Trade Peace

Those who insist that a trade war is about who wins or loses either in the short or long run most likely do not understand what international trade is.

Those who surmise that anyone pointing out the American consumers, especially the less well-off bear a huge brunt of the consequences from the trade war, are framing it as “Americans lose most” miss the point that trade is neither a war nor a competition of who loses most.

To understand trade, there are a few fundamental concepts that we must bear in mind when discussing this topic. So let me list them here, some taken from my previous tweets and posts, giving flavour to each of the concepts and trusting readers to dive into the definitions or deeper discussions available elsewhere if they so wish:

  1. Trade is a system

Trade is a system of networks consisting of:

  • Various agents, from entire countries to the smallest wholesalers who import and export widgets,
  • Manufacturers and producers, companies with their relative advantage derived from their respective locations, efficiencies and way of business, access to raw materials and natural resources, know-how and above all, their ability to scale,
  • Standardisation, rules, regulations and agreements forged by a history of drawn out negotiations,
  • The supporting financial, legal and logistical structures such as insurance, credit, guarantees and loans, collateral, contracts, shipping, warehousing, brokerage, advertising, trade-related technology including data and platforms. Furthermore, foreign direct investments and capital flow play an important part.
  • Governments and central banks with their policies, custom systems, currencies.

If trade is a system, therefore, a trade war is a system that is going to war with itself; like a man’s arm reaching for a saw to cut his own legs off.

  1. Comparative advantage

A country that does not appreciate its own comparative advantage will not make the best decisions, let alone policies on trade. For example, the UK’s comparative advantage is overwhelmingly concentrated in the service industries so it baffles me why it hasn’t tried harder to protect this sector from the effects of Brexit.

In the technology sector, China is quickly building up a workforce that are able to handle both design and high-tech manufacturing. My favourite example is in the development of neural networks which was going nowhere before 2011. Then, only a few hundred people were working on NN. It took ten thousand smart enthusiastic Chinese graduates to enter the field for it to move forward. In terms of the sheer number of graduates, organisation and pure profit motive, China now has the upper hand.

Currently, there is a massive push in China to advance its semiconductor and battery technology, which also covers technology for ancillary activities, such as lithium extraction for batteries. In fact, a Chinese government report declared that the cost of extracting lithium has been slashed to a “record low” of RMB 15,000 (US$2,180) per ton by a new breakthrough process.

It also niggles me that Donald Trump is so gung-ho on protecting steel and aluminium as well as certain agricultural sectors, rather than focus on what the US wants its future workforce to look like, with a long term plan that includes education and training. Just like China, the US needs its own “Made in US 2025”.

  1. Exchange rate pass-through

Exchange rates matter a lot. According to the IMF a few years ago, large depreciations substantially boost exports. The results indicate that these depreciations average 25 percent in real effective terms over five years. The export prices in foreign currency fall by about 10 percent, with much of the adjustment occurring in the first year. China has been accused of artificially keeping the RMB exchange rates low in order to maintain competitiveness.

What about the US? A 2016 study showed that the pass-through on imports and consumer prices is relatively modest. A 15 percent dollar appreciation reduces consumer prices by a quarter of a percentage point in the short run, and by four-tenths of a percentage point after two years.

It is not the same story for the US exports. Most of the trade balance adjustment following a dollar appreciation takes place through the export (and not the import) channel. The reason for this is that the US exports and imports are predominantly denominated in US dollars.

Fast forward a few years, the most recent episode of tariff drama shows that the main channel for the US is the inflation channel. Studies found that Chinese exporters did not absorb any of the tariffs in their profit margins and import-competing US producers raised their prices in response – a double-whammy for the American consumers.

In a small, open economy however, a depreciated currency may not be enough. UK exporters saw little benefit from the Brexit depreciation while UK consumers mostly had to pay up for increased import prices.

In contrast, Japanese exporters have a strange fixation to maintain the stability of their export prices in overseas markets and absorbing exchange rate fluctuations through profit margins.

  1. Barriers to trade

Free trade agreements increasingly focus on NTBs or non-tariff barriers to trade, with special emphasis on competitiveness and regulatory alignment. The EU-South Korea FTA for example, includes a competition chapter which prohibits and penalises certain practices which distort competition. Competition is hard to monitor and regulate. According to Cecilia Malmström, the EU trade commissioner, the EU is not particularly happy with the level of South Korean compliance.

Regulatory transparency and a new approach on trade and sustainable development are also features of the agreement. These may also monitor standards and values, including workers’ rights and environmental commitments as “comprehensive” trade agreements take on a whole new meaning in modern trade – helped along by woke consumers’ ethics and sensibilities.

Perhaps we should also not be naïve that there are “informal” non-tariff trade barriers where non-friendly countries can delay customs formalities at the ports or borders.

  1. Substitutability and intermediate goods

Roughly half of US imports are intermediate goods and not finished products. Tariffs will increase the cost of production for imported foreign components, unless these inputs are sourced domestically. For example, around one-third of auto imports for finished cars or trucks used at US factories are intermediate products. The larger the share of non-substitutable intermediates, the more problematic tariffs are for the firms.

Trump hopes that the tariffs on steel will induce investments in domestic steel production. The question remains, will there be investments and if so, which kind of steel will be prioritised by domestic companies? Will the choice of investments fulfil all the different types of steel products that the US requires? Investment decisions are taken with multi-decade horizons, far beyond anyone’s presidency. These are things to think about when it comes to substitutability.

Furthermore, global value chains are designed such that they are regulatory and logistically efficient. For that to happen, it is beneficial to belong to an economic area and even more beneficial that intermediate goods can ping-pong across borders until they become finished products. This is the gravity theory of trade – the less distance, customs formalities at the borders and time spent in transit the better.

Many goods are tied up with services as well. The EU head negotiator Michel Barnier complained that Theresa May wanted regulatory alignment for goods only and neglect services. He said that services are in every product – for a mobile phone it is 20-40% of the total value.

Speaking of phones, more than 50 percent of jobs in smartphone manufacturing are in the final stages of production, so policies that cause only parts of the supply chain to shift may not create many jobs. An estimate of a 37 percent increase in production costs if they were made in the US which in turn leads to about a 15 percent increase in the price for consumers in the US. It will also take at least 5 years to move supply chains for smartphones to the US.

  1. Globalisation and agreeing to a rules-based system

A rules-based system has its disadvantages but to my mind, the certainty and efficiency it provides to the global market is invaluable.

Rules may shape the global value chain. For example, the rules of origin in trade agreements that require a certain amount of content to be produced in a particular country determines the way companies organise their supply chains.

Rules give rise to arbitration facilities, consequences that will come into effect should a clause in the trade agreement be broken. Despite the poor health of the WTO, it is still an idea and institution that should be championed. A trade agreement is only as good as the legal infrastructure that upholds it.

Rules normally result in standardisation, which begins at the technical aspect of production and may eventually result in the rise in the quality of products through positive spill-overs, technology transfers and know-how.

In addition, the nobler purpose of trade as a tool for peace as both Ireland and Northern Ireland have found out, should not be underestimated. Trade peace rather than trade war should be the bandied terms to nurture a global prosperity.

The main message of this post is that if you want to discuss any trade war, you need to look at all these other issues as well, and more.

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Mr Barnier, you love the mountains.

barnier faz1

Mr Barnier, you love the mountains. Were you free to leave this summer?

I hiked in my homeland, in the Tarentaise, in the Savoy Alps. I grew up near Grenoble and represented this area in the French parliament for almost twenty years.

What did you have in mind when you were at the summit?

It was very nice. You feel a sense of serenity. I need nature, trees, forests and mountains. I need this for me personally. You spent a lot of time in closed negotiation rooms. I negotiate with passion and energy because I know that I can go back to nature afterwards. When you know the mountains, you need stamina and you have to divide your strength. You also have to watch where you put your feet so you don’t step into a hole or roll over. And you can’t go too fast to keep your rhythm. It helps if you keep an eye on the summit.

Are you talking about Brexit already?

I have always believed that we must broaden our political horizons. I had this experience when I supported and co-organized the 1992 Olympic Games in Albertville. The head of a team has to see the next horizon. If, on the other hand, you lower your eyes, everyone sees only himself. In Europe it is the same: we all remain who we are, with our culture, our language, our traditions. But we have a common horizon that relativises conflicts and differences. That is why I very much regret that the British are leaving the Union.

Is there nevertheless a broader horizon in the exit negotiations that you lead for the EU heads of government?

This can be seen in the unity of the 27 Member States, which from the outset have followed a clear, uniform line, together with Donald Tusk, Jean-Claude Juncker and the European Parliament. The Brexit electric shock, the attitude of the Trump government towards Europe, our difficulties with Russia, the stability of the Middle East, the challenges of migration, and ultimately the instability of the whole world – all this has caused a feeling of common responsibility and seriousness to grow among the heads of government. When they look at all these challenges and threats, one has to ask oneself: How are we going to face it? Every man for himself or all of them together? That’s the common horizon.

And it lasts until the end of the negotiations?

(Barnier digs a chart out of his records.) Here is a table showing David Cameron around five or six years ago, when he was Prime Minister and I was Commissioner for Internal Market and Services. It shows how the economic performance of the eight strongest countries will develop with normal growth. In 2016 there were four Europeans in the top 8, in 2030 there will be three, in 2050 only Germany; in seventh place behind India, Indonesia and Brazil. I have changed this table somewhat, adding together the economic strength of the EU-27 instead of the individual states. And lo and behold, the EU-27 will still be in fourth place in 2050! The United Kingdom, on the other hand, is completely out of the rankings.

The British nevertheless remain in Europe, as they themselves repeatedly say. And the negotiations are also about future relations. Is a common horizon developing for this?

Our perspective is an ambitious partnership such as has never existed before with a third country. We offer the United Kingdom a free trade agreement, cooperation in the fields of security, foreign policy and defence, police and judicial cooperation, research, transport and transport. We respect the fact that the British want to regain their national sovereignty completely. We expect them to respect our sovereignty as EU-27, our common market and what we stand for.

Now the British conservatives, both in government and in parliament, have different ideas about future relations with the EU. There are even two White Papers, the official one of Prime Minister May and an alternative one, which was written under the former Brexit minister Davis. Under these circumstances, how can we negotiate a common future with London?

We know, of course, that the situation in the United Kingdom is complicated. We are following the debates there and I am talking to all kinds of people, including the British opposition. In the referendum on the resignation, many consequences were concealed. But now we are sticking to the decision of the British alone, the position of Prime Minister Theresa May and her chief negotiator.

David Davis, as chief negotiator, had other priorities than Theresa May, as it turned out.

This is a negotiation with the British Prime Minister. In their view, the vote in the Brexit referendum means that the majority of British no longer want to respect the role of the European Court of Justice, no longer want to pay membership fees, no longer accept the four basic series of the internal market and conclude their own trade agreements. We respect that, and our proposal for future relations does justice to the restrictions chosen by London itself.

Mrs May has given the EU a written commitment on Northern Ireland: If it is not possible to avoid a hard border on the island of Ireland by consensus, Northern Ireland can remain in a customs union with the EU. In mid-July, the House of Commons decided that Northern Ireland should not become part of a separate customs territory. This means that this recidivist position, which was fought over hard in December, is now off the table again!

Mrs May tells us that this decision is not in contradiction with the commitment she made to us in December and which she reinforced in March. We’ll see! I kept to the word of the Prime Minister, for whom I have great respect.

Much has been said in recent weeks about the failure of the negotiations. The head of the British central bank has classified the risk as “unpleasantly high”, the Chancellor of the Exchequer has quantified the economic losses for the kingdom at eighty billion pounds a year. The EU Commission and now also the British government point out the consequences of an unregulated withdrawal in “technical notes”. What does that mean? Is there now a real risk that the negotiations will go wrong?

At my first press conference as chief negotiator in October 2016, I said that the Brexit will have many consequences: human, social, economic, technical, legal and financial. This applies to an orderly withdrawal as to a disorderly one. We need to prepare for all scenarios. We have therefore published 70 papers on all consequences of the Brexit. It’s high time the British did the same. When I meet British entrepreneurs, I tell them no matter what happens, there will be no business as usual.

Are the other Europeans well prepared?

I’m not more worried today than I was a year or two ago. Since then I advise everyone to use the time of the negotiations to prepare. However, it seems to me that sometimes the consequences are underestimated.

What does that mean in concrete terms? Which deficits do you mean?

More needs to be done in the transport sector and in the value chains between the United Kingdom and the rest of the European Union. This is, of course, the responsibility of the companies. Many products move back and forth in the manufacturing process between the UK and the EU. Outside the internal market and customs union, there are customs formalities and controls that hinder just-in-time production to a great extent. Or take the topic of rules of origin. In order for EU car manufacturers to benefit from the customs benefits of the EU-Korea Agreement, only a certain part of the services may have been provided in a car in a third country. The companies must therefore ensure that in future they will not install too many parts from Great Britain in their vehicles. Such rules of origin would also have to be agreed in a future free trade agreement between the EU and the United Kingdom. If the British Government were to decide on a customs union with us, which is still possible, then much would be easier. Because in a customs union like the one we have with Turkey, there are no rules of origin. In any case, I recommend the industry to make its value chains “Brexit-proof”.

Another problem arises at the borders. If every truck in Dover has to be handled individually, with customs forms, the British government estimates that the traffic will accumulate several dozen miles back because there is not enough space in the port. The same problem exists on the other side of the canal in Calais. Are the authorities prepared for this?

We are working on making controls as simple as possible with modern technology. But there will have to be border controls when the United Kingdom leaves the customs union. There’s no way around it. The Netherlands employs 700 additional customs officers, Belgium 400, France 1000. 440 million consumers, 22 million companies and the single market must be protected by our external border controls. Let me be clear: Brexit does not add value, it creates problems and new bureaucracies.

On the island of Ireland, both sides want to avoid a hard border. But if Northern Ireland cannot remain in a customs union with the EU, that will be difficult. The British government has proposed that it impose customs duties at its borders not only on goods that remain in the kingdom, but also on those destined for the EU – this revenue would then be passed on to Brussels. This should facilitate all trade in goods and at the same time be a solution for the Irish island. Why do you refuse?

For two reasons. We cannot transfer control of our external borders and revenue there to a third country – that is not legally possible. Incidentally, infringement proceedings are under way against London because, in the Commission’s view, Chinese textile imports have not been properly cleared through customs. Moreover, the British proposal is not a practical course, because it is impossible to determine exactly where a product ends up, on the British market or on the internal market. Sugar, for example, is transported by the ton in 25 kilo bags, so you can’t track every bag to its destination. This would only be possible with an irrational and unjustifiable bureaucratic effort. That is why the British proposal would be an invitation to fraud if implemented.

Since then, the British Government has been determined to prevent a hard border in the Irish Sea, i.e. between Northern Ireland and Great Britain, from replacing a hard border on the island of Ireland. Isn’t that legitimate?

There is no such thing as a hard border in the Irish Sea, as we have never proposed. Of course we respect the unity of the United Kingdom. We are only looking for a practical solution that does justice to the special situation of the island of Ireland. There are already certain controls in almost all areas, in particular veterinary and plant health controls for goods and raw materials brought to Northern Ireland from the rest of the United Kingdom. That’s all we’re talking about, no more.

The other major challenge besides Northern Ireland concerns the future trade in goods and services. Mrs May wants to establish a close regulatory link for goods, but not for services – she also recognises that British service providers will have less access to the European market. Isn’t that in Europe’s interest? Finally, the European Union has a huge surplus in trade in goods with the Kingdom, while in services itself it has a considerable trade advantage.

The interest of Europeans is to preserve the integrity of the common market. This is our special strength and the reason why we are respected all over the world, even in the United States. We have a coherent market for goods, services, capital and people – an ecosystem of our own that has grown over decades. You can’t play with that by picking parts. There is another reason why I am strongly opposed to the British proposal. Services are in every product. In your mobile phone, for example, it is 20 to 40 percent of the total value. .

. . but this is only the case with electronic devices, not with agricultural products.

You’re mistaken! As former Minister of Agriculture, I can tell you that agricultural products are produced under laws that regulate hygiene, health and environmental issues in the production process. Every litre of milk and every apple contains services. We must therefore prevent unfair competition if the United Kingdom has weaker legislation than we do. Otherwise we would be disadvantaging and weakening our own companies.

So the long-term protection of the internal market goes beyond short-term benefits that could be achieved in trade in goods with the UK?

That’s how it is. A great French politician, Pierre Mendès France, said that the future must never be sacrificed to the opposition. By the way, the British have a choice. They could remain in the binary market, like Norway, which is not an EU member either – but they would then also have to adopt all the rules and contributions to European solidarity associated with it. It’s your choice. If, however, we allowed the British to pick the raisins out of our set of rules, the serious consequences would be obvious. Then all kinds of other third countries could also insist that we offer them the same benefits. That would be the end of the internal market and the European project! I’m often accused in the United Kingdom of being dogmatic. But in fact, I’m only looking out for our fundamental interests.

If the problems are so serious, how is an agreement to be reached with London in the next two months?

About 80 percent of the resignation contract has been negotiated. We are close to our goal when we find a pragmatic and realistic solution for Northern Ireland. In addition, there will be a political clarification setting out the framework for future relations. We haven’t written a text yet, but we’ve done a lot of work. There is a great deal of agreement on foreign and security policy, as is internal serenity. We will be able to start writing this declaration in the near future. The conflict concerns the picking of raisins in future trade.

How do you envisage the political explanation? The British White Paper is a hundred pages long.

The decisive factor is not the length, but the content. My mandate, those are the guidelines of the European Council of March 2018, which are only a few pages long, but very precise. The aim of the negotiations is to identify the similarities between the position of the EU-27 and the British government. I think it could fill 15 to 20 pages.

If there is not enough time and all 28 states agree, the negotiations could be extended beyond 29 March. Are you considering this as an option?

The British have decided to leave the EU. Ms May herself chose the term in her letter of resignation and also enshrined it in British law. If there is a deal by then, we agree that the UK should be treated as a member for a transitional period until the end of 2020, albeit without voting rights. If we take account of the time taken to ratify the withdrawal agreement by the British Parliament and the European Parliament, we must conclude negotiations by mid-November. That’s possible. We don’t need more time. What we need are political decisions!

Thomas Gutschker spoke with Michel Barnier.

Barnier Interview 2 Sept 2018

 

 

Possible reasons the inflation and wage growth in Japan resist rising

Possible reasons why the inflation and wage growth in Japan have stubbornly refused to rise:

  • institutional factors in CPI,
  • using published unemployment in the Phillips curve,
  • a decline in potential growth,
  • structural changes in the labour market,
  • the long run stable relationship between wages and labour productivity.

Three of them are to do with prices and the last two with wages.

These are my notes based on a DB report.

Institutional factors in CPI:

Health care and education costs are largely decided by government policy, hence demand/supply effects are limited in Japan.

Enrolment in health insurance is compulsory for everyone in Japan. It is also government policy to lower drug, medical diagnostic and treatment costs. As a result, the share of medical spending in the CPI is much lower compared to France or the US.

Education up to secondary level is free while tuition for higher education is regulated by the government. Note: As a share of CPI, Japan has the highest education spending compared to other developed countries. This is attributed to spending on supplementary education (e.g. tuition classes, private school, prep school). However, the growth of the education cost is the slowest among the developed countries.

Imputed rents are more influenced by old houses, of which quality improvements/ renovations have been limited. Imputed rents in owner-occupied housing are not included in the CPI weighting in the main European countries. Japan has a tendency in which owner-occupied houses exhibit a deteriorating quality relative to rental houses because the former consists of a larger share of older wooden homes with limited maintenance being done and the latter consists of relatively new condos and homes with better maintenance. The price of the latter (actual rents) is less likely to decline than imputed rents. We also believe that quality adjustment to prices in this case has not been properly reflected. In other words, we need to raise imputed rents in order to reflect the quality deterioration, but this is not done. It is an opposite bias to the prices of IT goods. (In IT goods, an improvement in quality has to be reflected as a fall in prices in the CPI.)

Using published unemployment in the Phillips curve:

The Phillips curve shows the short-term relationship in the business cycle that exists between inflation on the vertical axis (not the rate of rises in wages but prices) and indicators showing the utilisation of factor inputs on the horizontal axis (e.g. the unemployment rate).

The Phillips curve is just another analytical tool to help with policy making. Like any other tools, analysis using the Phillips curve has its limitations.

Short-run constraints:

  1. It is common to use unemployment rates as indicators of labour market slack but if there is a long term structural change, this will also be reflected in the unemployment rate.
  2. When work sharing is carried out (e.g. with Japan’s part-time workers) because of the negative incentives to labour supply in the tax system, using published unemployment (e.g. headcount) may overestimate the tightness in the labour market. A polarization of labour markets between part-time and full-time workers in Japan and the fact that the interaction between the two has been limited is thought to be a Japan-specific factor contributing to the lack of emerging upward pressure on wages despite an improving economy. The order in which companies respond to an economic recovery is to increase part-time workers, to raise part-time workers’ wages, to increase the hire of new graduates and raise their starting salary, and to increase overtime pay and bonuses for full-time workers, with a very high hurdle to raising existing full-time workers’ monthly salary.
  3. Operating rates of capital are not reflected on the horizontal axis. Low capacity utilisation has been a global feature after the GFC, and not only in Japan. Focusing on just labour in the chart may over-estimate improvements in the economy.

Medium to long-run constraints:

  1. The slope of the long-run Phillips curve is vertical or extremely steep (economic policy is unable to sustain the trade-off between short-term improvements in prices and unemployment).
  2. Potential growth influences the location of the Phillips curve. A rise in potential growth accompanied by an upward shift in the Phillips curve. Similarly, a fall in potential growth is accompanied by a downward shift in the Phillips curve.

There is a general over-estimation of the utilisation of factor inputs (labour/capital) as it does not take into account voluntary job leavers, work-sharing by part-time workers and low utilisation of capital.

Japan is at the steeper part of the Phillips curve but the probability of Japan remaining there has been steadily falling since September 2015.

A decline in potential growth:

In the long run, inflation is influenced by:

  • Growth of broad money aggregates
  • Nominal GDP
  • Potential GDP

Over the past 21 years growth rates of these indicators have been lower compared to other developed countries.

A decline in potential GDP corresponds to a downward shift of the Phillips curve, thus accompanying a decline in terminal inflation.

A widely held argument in financial markets is that because potential growth declined in the US, economic expansion would easily cause the supply-demand gap to shrink enough to cause higher inflation, or that if Japan’s potential growth rose due to Abenomics, the supply-demand gap would struggle to shrink even with economic expansion and that deflation would continue. These stories however are one-dimensional and ignore the fact that the long-run correlation between potential growth and inflation is positive, not negative. For example, inflation in EM countries tends to be higher than in developed countries, partly because potential growth is higher in the former.

Structural changes in the labour market:

Increases in these contribute to the decline of nominal wages.

  • the employment rate (via diminishing marginal returns on labour)
  • part-time employment rate (including involuntary part-time workers)
  • increase in female participation
  • small amounts of immigration
  • relative wages of manufacturers over non-manufacturers

The long run stable relationship between wages and labour productivity

Wage growth falls when the decline in labour productivity is structural rather than cyclical. This in turn lowers terminal inflation.

Summary

The probability of Japan hitting the 2% target inflation is rather low. The only hope is to keep an accommodative monetary policy such that businesses and households that need to borrow could continue to do so. That in turn could lead to a faster rise in broad money and economic activity (nominal GDP), resulting in a rise in prices. If maintained over the long run, it may lead to an expansion in factor inputs or faster technological progress. All of this will perhaps raise Japan’s potential growth.

The Future of Work

Things are starting to change…

In his talk, “Ideas are Your Only Currency”, Rod Judkins recounted how a surgeon at the Royal Free Hospital, London, had asked him to teach a group of Applied Medical students on how to think more creatively. Rod Judkins is an author and lecturer from the prestigious art school, Central St Martins, College of Art.

The medical school recognised the pressing need to produce more ‘idea students’ rather than ‘students who have skills’. It was clear to them that a lot of the skill-based jobs at the hospitals are going to be redundant as many procedures, such as eye or kidney operations, can now be done by robots. Diagnostics too, are increasingly automated.

Instead, they would like to focus on training future doctors to apply creative thinking with the available medical technology. An example of this applied medical creativity is the ‘spray-on skin’ with stem cells for burn victims. They are also trying to get students to think about how current procedures can be improved. In other words, they wanted to produce more medical innovators rather than the typical doctors.

How much longer do we have until full automation?

Firstly, this depends on the sector. Some areas like agriculture, in particular grain production are already highly automated and have very little human input left. Other areas depend on coordination of a whole value chain, e.g. on-line grocery retailing, which can take decades to establish. There are also fields where human input is currently essential and full automation is only a distant prospect.

MachineLearning_decisions

From whatsthebigdata.com.

Secondly, the introduction of new technology may be delayed where cost benefit analysis fails to justify its implementation. Dejian Zeng is an NYU grad student who spent six weeks working undercover at a Pegatron iPhone factory in China. From the experience, he was convinced that with the current operation, the iPhone will likely never be made in the US. He said that with a wage of 2320 Yuan per Chinese worker, (around $400), it is impossible to pay even a base salary to US workers with that same amount. Thus, if the factories are to be relocated to the US the bulk of the work will have to be replaced by machines.

In other words, as long as the cost of labour is lower than the cost of machines the factories will remain in China due to the low wages. In fact, according to Zeng, tasks such as putting the camera and battery into their respective housing are already automated – hence, even the Chinese workers are under no illusion that their work station will be replaced very soon, too.

Thirdly, it depends on whether the new technology is being integrated into an existing system or is used to replace an old system entirely. If it is being slowly phased into an existing system, then coordination and fit would be the main challenges. The difficulty of coordinating the different elements of new and old technology should not be underestimated. The existing workforce needs to be retrained, including giving them an adjustment period for trial and error. In some cases, it would simply be easier and cheaper to scrap everything, re-vet the workforce, and start from scratch.

Lastly, the cause of delay to implementation may actually stem from political and legislative hurdles, and not so much from an economic one.

In a paper by Grace, Salvatier, Dafoe, Zhang and Evans, titled, “When Will AI Exceed Human Performance? Evidence from AI Experts”, a large survey asking machine learning researchers on their beliefs about progress in AI was conducted.

AI Human

The result is as follows:

The researchers predict that AI will outperform humans in many activities in the next ten years, for example:

  1. translating languages (by 2024),
  2. writing high-school essays (by 2026),
  3. driving a truck (by 2027),
  4. working in retail (by 2031),
  5. a bestselling book (by 2049), and
  6. working as a surgeon (by 2053).

The researchers believe that “there is a 50% chance of AI outperforming humans in all tasks in 45 years and of automating all human jobs in 120 years, with Asian respondents expecting these dates much sooner than North Americans”.

What kind of workforce will we have in the future?

1. Human to machine

Automation gives a picture of a completely hands-free operation. The reality is that grocery crates get stuck in between conveyor belts, sensors need replacing after clocking a certain number of hours, software needs to be debugged and computer security needs to be updated.

Another factor is what’s known in the industry as ‘contingencies’, which are unanticipated complications that cannot be programmed for. For example, self-driving container trucks in their long haul across state lines may experience accidental spillage of dangerous chemicals, bad weather conditions or even just flat tyres. That is why that despite self-driving trucks, truck drivers would still be needed for the trip as a monitor and a precautionary measure.

From those needs, there could be a new job industry arising purely for maintenance, monitoring and organising of the robots, AI, sensors, and various moving parts – in fact, the rise of a whole new breed of automation rangers or mechanics to upkeep the entire auto-ecosystem.

In the meantime, we also need humans to train machines, especially in areas where we don’t have millions of data points for training. This will be a huge industry in itself.

2. Human to human

In a recent article, “Never mind the robots; future jobs demand human skills”, Sarah O’Connor, writes, “By 2030, there will be 34 ‘super-aged’ countries, where one person in five is over 65. Robots can help workers to look after these people but they cannot replace them, nor should we want them to. As the chief executive of Adidas pointed out recently, robots cannot even lace shoes into trainers, let alone help a frail person into the shower. They do not possess any of the qualities that make humans good at caring for each other, like compassion, patience, humour and adaptability.”

The noble idea of how a substantial workforce will take care of the elderly is misleading – not many will have the stamina, perseverance or dedication to nurse an elderly. It is difficult to be convinced that many Mr or Ms Nightingale can be plucked out of this device-fixated generation. To be in the care industry, one must have a calling for it precisely because the job needs a lot of patience and compassion. Those who enter because there are no other alternatives are bound to be frustrated and carry out their job poorly.  As a cautionary note, look at how many abuses there are reported in the old folks homes.

The care industry may be the fastest growing for now, but only people who have never cared for an elderly would romanticise what is in essence a very emotionally and physically demanding, non-glamorous, solitary and repetitive job. To add, the elderly might not even want to be attended to by humans, preferring rather, robotic help as to retain their dignity and independence.

Nor do the old might even need to. Advances in health science will mean that the elderly are more mobile, with advanced medicine preserving most of their cognitive functions, and if they become invalid, there is even an exoskeleton that could be used as a walking aid.

Care is expensive and there are major challenges how to pay for it. Without immigration as a source of cheap labour automation is the only sustainable solution.

3. Human and government

Is it so far-fetched to imagine that due to reduced government budgets, many civil servant posts would be made obsolete or that many types of bureaucracy ranging from building permissions to passport renewals will be processed from end to end by machine learning algorithms?

Perhaps politicians at Westminster too, would be phased out. Imagine if policies were being produced by algorithms – minimising monetary and social costs, maximising benefits – for education, healthcare or immigration. For a discussion, one would tune in to BBC Parliament channel to watch the parliamentary debates on the algorithm-produced policy strengths and biases. One then votes for algorithms instead of politicians. Would this produce a better outcome than today’s method?

Our politics and their consequences have always been a jumbled muddle of hits and misses, luck-of-the-draw exercises where we are never sure whether promises will be kept and if kept, fulfilling them come with huge execution risks and incompetence.

Policy timing would no longer be a finger-in-the-air decision but rather dependent on the assistance of Big Data. For example, an idea to privatise a particular industry may be a good idea but a collection of data might tell the population to wait a couple of more years. Or it might flag that more legal infrastructure would first be needed to support the decision before it is carried out. In the future, AI and Big Data could act as both compeller and caution-device and benefit our political system tremendously in ways unimagined now.

It was Jacque Fresco, the futurist who had recently passed away, who said, “Computers don’t have ambition, they don’t say, ‘I want to control people.’ They don’t have gut instincts.”

4. Entrepreneurs and modular solutions

The beneficiaries of technology are not limited to those who know how to code. Just like how we are able to surf the internet through browsers or prepare spreadsheet through Excel without a lick of coding knowledge, so will there be solutions that bridge the gap for those less technology-literate.

Firstly, any tasks or potential businesses will be built upon modular solutions that can be bought off-the-shelf just as if buying the ingredients for a dinner you are about to prepare. These modular solutions can be sold individually or as packages to be assembled and tailored to your entrepreneurial requirement, neatly fitting with each other as Lego bricks would do. These packages can provide analytics, access to data providers, robotics, machine learning and other AI solutions.

Just as cloud computing lowered the bar of entry to internet start-up companies a similar data, machine learning and robotics start-up scene may develop that is built on common tools and services, without requiring detailed knowledge of all areas but the one the company is exploring.

5. Human and the financial market

The Economist claims that from trading to credit assessment to fraud prevention, machine learning is advancing. From the article, the start of 2019 will see even Chartered Financial Analysts needing AI expertise to pass their exam.

There is certainly a shift for Wall Street from hiring Ivy League jocks to siphoning-off as many quants into the industry, and the benefit of using so many quants have already begun to show. In fact, the Economist writes, “Quant hedge funds, both new and old, are piling in. Castle Ridge Asset Management, a Toronto-based upstart, has achieved annual average returns of 32% since its founding in 2013. It uses a sophisticated machine-learning system, like those used to model evolutionary biology, to make investment decisions.

It is so sensitive, claims the firm’s chief executive, Adrian de Valois-Franklin, that it picked up 24 acquisitions before they were even announced (because of tell-tale signals suggesting a small amount of insider trading). Man AHL, meanwhile, a well-established $18.8bn quant fund provider, has been conducting research into machine-learning for trading purposes since 2009, and using it as one of the techniques to manage client money since 2014.”

The rise of robo-advisors and other Fintech services signal coming changes as well. According to the BlackRock Global Investor Pulse Report, 58% of Millenials respondents would be interested in robo-advice compared to 26% baby-boomers.

6. Human and construction

According to the article “Why the Construction Industry May Be Robot-Proof”, “Well, there is something unique about housing. Typically, home construction activity is custom work – remodelling, renovation, teardowns replaced by a single home, maybe a few homes built on a cul-de-sac. And it is difficult to gain economies of scale – or to automate processes – when every job, or close to every job, is unique.”

Outside some prefab and highly standardised new builds using some 3D printing technology much of the building industry will remain very human centered. Although jobs like architects and interior designer could be machine learned, clients would still want to interact with humans when discussing the design of their house – unless it’s much cheaper to do otherwise. Automating a job like hanging wall papers, with all the non-uniform surfaces and odd corners in a typical house, cannot be done easily in the near future.

Construction is also happening in the virtual world. The virtual reality (VR) and augmented reality (AR) market will be worth almost $37 billion by 2027, according to the latest analysis conducted by IDTechEx. We are underestimating the number of creators, artists, programmers and audio specialists the developers will need for this space.

7. The unemployed and Jugaad

Many become unemployed as human capital becomes neither complementary to machines nor are they cheap enough to make using machines non-viable. This aggravates wealth and income inequality. In the US, the share of wealth owned by the bottom 80% has fallen from 18.7% in 1983 to 11.1% in 2010. Median family income has stagnated while incomes rose significantly for the top 1%.

In the case for technology, inequality may result in little or no access to new technologies for the lower rungs of society. A simple example would be where the poor could only afford bargain-priced ink-based printers while the rich have long upgraded theirs to germanium-based printers.

Jugaad, according to the Wikipedia, refers to “an innovative fix or a simple work-around, a solution that bends the rules, or a resource that can be used in such a way. It is also often used to signify creativity – to make existing things work, or to create new things with meagre resources.”

Just because you are unemployed, doesn’t mean that you don’t have to continue to ‘labour’ for your comfort. It may just be, that as a direct result of many becoming unemployed and lacking resources, they are forced to lengthen the lifetime of their existing technologies by repairing or modifying them. If a little part of their device gets broken for example, rather than throwing away the whole device and buying a new one, they may have to rely on a 3-D printer to print the replacement part. The 3-D printer may be operating commercially at a shop, or locally owned by the council for public use.

Necessity is the mother of invention and we might see the spirit of Jugaad being adopted not just in India, but everywhere else in the world.

Validity of the claim and does it matter?

In “The Zombie Robot Argument Lurches On”, Lawrence Mishel and Josh Bivens write that our claim of ‘robots taking over jobs’ is based on a flawed analysis and there is no basis for claiming “automation has led – or will lead – to increased joblessness, unemployment, or wage stagnation”.

Therefore, any policy recommendations based on this flawed analysis, ranging from redesigning education and retraining the workforce to providing universal basic income, would not make much sense. Furthermore, Mishel and Bivens emphasise that the automation narrative is not validated by the Acemoglu and Restrepo report, writing, “The estimated impact of robots is small, and automation broadly defined does not explain recent labour market trends.”

Here, Mishel and Bivens were referring to the Daron Acemoglu and Pascual Restrepo investigation into the equilibrium impact of industrial robots in local US labour markets. Acemoglu and Restrepo concluded that only a relatively small fraction of employment in the US economy are being affected by robots and therefore, there is no support of the view that new technologies will make most jobs disappear and humans largely redundant.

Mishel and Bivens urge us not to be distracted by this ‘zombie robot narrative’, focusing instead on current issues such as wage stagnation and the rising inequality stemming from failure of macroeconomic policy and globalisation. Which brings us to the question, is this the right way to frame the issue?

Whether you have evidence for this right now or not it is important to remember that many decisions have a very long lead time, such as how to educate our children or how to design government policy.

Personally, between the doubters and the dreamers, I know who I would choose to believe in.

What should we do to prepare?

1. Measure and track for good policy decisions

In the report, “Information Technology and The U.S. Workforce: Where are We and Where do We Go From Here?”, Brynjolfsson et al recommend developing a series of indices such as:

  • Technology progress index
  • AI progress index
  • Organisational change and technology diffusion index

To complement this, I think, would be to appoint a committee of ‘machine economists’ to produce a subjective, annual report of progress on technology and workforce – with good bullet point summaries for TL;DR readers. They can use proxies, such as the most impactful new device to come into the market or numbers of students graduating from technology related courses, and so forth. Whatever event that these ‘machine economist’ deem significant would be included in the annual report, keeping in mind that the intended readers are other economists, policy makers and journalists.

The idea is to focus more on the end result of the technological progress rather than adding up all the inputs that make up technology. Maybe this would be more useful as well as easier to account. One can then surmise the progress by following the evolution of the annually produced bullet points.

2. Innovative education more suitable for the ‘New Machine Age’

I think we have an imperative to redesign an education system better-suited to this technological revolution, not in token resistance to being replaced by machines, but rather to take advantage and multiply these technological dividends as much as we can. Looking at the welfare and social situations of many nations today, the decision to change the current education system may prove necessary rather than merely discretionary.

We need to equip the future workforce with a mind-set to take advantage of all the new possibilities that technology would bring. After all, didn’t Richard Hamming, the American mathematician say, “Teachers should prepare the student for the student’s future, not for the teacher’s past”?

Children need to be exposed to data handling and basic programming at a much earlier age – as early as four or five. In general, these concepts are currently introduced either during the secondary school or at the university.

By introducing data collection, probabilities and other statistics, arrays, IF/THEN, loops, and related ideas in bite-sized and fun format, the children will grow up being familiar with these concepts and learn them naturally. Furthermore, it’s good to teach children logic, a useful way of thinking that would benefit other areas of life too – much more useful than having them memorise the times-tables. I strongly believe that getting an education should be an adventure and not torture.

Creativity will be another important outcome of education, something that machines are still rather poor at, in contrast to rote learning of facts.

The objective is not that they all become programmers, but rather that they become technologically literate – think of how developing nations make the English Language as a subject in schools, not to have a bunch of English teachers, but so that the students can do jobs conducted in the English medium. Similarly, while we don’t know the exact nature of future jobs we can be fairly sure that reliance on machines for repetitive work will increase and humans will be required for more creative and lateral thinking type tasks.

3. Counter the negatives

Professor Ian Golding who runs the Oxford Martin programme on technological and economic change assessed that we are underestimating the shock that technology will unleash on the world. According to his interview with the Business Insider Australia, he believes that we are on the brink of a ‘premature de-industrialisation’ that will “rattle societies in developed and emerging nations, as huge amounts of industrial labour is re-shored to advanced economies with fully automated production systems.”

To quote him, “There will be a re-shoring of production to the advanced economies and of call centres and other machine processes. Of course, this won’t be a re-shoring which will be labour intensive; it will be capital intensive. So, it’s not going to create jobs. I see that one of the real downside risks associated with this is a rapid widening of inequality. Large swathes of people, I think, will find that it’s challenging to get decent jobs. There will be lots of jobs for unskilled and service people, things that don’t require much machinery.”

The implication of this is that for developing countries, the path where wealth can be achieved through stages of industrialisation has just vanished into thin air. The global consequences of this would be economic growth slowing long before catching up to developed levels. At the same time, adopting increasingly cheap technology from around the world should raise living standards even in the poorest places, even if countries fail to raise their productivity much on their own.

What of the developed nations? At the backs of our mind is the realisation that without a share of production, the bottom 80% would remain in relative poverty and little opportunity to improve their lot. This kind of social composition cannot possibly be sustainable, even in a developed country with relatively better social welfare.

Recently, Eric S. Lander, president of the Broad Institute of MIT and Eric E. Schmidt, executive chairman of Alphabet, worried about the lack of funding for research in the US, shared an op-ed in the Washington Post,

“The United States has the most dynamic private sector in the world, with entrepreneurs, investors, big companies and capital markets all eager to license technologies and launch start-ups. But those ventures are often driven by technologies that come from basic research. Few companies undertake such research because its fruits are typically too unpredictable, too far from commercialisation and too early to be patentable.

That’s where government comes in. While investing in basic research typically doesn’t make sense for a business, it has been a winning strategy for our nation. For 60 years, the federal government has invested roughly a penny on each dollar in the federal budget into research at universities and research centers. In turn, these institutions have produced a torrent of discoveries and trained generations of scientific talent, fuelling new companies and spawning new jobs.”

In other words – do.not.cut.funding.in.science.and.technology.

4. Competitive landscape

One major concern to be addressed is the rise of superstar firms. In “The Fall of the Labor Share and the Rise of Superstar Firms”, Autor, Dorn, Katz, Patterson and Van Reenen posit that if globalisation or technological changes advantage the most productive firms in each industry, product market concentration will rise as industries become increasingly dominated by superstar firms with high profits and a low share of labour in firm value-added and sales.

They found that, “firms with superior quality, lower costs, or greater innovation reap disproportionate rewards relative to prior eras. Since these superstar firms have higher profit levels, they also tend to have a lower share of labour in sales and value-added. As superstar firms gain market share, across a wide range of sectors, the aggregate share of labour falls.”

From the FT article “Competition is not for losers – even in the digital era”,  John Thornhill writes, “Competition policy has long been viewed predominantly as a tool to promote economic efficiency. But it remains a political and social construct. As such it must be reinvented to match the needs of our times, whichever economic story you believe.”

Unlike previous episodes of increasing firm concentration though these superstar firms may be the ones undertaking the kind of ground-breaking research that delivers a better future, without hurting consumers through higher prices which are often close to zero marginal cost anyway. It will be important to rebalance the patent system such that these new giants can’t lock out rivals forever through litigation and to occasionally make these new natural monopolies open up their data to others.

Conclusion

Nothing comes without costs, especially in a technological revolution such as this. We are potentially facing massive unemployment and a tsunami of shifting and re-ordering of the workforce as we have never known before.

What may place us at risk is our inability to reform ourselves, and our way of doing, in time to mitigate the negative impact on the workforce. What concerns me is that in assuming a defensive position against technology, we fail to capture all of the abundant dividends the technology may bring us.

Worse still, if we let the old technology crystallise for lack of enthusiasm and nostalgia for the past. All this, because we fear the future too much and act too little in the present.

We should approach the future of work with optimism instead. Creativity, lateral thinking and ambition are all human strengths that will allow us to achieve great things in conjunction with machines.

Given the rich bounty of automation we’ll also be able to raise the living standards of every human being on earth, while at the same time making the remaining work more meaningful and less soul-destroying, whether through fewer hours spread across more people or through more interesting work.

On technology and labour

In this week’s Economist Free exchange column entitled “Remember the Mane”, Ryan Avent asks why productivity lagged while technology adoption is on the rise. Reading the article, I can’t help but wonder whether we are focusing on the right things.

Firstly, many commentators tend to lump all types of technological progress under one header, but this leads to rather blunt analysis. There are many types of automation for instance; sensors, machine learning and robotics, just to name a few. These affect the rate of replacement of labour and productivity differently within each industry.

With each passing year, the price of sensors as well as their sizes get smaller and smaller. At the same time, coupled with better computer processing power, the fields of machine learning and robotics are advancing in leaps and bounds. Sensors may replace factory workers in charge of checking for defective products or fruit sorters in the farms. On the other hand, better machine learning may one day replace accountants, lawyers and journalists. (Economists, of course, are irreplaceable and safe from automation.) Like so much in economics, we need more micro and less macro!

Secondly, what if we don’t view this issue from a Luddite vantage point and concentrate instead on the possibility that we don’t make the breakthroughs required for society to thrive. What if the government and politics, or a whole hosts of other factors get in the way and cause a slowdown in technology? What if self-driving for instance, gets such a bad reputation through a series of unfortunate events that it becomes socially unacceptable to implement? What if genetic engineering degenerates into a war of patent lawsuits and stalls?

Living with “less work” plus “more technology” is a clear trend. Although we should worry about both parts of that equation, we should perhaps put greater emphasis on how to ensure the “more technology” part remains sustainable instead of attempting to mitigate the consequences of “less work”.

Thirdly, we are still at the point where the economy is able to afford automation, which unfortunately, replaces those under employment or keeps the remaining unemployed. What if one day, the economy cannot sustain the renewal of technology despite the availability and innovation of new technology. Much has been written about potential solutions for the unemployed, e.g. UBI, taxing robots, reducing working weeks etc. However, something that has not come up before could be the crystallisation of old technology.

What would such a world look like? Well, picture Cuba that was once rich. In the 1960s they were driving the latest American cars, but after a sharp drop in purchasing power they’re still driving those cars well past their normal asset life. In other words, automotive technology has not advanced for fifty years on the island, it has crystallised. One could argue that if technology deflation happens at a faster rate than the rate of fall in earnings we can keep holding off this effect, but then again, who knows?

Coaling China

From the Economist,

FIRST a tsunami of steel—next a flood of what? Industrialists all over the place might look nervously at China’s cooling economy and ask that question. The global glut in steel is most alarming because China’s industry dwarfs all others and its mills could easily produce more. Yet other sectors also have existing or looming gluts.

One is coal. Thanks to a massive expansion now under way, China’s coal industry could have 3.3 billion tonnes of excess capacity within two years, reckons Fitch, a rating agency; domestic consumption is less than 4 billion tonnes a year and dropping. Traditionally China has imported, not exported, coal—but that could change. Shenhua Energy, the country’s biggest coal miner, says it might export 10m tonnes soon, up from 1.2m tonnes last year.

A report by JP Morgan states,

The Chinese government is working to reduce coal’s share in its powergen mix by one percent to 63% this year. It is also taking steps to curtail as much as a billion tonnes of excess coal production capacity over the next few years. However there is about a billion tonnes of new capacity expected to come online over the next two years likely offsetting the capacity cuts. Though we see the anti emissions policies as real and China recently halted 15 “under construction” coal-fired power plant projects in Mongolia and Shanxi. Another emerging risk for the seaborne thermal market is of rising Chinese coal exports. Shenhua is considering exports of as much as 10mt of coal to Korea and Japan which, given lower freight costs, could hurt coal demand from Australia and Indonesia.

Maybe that’s why…

Lessons from Recent Market Turbulence

From Gavyn Davies, Lessons from recent market turbulence,

What, then are the main lessons from this turbulent period? Several spring to mind.

The global economy is not quite as weak as it appeared early in 2016, though this needs continuous assessment;

The Federal Reserve can readily be dissuaded from tightening monetary policy if global economic conditions deteriorate, or market turbulence returns;

The Fed is not “out of ammo” because actual and forward nominal interest rates are positive and can be impacted by policy statements;

Chinese foreign exchange rate policy may be particularly important in affecting the Fed’s thinking, though it is highly unlikely that any formal “agreement” has been reached between the US and China on currency policy;

Japan is now facing a crisis of confidence in Abenomics that needs to be quickly addressed through monetary, fiscal and exchange rate policy;

The ECB may find it quite difficult to banish deflation risks, since markets no longer seem to be impressed by increases in asset purchase programmes by central banks, at least when bond yields are below zero;

There are very serious disadvantages with negative interest rate policies, which can actually be counter-productive;

Expansionary fiscal policy, and maybe even helicopter money, would probably creep onto the policy agenda if there were a renewed economic downturn in the eurozone and Japan.

It is very good that we are able to look back and learn some important lessons on coordination and spillovers, but now we must look ahead and form prudent strategies, keeping in mind inter-generational effects and global contagion risks.