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Here’s The Case For An Upside Risk In The Global Economy

By VW Staff. Originally published at ValueWalk.

One of the true riddles in the economic world today is a steady drop in total global productivity over the last few decades. That’s in spite of the growing use of computers, robotics, and artificial intelligence.

In theory, productivity should have gone up, but it didn’t.

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Ray Dalio

Professor and Nobel laureate Robert Gordon and others have foreseen that the GDP growth will decline to less than 1%, and they have all sorts of data to back up their claim.

And then we come to an analysis of Matthew Tracey and Joachim Fels that predicts the opposite may be true. They ask the intriguing question, “Productivity: A Surprise Upside Risk to the Global Economy?”

Using microeconomic rather than macroeconomic analysis, they lay out a path by which they think it might be possible for productivity to actually rise over the coming decade.

While that would be a pleasant surprise, they also include one scenario in which that productivity growth actually has a negative social impact.

The authors take a truly nonstandard approach, reach conclusions that are outside the bounds of consensus, and make us think.

So without further ado, I’ll give the floor to Matthey Tracey and Joachim Fels.

Productivity: A Surprise Upside Risk to the Global Economy?

A bottom-up look at major industries around the world reveals significant potential for productivity growth.

By Matthew Tracey, Joachim Fels

May 2017

Is productivity dead? It is no secret that global productivity has languished in the post-financial-crisis years—with precious little evidence of a turnaround. If robust productivity growth were indeed a relic of the past, the long-term consequences for investors would be profound: Lower-for-even-longer interest rates would prolong the pain for yield-starved savers, pension funds, and financial institutions; equity markets might underwhelm in a low-growth world; and PIMCO’s New Neutral might begin to look permanent.

But what if amidst all the doom and gloom there were a productivity-revival story in its infancy? That world would look starkly different. Imagine: World growth stages a comeback, interest rates normalize to the benefit of fixed income investors globally, and fears of secular stagnation give way to a renewed optimism in our future economic potential.

The productivity question couldn’t be more important. After all, there are only two ways to grow an economy: boost productivity or grow the labor force (demographics). And we’re certainly not going to get much help from demographics. Fortunately, the upside potential for global productivity is growing (or, in economist-speak, productivity’s “right tail is getting fatter”—referring to the rising probability of a positive surprise in the range of outcomes). You might never recognize productivity’s upside potential, however, looking through the lens of macroeconomics alone. So let us look instead to microeconomics (sacré bleu!) for insights. Our thesis in a nutshell: Don’t rule out a global productivity rebound in the coming years that ushers in “old normal” (4%+) global growth. While a strong rebound is not PIMCO’s baseline view, it’s a tail that is fattening—and the microeconomic catalysts may have arrived.

Productivity optimists versus pessimists: clash of titans

Labor productivity—or GDP per human hour worked—is in the dumps. Throughout the entire post-financial-crisis period we’ve observed declining productivity growth in economically significant countries worldwide (see Figure 1).

Global Economy

Productivity pessimists typically blame secular stagnation for the slump. Here, the arguments fall into two camps. “Demand-side” secular stagnation devotees, notably Larry Summers (a guest speaker at PIMCO’s upcoming Secular Forum), suggest that a chronic deficiency of aggregate demand and investment is responsible for the dismal productivity growth we’ve seen in recent years… and that absent a rebound in demand, we’re doomed to more of the same. Meanwhile, “supply-side” secular stagnationists such as Robert Gordon believe innovation today isn’t what it used to be and that productivity gains from the computer revolution (formally, the “information and communications technology” or “ICT” revolution) have mostly run their course. These supply-side pessimists argue that today’s innovations are mostly non-market—namely they help us enjoy our leisure time, but that’s about it (think iPhones loaded with fancy new apps). Gordon himself has suggested that “The future of technology can be forecast 50 or even 100 years in advance” and that he sees nothing on the horizon that will rival the breakthroughs of the past (see references list at the end of this paper—Gordon 2014).

Yet it is hard to look around and not see promising new technologies everywhere: self-driving cars, drones buzzing overhead, and “smart” everything, to name just a few. Enter the techno-optimists: people who argue we’re on the cusp of radical breakthroughs that will drive huge gains in productivity and living standards. In our increasingly knowledge-based economy, they suggest, we’re moving from a zero-sum game of trade in goods to a positive-sum game of trade in information and ideas—with exponential benefits that our brains are not wired to foresee. (If you want to become a techno-optimist, read “Abundance: The Future Is Better Than You Think,” by Peter Diamandis and Steven Kotler.)

And so the debate rages on. It is certainly true that many consumer inventions—Facebook, Fitbit, Apple Watch, and the like—don’t help workers produce more output per hour on the job. But what if these same underlying technologies (big data, microsensors, ever-smaller computers) join forces in less obvious ways to revolutionize the way firms, and whole industries, operate? And, we ask, is the future actually as predictable as Gordon would have us believe? Legend holds that an 1876 internal memo from Western Union, the telegraph monopolist, read: “The telephone has too many shortcomings to be considered as a serious means of communication.” Well, we all saw how that turned out.

Bottom line: Rapid innovation—as Robert Solow might say—is everywhere except in the productivity statistics. So what gives? Macroeconomics may not have the answer. As Dr. Olivier Blanchard reminded us during our May 2016 Secular Forum, we macro folks actually know very little about productivity. So let us turn, instead, to microeconomics.

Microeconomics: a right-tail picture of global productivity

When we look at the state of industry in 2017 from the bottom up—sector trends down to company-level innovations—we see a global economy with underappreciated potential. A productivity-driven return to “old normal” 4%+ global GDP growth may lie within reach in the coming years, based only on the spread (“diffusion”) of existing technologies.

How? A handful of technologies have emerged that are radically changing the way firms do business. These technologies—offspring of the computer revolution—include artificial intelligence (advanced robotics), simulation, the cloud, additive manufacturing (3D printing), augmented reality, big data, microsensors, and the “internet of things” (web connectivity of everyday objects). These technologies are now being used, in many cases for the first time, in synergy with one another. Together, they enable businesses to experiment more effectively, better measure their activities in real time, and scale their innovations — and those of their peers—faster. (See the works of Erik Brynjolfsson and Andrew McAfee for more.) Here’s the key: Smarter experimentation plus faster scalability of winning ideas can speed up the diffusion of best practices from productivity leaders to laggards. And global “catch-up” potential is huge, especially in emerging markets (EM). The productivity gap between leading, “frontier” firms and all others has widened dramatically in recent years—see Figure 2. (Note: This gap does not merely reflect productivity differentials across industries.) The gap cannot widen forever; inefficient and unproductive firms can play defense for a while—creative destruction takes time—but eventually they will

The post Here’s The Case For An Upside Risk In The Global Economy appeared first on ValueWalk.

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