Economic trajectories into the future – understanding innovation

The Digital Revolution started only about 40 years ago. While much of it is still in the future, some of the challenges and opportunities ahead are already clearly visible. In essence, there are two major forces at work: One is the breakthrough of information as the next dominant economic fuel that I addressed in the previous post, the other is the diversity of economic realities around the globe. Today, I’ll take a deeper look at this diversity and how it might evolve in the future.

To start with, we have to realise that the Digital Revolution did not start on a level playing field. On the contrary, it emerged at a time when the Industrial Revolution had not yet reached every corner of the planet. As a consequence, we observe mixed economic realities around the globe, between countries, and sometimes even within countries. While it is only natural to assume that current economic situations define choices toward the future, this economic diversity creates challenging inter-dependencies between countries that policy-makers need to come to terms with. Roughly speaking, any economy might take one of three different trajectories, based on its current state of development: advanced, advancing, or developing.

Advanced economies

Today, the most advanced economies are mainly those that embarked on industrialisation early. They are moving towards post-industrialism, as information gradually replaces fossil fuels as the dominant economic fuel. In these high-wage economies, the Digital Revolution transforms the work environment: moving away from labour-intensive production of tangible goods and shifting towards intangible, data-driven or information-based services. While this trend itself is evident, it leaves these economies with two conundrums: one for production and one for the work force.

• The advanced economies have perfected consumerism, a lifestyle centred on and built around the consumption of manufactured goods. Even in a post-industrial economy, those goods must come from somewhere. And there are only two options: either production is off-shored to the advancing or even the developing economies (see below), or production is retained in the advanced economies, but left to automation. Hence we’ll observe a dynamic competition between increasing labour cost in advancing or developing economies and decreasing cost of robots for automated industrial production in the advanced economies. However, I wouldn’t expect a single race for the perfect one-size-fits-all solution. Instead, I’d foresee individual decisions, sector by sector, product by product. Such decisions will need to be re-evaluated as economic and technological conditions evolve. Today’s decisions will be tailored to the current and projected cost of labour, and cost and capabilities of robots. As these three parameters change, previous decisions will be challenged, and will likely be adjusted, potentially even revoked. In ever-changing conditions, adaptability will be a key competitive advantage, for businesses, for industries, and for entire economies.
• For the work force in the post-industrial economies, the big challenge is employability. When more and more production jobs are lost (regardless whether to off-shoring or automation), the question for the former industrial production employees is: Can they be re-trained or up-skilled for the newly emerging jobs in the information economy? Some might see that as a tough-luck situation for the individual, but I’d argue that, given the global scale of the ongoing transformation, this is a whole-of-society challenge. If society does not accept growing numbers of former production workers being out-of-job and out-of-income, then it must invest systematically in education, training, and life-long learning. Now!

The hallmark of the evolving information economies is a fundamental shift in value-generation: away from the labour-intensive production of tangible goods, towards intangible services and automation. In the longer run, this transformation of the value chains could effectively separate the generation of wealth from its distribution and create the conditions for the wide-spread introduction of a Universal Basic Income. At the same time, it would certainly change the very value system the societies of the advanced economies are built upon.

Advancing economies

Until now, the advancing economies have essentially followed the trajectory of the advanced economies, but with a significant time-lag. Most of them entered into industrialisation only when the colonial empires fell apart and a new economic and political world order emerged. But they made up for a later start with phenomenal speed: In roughly 50 years, they achieved improvements in health and wealth (measured in life-expectancy at birth, and GDP per capita) that took the pioneers of industrialisation about 200 years. In part, they benefitted from the example of industrialised economies, as they could take into account what had worked and what hadn’t. Thus venturing into already charted territory, they were less exposed to uncertainty and risk. On the other hand, all the low-hanging fruit were already picked, all the promising niches already occupied, and the advanced economies had no interest in giving up their economic dominance.

Initially, the advancing economies competed on labour cost, which was significantly lower than in the advance economies; so much lower, that it easily compensated the additional cost of transportation (for raw material and for manufactured goods). Low labour cost was the competetive advantage that led them to becoming the extended workbench of the advanced economies. But they didn’t stop there. Embracing the opportunities of globalisation that facilitated the transfer of goods and ideas all over the planet, they quickly gained experience and skills that allowed them to move up the value chain and take larger shares of the market.

For the near future, as the advanced economies gradually shift towards the information economy, the advancing economies will initially benefit from the off-shoring of production jobs. However, the advancing economies’ labour cost advantage is facing tough new challenges: one upwards, one downwards. In the upwards competition, the advancing economies must to keep up with the cost of increasingly capable robots in the advanced economies (see above), while they’ll struggle downwards with the direct competition from labour cost in the developing economies (see below). In this cut-throat competition, the current advantage of the advancing economies can only last so long. Still, even a temporary advantage in labour cost is helpful to buy a little time to prepare for entering the information economy.

The big question for the advancing economies is whether they want to keep replicating the trajectory of the advanced economies, and follow them in their wake, or whether they are ready for a bold move, to chart their own trajectory and get ahead. Take the example of South Korea, a world leader in national expenditure in Research & Development (R&D): in 2016, South Korea poured 4.2 % of its Gross Domestic Product (GDP) in R&D (compared to 2.1% on average in EU countries, 2.3 % on average in OECD countries, or 2.7 % in the U.S.). And that’s not just a snapshot, it’s the result of a long-term and sustained increase in R&D expenditure that South Korea remained committed to while many other nations saw a stagnation or even decrease. This long-term strategic investment is paying off today, as companies are globally competitive market leaders in many sectors already. And given the time-lag between R&D investment and market success, it is highly likely the South Korea’s competitiveness will improve further for the years to come.

Of course this is only one example, but it should demonstrate that we must not take the old order for granted that “once you’ve raced ahead, you’ll stay ahead“. This convenient and comforting assumption of the past, still widespread in the advanced economies, is now unmasked as what it always was: wishful thinking.

Developing economies

Today’s developing economies have struggled with many conflicts, challenges, and crisis, which denied them the path to prosperity and progress. Even those that experienced stability over longer periods only saw the enrichment of the small elite that supported the authoritarian regime, while the lot of the population didn’t change. For these countries, the path to economic improvement is not a question of preference, it’s only a question of effect: they will take whichever direction that promises to close the gap to the advanced and advancing economies: either following the route of the advancing economies, thus replicating the steps they have taken; or leap-frogging the advancing and potentially even the advanced economies by finding an own path to prosperity. So the big question for the developing economies is: Industrialise first and go digital thereafter? Or skip industrialisation altogether and go digital right away?

Either way, they have to face the competition of the advanced and advancing economies. But how successful could the developing economies be in competing on the terms already defined by the advanced and advancing economies, in competing over products and markets where these competitors already have decades and even centuries of experience? Wouldn’t it be more promising, wouldn’t it simply be the smarter move to compete on entirely new terms? On a level playing field that denies the advanced and advancing economies their advantages? Isn’t this the time for a disruptive approach that rejects the established rules and overcome traditions? Isn’t this the time for a fresh look?

It is easy enough to agree on asking such a theoretical question. But what could practical responses look like? To my mind, the linchpin is infrastructure, and how we think about it. Just recall how the railway stimulated development in Europe during the early Industrial Revolution, or how the Interstate Highway System boosted the U.S. economy after World War II. Infrastructure projects are large-scale investments in public goods, their construction immediately injects significant amounts of capital into the economy, and the newly created network effectively shrinks the distance between different economic actors: Infrastructure thus facilitates and stimulates economic activity, and ultimately development. This theory is well-known. It has proven successful in many cases, but not all. The source of the initial investment plays a major role (Foreign or domestic? Private or public?), the dimension of the project matters (Are the assumptions about future traffic realistic?), and the conditions for executing and refunding the loan for the project are important as well (Where does the workforce come from? Does the project need to recover its cost during its operation?).

In many respects, Africa serves as the case in point. Historically, railroads have been partially successful, but roads only to a lesser extent. Many prestigeous projects turned out over-dimensioned for the actual traffic, or couldn’t be sustained in operation. Today, we see serious Chinese investments (for example, in Tanzania), backed by the Chinese government and built on the experience gained in developing the Chinese economy over the last 40 years. While I clearly see the merit such projects could bring, and admire the ambition and commitment of all parties involved, I hesitate to see them as the most promising path to sustainable growth. Here’s why.

Most of our ideas about infrastructure are still shaped by the period of industrialisation, by the old economy, by heavy industry, by fossil fuel use; we still think in physical dimensions, it’s got to be visible and tangible. Hence we consider the absence of physical infrastructure to be the principal problem that must be solved before any development or progress could occur. However, if we think about the new economy right from the start, new opportunities emerge. Consider drones delivering medicine in Rwanda, microgrids supplying electricity in Nigeria, or GSM-based banking in Kenia. These examples actually combine the best of two worlds: they employ the latest technology to solve known problems. Most importantly, the absence of conventional infrastructure solutions (roads to every village, centralised electricity supply, or bank accounts for everybody) opened the doors for the unconventional ideas that are now being implemented.

Granted, these three example are tiny when compared to Chinese investments. Still, I consider them heartening as they teach us two important lessons: In specific, the solution to an infrastructure problem is not automatically more infrastructure. In general, the thinking of the past is not the only path to future solutions.

Outlook

This global diversity across the economies will remain for many decades. We’ll have to get used to temporary partnerships and alliances, which will regularly be re-evaluated for their utility, expanded or reduced accordingly, even cancelled and replaced with more promising arrangements. Of course the competition over market shares is a race against competitors, against others that pursue similar goals. But at the same time, given the dynamic interactions between competitors, markets, and customers, this is essentially the race towards a better future for all of us. We are in this race whether we like it or not. So let’s run this race together.