service-based technologies like cloud computing.

The original rationale for capital incentives was to address the fixed costs of capital investments and financial market failures that hinder smaller firms and startups. However, the advent of cloud computing reduces some of the need for such incentives by lowering the fixed IT costs firms must bear. The evidence suggests that policies crafted for a business environment dominated by PCs, servers, and physical infrastructure may need to be re-evaluated in light of business models increasingly built on data and digital services.

While capital incentives have historically played a vital role in supporting technology adoption, they may now be imperfectly aligned with the realities of a rapidly evolving digital economy. Policymakers should consider adapting these incentives to better support the adoption of cloud, big data, and AI—technologies that are essential for future growth and competitiveness.