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Principal Global Investors Interpreting the facts: Technology, populism, and the economy Jim McCaughan, CEO, Principal Global Investors Facts are facts. The challenge arises in how we interpret and apply those facts. Circumstances change. Views mature. Knowledge progresses. What was state-of-the-art becomes obsolete. Each of these processes affects how we interpret and apply facts over time. With technological progress, the underlying fabric of our society is also shifting at a rapid pace, while at the same time change, maturation, and progress occurs, complicating the picture even more. 2 Since our topic is technology, consider the term “Luddite” as an example of misinterpretation. Now commonly understood as a person who is opposed to, or inept at, using technology, the term originated in the early 1800s after a series of manufacturing disturbances where workers destroyed laborsaving machinery. With the origin of the term some 200 years distant, popular assumption and romanticism supposes that a group of skilled artisans destroyed modern industrial equipment because they feared the obsolescence of their handmade craftwork. The truth is more nuanced. Jim McCaughan, CEO, Principal Global Investors Luddites, named after their fictitious leader Ned Ludd, were, in truth, factory workers. The technology they destroyed (mechanical knitting machines were a popular target) was hundreds of years old by the time the Luddites brought their hammers and axes down. Rather than any fear of technology, the Luddites were actually motivated by poor wages and working conditions.1 In the absence of labor unions, destroying textile equipment was one of the only mechanisms available to workers to protest their treatment by the factory owners. This “collective bargaining by riot” was more akin to a labor strike than a political statement against technological progress.2 The facts remain the same: workers destroyed machines. It is the interpretation that has changed. I believe rapid technological progress, an unquestioned benefit to humanity, is at the same time leading to misinterpretation and misreading of some of the basic measurements that define our lives, our livelihoods, and our economies. In this paper, we will explore some of these common misinterpretations, their effects on the economy and capital markets, and potential solutions for making progress into the future. 1 2 Conniff, Richard. “What the Luddites Really Fought Against.” Smithsonian Magazine, March 2011. Hobsbawm, Eric J. 1965. Labouring Men: Studies in the History of Labour. London: Basic Books Interpreting the facts: Technology, populism, and the economy | 3 Technology and populism: the political response Technological progress has been a critical component in an advancing standard of living throughout history. Tools and implements made work quicker, easier, and safer. Advances in printing and communications spread the knowledge further. Better, cheaper goods and services, together with ideas that people had previously never thought of, have been great drivers of progress. However, progress has always brought disruption with it – an adjustment to the status quo. In 1869, a man named Leland Stanford used a silver hammer to tap a golden spike into place at Promontory Summit in Utah. The ceremony was the joining of the Central Pacific and Union Pacific railroads. This new transcontinental railroad was the epitome of technological progress, because it truly connected the vastness of the United States for the first time. The tapping, though, also signaled the eventual end of a network of thousands of people who worked to provide horses for long-distance transit. But, as faster, more reliable transportation led to industrial development, all of those displaced workers, and more, found new employment. For every verse that technology erases with the left hand, it pens two new ones with the right. However, in the moment, this balance between wither and bloom is not always seen for what it is. As with the example of the Luddites, technological disruption has sometimes been associated with civil and political disruption. Around the world, there is now a rise in populist politicians proclaiming to be the voice of the common worker. Where jobs have been lost, populist presidents and prime ministers promise to bring those jobs back. This current strain of populism portrays job losses as the predation of foreign countries and immigrants taking “our” jobs, lending notes of isolationism and nativism. But, this is misinterpretation; the real reason behind the loss of jobs, particularly manufacturing jobs, is changing technology. 4 This trend is nothing new. Populism of this sort was common in Latin America in the latter part of the 20th century, with generally nasty economic results. There are also parallels to be drawn with the 1930s; though, history should hopefully develop in ways that are more benign. But, even in best-case scenarios, this tendency suggests more economic and market instability, and increasing impediments to trade over the next few years. Economic growth slower than would otherwise have been possible seems almost inevitable. The earliest manifestations of this most recent shift to populism were prime minister Shinzo Abe in Japan and president Xi Jinping in China. Both are highly nationalist, and proclaim “Japan First” and “China First” agendas, respectively. Next, the world saw a further progression of populism in the 2016 Brexit vote, in the rise of Mme LePen in France, the Euroscepticism of the Alternative for Germany (AfD) party, and in the political instability in Italy. In the United States, Donald Trump brought his own brand of modern populism to the White House with his “America First” ideology. Trump campaigned on some of these nationalist and anti-trade ideas, but evidence of their post-inaugural implementation is mixed. If policy precedence goes to the isolationist agenda of tariffs, deportations, immigration curbs, and a southern border wall, we could see a U.S. recession in the next two or three years. But, if the focus is on infrastructure spend, lower taxes, and deregulation, then U.S. growth could persist or even accelerate. So, this populist president, essentially brought to power by the effects of technological change, misinterpreted as beggarthy-neighbor mercantilism, is not necessarily good or bad for the economy. Though, uncertainty around his agenda widens the funnel of doubt. All of this is not to say that we should demonize technology and blame robots for unemployment. Quite the opposite. Embracing the technological trend and adjusting how we approach skills training is one of the only real long-term solutions. More on that later. Technology and the economy: the economic response The global saving glut (an excess of savings over capital investment) is an active and controversial topic. Some economists and politicians have named “secular stagnation” as the reason, brought on by a shortfall in demand. I propose that this too is misinterpretation. I suggest that maybe the global economy can now function with less capital than was previously needed. This new capital efficiency, brought to you by the sharing economy and other technological developments, is a concept I explored in detail in “The High-Tech Lever” in 2016. Sharing economy enterprises such as Airbnb and Uber are one part of the story, but comparable system development makes usage of the capital stock elsewhere in industry more intensive. Accordingly, the economy becomes less capital intensive. If my assertion turns out to be true, it would seem likely that the excess of savings over capital investment may be structural and permanent. In this scenario, excess savings, and excess demand for securities, will keep interest rates lower than they would otherwise have been. Yet another reason for “lower-for-longer” interest rates. The most scrutinized measure of prosperity is real, or inflation-adjusted, gross domestic product (GDP). The ubiquity of real GDP in modern economic conversations belies a strangeness that many users do not seem to grasp. Real GDP is based on expenditures. When a typhoon swipes the coastal regions or an earthquake shakes the ground below us, the spending to repair the damage is recorded as part of GDP. The calculation, however, ignores the obvious loss of wealth. The disaster increases GDP, even though clearly it reduces wealth. Collision-mitigation technology in automobiles has a similar but opposite effect. By avoiding a dangerous collision, the car’s owner also avoids a trip to the repair shop. Magnified across an entire economy, fewer trips to the mechanic hurt GDP, even though car owners, who have less expenses, likely feel more prosperous. Real GDP adds another layer of complexity. Since real GDP is inflation-adjusted, a problem arises in measuring changing volumes in the economy when product quality and functionality are experiencing rapid changes. If these changes are not accurately captured, GDP will not fully reflect the volume in the economy. Here is another potential source of misinterpretation. Recently, it seems to me that GDP has not fully reflected the quality improvements brought about by technology. Maybe real growth is faster than has been recorded. In line with this, productivity may be growing faster than the official statistics suggest. If true, this would be an answer to a strange conundrum. Currently, the difficulty lies in finding the appropriate way to discover the facts and interpret them. The use of technology applied to work is highly visible. And technologically inspired productivity gains are quite clear at the individual or micro level. However, increases in the broadest economic statistics have not seen technology’s shining light. Many economists recognize these measurement errors, but suggest they are insignificant. I submit that the higher pace of technology adoption in the last 10 years has caused real confusion. This would suggest that inflation is lower than the official numbers. Lest we think this is an academic problem, there are potential impacts to the monetary policy of central banks. Measures of inflation or economic growth that do not reflect the reality of the underlying economy could lead to inaction when action is warranted, or vice versa. Since this is an arena where hundredths of a percentage point can make a difference, even small discrepancies could matter. Interpreting the facts: Technology, populism, and the economy | 5 Investment Implications If a combination of technological change and aging demographics leads to persistent low interest rates, there is a potential pitfall for retirement planning. A recent report from the IMF suggests that many defined-benefit plans around the world will need a rescue by reducing benefits, injecting capital, or both.3 The political will to give government guarantees and prop up social safety nets seems likely to fade, so it may be dangerous to rely totally on some of these arrangements. Fixed annuities are one answer, if provided with matched assets. However, the rates on these annuities may not look attractive to many, even though the guarantees are worth it. Otherwise, income-producing assets will be in high demand, pushing up prices and reducing yields. So getting that income from investment, at just the time retirees and savers will need that income most, is likely to become more difficult. It is hard to envision interest rates descending much from current levels, even in the United States where rates are high by world standards. That means the massive bull market in bonds from the early 1980s to 2010, which took the 10-year Treasury yield from 15% to 1.5%, is very unlikely to continue. Whereas Treasurys had defined the bond market with a risk-free return, we may now be entering a time where fixed income’s duration is a return-free risk. Investing to provide secure income seems to be the central problem facing retirement plans. 3 6 A period of very low interest rates will also affect stock investors. Low interest rates mean lower discount rates. In turn, the lower discount rates increase the discounted value of future earnings and dividends. That means that the rewards for success and the penalties for failure will be much greater than they are in a high-rate environment. All this suggests to me that it may be worth looking for active investment in growth stocks. The future is uncertain, and the medium- and long-term view is particularly hazy. Policy changes and macro events will make a big difference in the coming years, but there are clear structural changes in the world economy that will also tend to drive returns. In my mind, the foremost of these structural factors are technology and demographics. To me, these are structural factors that seem more predictable than the vagaries of political sentiment or the randomness of global macro events. Long-term savers, both retail and institutional, should incorporate these structural changes into their thinking to avoid misinterpreting the facts that lay before them. In my mind, the foremost of these structural factors are technology and demographics. To me, these are structural factors that seem more predictable than the vagaries of political sentiment or the randomness of global macro events. International Monetary Fund. “Global Financial Stability Report: Getting the Policy Mix Right.” April 2017. Next steps Research and hard work The solutions, as I see them, are simple, but not easy, nor quick. Research and hard work are mandatory to truly understand how technology is driving measurement errors in economic and inflation statistics. To my economist and capital market colleagues, I encourage you to investigate and take this seriously. We live in an era where yesterday’s heuristics can rapidly become outdated. With the advent of big data and adjacent cognitive technologies, these connections would be a laudable target of attention. Upgrade your gray matter I believe technology holds a key to understanding other solutions. Modern smartphones are such elegant and economically productive pieces of technology primarily because of their versatility. Without any changes to the hardware, a phone effortlessly transforms into a camera, a map, an entertainment center, a health monitoring tool, etc. It is the software that drives the versatility and adaptability. We humans can take this as our inspiration. The software of the human mind is education. I think the effects of education in making people economically active are essentially unchallenged. I propose that, to keep up with the pace of change, an emphasis on education – continual education – is critical for workers at all levels of the economy. The idea that education ends when we walk across a stage and grab a diploma is becoming a dusty relic. A formal education that ends at age 18 or earlier will become of increasingly diminishing value in the world of tomorrow. Education must continue throughout our lives. Continually updated skills and exposure to new ideas will be what makes the workforce of tomorrow powerful and adaptable. And this isn’t just a solution for a developed-world problem. Emerging markets, many of whom currently rely on cheap manufacturing labor to power their economies, will eventually face this exact same challenge. The answer isn’t to ignore the effects or adopt an anti-technology stance. The answer is to recognize what’s happening, adjust our system to benefit from it, and strive for progress. To aid and facilitate this progression, business should emphasize and encourage education. Programs like worker training and tuition reimbursement are good starts, but they favor certain segments of the workforce. Consider Germany, whose Mittelstand is one of the rare bastions of developed-market manufacturing might. A well-functioning apprenticeship program, endorsed by these small- and medium-sized businesses, provides trainees with the exact skill sets that employers want and need. Scaled up and expanded, this type of program would have a tremendous impact on employment and productivity. This apprenticeship program is also a main reason that Germany has one of the lowest youth unemployment rates in Europe. Or, imagine a lifelong education account, similar to a defined-contribution retirement account. Such a transportable saving tool could incentivize people to save for their own ongoing education, be that training, retraining, continuing education, or college. Ingenuity and innovation have driven technological advancement throughout history. If we apply that same ingenuity and innovation to researching the economic impacts of technological progress, and to finding new educational systems that will serve our workers over an entire lifetime, we could prepare future generations not just for the next tomorrow, but for every tomorrow. Interpreting the facts: Technology, populism, and the economy | 7 Disclosures Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of April 2017. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of future performance and should not be relied upon to make an investment decision. The information in this document contains general information only on investment matters. 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