The Economy from 85,000 feet

The question in TonyP’s economics final was:  “Are economies driven by supply and demand, or by transport and storage?”  Prices are impacted by changes in supply and demand.  Big changes in supply drive big changes in price which can in turn drive big changes in demand (think consumer electronics).  But what transforms an entire economy is revolutionary change in transport.  We are now experiencing the results of such a revolution, technology that transports information.  Our fortunes are now governed by flows of capital, goods, labor, and information across national borders. 

Information transport and ever-increasing automation are having profound social consequences.  In the 20th century, developed economies established a prosperous middle class.  The end of colonialism enabled formerly underdeveloped nations to start catching up.  Their progress is accelerated by computer, communications and other technologies.  But while economic inequality among many nations is shrinking, the gap between rich and poor inside nations is widening. That is because more highly developed economies are less equal.  The Gini coefficient, the difference between top and bottom earners, is two-thirds higher for service economies than manufacturing and 150% higher for service than agrarian.  Furthermore, agrarian economies enable almost all to work, manufacturing also provides jobs for most people most of the time, but only knowledge workers thrive in information economies and low-skill jobs are automated out of existence. 

The problem is already upon us.  A 10% unemployment rate in the US gets the headlines but reality is much worse. The unemployment rate for the highest-paid 10% of the population is 3% but in the bottom decile it is over 30%.  More than a third of the US unemployed are now long-term unemployed which makes it increasingly hard for them to get a job when employment rises.  Income volatility is also increasing. From the 1970s to 2008, income volatility rose by a third in the US.  Each year, 15% of US households now see their income cut by as much as half.  This is because highly unequal income distribution makes an economy dependent on investment and luxury purchases that are more erratic than food, housing and suchlike spending by the majority.  Furthermore, investment is increasingly made overseas.  The lower income half of all US households is unprepared for emergency needs.  They not only have little or no savings but 28% say they definitely could not and 22% probably could not raise $2K within 30 days.  And it’s getting worse.  The US Gini index is rising:

The top 10% of Americans now earn around 50% of our national income.  Two thirds of the income growth between 2001 and 2007 went to the top 1% of all Americans.

A century ago management innovation focused on improving the productivity of factory workers.  Now we see rapid evolution of techniques for managing people who think for a living.  Businesses with higher concentrations of knowledge workers (above 35% of the workforce) create returns per employee three times higher than businesses with fewer knowledge workers (20% or less of the workforce).  Fully 85% of new jobs created in the US in the past decade required complex knowledge skills: analyzing information, problem solving, rendering judgment, and thinking creatively.  Intellectual property, brand value, process know-how, and other products of brain power are estimated to have generated more than 70% of all the US market value created over the past three decades.

Economies can grow just by putting more people to work.  They prosper by producing more with fewer workers.  In the 1970s, a growing US labor force generated around four fifths of GDP growth.  To maintain annual GDP growth of 2% to 3%, three quarters of future increases must come from productivity gains.  Over two thirds of productivity growth comes from product and process innovation so we have high incentives for innovation as well as ample opportunity.  Our innovators will prosper.  What about the other half of our population, those with below average capability for knowledge work?

Apologies for reusing a productivity arc I’ve used many times before.  The gas engine came into use on US farms around 1845.  For half a century, agricultural productivity continued to grow at its traditional slow pace.  But in the next half century, it accelerated at an ever increasing pace.  Why?  Because new methods of farming were adopted, methods that were possible only with gas engines.  Farm workers whose jobs were lost found new ones in manufacturing and new kinds of jobs were developed that created more incremental value than is possible for a farm worker.  At the end of that second half-century the computer came into use.  Network and other computer-based technologies followed but, just as it took gas engines half a century to change farming, so it was with computers.  Mass adoption of computer-enabled process changes began around the mid-1990s.

The loss of US manufacturing jobs to off-shoring still gets most of the headlines but ours is now a service economy.  The elimination of service jobs by computer-based process changes is even more important.  You call a voice response system to reach an off-shore call center, you self-checkout at the supermarket because there are fewer cashiers, you get cash from an ATM not a bank teller, you teleconference not travel for business because it costs less and is faster, you book leisure travel not via a travel agent but online and you get elective surgery on a visit to Bangkok where it costs less, you order fast food on a touch screen not by talking to a person, you manage your investments online not by calling your broker.  And so on.  Service jobs at every skill level in developed economies that can be automated, in whole or in part, or be provided remotely are being eliminated.

Our service institutions already are what Henry Ford’s mass production assembly lines were to blacksmith shops.  Assembly lines were replaced by robotic manufacturing with just-in-time logistics across global value-added chains, a second quantum leap in process transformation.  Service institutions will also undergo a second quantum leap.  

Nations will compete for higher and higher capability service knowledge workers.  Singapore’s government has invested heavily in education and training to attract multinational firms and offers subsidies to companies locating there.  What is the future for lower-end US  service workers who cannot compete with those in emerging economies who work 12 hours a day for a fraction of the US minimum wage?  And what is the future for our middle-end workers who will not get jobs in the kinds of business Singapore is working to attract?

It is said that when your horse dies you should get a new one.  You should not, as many do, buy a bigger whip, appoint a horse study committee, declare your horse better, faster and cheaper dead, or strap several dead horses together.  But sometimes getting a new horse is not the best strategy.  Sometimes, you should get a motorbike or stay home.  This feels like one of those times.  Our economy will not thrive by accident but by adopting policies that stimulate appropriate investment.  What are the appropriate investments to restore the great American promise, opportunity for all? 

I do not know.  I think we should invest in alternative energy research and deployment because the difference between our energy needs and our secure supplies makes us desperately vulnerable.  The same is true for other developed economies so it’s also a humungous export opportunity.  I think we should also invest in new physical transport infrastructure that is massively more energy-efficient.  I will return in future posts to what we should fix, social security, healthcare, defense, taxation etc.  What to do with them is growing clearer.  But while the numbers tell me we’re in an economic revolution with potentially devastating social consequences, I’m not clear what direction we should set.  Please comment.

Note:  Many of the above stats come from McKinsey.  I have not cross-checked them all but they all seem dependable.

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