Pivoting To the New Economy

It is a couple of years since the world said goodbye to the Covid-19 pandemic and made an attempt to get back to business and revive economic growth. Admittedly, from all the reporting on business and economic news, we are still in a tentative soft-landing phase, and monetary policy is still in a wait and watch mode. In fact, September is the month the whole world has been waiting for to see if the US Federal Reserve announces its first rate cut, and by how much. Expectations are for a 25 bps cut. Meanwhile, the ECB has cut interest rates for the second time by 25 bps as expected, after the European economy revised its Q2 2024 GDP growth downward to 0.2% from the earlier reading of 0.3%.

While inflation cools and economic growth slows down in most parts of the world, there are also the longer-term structural economic changes to plan for, and implement. As I have written in previous blog posts, technological change, especially AI, and climate change are the two forces compelling us to consider changing the way we produce goods and services and the way we do business. These two forces are not negotiable, they can only be pushed further down the road in order to buy time. And that will only increase the pace and intensity with which economies will have to pivot, in order to make up for lost time.

The World Economic Forum has been writing and discussing Industry 4.0 for many years now but because the world had the pandemic to contend with, serious attempts to pivot our economies have been delayed. Not for long, though. To add to the economic complexity, we also have two wars to cope with, and while the consequences in terms of oil prices has been somewhat benign because of a global economic slowdown and lower demand from China, the wars’ impact on food, metals and chemicals are still considerable.

Industry 4.0 as defined by the WEF is one that is driven by digital technology, the internet as well as AI and automation. It is also one that is expected to be less energy-intensive – at least where fossil fuels are concerned – while driving the clean energy transition. While many aspects of this new kind of economy have manifested themselves in various ways, mostly in the form of the internet-based economy, e-commerce, the gig-economy, as well as the growth of subscription services, the heart or core of the industrial economy has yet to transform to one that is more conducive to Industry 4.0.

In advanced economies these changes might have been set in motion earlier, but they too have a lot of work ahead. The emerging and developing economies are far behind, except perhaps for east Asia and China where technology advancements have kept pace with the times. How the world is grappling with the demands of Industry 4.0 and the pivot, is best seen in Germany and in China. These economies indicate in sharp relief, the challenges of managing the transition while also trying to eke out economic growth. In both Germany and China, economic growth is weak largely due to weak domestic consumption. In Germany, this is due to high inflation, while in China it isn’t inflation but depressed consumer sentiment thanks to the real estate sector collapse that is causing it.

The two countries show us, in quite different and even opposite ways, why and how the pivot to the new economy is necessary and how it must be eased in gradually over time. Germany suffered the energy crisis brought on by the war in Ukraine more than other European economies, because its industry is of the older, more fossil-fuel dependent energy-intensive kind. The core of Germany’s industry are metals, chemicals and paper, all of which are energy-intensive. After years of being dependent on cheap Russian gas, the country had to make alternate arrangements, but changing the technology that powers industry takes an even longer time. While Germany did go off nuclear energy completely after the Fukushima disaster in Japan – which was not a terribly wise decision – it depended on dirtier fossil-fuels such as coal and lignite. There was a push toward renewables, but not fast or adequate enough to power industry.

While Germany has a large and important automobiles industry, this too is caught up in the transition to clean energy as well as regulatory issues. The engineering and machinery equipment that Germany’s mittelstand companies are famous for are also not yet digital-technology led. The economic powerhouse of Europe has slowed down considerably. The IMF is right to point out that Germany’s weakness comes from its ageing demographic, its regulatory hurdles and inadequate investment in infrastructure. I think it is a combination of all these and its older-era industry that are responsible for the country’s economic slowdown. Besides, Germany’s economy is too export-dependent and that too, on China which is caught in a slowdown as well. Browsing through the website of Germany’s industry body, BDI – which has changed since I last saw it and shared a link long ago, and it reeks of unprofessional PR agency mischief now – one senses at least an acknowledgement of the fact that Germany lags in new digital technology which is good; now, for the policy actions and investments that must follow. Given Germany’s well-trained workforce, it shouldn’t take them long to upskill for the new economy since they are already operating at a high level of technical proficiency.

Let us turn to China now, where the post-pandemic recovery that everyone was expecting was not to be. The Chinese economy which was hit by the real estate and housing sector fiasco has had a hard time trying to boost domestic consumption. As I have written in a previous blog post there are concrete steps that the Chinese government can take in order to bring about structural reforms that will increase the urban consumer base in the country. While they are yet to announce any such reform measure, they have been keeping interest rates accommodative and have introduced some fiscal stimulus to try and incentivise consumer purchases in the hope that consumer demand will revive.

The Chinese economy is still managing to grow by around 5%, because of its high-tech industry churning out more of all the chips, components, consumer electronics and EVs that it can export at really competitive prices. Therefore, even with the global economic slowdown, China’s high-tech industry is managing to power the economy ahead, something Germany is unable to do right now. In fact, it is these Chinese high-tech exports that the US and Europe have been complaining about when they cite its overcapacity and dumping on other countries. This doesn’t help revive domestic consumption which is the real problem in China, but the economy is at least able to chug along. Industrial profits in China have been growing at a reasonably good pace, even with slowing industrial production, and I suppose it is due to good exports growth.

In the past, China’s automatic stimulus measure in a downturn would have been to crank up infrastructure investment. Now with the real estate sector in the doldrums, and with enough built-up urban infrastructure already across the country, China has had no alternative but to pull the lever of high-tech industrial production and exports.

Both countries’ cases are symptomatic of the real economic challenges facing the world today: how to generate broad-based economic growth in an era when digital technology and high-tech industries are the ones that will lead it. It requires businesses and governments to acknowledge the challenge and the need as real and immediate, and start preparing to pivot their economies. In this context, I thought I’d reflect a little on what the main features of this new economy might be in the future and their implications.

The first and most significant aspect of the new economy in my opinion, is the fact that it is technology based, and mostly electronic and digital technology-based. These kinds of technologies are going to be part of a swathe of industries, including services and agriculture. I have been writing about how agriculture will itself have to transform, not least because of extreme weather events and climate change. Even in what are called core sector industries such as steel, aluminum, cement, fertilisers and chemicals as well as oil and gas, there is going to be a push towards cleaner technologies, that will perhaps also reduce the consumption of fossil fuels. In fact, these will have to be the first to lead the change to the new economy, as Europe seems to have already mandated with its CBAM policy.

In the context of the Indian economy, where private sector investment has yet to pick up after a massive increase in government capex for the past couple of years or more, I have been thinking that technology upgradation is one kind of private investment that companies can engage in, while they wait for consumer demand to revive more strongly. Private business investment needn’t only be expansionary, it can be transformative. If the future requires businesses to invest in a technology overhaul of sorts, we might as well plan for it and start now; there’s no reason why this should not be considered private capex, when every bit of it is to make our industry future-ready.

The second important feature of the new economy is that more of it will be services-based. This can be misleading if we think of services as only those that are internet-driven like e-commerce or delivery services, or the gig economy that all run on apps. I am thinking of deeper changes in services such as healthcare, education, financial services, mobility, media and communications, information technology, telecom, transportation, etc. that are driven by technology.

Yet another feature of the new economy is the kind of investments that will be required to adapt to, and mitigate, climate change. Carbon capture and storage, as well as clean hydrogen and other new technologies ought to make progress, while bringing down costs. EV and hybrid technologies too need to reduce costs, in order to become more acceptable by masses of consumers across the world. An important part of this, which the world hasn’t given enough consideration to, are new agriculture technologies as well as water management technologies.

When discussing new and digital technologies, especially with increased automation and AI, we know there is going to be a huge impact felt in the labour markets. Pivoting to the new economy will require more considerate and humane labour policies and practices, and must make amends for the capital-gains-all type of approach that began at the start of this century. Which is why I think that pivoting to the new economy or to Industry 4.0 shouldn’t be rushed and unplanned; it requires governments to frame the right sets of labour policies as well, so that in the transition to the new economy, millions of people are not left behind. As always, there will be arguments made that new industries and new jobs will be created. We need to think ahead and plan for what those might be, where the right skills will be available and how to develop them.

Perhaps it makes sense to focus on factor conditions and markets as will be seen in the new economy at this stage. While labour is no doubt one of the most important factors that needs greater attention, other factors such as land and capital too are important. In the new, digital-led economy, newer kinds of natural resources and commodities will gain importance because of their use in electronics, such as lithium, cobalt and rare earth minerals. On the other hand, land will also face competing demands from agriculture (for as long as it is land-based) and from bio-fuels such as ethanol. Urbanisation too will prove to be a big force affecting land use, especially in developing countries with growing populations, such as those in Asia, Africa and Latin America. In fact, these regions face the biggest conflicts over land use, for they are largely agricultural economies with growing populations and they are also the biggest commodity producers and exporters. It is imperative that these economies are at least up to speed with Industry 2.0 and 3.0, while the advanced world shifts to the new economy.

Finally, none of this is going to be possible without greater global cooperation and investment. The new economy isn’t going to be confined within national boundaries or geographies; like the internet, it will spread across the world because digital technology and clean technologies are required everywhere. Different parts of the world will adopt, adapt and accept it at varying rates and speeds, depending upon their capacity for change and investment, but like globalisation, the new economy is here to stay.

Few countries are fully ready for it, even in the advanced world. It might not be apparent now, but if you consider Biden’s economic plan and investments that were prompted by the need to compete with China, they are really the fundamentals of the new economy infrastructure being put into place in America. That would be a better way to look at it, despite the acrimony and tensions between the two superpowers. China is well on its way in the transition to the new economy and perhaps some countries in East Asia as well. Incidentally, even countries such as the UAE and Saudi Arabia in the Middle East seem to be diversifying and investing considerable sums in new and digital technology according to the World Economic Forum. Europe is the one region in the advanced world that really needs to pull itself up by its bootstraps and get competitive by investing in the right kinds of technologies to stay relevant. Here again, there is an acceptance of the problem and efforts to find a solution are already underway, with the EU recently launching a report by Mario Draghi on improving European competitiveness.

Which brings me to another issue that I have been thinking about. Whatever happened to technology transfer? It used to be such an integral part of FDI and companies collaborating across geographies; nowadays one doesn’t here of it so much. Is the globalization of supply chains and the fragmentation of manufacturing that is to blame, or is there another reason? Perhaps in the new digital age economy, we will once again learn to collaborate and share technologies. If we can think of new technologies as systems, that is. If we can think and devise them as systems instead of components and chips, bits and bytes, we might be able to transfer and diffuse technologies faster than has happened in the past couple of decades. A discussion for another day.

This article was first published on my blog on September 19, 2024.?????