insights on the trends and disruptions of our economic moment
A McKinsey report titled “Leading Through Uncertainty” offered some notable guidance for businesses dealing with unpredictability. “To avoid impulsive, uncoordinated, and ultimately ineffective responses, companies must evaluate an unusually broad set of macroeconomic outcomes and strategic responses and then act to make themselves more flexible, aware and resilient.” That report was published in December 2008, in the midst of a crisis that challenged the world economic order.
Uncertainty is currently at its highest level since the 2008 financial crisis, and Bart van Ark, executive vice president and chief economist at the Conference Board (TCB), spoke to AESC about the global economy, the factors contributing to economic growth and how business leaders can navigate unpredictable waters.
Global growth in real output (measured as GDP, adjusted for inflation) has dropped off to 2.5 percent in 2016—its lowest rate since the end of the global recession in 2009. That is a full percentage point below the 3.6 percent rate experienced between 2010 and 2015 and well below the 4.1 percent growth rate in the decade before the crisis (1996 –2007). The Conference Board Global Economic Outlook 2017
Van Ark and TCB describe the market response to uncertainty through 2016 as a “holding pattern” in which businesses are taking a “wait-and-see” attitude toward investment, further slowing economic growth, and that ongoing deceleration is complicated by the threat that the sources of growth may decline even further.
The International Labour Organisation (ILO) 2016 report on World Employment and Social Outlook identifies the decline in long-term capital investment among drivers of the global growth slowdown, reflecting that “wait and see” approach to uncertainty. According to the ILO report “as of October 2015, the Fed [U.S. Federal Reserve] has excess reserves of $2.6 trillion, which represents nearly 75 percent of total assets purchased by the Fed since the onset of the financial crisis. The ballooning of excess reserves since the crisis demonstrates that financial institutions generally chose to park their cash with the Fed instead of increasing lending to the real economy.”
Economic growth depends on expanding the labor market and increasing labor productivity.
Distraction versus Disruption
The shocks and uncertainties that affect the economy in the short term are, according to van Ark, the “noise” we deal with every day. Shocks and uncertainties are the “confusing, conflicting messages that make business leaders very uncertain about what’s going to come next.”
Business leaders generally take one of two courses of action when confronted by such distractions: hold back, or take a chance. According to the United Nations report on World Economic Situation and Prospects, 2016, “an uncertainty shock also generates a negative productivity shock, as uncertainty can freeze reallocation of human and financial resources within and across firms. As such, these shocks are expected to be short-lived. Yet, seven years since the global financial crisis, uncertainties remain elevated.”
Van Ark describes another reaction to uncertainty in the aftermath of the recent US Presidential election. “A lot of the high business confidence that we’ve been seeing, for example, since the U.S. presidential election, was related to the fact that a lot of business people recognized the likelihood of change after quite a few years of slow economic growth, and their reaction was ‘let’s go!’ What we were seeing was a lot of enthusiasm about possible change, and now were beginning to gradually see some leveling off.”
Another example of a short-term shock was the United Kingdom voting to leave the European Union. Van Ark explains, “Brexit created, at first, a lot of uncertainty. Now people are figuring out that this is going to take a few years.” Van Ark adds, “Uncertainty is not always bad, but it can have these double reactions.”
Uncertainty can make economies deviate in the short term, but those shocks and distractions don’t change trends in the longer term.
Trends are medium-term (around ten years) patterns that don’t change very quickly. The economy has an underlying growth trend, which in the U.S. is roughly two percent per year. Van Ark explains “all the short term noise can make the economy sometimes grow three percent, sometimes grow one percent, but it usually comes back to two percent.”
The forces driving this trend are the growth of the labor market and the growth of labor productivity, or output per worker. Together, the growth of the labor market and growth of labor productivity make up the growth of the economy. Both the labor market and labor productivity have been slowing down in the past decade.
The slowdown in the labor supply is, at least in part, due to the aging of our populations. While demographic trends are different in different countries, overall more people are leaving the workforce than are entering it. In addition, a large number of people, for various reasons, no longer participate in the labor market.
The 2016 ILO report makes a concerning prediction. “[Employment] participation rates are expected to stabilize at 62.8% of the global working-age population (aged 15 years and above) but then to follow a moderate downward trend, reaching 62.6% in 2020 and falling further in subsequent years.” That low rate of participation combined with an otherwise shrinking workforce, results in a deeply declining labor market.
Van Ark suggests that business leaders have different options to address the labor market trend. One is to encourage workers to postpone retirement. “A business leader has to think about how to give people the skills they need, and how to accommodate different working schedules, in order to retain older people in the workplace.” Secondly, employers can push for more immigration in order to recruit knowledge workers from abroad. Van Ark adds, “That gets to the policy environment, which isn’t particularly favorable at this point, even for skills and knowledge workers.”
Van Ark explains that if business leaders and policy makers are unable to increase the size of the labor market, the other way to deal with the economic slowdown is to ramp up labor productivity. However, “In the US and even globally, labor productivity growth—the growth in output per worker on average—is now lower than it has ever been in the last five or six decades outside of recession.”
But why? Shouldn’t technology have allowed the workforce to do more with less, thereby compensating for the decreasing number of people working?
In 2012, economist Robert Gordon argued, “Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motorcars, or indoor plumbing changed it.”
Van Ark says, “We have a lot of new technology, but somehow we don’t have the productivity growth.” Economists call this “the productivity paradox” of the digital economy. That paradox leads to the next category of economic events, disruptions. Van Ark explains, “Shocks can temporarily deviate the economy from the trend, but disruption can change the economy, change the trend growth permanently.”
Global growth prospects face considerable headwinds in the near term, amid a macroeconomic environment of falling inflation and weak employment generation. Five major headwinds—both cyclical and structural—will continue to shape the near-term outlook of the global economy as well as its longterm prospects:
- Persistent macroeconomic uncertainties and volatility;
- Low commodity prices and declining trade flows;
- Rising volatility in exchange rates and capital flows;
- Stagnant investment and diminishing productivity growth;
- Continued disconnect between finance and real sector activities.
- World Employment Social Outlook Report, 2016 International Labour Organisation
Several different disruptions can shift long-term economic growth trends, including fiscal and monetary policy, changes in the energy landscape, and deglobalization. Van Ark says, “The current trend we are seeing in the economy around de-globalization including less international trade, less migration, and the trend toward becoming more inwardlooking is very disruptive.” Van Ark believes another disruption worth talking about in depth is the digital transformation of the economy.
You can see the computer age everywhere but in the productivity statistics.
Speaking of the digital transformation of the economy van Ark says, “This should be changing the growth performance in a way we expect: digital transformation is going to lead to more innovation, which means more products and services, which should drive people to consume more of those products and services thereby making companies more productive.”
Somehow we are not seeing that reflected in our economy. We are seeing productivity numbers come down.
A June 2016 New York Times story reported on the question, quoting a recent McKinsey analysis. “Only 18 percent of the American economy is living up to its ‘digital potential,’ the report concluded. And if lagging industries do not catch up, we will not see much of a change in national economic statistics.”
Van Ark provides a possible explanation for that phenomenon.
He posits that the digitalization has worked well for consumers, but for businesses that are not digital natives, new technology has been incredibly difficult to apply. Van Ark asks, “How are businesses going to use cloud storage and cloud computing in their companies in terms of big data analytics? How are they going to develop AI into products that consumers will want and need?” Many businesses that did not evolve out of or emerge with new technology are having to deal with competition coming from unexpected places. Van Ark asks, “If I’m a bank, for example, I would not have thought ten years ago that Google and Apple would be my main competitors when it comes to new payment systems.” Banks, among other businesses, have been blindsided by disruption.
Wait—what? We keep hearing about acceleration!
Acceleration in an economic downturn is not, actually, a contradiction. The pace of change is indeed accelerating, and the rate at which businesses must respond is accelerating, too. But ramping up change does not equate to the ramping up of the economy. It seems we have to accelerate in order to stand still.
Productivity is the most important determinant of long-term growth, and logic suggests that since technology increases speed, accuracy and efficiency, it should also increase productivity. Yet despite exponential growth in the development and deployment of new technologies, productivity growth has stagnated around the world.
Companies that have been in business for a long time are new comers to the digital economy, and they are having a hard time. Van Ark says, “We know all the success stories about the Googles and the Apples, the IBMs and Ubers, but they are what we call digital natives – those businesses have grown up in this digital environment. Most of our companies are coming out of the non-digital environment and they are immigrating to this new digital economy.”
This digital adoption and implementation, and the cultural, structural, and skills shift it will require takes time, which is why productivity growth is so slow. Van Ark says, “The good news is we do see some changes: organizations are beginning to get their arms around this technology, they’re beginning to achieve faster top line growth, they’re beginning to see revenue, and they’re beginning to save more costs, and that is something that will ultimately turn the picture around and drive up productivity growth.”
The question is whether that growth will be enough to offset the slow down in labor supply. That’s not so certain.
What to do?
To van Ark, the leadership implications are clear. “Leaders must deal with the short term noise; they need to have contingency plans, but they can’t hunker down permanently.” Reflecting on the difference between shocks and true disruptions, van Ark cautions leaders to be careful that they not get distracted. “Leaders should try to watch for the disruptions that are going to disrupt them, or the disruptions they need to implement in order to disrupt others.”
Finding the balance between shortterm challenges and long term focus is the key leadership skill that is required in this very difficult, very noisy economic environment.
About The Conference Board
The Conference Board is a global non-profit organization of public and private companies from 60 countries. The Conference Board conducts research and thought leadership, and is considered a trusted, unbiased source for information on economic trends. The Conference Board publishes a number of regular indicators for United States and international economies that are widely tracked by investors and policy makers, including U.S. Consumer Confidence Index, Leading Economic Indexes, Employment Trends Index, and CEO Confidence Survey