Forecast 2014: The Human Transformation Revolution

By John Mauldin

January 4, 2014

The End of Growth?
Killer Robots
The Primacy of Human Capital
The Age of Transformation
Dubai, Riyadh, Vancouver, Edmonton, and Regina

It is that time of the year when we peer into our darkened crystal balls in hopes of seeing portents of the future in the shadowy mists. This year I see three distinct wisps of vapor coalescing in the coming years. Each deserves its own treatment, so this year the annual forecast issue will in fact be three separate weekly pieces.

The final letter of the series will discuss what I see as potentially developing in the markets this year, but such prognostication has to be framed within the context of two larger and far more important streams. Next week we will examine the larger economic problems facing much of the developed world, and specifically we’ll consider the Era of Unfulfilled Expectations. What happens when governments and central banks find it impossible to live up to the promises that they have made to their constituencies? Throw in a mix of frustrating demographics and disastrous economic policy choices, and you have a witch’s brew of uncertainties.

Thankfully, an even greater force of progress will ultimately overwhelm the unintended consequences of meddling governments to ultimately deliver a very positive future, even if the the benefits are somewhat unevenly distributed in the shorter term. In this week’s letter we’ll look at the economic effects of the Age of Transformation, countering the arguments that call for a bleak, low-growth future wherein all the marvelous innovations that have occurred in the course of the human experience are behind us. Are we not to see yet again a development with the impact of the steam engine, electrical grid, telecommunications, or combustion engine? I think we will – in fact, fundamental, life-changing innovations are happening all around us today. We are just looking in the wrong places, expecting the future to resemble the past. If the depressing models of zero future growth are right, then our investment choices should be far different than if we have an optimistic view of the human experiment. Yes, we must balance our optimism with an appreciation of the uncertainties that will inevitably result from the antics of overreaching governments and their hubristic economic and monetary policies; but we must first and foremost have our eyes wide open to possibilities for growth.

It might help to think of the process as one of exploration. I imagine a group of intrepid adventurers (I picture in my mind Daniel Boone) topping one mountain pass after another, each time gazing off into the distance … to the next mountain pass. Between them lie beautiful valleys and rivers – as well as parched deserts and dead-end canyons full of potentially hostile natives. So the path is both uncertain and unending, as we head toward some ultimate destination we can barely even speculate about. Such a journey should not be undertaken without a great deal of thought and preparation, and it helps if you can find an experienced guide to assist in the process.

Before we set off on this week’s leg of the journey, since this New Year’s Thoughts from the Frontline is normally the most widely read issue of the year, let me welcome new readers and note that this weekly letter is free, and you can subscribe at http://www.MauldinEconomics.com. And feel free to send this letter on to your friends and associates – I hope it will spark a few interesting conversations.

The End of Growth?

There is a school of thought that sees the first and second industrial revolutions as having been driven by specific innovations that are so unique and so fundamental that they are unlikely to be repeated. Where will we find any future innovation that is likely to have as much impact as the combustion engine or electricity or (pick your favorite)?

This is a widespread school of thought and is nowhere better illustrated than in the work of Dr. Robert Gordon, who is a professor of economics at Northwestern University and a Nobel laureate. I have previously written about his latest work, a paper called “Is US Economic Growth Over?”

Before I audaciously suggest that he and other matriculants in his school of thought confuse theproducts of industrial revolutions with their causes, and thus despair over the prospects for future growth, let’s examine a little bit of what he actually says. (You can of course read the original paper, linked above.) To do that we can turn to an article by Benjamin Wallace-Wells that I cited in Outside the Box last June. He explains Robert Gordon’s views better than anyone I am aware of.

“[T]he scope of his [Gordon’s] bleakness has given him, over the past year, a newfound public profile,” Wallace-Wells notes. Gordon offers us two key predictions, both discomfiting. The first pertains to the near future, when, he says, our economy will grow at less than half its average rate over the last century because of a whole raft of structural headwinds.

His second prediction is even more unsettling. He thinks the forces that drove the second industrial revolution (beginning in 1870 and originating largely in the US) were so powerful and so unique that they cannot be equaled in the future.

(A corollary view of Gordon’s, mentioned only indirectly in Wallace-Wells’s article, is that computers and the internet and robotics and nanotech and biotech are no great shakes compared to the electric grid and internal combustion engine, as forces for economic change. Which is where he and I part company.)

Gordon thinks, in short, that we do not understood how lucky we have been, nor do we comprehend how desperately difficult our future is going to be. Quoting from Wallace-Wells:

What if everything we’ve come to think of as American is predicated on a freak coincidence of economic history? And what if that coincidence has run its course?

Picture this, arranged along a time line.

For all of measurable human history up until the year 1750, nothing happened that mattered. This isn’t to say history was stagnant, or that life was only grim and blank, but the well-being of average people did not perceptibly improve. All of the wars, literature, love affairs, and religious schisms, the schemes for empire-making and ocean-crossing and simple profit and freedom, the entire human theater of ambition and deceit and redemption took place on a scale too small to register, too minor to much improve the lot of ordinary human beings. In England before the middle of the eighteenth century, where industrialization first began, the pace of progress was so slow that it took 350 years for a family to double its standard of living. In Sweden, during a similar 200-year period, there was essentially no improvement at all. By the middle of the eighteenth century, the state of technology and the luxury and quality of life afforded the average individual were little better than they had been two millennia earlier, in ancient Rome.

Then two things happened that did matter, and they were so grand that they dwarfed everything that had come before and encompassed most everything that has come since: the first industrial revolution, beginning in 1750 or so in the north of England, and the second industrial revolution, beginning around 1870 and created mostly in this country. That the second industrial revolution happened just as the first had begun to dissipate was an incredible stroke of good luck. It meant that during the whole modern era from 1750 onward – which contains, not coincidentally, the full life span of the United States – human well-being accelerated at a rate that could barely have been contemplated before. Instead of permanent stagnation, growth became so rapid and so seemingly automatic that by the fifties and sixties the average American would roughly double his or her parents’ standard of living. In the space of a single generation, for most everybody, life was getting twice as good.

At some point in the late sixties or early seventies, this great acceleration began to taper off. The shift was modest at first, and it was concealed in the hectic up-and-down of yearly data. But if you examine the growth data since the early seventies, and if you are mathematically astute enough to fit a curve to it, you can see a clear trend: The rate at which life is improving here, on the frontier of human well-being, has slowed.

“Some things,” Gordon says, and he says it often enough that it has become both a battle cry and a mantra, “can happen only once.”

Gordon has two predictions to offer, the first of which is about the near future. For at least the next fifteen years or so, Gordon argues, our economy will grow at less than half the rate it has averaged since the late-nineteenth century because of a set of structural headwinds that Gordon believes will be even more severe than most other economists do: the aging of the American population; the stagnation in educational achievement; the fiscal tightening to fix our public and private debt; the costs of health care and energy; the pressures of globalization and growing inequality.

Gordon’s second prediction is almost literary in its scope. The forces of the second industrial revolution, he believes, were so powerful and so unique that they will not be repeated. The consequences of that breakthrough took a century to be fully realized, and as the internal combustion engine gave rise to the car and eventually the airplane, and electricity to radio and the telephone and then mass media, they came to rearrange social forces and transform everyday lives. Mechanized farm equipment permitted people to stay in school longer and to leave rural areas and move to cities. Electrical appliances allowed women of all social classes to leave behind housework for more fulfilling and productive jobs. Air-conditioning moved work indoors. The introduction of public sewers and sanitation reduced illness and infant mortality, improving health and extending lives. The car, mass media, and commercial aircraft led to a liberation from the narrow confines of geography and an introduction to a far broader and richer world. Education beyond high school was made accessible, in the aftermath of World War II, to the middle and working classes. These are all consequences of the second industrial revolution, and it is hard to imagine how those improvements might be extended: Women cannot be liberated from housework to join the labor force again, travel is not getting faster, cities are unlikely to get much more dense, and educational attainment has plateaued. The classic example of the scale of these transformations is Paul Krugman’s description of his kitchen: The modern kitchen, absent a few surface improvements, is the same one that existed half a century ago. But go back half a century before that, and you are talking about no refrigeration, just huge blocks of ice in a box, and no gas-fired stove, just piles of wood. If you take this perspective, it is no wonder that the productivity gains have diminished since the early seventies. The social transformations brought by computers and the Internet cannot match any of this.

But even if they could, that would not be enough. “The growth rate is a heavy taskmaster,” Gordon says. The math is punishing. The American population is far larger than it was in 1870, and far wealthier to begin with, which means that the innovations will need to be more transformative to have the same economic effect. “I like to think of it this way,” he says. “We need innovations that are eight times as important as those we had before.” [emphasis mine]

It is hard not to nod your head as you peruse Gordon’s work, as it is well-written and speaks to many of our prejudices. But it makes several assumptions that are wrong, in my opinion.

First, we will not need innovations that are eight times as important. We just need eight times as many innovations. And there I bring hope, because we will see many times that number.

Let’s go back to James Watt and the steam engine. When Watt was tinkering with the power of steam, there were maybe a dozen scientists in all of Europe who could understand what he was doing and fewer who had access to his tools. Today we routinely throw 1000 scientists and engineers at what are relatively trivial problems. In the grand scheme of things, perhaps most of them are

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