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Joseph Mariathasan: Politics, markets and long-term challenges

The start of 2018 sees the global economy looking in healthy shape, but the dynamics of populist politics in Europe and the US should still raise concerns over what the long-term future holds.

Karen Ward at JPMorgan Asset Management (JPMAM) in a recent presentation highlighted key questions for 2018.

First, can the global economy sustain momentum in 2018? To which JPMAM’s answer was ‘yes’, particularly if there is a revival in productivity.

Second, how much should we worry about central banks normalising policy? The asset manager’s view was ‘not too much’ – normalisation is likely to be gradual, but beware of duration and liquidity risk.

Third, are equity valuations now stretched meaning it is time to derisk? JPMAM’s view was ‘no’. Macro-economic factors matter more than valuations over a one- to two-year timeframe. The main risk is inflation, so derisking to cash or fixed income does not make much sense.

If 2018 looks fine, what lies beyond?

Unemployment rates in the US are now below 5%, having been around 10% following the financial crisis. UK figures have shown a similar fall. In the euro-zone, levels are still high at not much below 9%, but they are down from peak levels seen a couple of years ago. However, what has been increasing – and is clearly evident in the US – is a huge rise in inequality. The new jobs that are being created are not of the same quality and wage levels of the middle-income jobs that have disappeared.

Over periods of 10 or 20 years, the developed world faces two major structural challenges that are becoming the driving forces of populist politics. They both lead to rising inequality and the disappearance of middle-class jobs.

The first appears to be the rise of emerging markets, where educated workforces at lower wage levels than developed markets provide an economic arbitrage in whole sectors, particularly manufacturing. The rise of automation, internet and artificial intelligence (AI) in their widest forms is also serving to destroy large numbers of low-level and even mid-level service jobs in areas such as banking, law and insurance.

Trump’s ‘America First’ policy is an attempt to roll back globalisation and the export of middle-class jobs to emerging markets. Some 400 years ago, the per-capita income in China and India was higher than that of Europe. Within one or two generations, the same could be true again.

Trying to stop that realignment smacks of King Canute trying to hold back the tide (he was actually making the point to his courtiers that the powers of a ruler are limited – something that perhaps President Trump has yet to learn).

The rise of emerging markets is something to celebrate. Their rising prosperity is also an enabler for rising prosperity in developed markets. However, the issue that has not been addressed is how rising prosperity in developed markets should be redistributed across the population. It is rising inequality within developed markets, rather than a narrowing of the gap with emerging markets, that politicians need to be addressing.

The second key challenge has to some extent, been explored in a recent paper by Nobel prize-winning economist Joseph Stiglitz (together with Anton Korinek). Korinek and Stiglitz point out that, while some commentators propose that advances in AI are merely the latest wave in a long process of automation, others emphasise that AI critically differs from past inventions.

“As artificial intelligence draws closer and closer to human general intelligence, much of human labour runs the risk of becoming obsolete and being replaced by AI in all domains,” they say.

They argue that the primary economic challenge posed by the proliferation of AI will also be one of income distribution. If redistribution is too costly, it may be impossible to compensate the losers of technological progress, and they will rationally oppose progress, much as the famed Luddites who destroyed machinery at the dawn of the first industrial revolution.

Korinek and Stiglitz argue that inequality rises because innovators earn a surplus: “Unless markets for innovation are fully contestable, the surplus earned by innovators is generally in excess of the costs of innovation.”

In addition, innovations change the demand for factors such as different types of labour and capital, which affects their prices and generates redistributions. AI, for example, may reduce wages and generate a redistribution to entrepreneurs.

Understanding and dealing with these two challenges should be a long-term priority of political parties throughout developed markets. Both should be regarded as unambiguously positive.

But, as Korinek and Stiglitz warn, while individuals and economies may be able to adjust to slow changes, they may struggle when the pace is rapid. The more willing society is to support the necessary transition and to provide support to those who are ‘left behind’, the faster the pace of innovation that society can accommodate.

“A society that is not willing to engage in such actions should expect resistance to innovation, with uncertain political and economic consequences,” declare the authors. Politicians should take note.

Korinek and Stiglitz’s paper is available here.

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