The third great wave

The first two industrial revolutions inflicted plenty of pain but ultimately benefited everyone. The digital one may prove far more divisive, argues Ryan Avent

Oct 4th 2014

MOST PEOPLE ARE discomfited by radical change, and often for good reason. Both the first Industrial Revolution, starting in the late 18th century, and the second one, around 100 years later, had their victims who lost their jobs to Cartwright’s power loom and later to Edison’s electric lighting, Benz’s horseless carriage and countless other inventions that changed the world. But those inventions also immeasurably improved many people’s lives, sweeping away old economic structures and transforming society. They created new economic opportunity on a mass scale, with plenty of new work to replace the old.

A third great wave of invention and economic disruption, set off by advances in computing and information and communication technology (ICT) in the late 20th century, promises to deliver a similar mixture of social stress and economic transformation. It is driven by a handful of technologies—including machine intelligence, the ubiquitous web and advanced robotics—capable of delivering many remarkable innovations: unmanned vehicles; pilotless drones; machines that can instantly translate hundreds of languages; mobile technology that eliminates the distance between doctor and patient, teacher and student. Whether the digital revolution will bring mass job creation to make up for its mass job destruction remains to be seen.

Powerful, ubiquitous computing was made possible by the development of the integrated circuit in the 1950s. Under a rough rule of thumb known as Moore’s law (after Gordon Moore, one of the founders of Intel, a chipmaker), the number of transistors that could be squeezed onto a chip has been doubling every two years or so. This exponential growth has resulted in ever smaller, better and cheaper electronic devices. The smartphones now carried by consumers the world over have vastly more processing power than the supercomputers of the 1960s.

Moore’s law is now approaching the end of its working life. Transistors have become so small that shrinking them further is likely to push up their cost rather than reduce it. Yet commercially available computing power continues to get cheaper. Both Google and Amazon are slashing the price of cloud computing to customers. And firms are getting much better at making use of that computing power.

In a book published in 2011, “Race Against the Machine”, Erik Brynjolfsson and Andrew McAfee cite an analysis suggesting that between 1988 and 2003 the effectiveness of computers increased 43m-fold. Better processors accounted for only a minor part of this improvement. The lion’s share came from more efficient algorithms.

The beneficial effects of this rise in computing power have been slow to come through. The reasons are often illustrated by a story about chessboards and rice. A man invents a new game, chess, and presents it to his king. The king likes it so much that he offers the inventor a reward of his choice.

The man asks for one grain of rice for the first square of his chessboard, two for the second, four for the third and so on to 64. The king readily agrees, believing the request to be surprisingly modest.

They start counting out the rice, and at first the amounts are tiny. But they keep doubling, and soon the next square already requires the output of a large ricefield. Not long afterwards the king has to concede defeat: even his vast riches are insufficient to provide a mountain of rice the size of Everest. Exponential growth, in other words, looks negligible until it suddenly becomes unmanageable.

Messrs Brynjolfsson and McAfee argue that progress in ICT has now brought humanity to the start of the second half of the chessboard. Computing problems that looked insoluble a few years ago have been cracked. In a book published in 2005 Frank Levy and Richard Murnane, two economists, described driving a car on a busy street as such a complex task that it could not possibly be mastered by a computer. Yet only a few years later Google unveiled a small fleet of driverless cars. Most manufacturers are now developing autonomous or near-autonomous vehicles. A critical threshold seems to have been crossed, allowing programmers to use clever algorithms and massive amounts of cheap processing power to wring a semblance of intelligence from circuitry.

Evidence of this is all around. Until recently machines have found it difficult to “understand” written or spoken language, or to deal with complex visual images, but now they seem to be getting to grips with such things. Apple’s Siri responds accurately to many voice commands and can take dictation for e-mails and memos. Google’s translation program is lightning-fast and increasingly accurate, and the company’s computers are becoming better at understanding just what its cameras (as used, for example, to compile Google Maps) are looking at.

At the same time hardware, from processors to cameras to sensors, continues to get better, smaller and cheaper, opening up opportunities for drones, robots and wearable computers. And innovation is spilling into new areas: in finance, for example, crypto-currencies like Bitcoin hint at new payment technologies, and in education the development of new and more effective online offerings may upend the business of higher education.

This wave, like its predecessors, is likely to bring vast improvements in living standards and human welfare, but history suggests that society’s adjustment to it will be slow and difficult. At the turn of the 20th century writers conjured up visions of a dazzling technological future even as some large, rich economies were limping through a period of disappointing growth in output and productivity.

Then, as now, economists hailed a new age of globalisation even as geopolitical tensions rose. Then, as now, political systems struggled to accommodate the demands of growing numbers of dissatisfied workers.
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Some economists are offering radical thoughts on the job-destroying power of this new technological wave. Carl Benedikt Frey and Michael Osborne, of Oxford University, recently analysed over 700 different occupations to see how easily they could be computerised, and concluded that 47% of employment in America is at high risk of being automated away over the next decade or two. Messrs Brynjolfsson and McAfee ask whether human workers will be able to upgrade their skills fast enough to justify their continued employment. Other authors think that capitalism itself may be under threat.

The global eclipse of labour

 

This special report will argue that the digital revolution is opening up a great divide between a skilled and wealthy few and the rest of society. In the past new technologies have usually raised wages by boosting productivity, with the gains being split between skilled and less-skilled workers, and between owners of capital, workers and consumers. Now technology is empowering talented individuals as never before and opening up yawning gaps between the earnings of the skilled and the unskilled, capital-owners and labour. At the same time it is creating a large pool of underemployed labour that is depressing investment.

The digital revolution is opening up a great divide between a skilled and wealthy few and the rest of society

 

The effect of technological change on trade is also changing the basis of tried-and-true methods of economic development in poorer economies. More manufacturing work can be automated, and skilled design work accounts for a larger share of the value of trade, leading to what economists call “premature deindustrialisation” in developing countries. No longer can governments count on a growing industrial sector to absorb unskilled labour from rural areas. In both the rich and the emerging world, technology is creating opportunities for those previously held back by financial or geographical constraints, yet new work for those with modest skill levels is scarce compared with the bonanza created by earlier technological revolutions.

All this is sorely testing governments, beset by new demands for intervention, regulation and support. If they get their response right, they will be able to channel technological change in ways that broadly benefit society. If they get it wrong, they could be under attack from both angry underemployed workers and resentful rich taxpayers. That way lies a bitter and more confrontational politics.

Emerging economies

Arrested development

The model of development through industrialisation is on its way out

Oct 4th 2014
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THIRTY-FIVE YEARS ago Shenzhen was a tiny fishing village just over the river from British Hong Kong. Its inhabitants, like most Chinese, lived in poverty. In 1978 the average income in America was about 21 times that in China. But in 1979 China’s leader, Deng Xiaoping, chose Shenzhen as the country’s first special economic zone, free to experiment with market activity and trade with the outside world. Shenzhen quickly found itself at the leading edge of Chinese economic development, using the same model as Japan, South Korea and Hong Kong itself had done at earlier stages. In the late 1970s China was bursting with cheap, unskilled labour. It opened its doors (a crack, in lucky places like Shenzhen) to foreign manufacturers waiting to take advantage of these low labour costs. Even though wages were at rock bottom, both productivity and pay in urban factories were dramatically higher than in agriculture, so China’s fledgling industrialisation attracted a steady flow of migrants from the countryside.

Over time local production became more sophisticated and wages went up. Industrial cities served as escalators for development, linking the Chinese economy with global markets and allowing incomes to rise steadily. The fruits of this process are clearly visible. As visitors approach the checkpoints between Hong Kong and the mainland, a modern skyline rises on the horizon. Great glass-sheathed skyscrapers reach upwards in central Shenzhen, which boasts some of the world’s tallest buildings. At street level Chinese workers stroll past shopfronts displaying Western luxury brands: Ferrari, Bulgari, Louis Vuitton.

Governments across the emerging world dream of repeating China’s success, but the technological transformation now under way appears to be permanently changing the economics of development. China may be among the last economies to be able to ride industrialisation to middle-income status. Much of the emerging world is facing a problem that Dani Rodrik, of the Institute for Advanced Study in Princeton, New Jersey, calls “premature deindustrialisation”.

For most of recent economic history, “industrialised” meant rich. And indeed most countries that were highly industrialised were rich, and were rich because they were industrialised. Yet this relationship has broken down. Arvind Subramanian, of the Peterson Institute for International Economics and reportedly soon to become chief economic adviser to the Indian government, notes that, at any given level of income, countries today are less reliant on manufacturing, in terms of both output and employment, than they were in the past, and that the level of income per person at which reliance on manufacturing peaks has also declined steadily (see chart 4). When South Korea reached that point in 1988, its workers’ earnings averaged just over $10,000 (in PPP-adjusted 2011 dollars) per person. When Indonesia got there in 2002, average income was just under $6,000, and for India in 2008 it was just over $3,000.
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Premature non-industrialisation

 

Early loss of industry (or, in India’s case, what Mr Subramanian calls “premature non-industrialisation”) is a distressing trend, given the role that exports of goods have historically played in economic development. Productivity in export industries is generally high, otherwise they could not compete in global markets. Over time, productivity in making traded goods tends to rise as firms and workers in the industry become familiar with the technologies involved. Past developmental success stories such as the Asian tigers moved from low-margin, labour-intensive goods such as clothing and toys to electronics assembly, then on to component manufacture and, in the textbook cases of Japan and South Korea, to advanced manufacturing, design and management.

Export success trickles down to the rest of developing economies. Since producers of non-traded goods and services, such as housebuilders and lawyers, must compete with exporters for labour, they need to pay attractive wages. At the same time the chance of well-paid work in manufacturing creates an incentive for workers to move to cities and invest in education. An industrialising export sector is like a speedboat that pulls the rest of the economy out of poverty.

Loss of industry at low income levels, by contrast, caps the contribution that manufacturing can make to domestic living standards. That is no small problem: there is no obvious alternative strategy for turning poor countries into rich ones.

The change in technology’s role in development began in the 1980s. Richard Baldwin, an economist at the Graduate Institute of International and Development Studies in Geneva, explains that for much of modern economic history the driving force behind globalisation was the falling cost of transport. Powered shipping in the 19th century and containerisation in the 20th brought down freight charges, in effect shrinking the world. Yet since the 1980s, he says, cheap and powerful ICT has played a bigger role, allowing firms to co-ordinate production across great distances and national borders. Manufacturing “unbundled” as supply chains scattered across the world.

According to Mr Baldwin, this meant a profound change in what it is to be industrialised. The development of an industrial base in Japan and South Korea was a long and arduous process in which each economy needed to build capabilities along the whole of a supply chain to manufacture finished goods. That meant few economies managed the trick, but those that did were rewarded with a rich and diverse economy.

In the era of supply-chain trade, by contrast, industrialisation means little more than opening labour markets to global manufacturers. Countries that can grab pieces of global supply chains are quickly rewarded with lots of manufacturing employment. But development that is easy-come may also be easy-go. Unless the economies concerned quickly build up their workers’ skills and infrastructure, wage increases will soon lead manufacturers to up sticks for cheaper locations.

From stuff to fluff

 

Another mechanism through which new technology is changing the process of development is the dematerialisation of economic activity. Consumption the world over is shifting from “stuff to fluff”, reckons Mr Subramanian. People everywhere are spending a larger share of their income on services such as health care, education and telecommunications. This shift is reflected in trade. Messrs Subramanian and Kessler note that, measured in gross terms, goods shipments dominate trade as much as ever. They accounted for 80% of world exports in 2008 (the most recent figure available), down only slightly from 83% in 1980. Measured in value-added terms, however, the importance of goods trade tumbled, from 71% of world exports in 1980 to just 57% in 2008, because of the increasing weight of services in the production of traded goods. Much of the value of an iPhone, for example, derives from the original design and engineering of the product rather than from its components and assembly.

A recent report by the McKinsey Global Institute put the value in 2012 of “knowledge-intensive” trade—meaning flows of goods or services in which research and development or skilled labour contribute a large share of value—at $12.6 trillion, or nearly half the total value of trade in goods, services and finance. Physical assembly accounts for a declining share of the value of finished goods.

The knowledge-intensive component of trade is also growing more quickly than trade in labour-, capital- or resource-intensive products and services. At the same time the dramatic decline in the cost of information and communications technologies has opened up trade in some high-value services. Skilled programmers in India, for example, can sell IT services around the world despite the low overall level of development of the Indian economy.

India has masses of cheap, unskilled labour that ought to be attractive to firms wanting to set up low-cost manufacturing facilities. Yet operating them would require at least some skilled workers, and the rising premium on these created by trade in ICT services makes it uneconomic for many would-be manufacturers to hire the necessary talent. Mr Subramanian and Raghuram Rajan, another Indian economist, have dubbed this the “Bangalore bug”, a reference to the extraordinarily successful ICT cluster in the southern Indian city of Bangalore. But other emerging economies are similarly affected.

Other advances are eliminating the need for human labour altogether. Walking through an electronics production line at Foxconn’s Longhua campus in Shenzhen, a worker points out places where people have already been replaced by machinery—“to reduce injuries to workers”, he says. Elsewhere on the line he indicates a place where a robot is being tested to take over a range of tasks from humans. Perhaps 10% of the staff at Longhua now consists of engineers working on such automation.

Successful solutions will be rolled out to other Foxconn facilities, says Louis Woo, a special adviser to Foxconn’s chairman, Terry Gou. And Foxconn has even greater ambitions. In Chengdu it is working on a “lights out”, entirely automated, facility which serves a single, as yet unnamed, customer. In fast-developing and rapidly ageing China workers are becoming increasingly expensive, as well as hard to find. Automation provides a means to hold on to work that might otherwise pack up and move to another country.

It also saves a lot of trouble. Vast areas of Foxconn’s Longhua campus are given over to support services for the roughly quarter of a million workers employed there: shops and restaurants, a massive central kitchen with automated rice-cooking equipment, dormitories that house about half the staff, schools for workers’ children and counselling services for distressed employees. Foxconn’s dormitories are ringed with netting, a precaution prompted by an epidemic of suicides by workers that set off a torrent of bad press for the company and its customers. Indeed, notes Mr Woo, it is often customers that are behind the push for greater automation of Foxconn’s facilities.

The falling cost of automation makes the use of robots attractive even in India, where cities are swarming with underemployed young workers. The main reason for that is the country’s thicket of red tape. Mr Subramanian thinks India’s best hope now may be to concentrate on churning out more highly skilled workers, rather than count on manufacturing to mop up its jobless millions.

The rapid growth in emerging economies over the past 15 years was good for many very poor countries in Africa and Central America, but most still grew more slowly than richer developing countries in Asia and South America. Given the institutional weakness, inadequate infrastructure and modest skills base in many of the world’s poorest places, even rock-bottom wages there may be insufficient to attract much manufacturing.

That is a distressing prospect. The United Nations estimates that sub-Saharan Africa’s population will roughly triple over the next half-century, to about 2.7 billion. A development model in which rapidly rising incomes are limited to a highly skilled few is unlikely to be sustainable. Many talented workers are already thinking about emigrating, yet rich economies trapped by growing social spending and shrinking tax bases are more likely to slam their borders shut. Over the past decade or two inequality, despite rising within many economies, has shrunk at the global level, thanks to rapid growth in large emerging markets. But in the absence of a new development model, that happy state of affairs may soon be reversed.

Review & Outlook

The President of Inequality

Policies promoting equality over growth have damaged both.

                                             

Getty Images

        

Oct. 2, 2014 7:26 p.m. ET 

 

In the latest grim tiding of the public mood, merely 42% think the American dream that "if you work hard, you'll get ahead" remains true, down from 53% in 2012 and 50% in 2010. According to the Public Religion Research Institute poll last week, the steepest declines in belief in the last two years were among people under age 30 (down 16 percentage points), women (14 points) and Democrats (17).

 

In other words, the most disillusioned belong to the coalition that elected President Obama. But before giving up on upward mobility, they ought to blame the policies he has enacted. Mr. Obama has been the best President for slow growth and inequality in modern history, as new economic surveys show.

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Start with the Census Bureau's annual poverty and income survey, which came out this month. Real U.S. median household income—or the wages earned in the middle of the wage distribution—was $51,939, a 0.3% increase over 2012. But the 2013 figure is still 3.9% lower than the median income when the recession ended in 2009, and 7.9% lower than the median in 2007.

 

One trick some liberals use to obscure the uniquely bad performance of the Obama years is to go back to the height of the dot-com bubble in 1999 when real income peaked at $56,895 and compare it to 2013. But this conveniently ignores that real median household income rebounded smartly in the middle of the last decade. That rebound occurred after the Bush tax cuts on capital income and marginal income-tax rates became law in 2003.

 

                

As the nearby chart shows, incomes fell after 1999 through 2004 but then rose again for three straight years and nearly reached the 1999 level in 2007 at $56,436. The bottom fell out with the 2008 financial panic and recession, as you would expect. But the amazing fact of the Obama years is that incomes did not rebound with the recovery as they have in every other expansion. Only in 2013 did incomes begin to pick up modestly, five long years into recovery.

 

Even then real median income did not increase in 2013 in 36 states. Instead, the gains were concentrated in metro areas like Washington-Arlington-Alexandria (median: $90,149), San Francisco-Oakland-Hayward ($79,624) and Boston-Cambridge-Newton ($72,907). Wyoming amid the fracking revolution was another standout, with the median rising 5.7%.

 

This slow, uneven growth has also led to an increase in inequality by the measures the President's favorite economists like to cite. The Census reports that the U.S. Gini Coefficient, which measures income inequality, "was significantly higher" in 2013, rising to 0.481 from 0.476. About 45.3 million people or 14.5% of the population live below the official poverty line, down from 15% in 2012 but statistically the same number of people. Poverty over the prior four years rose to the highest levels since the mid-1960s. The poverty rate was 14.3% in 2009 and 12.5% in 2007.

 

This month the Federal Reserve also published its triennial Survey of Consumer Finances examining the 2010-2013 period. Overall average real family income rose 4%, but median income fell 5%, "consistent with increasing income concentration." There were essentially no changes for people between the 40th and 90th income percentiles after steep losses from 2007-2010, while median income rose 2% among the top 10% and fell 5.5% among the bottom 40%.

 

All of this is especially notable because it follows the most sustained policy focus on reducing inequality in decades. President Obama's stimulus spending in 2009-2010 was devoted mainly to transfer payments like Medicaid and jobless benefits. Expanding the number of Americans on food stamps and disability payments have been explicit policy goals. ObamaCare is designed to provide "free" health care to millions of Americans by taxing the wealthy and those who already have insurance.

 

Mr. Obama has also focused on income redistribution to punish the affluent while financing income transfers. So he cornered Republicans in the 2013 fiscal cliff and succeeded in raising the top income tax rate as well as levies on capital gains, dividends and small-business income.

 

On CBS 's "60 Minutes" on Sunday Mr. Obama answered a question about economic anxiety by offering another increase in the minimum wage. But the Nancy Pelosi Democrats raised the minimum wage in three stages to $7.25 an hour in 2009 from $5.15 in 2007. If mandated wages are so beneficial to the American worker, where is the evidence?

 

The Census data show that every income group that was supposed to benefit from the higher wages is worse off than before the minimum wage was increased. This is because the benefits of mandated wage increases for some workers are dwarfed by the overall negative economic trends of slower growth and reduced opportunity.

 

Another culprit in this skewed economic recovery has been monetary policy. The Fed's QE exertions have been explicitly targeted at raising asset prices, such as stocks and real estate, that are disproportionately held by the affluent. Meantime, Americans without such assets have received a pittance on their savings. The White House has been a stalwart supporter of these Fed policies.

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Census data like this used to get banner headlines, but these days they barely get media notice. Perhaps it is too embarrassing to point out that the policies flaunted to reduce inequality have presided over so much more of it. Instead, liberals use the fact of flat or falling incomes to call for more of the same policies that have resulted in flat or falling incomes. By making equality a higher priority than economic growth, Mr. Obama has reduced growth and increased inequality.

 

What's needed now is a return to policies that put growth as the country's highest economic priority. The wealthy may get richer as a result, but so will the middle class and poor who haven't benefitted from Mr. Obama's focus on inequality.

 

The good news is that the public may be ahead of the politicians in seeking this change, and it is certainly ahead of the media. A survey this year by the Global Strategy Group found that by 59% to 37% Americans prefer a political candidate who focuses on economic growth to one who focuses on fairness. Thus is Mr. Obama creating, albeit unintentionally, a new opening for the politics of growth.

Read This, Spike That

The Cracks in the Economy

Several articles show that a positive jobs report and 5.9% unemployment don’t tell the full story.

By John Kimelman

Updated Oct. 3, 2014 5:06 p.m. ET

China’s Inscrutable Contraction

Kenneth Rogoff

OCT 3, 2014

Gold Is Against The Ropes
             

October 2, 2014 10:59 pm

Dwindling US inflation casts shadow

©Reuters

 

Market expectations of US inflation have slid to levels rarely seen over the past decade, overshadowing the outlook for growth for the world’s largest economy and posing a challenge to central bank policy makers.

 

With Japan and the eurozone pushing for weaker currencies to boost their struggling economies, a strengthening dollar since the summer has cut inflation pressures for the US. That raises the prospect of global disinflationary forces swinging back and forth between regions, reinforcing the current cycle of low interest rates and lacklustre growth.

 

“Investors are beginning to realise that, contrary to their confident actions and assurances, the Fed and the European Central Bank have failed to prevent a dreaded replay of Japan’s deflationary template a decade earlier in the west,” said Albert Edwards, strategist at Société Générale.

The Fed will get its latest reading on the health of the jobs market on Friday, with the release on non-farm payrolls data for September, expected to show 215,000 new jobs and a steady 6.1 per cent unemployment rate.

Some Fed officials are starting to think about the strength of the dollar, and the broader weakness of the global economy, as a threat to the US growth outlook. Fed chairwoman Janet Yellen warned of “a number of risks to the global economy” in her most recent press conference.

 

“Given the relative movements of exchange rates, it seems likely that our net export position is going to be a challenge for those of us in the US,” said Charles Evans, president of the Chicago Fed, on Monday.

 

He questioned whether the US can decouple from weak growth elsewhere in the world. “It would be pretty surprising to have a very strong economy in an otherwise weak world economy,” he said.

The US central bank follows a dual mandate of maximum employment and stable prices, which it defines as 2 per cent inflation. Since late 2008 the Fed has undertaken several rounds of bond purchases designed to stimulate the economy, boost job creation and firm up consumer prices.

While employment has steadily improved over the past 18 months, the inflation outlook has lagged behind the Fed’s target, with consumer prices recently retreating anew due to a stronger currency and lower commodity prices.

Now as the Fed looks to formally end quantitative easing this month, a key market measure of inflation expectations that is followed by the central bank has dropped back to 2.17 per cent, near levels that in the past provoked aggressive bond purchases from the central bank.

Alan Ruskin, strategist at Deutsche Bank, said the drop in inflation expectations “is bound to gain some attention among US officials, especially if it shows persistence at levels near 2 per cent”.

The Fed follows a specific measure that looks at five-year inflation expectations that start five years from now. The so-called five-year into five-year break-even rate loiters at 2.15 per cent, near the low from September 2011 and just above the financial crisis nadir of 1.95 per cent seen in December 2008.

Mario Draghi, president of the European Central Bank, said on Thursday that eurozone inflation expectations, as measured by the region’s five-year, five-year inflation swap rate, were still below the ECB’s target, but close to 2 per cent.

Beyond the energy and global growth story lowering US inflation expectations, the Treasury inflation market has also been influenced by the travails at Pimco. Bill Gross, the former manager of the Total Return Fund, was an advocate of inflation-protected bonds and the tens of billions of outflows from Pimco during September has compelled investors to pre-empt sales by the investment firm.

The Fed watches inflation expectations closely and similar drops were a factor in its decision to launch QE2 in 2010 and the so-called Operation Twist in 2011. They are particularly important to certain Fed officials, such as James Bullard of the St Louis Fed, who are otherwise inclined towards early rate rises.


 

Copyright The Financial Times Limited 2014.

Can Your Gold Be Confiscated?
             

Oct. 2, 2014 12:48 AM ET

 

by: Avi Gilburt     

     

Hong Kong erupts even as China tightens screws on civil society

By Simon Denyer

September 30