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The Difference Between Productivity and Innovation – and the Implications for Growth and Equity Markets 12.04.2018   

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The Difference Between Productivity and Innovation – and the Implications for Growth and Equity Markets 12.04.2018    Fund Search Luxembourg Our Firm Our Funds Our Firm Sustainability Our Funds Insights SEARCH The Difference between Productivity and Innovation – and the Implications for Growth and Equity Markets 12.04.2018 Summary Official productivity measurements have been falling for decades – a puzzling development given the rapid pace of high-tech innovations. But rather than functioning as productivity-enhancers, many of these innovations disrupt economies and markets. This could have major implications for jobs and productivity, and trigger unforeseen amounts of social and political change. 1 WELCOME TO THE FOURTH INDUSTRIAL REVOLUTION Technological innovations are taking place at a rapid and accelerating pace. Apps on our mobile phones enable us to search and find information to an extent that was unimaginable only a few years ago. The digital footprints we leave on the internet allow companies to use vast amounts of data to provide tailor-made advertisements. Self-driving cars will probably become commonplace in the not-too-distant future, while self-learning machines are already taking over functions that were once carried out by highly trained specialists. And these are just a few examples. Innovations in the digital world, notably artificial intelligence (AI), are likely to have an even more profound effect on a range of industries in the future – energy, manufacturing, retail, finance, legal and even healthcare are all expected to change significantly. In fact, the scale and scope of these technological changes have been described as a new industrial revolution – one that may be taking place right under our noses. The First Industrial Revolution – from the late 18th to mid-19th centuries – was all about the introduction of mechanical production processes, steam power and railways. The Second Industrial Revolution – from the late 19th century to the early 1930s – was characterised by major breakthroughs in the use of electricity, and by the invention of telephones, automobiles, the radio and plastics. The Third Industrial Revolution – from around 1950 to the early 2000s – saw the development of mainframe computers, personal computers (PCs), mobile phones and the internet. Since the beginning of this decade, some argue, we have been in the midst of a Fourth Industrial Revolution – one in which we can observe the fusing of the digital, physical and biological worlds. One of the earliest champions of this theory was Klaus Schwab, the founder of the Davos World Economic Forum. He has described the changes presented by the Fourth Industrial Revolution as “so profound … there has never been a time of greater promise or potential peril”. 2 WHERE HAS ALL THE PRODUCTIVITY GONE? The promise and perils of the Fourth Industrial Revolution can be applied first-hand to the concept of productivity. In other words, while today’s technological innovations may lead to significantly higher productivity – that is, much higher output per unit of input, often measured as output per hour worked – many of these technologies could also disrupt existing business processes. This could have major implications on labour markets, and trigger unforeseen amounts of social and political change. When we think about productivity in a traditional sense, we expect it to respond positively to the major technological innovations of the last few years. However, when analysing official productivity numbers, both in developed markets and in the emerging-market world, this does not seem to be the case. One is even tempted to repeat the famous Robert Solow quote from 1987: “You can see the computer age everywhere but in the productivity statistics”. According to Robert Gordon, one of the godfathers of productivity research, US labour productivity was around 2 1/3 per cent per year from the late 19th century onwards – that is, until the early 1970s. Since then, labour productivity has fallen to around 1 1/3 per cent per year, with the exception of a few years around 2000. Data provided by the Conference Board confirm these conclusions (see Figure A). Labour-productivity growth has been trending down in the developed markets for many years already – a trend that started well before the global financial crisis of 2007/2008. Even in China, the biggest emerging economy in the world, labour-productivity growth peaked in 2006. A: YEAR-OVER-YEAR PERCENTAGE CHANGE IN LABOUR PRODUCTIVITY, 3-YEAR CENTRED AVERAGE Source: Allianz Global Investors Global Economics & Strategy, The Conference Board. Data as at 2017. So how can we explain this perceived disconnect between technological innovation and low productivity numbers – and where has all the productivity gone? Unfortunately, as is often the case in the field of economics, there is no definite answer. Optimists would argue that we are still early in the multi-phase technological revolution cycle. During the current instalment phase – which is marked by the introduction of new innovations – aggregate productivity numbers still tend to be rather low. However, once we enter the deployment phase, new technologies are likely to be widely used. And once the labour force learns how to best use and apply these technologies, the argument goes, productivity is likely to pick up. In other words, optimists believe that it is only a question of when – and not if – the economy-wide productivity numbers will ultimately rise. The sectors that are likely to contribute most to productivity growth should be the most intensive digital-using sectors, rather than the tech sectors themselves. Seen through this lens, the problems presented by the potential mismeasurement of productivity are of negligible relevance, as various studies have shown. Robert Gordon1 and others take a much more pessimistic view of the long-term trend in productivity. To those in this camp, it is the lack of a “new general-purpose technology” that explains the structural decline we are seeing in productivity growth. Case in point: electricity, the major technological advance of the Second Industrial Revolution, is a technology sine qua non – one that drastically altered production processes across the board and had a massive impact on consumer behaviour. For evidence of how dependent we are on electricity, consider what happens during power outages: only a few hours after the lights go out, the world seems to come to a standstill. On the contrary, today’s technological innovations are potentially much less far-reaching – or so the argument goes. Moreover, Robert Gordon points to the overall declining trend of educational attainment – which is not only happening in the US – as an additional explanation for relatively weak productivity growth. There is another argument – and a very different one – for why the productivity trend has been declining, and it relates to monetary policy. According to this view, easy monetary conditions from central banks have lasted for too long, depressing the costs of capital and contributing to the misallocation of resources. With an artificially reduced hurdle rate for investment, there is an increasing likelihood that investments that deliver little or no boost to productivity growth will be implemented. Overinvestment in real estate during the “noughties” – which directly followed the popping of the tech bubble in 2000 – provides a classic example. The low interest rates in effect at that time pushed capital into the real-estate market, which is not a sector that has traditionally contributed a significant amount to productivity growth. In this context, one could even make the argument that monetary policy in the US and Europe since the mid-1980s has been asymmetric: expansionary in times of actual or expected economic downturns and crisis, but not sufficiently restrictive in boom times. As a result, this asymmetric monetary policy has contributed to the secular decline in productivity growth rates. The long-term solution is for central banks to normalise monetary policy, rather than to maintain or extend their ultra-easy stance. The jury is still out on which argument – the optimistic or pessimistic view – will answer the question of why productivity is falling, even as technological advancement is growing. Yet the facts are clear: the most recent wave of technological innovations has not yet led to a more efficient economy. It also seems that today’s technological revolution is likely to exacerbate labour-market trends that have been in place since the 1980s, as a consequence of the move towards automation and globalisation: In the middle-income segment of the population, there has been a decline in the demand for routine jobs such as clerking and manufacturing (seeFigure B). In the high-wage bracket, the share of labour has been growing in all major developed economies, due to rising demand for highly skilled employees. Interestingly, in the low-wage segment, the share of labour in most economies has been stable to rising – albeit accompanied by falling real wages. "THE MOST RECENT WAVE OF TECHNOLOGICAL INNOVATIONS HAS NOT YET LED TO A MORE EFFICIENT ECONOMY." B: ROUTINE JOBS ARE IN LESS DEMAND Source: C. B. Frey, T. Berger, C.Che, Political Machinery: Automation Anxiety and the 2016 U. S. Presidential Election, 2017 This trend seems likely to continue as new technologies make routine and manual jobs increasingly obsolete, while making highly skilled jobs harder to fill. For example, consider the skills that are in high demand in a technology-driven work environment: Strong IT and analytical skills (eg, data scientists) Soft skills such as creativity and communication (eg, public relations) Complex perception and refined manipulation tasks (eg, physicians) Contrast these professions with, for example, the taxi or lorry drivers whose jobs might eventually be replaced by driverless vehicles. While there is a wide range of estimates on how many jobs will be affected by the introduction of new technologies – from less than 10 per cent to almost 50 per cent – the majority of recent studies seem to agree that highly skilled, highly paid labour will be in rising demand, and low-skilled labour carrying out routine jobs will see a marked decline.
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