What does the next 10 years look like?

This week, Alan Budenberg, Senior Investment Consultant, talks to Will Hobbs, CIO, about why the next 10 years might be exciting from the perspective of innovation and why it pays to be invested during such times.

Alan: We know that productivity, humankind’s seemingly endless ability to make more output from a given set of inputs, is the driving force of medium- to long-term returns from a diversified portfolio. This is so much so that you and the team often argue that we should ignore everything else! Nonetheless, the question I’m often asked at the moment by clients is whether crises can be good periods for such innovation – people are forced to find efficiency and adopt new technology, where previously they might have been a bit reluctant?

Will: Yes, this crisis is a good example as you know, Alan. The multiple technologies that we have needed to relocate work during this pandemic have been coalescing for decades. Breakthroughs in areas such as reliable laptop computers, video conferencing tech, high speed internet and even smartphones meant less individually than they came to mean collectively in this pandemic from a productivity perspective.?

There is some precedent too actually. Somewhat weirdly there has been a long running scrap between academics about whether or not the 1930s was the most technologically progressive decade in US economic history. This is the same 1930s which played host to one of the worst and most protracted economic downturns in US economic history remember. As with today, you found that previous far-flung breakthroughs from preceding decades, from cracking the periodic table to widely available electricity, organised to facilitate a step-change in efficiency over the decade. I think there is certainly an element of necessity being the mother of invention as you suggest.

You can also argue that recessions and crises are sometimes helpful in cutting away the dead or dying corporate flesh, in the process helping to free up the more productive businesses/sectors to play a greater role. The idea being that if there is a finite amount of resources to play with in the world (from workers to financing), you want your most efficient and dynamic businesses from the frontier sectors commanding them to get the best productivity outcomes.

I think with reference to this crisis in particular though, there is this key interaction between living standards and productivity. There is a link here to revolutions past but also potentially an important difference. We know that life expectancy (at birth) has increased by around 30 years in much of the developed world since 1900 and by more in many emerging market countries (Figure 1).

We can also link this happy statistic to the rapidly evolving technological context and what that has meant for the availability of nutrition and prevalence of disease. Some have even argued in the past that cause can run the other way – from healthier humans to more productivity. This makes sense if you think about it. Innovation comes from us. The more of us there are, replete with food and education, the more sources of potential innovative breakthroughs you have. This can certainly be argued for the all-important first industrial revolution for example – there was a surge in nutrition in the 1730s, thanks to a run of bountiful harvests in the UK. Some make the link between this and the birth of a cohort of British innovators who would grow up to change everything for everyone (Figure 2).[1]

As noted, this story has only become more tangled in this crisis – health and the prospects for the economy are indelibly linked. Some are arguing that this fact may have changed the cost benefit calculation of investment in health technology for example. The result of all this extra attention, investment, and brainpower applied to the area of health could be a surge in life expectancy. The point I think really to get across is that the more of us there are, the better life gets.

Alan: Do these incoming advances that have been so essential to mitigating the effects of this pandemic get rolled up in what is often called ‘the fourth industrial revolution’? And I guess within that it would be helpful to be a bit more specific about what we mean by the term ‘industrial revolution’?

Will: Yes, the concept of industrial revolution is probably a bit misused. I think you can think about it as a sustained quickening in the pace of the change, facilitated by the arrival of what are called ‘General Purpose Technologies’. These are things like electricity, the computer chip, and the steam engine that have multiple potential applications. The point is that in the last few hundred years, really since the first industrial revolution, the world has been in a near-permanent state of technological revolution (Figure 2 again) however there have so far been three identifiable phases where this has quickened substantially. The first was really about harnessing steam and water to mechanise production. The second then benefited from advances in steel and electricity to create the potential for mass production. The third centred around the computer chip, with work moving from factories to the offices amidst the march of the ‘knowledge economy’. The fourth is essentially ongoing and surrounds, but is certainly not limited to, the application of the digital economy.

I think there are a couple of points to make. First, the more closely you study these revolutions the more they become hard to characterise with a single technological breakthrough. There tend to be myriad overlapping and interacting influences, sometimes taking decades to take shape. Second, it is amazing how the demands on the workforce have changed over this time. Prior to the first industrial revolution in England, it was cottage industry that dominated – essentially family textile businesses. The industrial revolution ripped production out of the home and moved it forcibly to the proliferating factories and the cities they were housed in. These were brutal jobs and humankind paid a short-term price in life expectancy and living conditions for the pleasure. Eventually, the advent of the computer chip started a move from factories to offices. A boon for brains over brawn.[2] Some are suggesting that the incoming revolution in Artificial Intelligence (AI) could further change the skills needed. Empathy and emotional intelligence may begin to trump IQ in terms of valuable traits in the new economy.

Alan: I know this is still a topic of hot debate in economics circles, but what are some of the determining factors in which countries and areas benefit the most from these revolutions? Why did the first industrial revolution benefit Britain so much more than it seemed to the rest of the world, and could it be that China, for example, could really dominate the commanding heights of the fourth industrial revolution to the exclusion of others?

Will: On the UK, there are still loads of different theories here. It’s hard to think of an area that has attracted more thought from the economists of the world over the years. One of the more convincing to me revolves around the interaction of a high wage economy (Britain’s workers were expensive at the time thanks to the nation’s success in textiles in the preceding centuries) with abundant and (relatively) easily accessible coal deposits.[3] This mix certainly helped to make the pay-out from swapping people for machines very attractive.

However, then and now, I do think there is a really important role for the institutional context. Some academics called Acemoglu and Robinson have written very convincingly on this.[4] Their investigation begins with the weird case of Nogales, a city bestriding the US/Mexican border. There is a chasm in educational attainment, life expectancy, and almost every single meaningful wellbeing indicator between Nogales, Arizona and Nogales, Sonora. The question they ask is why? The answer, convincingly illustrated through these two cities’ very different development paths, lies with the very different role the respective states have evolved to play. Within this, it is the ability of a presiding authority to accept the chaos that comes with sustained innovation and productivity.

Entrenched interests, vested profitably in the status quo, tend to find the disruptive potential of innovation and all the labour force and wider attendant organisational chaos, very unappealing (naturally). In the UK, the more visible turn to that necessary check on executive power is often seen coming with the glorious revolution of 1688. There is a famous incident when Elizabeth I refused to grant an inventor, William Lee, a patent for his ‘knitting machine’ on the grounds that it would make ‘beggars’ of her people by depriving them of employment that is sometimes seen as illustrative of England (and others) pre-1688.

So history does show that it is possible to miss out on the fruits of these revolutions, because they can be painful and difficult to pick and the benefits can take many years to show up. There are plenty of examples of countries that have managed to ride one productivity surge but failed to repeat the trick. A state of permanent reinvention, with all of the challenges that brings in maintaining a stable social contract, is extremely challenging to maintain. Self-interest can be a potent block on change if executive power is sufficiently concentrated and unchecked.

I guess with China, the jury is still out (Figure 3). There are certainly areas of the current technological context where China has a lead. So, the country is seen as being very strong in applications for example – the integration of lots of other complicated tech and systems. One question will be whether Chinese institutions are sufficiently supple to navigate the sustained change that comes with an industrial revolution. One risk is that the more power that is amassed centrally, the more you head down the path of the economically-deleterious entrenched interests discussed by Acemoglu and Robinson.

Alan: And I guess you and the team are always making the point that the real rewards, in terms of investors and more broadly, can often be far from the initial innovation. You always use the shipping container as an example, but what about something from the current context?

Will: Yes that is true. It always seems like the answer has to be to buy a basket of the most exciting sounding technology companies and let the good times roll. However, the rewards to innovation often don’t work like that as you point out. I think today you could think of the real winners from a potential wider application of the Messenger RNA vaccine technology. The diseases that could wilt under this new technology have tended to bully emerging world populations, not the already developed. The benefits to life expectancy, growth, and investor returns could be most keenly felt there. You may miss the gains by just focusing on owning the innovators.

Alan: There is a quote from Bill Gates who argued that: “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction.” So, if we let our imaginations run riot, where could we get to in 10 years?

Will: If I knew that Alan… I think one interesting area where you are going to see a lot of application is Artificial Intelligence. I think we have to be specific here though. The breakthrough to the kind of AI described in dystopian science fiction, where at the point of ascension the confused robot decides that humankind needs to be tossed in the bin, that is still a long long way away.

However, within areas like machine learning, the recent advances in computing power have pushed us into more tangibly interesting territory. To your earlier point, this crisis has also given AI a ‘battlefield upgrade’. One use I read about the other day is within a hospital with an algorithm reading chest x-rays for signs of Covid-related lung infections, helping medical staff to prioritise efforts.

In many cases, but far from all, you are going to find that artificial intelligence will simply be quicker and better at assimilating vast amounts of information and making a related call than we are. This will significantly increase the efficiency of many processes across a range of sectors. The amazing thing is that an advanced image recognition system takes about a week to train using today’s computers. Performing the same number of calculations necessary in some of these applications but using the best workstations available in the early 1990s would have taken hundreds of thousands of years (Figure 4).

In terms of the more speculative stuff, there are some pretty jaw-dropping potential applications if the stories of viable quantum computing capacity being within reach bear fruit. From computational chemistry to drug design to carbon sequestration, you could see previous ceilings of understanding rapidly shattered.

Alan: What about some risks of all of this potential change – what are the lessons from history here? How do governments and regulators, among others, need to respond?

Will: Well one of the main risks, as we’ve already touched on, centres on this idea of creative destruction. While the economy opens new doors in these periods, it also necessarily closes others. That means jobs and industries are destroyed. Skills that were valuable in a prior economic paradigm are suddenly redundant. The role of the state in such periods is especially tricky. How does one make sure that you are allowing the forces of disruption sufficient space, whilst also protecting your citizens from its worst effects? How do you retain your social contract through this period? I think high on the agenda here should be education and training. Making sure that your workforce is constantly being retooled to best equip it for the ever-changing demands in terms of skills is key.?

Alan: And what about investors? What does history teach us about these accelerated periods of innovation when it comes to the returns from a diversified portfolio??

Will: I think the most important point is diversify. You and I can banter on about the next technological breakthrough and what its effects might be to our hearts content. However, the reality is that the next breakthrough could really come from anywhere at any time from anyone. The only logical response is to make sure that you design your investment net to reflect this inherent uncertainty. Make sure that you have that core exposure to the potential of the world, not just some recently successful part of it. Once you have the world in your hand, you can then garnish it with more specific investments to your heart’s content. That overall exposure should help you face your long-term financial future with a little more confidence – the inventive capacity of the entire planet will be working with whatever savings you can spare to deploy, day and night.

?[1] John Komlos, “Nutrition, Population Growth, and the Industrial revolution in England”, Social Science History, Spring, 1990, Vol. 14. No1 pp 69 - 91

[2] Vox EU CEPR, Globalisation, automation and the history of work: Looking back to understand the future, https://voxeu.org/content/globalisation-automation-and-history-work-looking-back-understand-future, January 2019

[3] Robert C Allen, The British Industrial revolution in Global Perspective – Cambridge University Press, 2009.

[4] Acemoglu and Robinson, Why nations fail – the origins of power, prosperity and poverty – Profile Books, 2013.

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