Download Interpreting the facts - Principal Global Investors

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. It does not take account of any
investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice,
an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding
a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change
without notice. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such
investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a specific security for any
client account.
Principal Financial Group, Inc., Its affiliates, and its officers, directors, employees, agents, disclaim any express or implied warranty
of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document or in the
information or data provided in this document.
Any representations, example, or data not specifically attributed to a third party herein, has been calculated by, and can be
attributed to Principal Global Investors. Principal Global Investors disclaims any and all express or implied warranties of reliability
or accuracy arising out of any for error or omission attributable to any third party representation, example, or data provided herein.
All figures shown in this document are in U.S. dollars unless otherwise noted.
This document is issued in:
•The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
•Europe by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London EC2V 7JB, registered in England, No.
03819986, which has approved its contents, and which is authorized and regulated by the Financial Conduct Authority.
•Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary
Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act
(Chapter 289).
•This document is issued in Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS License No.
225385), which is regulated by the Australian Securities and Investment Commission and is only directed at wholesale investors
(as defined in sections 761G and 761GA of the Corporations Act).
•This document is issued by Principal Global Investors LLC, a branch registered in the Dubai International Financial Centre
and authorized by the Dubai Financial Services Authority as a representative office and is delivered on an individual basis to
the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organization. This
document is intended for sophisticated institutional and professional investors only.
•Japan by Principal Global Investors (Japan) Ltd. (Kanto Local Finance Bureau (Kinsho) No. 462, Japan Investment Advisers
Association; Membership No. 011-01627).
•In Europe, this document is directly exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by
Retail Clients (all as defined by MiFID). In connection with its management of client portfolios, Principal Global Investors (Europe)
Limited may delegate management authority to affiliates that are not authorised and regulated within Europe. In any such case, the
client may not benefit from all protections offered by rules and regulations enacted under MiFID.
•India by Principal Pnb Asset Management Company Private Limited (PPAMC). PPAMC offers only the units of the schemes of
Principal Mutual Fund, a mutual fund registered with SEBI.
•This document is issued in Hong Kong by Principal Global Investors (Asia) Limited, which is regulated by the Securities and
Futures Commission and is directed exclusively at professional investors as defined by the Securities and Futures Ordinance.
Investing involves risk, including possible loss of principal.
Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline. Equity investments involve
greater risk, including higher volatility, than fixed-income investments.
This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution
or use would be contrary to local law or regulation. Insurance products and plan administrative services provided through Principal
Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Principal
Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc. and
Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.
©2017 Principal Financial Services, Inc.
Principal, Principal and the symbol design and Principal Financial Group are trademarks and service marks of Principal Financial Services,
Inc., a member of the Principal Financial Group. Principal Global Investors is the asset management arm of the Principal Financial Group.
t170420083v
MM9214