A challenging backdrop
While many continue to hope against hope for a return to ultra-low interest rates, as inflation persists across developed economies, this hope seems increasingly remote. Since the end of last year, many leading institutions have been speculating about a new era of higher inflation and, as a result, higher rates.
Higher borrowing costs mean, at a very basic level, that companies need to make money in order to survive, let alone provide a healthy return to their shareholders. All other things being equal, this means lower shareholder returns overall.
What are the potential countervailing factors?
Governments are facing high levels of debt and are unlikely to be able to prop up their economies with stimulus spending, as was common in the onset and immediate aftermath of the pandemic.
So, in the face of higher costs - materials, labor, and capital - and without generous government support, something else will be needed in order to avoid an era of stagnation.
Lessons from the 1990s
The 1990s present an interesting reference point for our current dilemma. While seen in retrospect as a golden age for the US economy, both inflation and interest rates remained ‘high’ throughout the decade, averaging 3% and 5% respectively - similar to today’s levels.
What, therefore, was behind the boom? There is a general consensus that improvement in productivity, thanks mainly to private sector investment in technology, played a large role in driving economic growth.[1]
The wider adoption of computer hardware (PCs) and software (Windows, Microsoft Office), together with the early growth of the internet, made it possible for companies to utilize their workforces more effectively, and so improve the bottom line.[2]
This would have been hard to predict at the beginning of the decade when growth was sluggish and the economic outlook appeared grim. Could we see a similar story unfold in the latter half of the present decade?
Two potential drivers
There are two rays of hope for the productivity outlook, which could drive a repeat of the 1990s boom.
The first is, in a sense, already much discussed: the proliferation of automation (for manual labor) and increasingly AI (for cognitive labor) could have as great or an even greater effect on the ability of companies in sectors such as healthcare to achieve higher output for lower costs, thus neutralizing the effects of inflation and a potentially higher tax burden.
Focusing specifically on the role of generative AI, we see its potential to revolutionize industries by automating complex processes, generating new content, and enhancing decision-making. Generative AI can assist in creative tasks such as content creation, design, and even strategic planning, providing businesses with tools to innovate at a pace previously unimaginable. By leveraging generative AI, companies can not only streamline operations but also unlock new avenues for growth and efficiency, making it a cornerstone of the next productivity boom.
The second is not only less discussed but - in our view - framed incorrectly as a challenge rather than an opportunity: the ‘aging population’. The received view is that older members of society will exert a net negative effect on economic growth, and that longer life expectancy will serve only to make the problem worse.
This, however, is based on the assumption that older workers exit the workforce at the standard retirement age and cease all economic activity. The reality - only recently winning recognition - is that older members of society are not only willing to continue to work but are also uniquely positioned to contribute in a knowledge-based economy.
We are therefore not seeing an ageing crisis, but a longevity windfall.
Source: Federal Reserve Bank of Richmond
The labor participation rate of older workers is already increasing, and advances in technology in particular AI will - arguably - make the wisdom that comes from experience more valuable, as more mechanistic skills are replaced by faster-automated alternatives.
Conclusion
When forecasts fail, they very often do so owing to assumptions about the future that are based on the past. In the 1970s, claims that we had reached ‘peak oil’ were based on the incorrect view that no further significant reserves would be found and that extraction procedures would not continue to develop.
Similarly, there are rich seams of opportunity - perhaps hidden to many - in the global economic landscape. Looking back at the history of human innovation, an optimistic attitude seems to be a rational choice.