World’s Largest Economies Prioritizing Productivity by Robert McConnaughey, Columbia Threadneedle Investments
- Demographic trends in the world’s largest economies put an urgent focus on potential drivers of productivity.
- We believe that actively seeking investments that can positively impact economic productivity will be a pillar of successful investing.
- Opportunities exist with vendors of productivity-enhancing solutions; shifts in business models that enhance productivity; productivity-enhancing corporate reforms; governments managing their balance sheets to boost efficiency and growth.
We live in a world where aggregate economic growth has been running at a sub-normal pace. This seems likely to persist. Demographics in the world’s largest economies represent one of the major challenges as we look forward. The developed world is aging rapidly, and overall fertility rates continue to fall. Working age population growth for the U.S. is not as problematic as it is for Japan and Europe, but it appears likely to remain below 1%. The total population of the most developed group of countries is expected to start shrinking by 2030, with the working age cohort increasingly challenged to support the growing percentage of elderly citizens.
Even in the emerging world, we see demographic challenges arising. Some observers note that an aging China is at risk of “growing old before it gets rich”. When we view the intersection of this likely shrinkage of working age population in the world’s largest economies with the current enormous societal debt loads, headwinds to growth are clear. If economic growth is essentially a function of working age population multiplied by worker productivity, this demographic backdrop puts an urgent focus on potential drivers of productivity. We believe that actively seeking investments in countries, industries and businesses that can positively impact economic productivity will be a pillar of successful investing in the years to come. We would highlight four ways to think about finding such investments:
- Vendors of productivity-enhancing solutions
- Shifts in business models that enhance productivity
- Governments that are incentivizing productivity-enhancing corporate reforms
- Governments that are effectively managing their national balance sheets to boost efficiency and growth
With little aggregate tailwind of economic growth, virtually every industry is in a scramble for tools to enhance their productivity. In the post-crisis era of belt-tightening, much of the easier cost-cutting opportunities have already been captured. Therefore, vendors of products and services that can demonstrably boost productivity are in a seller’s market and likely to thrive. One example of these sorts of businesses lies in factory automation and robotics. While certain manufacturing businesses such as the automotive industry have long relied heavily on highly automated processes, the penetration of robotics is growing rapidly in new fields. Not only can robots do repetitive and potentially dangerous tasks around the clock, but increased automation is changing the need to chase the lowest cost human labor sources. This trend is allowing products to be manufactured “on-shore,” closer to their end consumers.
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Perhaps even more revolutionary than robotics is the development of artificial intelligence systems, augmenting and efficiently informing human effort (and sometimes replacing it altogether). Even in extremely white-collar professions, computers are now able to almost instantly comb through immense troves of legal documents and medical journals to direct the efforts of lawyers and doctors. One can imagine a near future where a doctor’s failure to consult a learning machine before making a diagnosis would be cause for malpractice. And finally in health care, advances in medical research are coming with far greater transparency into the building blocks of life itself through genetic mapping. Biotechnology companies are beginning to move beyond the trial-and-error research practices that have brought us many of the medicines we use today towards a world where we can target specific, individualized anomalies to cure patients.
Investable opportunities in productivity can also arise from companies and industries rethinking business process and structure. One example of such a process shift is the video game industry. Video game manufacturers were historically “boom and bust” businesses not unlike movie studios. These companies would rise and fall on the back of cycles of game consoles and the fickle, hit-and-miss nature of their game launches. However, in the last few years game manufacturers have moved from selling games via disks/cartridges to digital delivery because consoles are now internet-connected. This might seem like a subtle distinction, but it has reduced the cyclicality of the business dramatically. With the ability to monetize a popular franchise with incremental extensions (new geographies, characters, weapons, etc.) with online, seamless purchases rather than the need to launch an entirely new game, the volatility of profits has been significantly reduced. This, in turn, increases the multiples afforded to the industry’s stocks.
The success of digitization goes beyond reducing cyclicality. The ability to gain revenues through incremental game extensions has enhanced both revenue growth and margins. Digitization is also opening new markets. Large parts of the potential global customer base live in countries where game piracy had made doing business there impractical. However, with the constant flow of incremental game extensions and online/interactive play, the necessity of playing the up-to-date, legitimate game version has increased dramatically. We are now seeing higher growth across a growing customer universe with lower cyclicality all via a change in the means of product delivery. This playbook is being pursued in other areas such as the SAAS (software as a service) evolution and in the “sharing economy,” where services such as taxis are being fundamentally rethought in ways that enhance the customer experience AND the productivity of existing assets.
Embracing productivity enhancement isn’t always easy. Productivity increases can come at the expense of job security and be difficult to accept politically. Japan is the most striking example of a society where protection of the status quo and job stability had been at the heart of a decades-long economic malaise. However, the looming demographic challenges and a loss of standing in the world have helped to create a backdrop where there now exists the political will for a new direction. Prime Minister Abe’s “third arrow” is effectively a game plan for change in productivity. Through a variety of incentives — most notably the use of the massive, government controlled pension assets — Abenomics policy is demanding improved corporate governance (independent directors, for example) and driving improved results as measured by metrics such as returns on equity. As my colleague Mark Burgess notes, it is as if “they have rediscovered capitalism!”
The path to changing years of embedded cultural practices is not easy and has languished in some places. For example, South Korea has long discussed the concept of “third arrow”-type efforts to reform its chaebol system and the need to drive increased innovation, but the government has struggled to deliver results. Still, the number of experiments in governments incenting corporate reforms is growing, and when such experiments are successful, the results can be powerful. Massive economies such as China, India, Brazil, and much of Europe are all wrestling with how to approach these issues to unleash greater productivity and growth. We are monitoring their actions carefully and looking for where the tangible actions match the rhetoric, as that has the potential to create powerful investment opportunities.
Finally, we would note that it often takes a challenge to catalyze real change and creative breakthroughs. The world faces very real economic challenges, and those challenges are acute enough that they may inspire real step-function changes. One possible avenue for such change is the potential for improved national governance and fully harnessing the societal balance sheet. In some parts of the world that may be as simple as governance reform for state-owned enterprises such as national oil companies. China, Brazil, and Mexico are current examples of countries working through SOE reform issues. But what I am talking about goes beyond just SOE’s to a more comprehensive vision of effective governance. A recent report by Citigroup, The Public Wealth of Nations, notes that:
“…governments around the world have an estimated $75 trillion of public assets, ranging from corporations to forests, which are often badly managed and frequently not even accounted for on their balance sheets. Over recent decades, policymakers have focused almost solely on managing debt while largely ignoring the question of public wealth. Given that in most countries public wealth is larger than public debt, just managing it better could help to solve the debt problem while also providing the material for future economic growth. A higher return of just 1% on global public assets would add some $750 billion to public revenues.”
There is a massive opportunity for public/private partnership around infrastructure and government-owned assets overall that could boost economic growth, reduce corruption, and more effectively meet the needs of the world’s citizens. India may be the best example of the vast potential for such action, and we are encouraged by the longer term vision of Prime Minister Modi. While he certainly faces daunting challenges, sometimes it takes such challenges to forge the political will to accomplish difficult things.