NS3040 Fall Term 2015Michael Spence

New World Order: Power Law Economy

New World Order I• Erik Brynjolfsson, Andrew McAfee, and Michael Spence,

Labor Capital and Ideas in the Power Law Economy, Foreign Affairs (July/August 2014

• Main Propositions:• Recent advances in technology have created an increasingly

unified global marketplace for labor and capital.• Ability of both to flow to their highest value uses regardless

of location is equalizing their prices across globe.• In recent years this broad factor price equalization has

benefited nations with abundant low cost labor and those with access to cheap capital

• Machines are substituting for more types of human labor than before

• As they replicate themselves they are also creating more capital

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New World Order II• Means that real winners in the future will not be providers

of cheap labor or owners of ordinary capital – both will be increasingly squeezed by automation.

• A third group will be favored – those who can innovate and create new products, services and business models

• Distribution of income for this creative class typically takes the form of a power law – a small number of winners capturing most of he rewards and a long tail consisting of the rest of the participants

• In the future, ideas will be the scarce inputs in the world– scarcer than labor and capital and the few who provide good ideas will reap huge rewards

• Assuring an acceptable standard of living for the rest and building inclusive economies and societies will become increasingly important challenges in the years to come.

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New World Order III

• Labor Problems

• Technology has dramatically lowered communication and transportation costs

• Moved the world much closer to a single large global market for labor, capital and other inputs to production

• Even though labor not fully mobile, other factors increasingly are

• Various components of global supply chains can move to labor’s location with little friction or costs.

• About one third goods and services in advanced economies are tradable – figure is rising

• The effect of global competition spills over to the non-tradable part of the economy in both advanced and emerging economies

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New World Order IV

• Process creates opportunities for not only greater efficiencies and profits but also enormous dislocations

• If worker in China or Bangladesh can do the same work as one in US then laws of economics say they will wind up earning similar wages

• Good for consumers and workers in developing countries but not for workers in developed countries who now face low cost competition

• Research indicates tradable sectors of advanced industrial countries have not been net employment generators for two decades.

• Means job creation now takes place almost exclusively within large non-tradable sector

• But here wages are held down by increasing competition from workers displaced from tradable sector

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New World Order VBigger problems ahead

•Automation, artificial intelligence, robotics, 3-D printing

• Repetitive jobs will soon be done almost exclusively by robots – especially structured environments such as factories.

• Offshoring is often only a way station to automation

•Foxconn Chinese company that assembles iPhones and iPads employs more than a million low-income workers now

• Quickly replacing them with robots.

• Official Chinese figures show a decline of 30 million manufacturing jobs or 25 percent of the total even as manufacturing output has increased by 70 percent

•As work stops chasing cheap labor it will gravitate toward wherever the final market is

• Will add value by shortening delivery times, reducing inventory costs

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New World Order VI

• Growing capabilities of automation threaten one of the more reliable strategies poor countries have used to attract outside investment

• Offering low wages to compensate for low productivity and skill levels

• Trend will extend beyond manufacturing

• Interactive voice response systems are reducing the requirement for direct person-to-person interaction – trouble for call centers

• Increasingly reliable computer programs will cut into transcription work now often done in developing world

• In more and more areas the most cost-effective source of “labor” is becoming intelligent and flexible machines as opposed to low wage humans in other countries.

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New World Order VII

Capital Problems•If cheap abundant labor is no longer a clear path to economic progress then what is?•One school of thought points to the growing contribution of capital: the physical and intangible assets that combine with labor to produce goods and services•Thomas Piketty argues in his book Capital in the Twenty first Century that capital’s share of the economy tends to grow when the rate of return on it is greater than the general rate of economic growth •Situation likely in future as robots computers and software (all forms of capital) increasingly substitute for human workers.

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New World Order VIII

• In past decade shares of national income going to labor and that going to capital have changed significantly

• Labor share averaged 64.3% from 1947 to 2000

• Labor share as declined over the past decade falling to its lowest point in 3rd quarter of 2010 – 57.8%

• Recent decisions to reshore production from aboard will do little to reverse trend

• In order to be economically viable these new manufacturing facilities will need to be highly automated

• Other countries similar trends – lower price of investment goods explains roughly half of the observed decline in the labor share

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New World Order IX

• Increasing trend of capital share in national income may be in jeopardy as faces challenge not from revived labor sector but – digital capital

• In free market the biggest premiums go the scarcest inputs needed for production

• In world where capital such as software and robots can be replicated cheaply – its marginal value will tend to fall even if more is used in the aggregate

• As more capital is added cheaply at the margin, the value of existing capital will be driven down

• Unlike traditional factories many types of digital capital can be added extremely cheaply

• Software can be duplicated and distributed at almost zero incremental cost

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New World Order X• Many elements of computer hardware governed by variants of

Moore’s law get quickly and consistently cheaper over time• Digital capital is abundant, has low marginal costs and is

increasingly important in almost every industry• Even as production becomes more capital intensive therefore,

the rewards earned by capitalists may not continue to grow relative to labor

• Shares will depend on the exact details of the production, and distribution systems

• The payoff will depend on which inputs to production are scarcest.

• If digital technologies create cheap substitutes for a growing set of jobs then labor loses

• However if digital technologies increasingly substitute for capital then owners of capital will not receive outsized returns either

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New World Order XI

• Spence argues the scarcest and most valuable resource in the “second machine age” – era driven by digital technologies and their associated economic characteristics

• Will not be ordinary labor nor ordinary capital but people who can create new ideas and innovations

• These people have always been economic valuable, but had to share their returns on their ideas with the labor and capital that were necessary for bringing them into the marketplace

• Digital technologies increasingly make both ordinary labor and ordinary capital less necessary so a greater share of the rewards from ideas will go the creators, innovators and entrepreneurs

• People with ideas not workers or investors will be the scarcest resource.

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New World Order XII

• Technology may not affect all inputs equally but instead favor some more than others.

• Skilled based technological change plays to the advantage of more skilled workers relative t oles skilled ones

• Capital based technological change favors capital relative to labor

• Both have been important in the past but increasingly a third type – superstar technical change is upending global economy

• Today possible to make many important goods services and processes and codify them

• Once codified they can be digitized and once digitized they can be replicated.

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New World Order XIII

• Digital copies can be made at virtually zero cost and transmitted anywhere in the world almost instantly

• Returns in such markets typically follow a distinct pattern – a power law in such a small number of players reap a disproportionate share of rewards

• Network effects whereby a product becomes more valuable the more users it has can also generate these kinds of winner take most markets.

• Instagram – photo-sharing platform – example of the economics of the digital, networked economy

• The 14 people who created the company didn’t need a lot of unskilled human helpers, nor did they need much capital

• They built a digital product that benefited from network effects and when caught on quickly able it sell it in a year and half for nearly three quarters of a billion dollars

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New World Order XIV

• Ironically several months later Kodak that at its peak has employed some 145,000 people and held billions of dollars in capital assets declared bankruptcy

• Instagram is an extreme example

• Not only software and media that are being transformed. Digitization and networks becoming more pervasive in every industry and function across the economy

• Even top executives have seen a big jump in incomes

• In 1990 CEO pay in US wan on average 70 times as large as the salaries of other workers; in 2005 it was 300 times a large

• Research suggests a portion of the growth is linked to the greater use of information technology.

• Technology expands the potential reach, scale and monitoring capacity of a decision maker – increasing the value of a good decision maker by magnifying the potential consequences of his or her choices 15

New World Order XV

• Today the larger the market value of a company the more compelling the argument for trying to get the very best executives to lead it.

• When income is distributed according to a power law, most people will be below the national average

• The U.S. today features one of the world’s highest levels of real GDP per capita even as its median income has essentially stagnated for two decades

• Implications for US –

• Likely to win back some businesses as re-shoring occurs

• Unfortunately the dynamism and creativity that have made US most innovative nation in world may be faltering

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New World Order XVI

• Because of the digital revolution, deign and innovation have now become part of the tradable sector of the global economy and will face the same sort of completion that has already transformed manufacturing

• Leadership in design depends on an educated workforce and entrepreneurial culture

• However American leadership in these areas is declining• Although US once led world in the share of graduates in the

work force with at least an associate’s degree it has fallen to 12th place

• Despite talk of entrepreneurship in Silicon Valley data show that since 1996 the number of U.S. startups employing more than one person has declined by over 20 percent.

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New World Order XVII

Policy implications

•If current trends are global, their local effects will be shaped in part by social policies and investments countries choose to make

• Education sector specifically and

• In fostering innovation and creating an entrepreneurial friendly environment

•Currently the U.S. needs to do much more in each area

•Globalization will not work to everyone’s advantage in short to medium term

•Ordinary workers will continue to bear brunt of changes, benefitting as consumers but not necessarily as producers

•Without further intervention economic inequality is likely to continue to increase

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New World Order XVIII

• Critical challenges can and need to be addressed through public provision of high quality basic services including education , health care and retirement security

• Such services will be critical for creating genuine equality of opportunity in a rapidly changing economic environment

• As for spurring economic growth in general – basic strategy simple

• Boost public sector investment over the short and medium term while making such investment more efficient – has very high rate of return

• Putting in place a fiscal consolidation plan for the longer term

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New World Order XIX

Conclusion

•If digital revolution continues to be as powerful as in recent years

• Structure of modern economy and the role of work may need to be rethought

• Our decedents may work ferwer hours and live better

•But both work and rewards could be spread more unequally with a variety of unpliant consequences

•Creating sustainable, equitable and inclusive growth will require more than business as usual

•Need to start with a proper understanding of just how fast and far things are evolving.

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