Category: Technology

A New Path for Industrial Policy in Brazil

In recent decades, very few developing countries have reduced the income gap with rich nations, and those that have are either in East Asia or Eastern Europe. The successful “climbers” have prospered by integrating themselves into an increasingly globalized economy, gradually increasing the volumes and complexity of their exports. The “laggards” across the developing world have typically suffered from economic and political instability and shunned the competition of global markets. Brazil, the “poster child” for the laggards, has been stuck in a “middle-income trap” for over thirty years, caused by public policy errors resulting from political dynamics.

Since the 1980s “lost decade” Brazil’s politicians have pursued “distributional politics” aimed at correcting wealth disparities between regions and social classes. The previous model (like China’s current model), which for three decades (1950-1980) had been aimed at building mass production manufacturing and infrastructure, was largely discarded as inefficient and costly.

The new development model for Brazil, still very much extant today, has been driven by the “Welfare” Constitution of 1988 that imposed an extreme form of federalism which gives scarcely populated states enormously disproportionate representation in both chambers of Congress.

Unlike the successful economies of Asia and Easter Europe, since the 1980s Brazil’s industrial policy has been inward looking and aimed directly at achieving social objectives instead of economic results. The main goal of industrial policy has been to relocate industrial activity from rich states to poor states by providing abundant tax incentives to investors. The result has been the hugely wasteful Manaus Economic Free Zone and some uneconomic and nonproductive relocation of manufacturing facilities from the south to the north. Consequently, since 1980, Brazil has gone from being the prominent industrial nation in the developing world to a minor player undergoing large-scale deindustrialization.

The major winner from federal political dynamics has been the farm sector which is broadly diffused geographically in states with low population density. In this case the policies have led to massive increases in output and productivity.

In essence, Brazil’s farm sector is a disguised “Asian Tiger.”  Like in Asia, government support for Brazil’s farmers has been broad and extensive and consistent for decades. In addition to substantial fiscal, credit and export subsidies, the sector has benefitted greatly from the work of the national Brazilian Agricultural Research Corporation (Embrapa), which is widely recognized as a global leader in tropical agriculture research and has been instrumental in boosting crop productivity. Furthermore, the farm sector benefits from two more characteristics integral to the “East-Asian” development model. First, domestic competition is acute, therefore, even though state support is available to all, only the most productive farmers can thrive.  Second, because agricultural commodity markets are global in nature, the sector is export driven. This means that Brazilian farmers compete with American farmers and must remain at the forefront of technological innovation.

Unfortunately, the farm sector is not a good substitute for industry. In contrast to the job creation, work training and other multiplier effects that are integral to Asian industrial policy, the farm sector in Brazil is highly capital and technology intensive and does not generate many jobs or ancillary economic activity. Also, its success has significantly increased the commodity dependence of the Brazilian economy and led to a structural appreciation of the Brazilian real. Finally, this commodity dependence generates economic and currency instability which further undermines the competitiveness of the manufacturing sector.

The challenge for Brazil is to find new growth sectors which can secure sustainable political support and lead to productive investments that generate quality jobs. The markets are very skeptical that this can be done.

A brief effort at industrial policy during the first Lula Administration collapsed under mismanagement and corruption and was followed by an equally brief romance with neoliberal policies under Bolsonaro.

Lula’s return to power this year has revived talk of industrial policy in Brazil, abetted by a shift away from neoliberalism in the United States and China’s aggressive state-led push to achieve industrial self-sufficiency in all “strategic” industries. Unsurprisingly, given Lula’s track record, market skepticism is high. Initial signs from the new government do not give much hope. The best that the new administration has come up with so far is a hare-brained scheme to provide temporary subsidies for purchases of automobiles.

Any viable industrial policy will need broad and sustainable political support in Congress. This means that the benefits must be broadly distributed geographically. Unfortunately, Lula’s atavistic vision of development is rooted in the state-led, capital-intensive model of the 1970s (e.g. Petrobras leading investments in refining and infrastructure).

A better approach would be to focus on strategies that have been successful in other countries: tourism and “green” energy, for example. Building a national consensus with political support to provide long-term  incentives for private businesses to invest in tourism and alternative energy could set Brazil on a new growth path. Policies should be structured so that  investors face both domestic and foreign competition to weed out the weaker players.

These are two sectors that are labor intensive and with potential for broad geographical dispersion of benefits. Brazil’s woefully underdeveloped tourism industry can learn from countries like Mexico and the Dominican Republic. In the case of alternative energy, the policies pursued by the Biden Administration in the U.S., the roll out of wind and solar capacity in Texas and initiatives pursued in many other countries can be copied. The roll out of wind and solar energy in Texas is highly relevant, as Brazil has outstanding conditions  to do this, with many locations in poor states. 150,000 well-paid clean energy jobs have been created in Texas over the past eight years and the sector is growing fast.

China’s Existential Threat to Emerging Market Economies

The model of development followed by most developing countries has been to gradually move up the value chain of manufactured goods while at the same time establishing control of the production of the basic inputs of industrialization which are steel, cement, ammonia, and plastics.

This model of development worked well for many of the current middle income emerging market countries. Brazil and Mexico, for example, developed its steel, cement, ammonia and petrochemical industries in the 1950s and 1960s while it concurrently dominated the process of mass production of motor vehicles, capital goods and many other basic consumer goods. Those years were the golden years for these countries and were broadly perceived as economic “miracles.” Most middle-income Asian countries (Thailand, Malaysia, Indonesia) repeated this process in the 1960s, 1970s and 1980s with similar success, now followed by Vietnam.

This process of basic industrialization was achieved with foreign investment and the transfer of mature technologies from the U.S. and other developed countries. The technologies were easy to transplant to developing countries and had the advantage of being scalable to different markets and often  large generators of low-skill “quality” jobs. Generations of Brazilians were integrated into the modern economy and learned the skills of industrialization and the routines of modern enterprises by working in manufacturing, and they entered into the middle class and became consumers (e.g., Brazil’s current president, Lula, worked in an auto plant in Sao Paulo in the 1960s as a metalworker before becoming a union leader).

Two things happened to dramatically undermine this trend. First, the neoliberal revolution of the 1980s spawned the “Washington Consensus” for free trade and capital movements and the great wave of hyper-globalization of the past decades. Second, in the 1980s,  China entered the phase of rapid development, following the path set by Brazil and others: exploiting foreign investment and technology transfer to dominate the production of the basic inputs of industry (steel, cement, ammonia and plastics) and the mass production of consumer and capital goods.

While the mass production technological cycle (“Fordism”) was exhausting itself in both the industrialized world and middle-income emerging markets, giving way to the Information and Communication Technology revolution (ICT), China gave it new life. With abundant cheap labor and clever incentives, China became the dominant global producer of most basic industrial goods,  replacing production capacity in both developed and developing markets. In a neoliberal era of free markets, multinationals gladly offshored the mature mass production function to China, to gain access to cheap labor, subsidies and lax environmental rules. The combination of a large and growing domestic market and access to international markets gave China a scale advantage which previous fast-growing developing countries had never enjoyed during this period of learning to dominate the mass production process.

The degree to which China has taken over the mass production paradigm is shown in the following charts: 1. Global Primary Energy Consumption; 2. Global steel production; 3. Global cement production; 4. Global ammonia production; 5. Global plastics production. The growth of output that China has experienced in all of these areas is astonishing in a historical context. China consumed one third the primary energy consumed by the U.S. in 1980 and 1.7 times as much in 2021; it produced about the same amount of steel as the U.S. in 2000 and now produces 10 times more; China’s cement output in 2020 was 27 times the U.S.’s peak production year; China produced 2.5 times more ammonia than the U.S. did in 2021; and China now produces 1.5 times the plastics made by the U.S.

 

As China moves up the manufacturing value chains, it now seeks to dominate global markets for consumer durables, such as computers, televisions and cars. The charts below show the astronomical growth of China’s car production and its recent progress in tapping export markets. China’s growth in auto production over the past decade is greater than the entire growth of the industry on a global basis. And now, China’s auto firms, as the economist Brad Setser recently noted, are ramping up exports. In a few years’ time, Chinese passenger car exports have grown to surpass those of the U.S. and Korea and match those of Germany. Most of these highly subsidized exports are finding their way to developing countries.

The extension of the mass production technology cycle was an unequivocal boon for China but a mixed blessing for developed countries and the middle-income emerging markets. In exchange for cheap consumer goods and high corporate profits, manufacturing sectors were decimated, jobs were lost and income inequality and political rage increased. Moreover, while the mass production cycle was extended, with dire consequences for CO2 emissions, the potential benefits of the ICT revolution were delayed. Instead of focusing on making industry more productive and greener, Silicon Valley has channeled most of ICT investments into social networking, search, delivery and gaming applications.

For developing markets, China’s rise is an existential threat. Unless they can defend themselves with tariffs, they are condemned to handing over their consumer demand for manufactured goods to China in exchange for commodities.

Latin America’s Pink Wave Faces Investor Skepticism

A pink wave of leftist governments has swept across Latin America. In recent years, first Mexico, then Argentina, Peru, Chile and Colombia and finally Brazil, have all elected governments with ambitious social agendas and plans for bringing back the state as the agent of economic development. Unfortunately for them, investors, both local and foreign, are not sticking around to see how this will work out.

The left in Latin America has a dismal record with its style of developmental activism centered around state companies, private firm “champions” and protectionism. Recent experience with Peronist Argentina, Bolivarian Venezuela and Brazil’s PT party have ended in economic collapse, inflation, currency devaluation, soaring debt and increased misery. The result has been a decade of severe capital and human flight.

The return of Lula and his PT party to power in Brazil promises more of the same big plans for state-led growth promoted by government agencies, state companies and public banks. It doesn’t matter that these policies previously ended in enormous losses caused by mismanagement and rampant corruption.

Unlike a decade ago, when Latin America’s left was going against the neoliberalism of the Washington Consensus, today state activism is back in favor in Western capitals. Partially as a response to Chinese policies but also because of a new concern for the many domestic losers of globalization, the Biden Administration has pushed through the country’s biggest-ever piece of climate legislation (The Inflation Reduction Act) which will provide lucrative tax incentives to companies that develop mines, processing facilities, battery plants and EV factories in the US. In addition, with bipartisan support, new laws have been passed to promote infrastructure and semiconductor investments. Moreover, these new programs now have strong intellectual support from academicians (Mariana Mazzucato and Carlota Perez are prominent examples) who argue that history points to the importance of government policies to induce investment, particularly at times of enormous technological disruption like the ones we are now living.

Chile’s president Gabriel Boric has sought the counsel of Carlota Perez, a Venezuelan economist who studies the interplay of long-term technology and financial cycles,  to understand how Chile fits into the current process of global technological transformation engendered by the Information and Telecommunications Technology (ICT) revolution. According to Perez, Latin America has been a major loser of this technology cycle which has crippled the mass production “Fordism” model (manufacturing jobs that pay enough for a worker to acquire middle class consumer goods) that was the foundation of the post WW II Latin American modern economy. These jobs have been destroyed across South America and replaced by low-pay/low-skills service jobs. Nevertheless, Perez actually sees a brighter future, as we have now entered the period of massive diffusion of ICT technologies, a “golden age of full deployment.” During the second half of long technology cycles, typically the productive sector replaces the financial sector as the driver of the economy. Perez sees a vital role for the state at this stage of the cycle to “tilt the playing field” through public policies (credit, taxes, subsidies, etc…) to support productive activities and “smart, green, healthy global growth.” She recommends that a country like Chile  promote  ICT diffusion by inducing investments into socially critical areas (e.g., the democratization of access to education and information) and into priority frontier industries (e.g., alternative energy technologies and supply chains).  Perez argues that those countries with political dynamics that allow for proactive public policies will  have a big advantage in coming years. Without these policies, ICT investments have primarily financed “escapist undertakings” such as computer games, social networks, parallel universes and delivery services for the rich, Perez says.

In line with the ideological shift towards state activism, Brazil’s Andre Lara Resende, a MIT trained economist who has joined president-elect Lula’s economic transition team, argues in favor of “alternative policies of public investment” to kick-start capital deployment in infrastructure, decarbonization, electrification and industrial revitalization. According to Lara Resende, these investments are productive and profitable and would  boost economic activity , and, therefore, would have a positive impact on fiscal accounts. His rationale relies on a proposed radical change in Brazil’s monetary policy from the current Fed-centric model to an independent one based on ‘’Modern Monetary Theory,” which assumes that public debt does not matter as long as rates are below nominal GDP growth.  Lara Resende would achieve this through financial repression (artificially low interest rates and directed lending), at the expense of what he sees as an over-sized financial sector divorced from the productive sector of the economy and at the service of the rentier class.

Though Lara Resende doesn’t say this, the logical consequence of his plan is a return to the strict capital controls that Brazil had until the 1990s. Of course, investors will try to anticipate this change. Boric faces the same issue in Chile which as seen huge levels of capital flight in expectation of structural changes to economic policy.

The president of Brazil’s Bradesco, Bank, Octavio de Lazari, this week warned president-elect, Lula that, given “an extremely challenging” 2023, there is no room for “tests and experiments,” and he suggested the government focus on reducing inflation and controlling fiscal deficits. From within Lula’s economic transition team, the sole orthodox member, the economist Persio Arida, echoed these thoughts, advising his colleagues to stick to the basic objectives —  ‘Opening the economy, making the state more efficient and reforming the tax system” — which have been pursued by  Brazilian economic policy makers, unsuccessfully, for the past 40 years.

Latin America faces a stark dilemma. The neoliberal polices of the Washington Consensus are deeply out of favor and blamed for currents ills, and the rich countries are moving away from these policies and are increasingly prone to fiscal and monetary experimentation and state activism. This could in theory provide an opening for policy changes in Latin America. However, investors believe that today’s Latin American states do not have the ability to implement state-led growth without the corruption and incompetence of the past. In a world of free capital flows, investors will prefer to move  their capital outside the country rather then risk it at home.

Long Technology Waves and Emerging Markets

The poor performance of many developing economies in recent decades has many explanations. Thought leaders such as prominent mainstream economists, the World Bank and the IMF tend to attribute failure to weak “institutions” which engender corruption, bureaucracy, lawlessness and poor human capital formation, and, consequently, result in a difficult environment for productive investments and capital accumulation to occur. In the countries themselves structural reasons often are preferred which tend to blame external forces: the legacy of colonialism and foreign oppression or the inequitable dependency of the “periphery” (developing countries) on the “center”  (rich countries). A third approach, put forward by experts on historical technological cycles, gives significant incremental insights on the question, and, more importantly, guidance on a path to better performance in the future.

The Russian Nikolai Kondratiev and the Austrian Joseph Schumpeter developed the idea during the 1920s that  long technological waves drive  the course of economic growth. Both of these “political economists” sought to understand the miraculous growth created by the industrial revolution over the previous century to better explain the post W.W. I  environment.

Schumpeter is best remembered for the idea that “creative destruction” is fundamental for progress and occurs in a recurring process: innovations made by scientists and tinkerers are turned into inventions by profit seeking entrepreneurs; eventually, the wide diffusion of disruptive technologies lead to widespread creative destruction as entire industries and sectors are transformed.

The chart below, from Visual Capitalist, summarizes the long-term technological cycles defined by Kondratiev and Schumpeter. Though the precise dates are debated by historians, the chart seeks to cover the entire era of the “Industrial Revolution.”  Five distinct “long waves of innovation” are described, each one of which was deeply transformative, not only for the firms and industries involved but also for the socio-political fabric of society. This framework puts us today in the fifth wave of technological progress, the Information and Communication Technologies Age (ICT).

Following  in the path of Schumpeter, the Venezuelan economist Carlota Perez and others have advanced the discussion of technological waves by incorporating the role of capital markets and exploring the implications for the development of “periphery” countries. Perez’s book, Technological Revolutions and Financial Capital (2001), has been hugely influential and is required reading in Silicon Valley boardrooms and venture capital firms.

Perez talks about technological revolutions as “great surges of development” which cause structural changes to the economy and profound qualitative changes to society, and she sees capital markets at the core of the process. Her “revolutionary waves,” as shown in the chart below are in line with Schumpeter’s, but she increases the scope to show the broad reach of these technologies on communications and infrastructure and, consequently, trade and commerce and society as a whole.

Perez’s technological cycles are divided into three distinct phases, which are determined by the diffusion rate of technologies.

During the initial phase – Installation – new innovations are slowly adopted by entrepreneurs with disruptive business models. As the kinks are worked out and the technologies become cost effective more entrepreneurs adopt the technologies with the backing of financiers (e.g. venture capital) who seek the high potential payoff of backing a future champion. This leads to a frenzy of capital markets speculation, which invariably results in overinvestment, hype, financial bubbles and financial crisis.

As shown below, every Installation phase has ended in a bubble, followed by a financial crisis, which Perez call the Turning Point. The canal mania of the British industrial revolution, the British railway mania of the Age of Steam, the global infrastructure mania (sometimes called the Barings mania) of the Age of Steel, the roaring twenties stock market bubbles of the age of mass production and the  Telecom, Media and Technology (TMT) bubble of  the ICT revolution all ended in financial crises.

For illustration purposes, the chart below shows Perez’s process at work for the current Information and Communications Technologies (ICT) revolution that we are currently living. The cycle is a typical S-curve which has a long incubation period of slow growth, followed by a sharp ramp up and an eventual flattening.  The current cycle can be said to have started in 1971 with the launch of the first commercial micro-processor chip by Intel, but this was only possible because of a prior decades-long incubation period of scientific research and tinkering. Financial speculation built up between 1995-1999 led to the great TMT bubble and the crash in 2000-2001. Following the crash, the Deployment Phase has caused the rise of the major winners through a consolidation process (FAANGS). (These consolidations are normal, according to Perez. For example, hundreds of auto companies engaged in brutal competition before consolidating into the three majors in the 1920s).

The Deployment Periods, which Perez calls the “Golden Ages”, is when the technologies become cheap and ubiquitous, and their benefits are widely diffused through business and society. Perez argues that we are on the verge of another “golden age” today, as we approach broad access to smartphones and the internet and massively powerful micro-chips are becoming almost ubiquitous in basic consumer products (the chip in an Iphone has a trillion times the computing power of those used by IBM’s mainframe computers in 1965.)

If it doesn’t feel now like we are entering another “Golden Age” it is because we are still experiencing the after-shocks of the previous phase of financial frenzy and economic collapse and its consequences: high inequality and populism. Perez argues that the successful countries of the next decades will be those that have governments that understand the moment and can actively promote the diffusion of ICT technologies to achieve broad societal goals (e.g. “green” technologies).

Technology Cycles and Emerging Markets

Looking back at history, one can see how this process has played out before for developing countries. We will focus on the last three technology cycles: The age of steel and mass engineering, the age of oil and mass production and the current ICT revolution.

The age of steel and mass engineering (1875-1908): This was the age of the wide diffusion of the steam engine and steel through mass engineering to provide the infrastructure for the first wave of trade globalization. The rise of Japan (the first of the Asian Tigers) occurred over this period as it methodically diffused all of the technologies developed in the West.  Latin America experienced its own “Belle Epoque,” as steamships and railroads made its commodities competitive in global markets. During this time, Argentina and Brazil were considered at the level of development of most European countries and attracted millions of European immigrants.

The age of oil and mass production (1908-1971) – Interrupted by two devasting world wars and marked by profound socio-political change, this age still generated wide-spread prosperity, though China, India and Eastern Europe did not participate. Initiated by the launch of Henry Ford’s Model T automobile in 1908, it saw the diffusion of the internal combustion engine, electrification, and chemicals under the structure of the modern corporation. Following the Second World War, broad diffusion of these technologies led to a “Golden Age” of capitalism throughout the Western World. This was also a period  of “miraculous” growth throughout Latin America as the wide diffusion of the mass production process, supported by import substitution policies and foreign multinationals, created abundant quality jobs in manufacturing and the rise of the middle class consumer.

The  Information and Communication Technologies  (ICT) Revolution (1971-today): All phases of technological revolutions overlap with their predecessor and follower as the diffusion process plays out. In the case of the ICT revolution the overlap has been particularly important and has created unexpected winners and losers. China’s economic reforms (1982) and the fall of the Berlin Wall (1989) had the effect of radically expanding the length and scope of the Mass Production Age at a time when the “creative destruction” of the ICT Age should have been undermining it. Instead of increasing productivity German corporations moved mass production to Eastern Europe and American corporations outsourced to China, to exploit cheap labor. Companies also were able to avoid expensive environmental costs by offshoring carbon-intensive, heavily polluting industries to China and the Middle East, delaying the diffusion of “green” technologies for decades. The Mass Production Age, with its high environmental costs, was extended to the enormous benefit of China and a few countries in Eastern Europe, at the expense of workers in Europe and America who were pushed into low-productivity service jobs, and the “Golden Age” of the ICT revolution has been delayed. ( U.S. productivity and growth have declined and inequality has risen sharply while Amazon makes it ever easier to buy Chinese-made goods.)

The slow diffusion of the ICT age and the extension of the mass production age has had very uneven consequences for emerging market countries. The winners of the ICT age have been those countries that were late comers to the mass production paradigm and understood that the ICT revolution would lead to massive reductions in communication and transport costs and a new wave of globalization. The Asian Tigers (Korea, Taiwan, China, Vietnam) and to a lesser degree Eastern European countries (Poland, Czech, Hungary) have been the champions by integrating themselves in global mass production value chains and assiduously working to add value. South-East Asian countries (Indonesia, Thailand, Malaysia) initially did well but increasingly find themselves sandwiched between newcomers like Vietnam and Bangladesh, which are competitive in low value-added products, and China for higher value-added products. Both India and the Philippines almost completely missed out on the mass production age revival but have made small niches for themselves in the ICT world with Business Process Outsourcing (BPO) and IT Services Outsourcing.

The big loser of the ICT age has been Latin America, which has undergone severe deindustrialization and has become mired in the middle-income trap. Mexico has suffered the greatest frustration. This country, led by its brilliant technocrats, did everything right to position itself for the mass production to ICT transition, entering into the groundbreaking NAFTA trade agreement with the U.S. and Canada. The thinking behind NAFTA was brilliant. It would facilitate a smooth transition out of mass production to ICT for U.S. firms while extending the benefits of the mass production age to a friendly neighbor operating under controlled conditions (labor, local content, subsidies, environmental, etc…). Unfortunately for Mexico, the dramatic rise of China as the factory of the world undermined all of these objectives, as China successfully dominated global value supply chains without having to meet any of the conditions Mexico had to comply with.

South America has not fared better. As high-cost producers with very volatile currencies and economies, these countries were unprepared to compete with China. These disadvantages were compounded by (1) the false hope created by the commodity boom  (2002-2012) which resulted in a typical boom-to-bust cycle and a vicious case of Dutch Disease (natural resource curse) that these countries have yet to recover from and (2) the adoption of “Washington Consensus” financial opening dogma (free movement of capital) which increased volatile flows of hot money and destabilized currencies.

The following chart shows economic convergence since 1980 (in terms of USD GDP/Capita) for a sample of developed and emerging market countries, which is illustrative of the winners and losers of the ICT Revolution.

The Golden Age of ICT

If Perez is correct and we are on the verge of a Golden Age of  extensive diffusion of ICT technologies through all segments and geographies what should countries be doing?

Perez and Raphael Kablinsky in his recent book, Sustainable Futures, An Agenda for Action, argue for activist government using its resources to incentivize private investment to achieve desirable societal goals (e.g., environmental sustainability, equal opportunity). The Biden Administration’s recent Inflation Reduction Act (IRA) and the Chips and Science Act are both in that spirit, aiming to promote investment in clean energy and energy efficiency and the re-shoring of  semiconductor production away from the Asian mass production value chain. These initiatives, as well as President Xi’s Made in China 2025 Plan, all assume that the great Mass Production Age extension through China-centric global value chains has run its course, and that ICT diffusion will now result in, without excess short-term costs, a return to more local/regional manufacturing and a more autarkic or segmented global trade system. Through massive state subsidies China already has taken a commanding lead in the production of “green” products such as electric vehicles and batteries and solar panels.

The return of activist government, coming after a 40-year period of neo-liberalism and government retrenchment, raises the question of what policies countries should pursue to fully reap the benefits of this final phase of the ICT Revolution.

Perez recommends two basic courses of action that many emerging economies and developing countries can pursue. First, governments should be active in promoting ICT diffusion in industries where competitive advantages are evident. For example, commodity rich countries like Brazil, Argentina and Chile can increase productivity by being at the forefront of ICT innovations applicable to farming and mining and, at the same time, aggressively move up value chains for these products. (Brazil, with its low carbon-dependent economy and enormous potential in solar, wind and biofuel energies, is well positioned to become a global leader in “green” farming and mining).  Second, Perez sees large opportunities for countries or regional groups to capitalize on climate change initiatives by deploying alternative energy sources and capturing their value chains through localized production. (Once again, Brazil with its large local market opportunity can achieve leadership).

The consulting firm McKinsey provides a roadmap for the future in a recent article, “Accelerating Toward Net-Zero; The Green Business-Building Opportunity” (Link). The following chart from McKinsey maps out the sectors expected to have the largest economic importance in a “greening” economy and, consequently, where governments and firms are advised to focus their efforts.

Ten-Year U.S. Treasury Rates and the Reflation Trade

The ten-year U.S. Treasury bond rate is the most important parameter in investing, used by investors of all types to establish relative return metrics. Ten years encompasses about two regular business cycles and is a practical time-frame for investors to work with: it avoids both counterproductive “shortermism” as well as the unfathomable long term. Therefore, investors estimate cash flows ten years in advance and discount these by the risk-free treasury rate added to a premium which measures the specific risk of the investment.

So, what happens when 10-year rates approach zero or even negative rates, as they now have across Europe and Japan? U.S. rates, currently around 0.60%, are at historical lows in nominal terms and well into negative territory in real (inflation adjusted) terms, as shown in the graph below.

 

What do these historically low interest rates tell us?  In the past, the nominal ten-year rate has been a relatively good predictor of nominal GDP growth. This relationship has been reliable over the 1970-2020 period when both nominal GDP and the 10-year Treasury rate have averaged a little over 6% per year. The current low rates, then, may point to a combination of deflation and low GDP growth in coming years, unless an argument can be made that rates are being artificially repressed by the Fed (and elsewhere).

If valuations for stocks are determined by discount rates linked to the 10-year rate, what are the investment implications of the current circumstances? On the one hand, very low rates imply high valuations, as long-term cash flows increase in value as discount rates decline; on the other hand, tepid economic growth pushes down valuations, as cash flows for most company are closely linked to economic output. In summary, what the investor gains from low valuations he losses from low cash flow growth.

The current state of the global economy is depressive with low growth prospects. Most countries face poor demographics and excess debt. Concurrently, most industries are being brutally disrupted by an eruption of practical innovations spawned by the “information and communications” revolution. In this environment of low growth and disruption, one would expect that, in general, corporate profit growth would be weak, but that those few companies enjoying growth and benefiting from disruption would be rewarded with high valuations. The current Covid-19 environment has starkly heightened these trends, as most companies  have been devastated by the crisis while for a few disruptors it has been a boon.

Of course, most of these winning companies are U.S. based, and that explains the high valuations for tech companies in Silicon Valley and other frontier industries. These companies either have predictable long-term growth (eg. Amazon, Microsoft) or exceptional market opportunities (eg., biotech). These sectors benefit from long-duration cash flows which discounted at today’s low rates result in very high values. When found outside the U.S. — tech in China, Korea and Taiwan, e.commerce in Latin America (Mercado Libre) or South-East (SEA) — these firms are also highly valued.

In both the U.S. and international markets, “growth” stocks have performed much better than “value” stocks over the past decade. This is because growth has been scarce and low discount rates have boosted the value of long-duration cash flows. The problem for international and emerging markets is that “growthier” sectors (information technology, fintech, e.commerce and bio-pharma) have much less weight than they do in the tech-heavy U.S. stock indexes. This is particularly true in emerging markets where financials, industrials and commodities dominate the indexes. To make matters worse for emerging markets, at the beginning of this period of low growth and great disruption, around 2010-2012, these sectors had extremely high valuations.

Take the case of financials. In the past in emerging markets highly profitable banks with dominant market positions were favorites of investors. 10 years ago, financials in EM represented 24% of the index, led by the Chinese and Brazilian banks. Today, financials in EM represent only 18.5 of the MSCI index and they are suffering from a combination of low growth, historically low interest rates and attacks from tech-enabled disruptors which are often abetted by regulators. Technology only represents 16.5% of the EM index (most of which is in China) compared to about 45% of the S&P 500, while financials have fallen to only 10% of the U.S. index.

So, what could change the current paradigm of the market and make emerging markets attractive again?

Well, obviously a rise in inflation and interest rates would be beneficial, since this would reverse the cause of high valuations for growth stocks. A spike in the ten-year treasury rate would have a large impact on the valuation of companies with long-duration cash flows and cause a major shift in valuations, allowing “value” stocks to outperform in relative terms. However, this does not appear to be imminent. On the contrary, rates continue to be on a strong downtrend.

Nevertheless, we may be seeing some  “green shoots” of a reflation trade. These can be listed as follows:

  • High valuations for growth stocks are causing a rotation into underperforming segments of the market, including emerging markets.
  • China stimulus is pushing up commodity prices. Industrial commodities, led by copper and iron ore, have rebounded strongly.
  • Potential inflationary shifts in U.S. public policy: forced reshoring of manufacturing, boosts in minimum wages and union influence, universal income and expansive monetary and fiscal policy.
  • A weakening dollar and concurrent rise in alternative currencies (gold, bitcoin).

The USD has weakened significantly from the March high, and an extension of this trend would be important evidence supporting a regime change towards higher inflation

Emerging Markets’ Innovation Problem

The Global Innovation Index ( GII)  measures how countries compare in their ability to innovate. Presumably, innovation drives productivity and development, and, therefore, the most innovative economies are also those enjoying the best growth in living standards. Today we face revolutionary breakthroughs in artificial intelligence and automation technologies which promise to radically change  for the better the way we work and live. However, these changes present a heavy challenge for many emerging markets as new technologies eliminate the rote manufacturing jobs traditionally off-shored to labor-abundant developing countries.

Sponsored by Cornell University, INSEAD and WIPO (World Intellectual Property Organization),  since 2007 GII ranks countries in terms of their innovation potential. This gives us a decade of observation to gauge how different countries are progressing. Unfortunately for emerging markets, the evidence is disappointing, with a few important exceptions. By and large, emerging markets appear to be falling behind in their innovation capacity.

The chart below shows the rankings of the top 25 most innovative countries in both 2007 and 2017, with arrows pointing to the change in position.

 

The rise of small European countries is highly significant. Switzerland, the Netherlands, Ireland and the Nordic countries have all progressed very positively. This contrasts to the relative decline of France, Germany and Italy. In any case, eight  of the top 10 innovators in the ranking are European countries, which belies the prevalent market pessimism on the prospects for Europe. Italy, India, UAE and Belgium fell out of the “elite “top 25, replaced by China, Czech, Estonia and New Zealand.

In relation to emerging markets, the chart highlights the radical divergence of India and China. China has had a steady rise up the rankings from 29th in 2007 to 25th in 2016 and 22nd  in 2017. South Korea has also had an impressive escalation, from 19th to 11th; and, remarkably, it has surpassed Japan which has fallen from 4th to 14th. However, the most concerning performance has come from India which has seen its ranking fall from 23rd to 59th.  This result raises serious questions about the quality of Indian growth.

India’s decline is emblematic of a wider problem in emerging markets, as the below chart highlights

 

The chart highlights how the GII rankings have changed for the 18 most important countries for investors in emerging markets.  Of these 18, two-thirds have had significant declines in their rankings and only one-third has experienced improvement. Of these EM countries, only eight rank in the top 50 for innovation, compared to eleven in 2007. Aside from China and Korea mentioned above, Vietnam, Poland and Russia have risen in the rankings. The rise of Vietnam is impressive and gives credence to its claim as the rising star of “frontier markets.”

On the negative side,  India, Brazil, Mexico, South Africa, Thailand, Colombia and Indonesia are evolving very poorly, raising questions about how they can compete effectively in an increasingly competitive, technology-driven global economy. Also in this camp, the Philippines and Argentina are in dire situations. These countries do not seem able to nurture the institutions and make the public investments required for investment and productive innovation to take place. Consequently, their best minds are deserting, immigrating to more hospitable places.

Macro Watch:

India Watch:

  • India pushes coal (SCMP)
  • Samsung opens world’s largest smartphone factory in India (Bloomberg)
  • Scarsity of visas is shaking up Silicon Valley (SF Chronicle)

China Watch:

  • Why was the 20th Century not Chinese (Brad Delong)
  • The Chinese view Trump as cunning strategist (FT)
  • US-China Trade War – How we got here (CFR)
  • China will not reflate this time (Marcopolo)
  • Xi’s vision for China global leadership (Project Syndicate) (Kevin Rudd)

China Technology Watch

 

  • China’s BOE targets Apple screens (WSJ)
  • Tsinghua Unigroup bids for French tech firm Linxens (SCMP)
  • Interview with AI expert Kai-Fu Lee (McKinsey)
  • JD.com is driving commerce in rural china (Newyorker)

EM Investor Watch

  • Can Iran by-pass sanctions (Oil Price.com)
  • Brazil’s military strides into politics (NYtimes)
  • An update to the big mac index (Economist)
  • Interview with Kissinger (FT)
  • Erdogan’s “New Turkey” (CSIS)

Tech Watch

  • Seven reasons why the internal combustion engine is dead (Tomraftery)

Investing

 

 

 

 

Deglobalization and Technological Disruption

Deglobalization and rapid technological change are likely to be the two main drivers of economic and stock market performance in emerging markets for the next five years. Every country faces different combinations of challenges and opportunities and how they deal with these will make a big difference in whether they prosper in our rapidly changing world.

Deglobalization

The intense globalization of the past decades, which had not been seen since the last decades of the 19th century, was a boon to the global economy, while at the same time dramatically redistributing relative income: to the poorer countries and away from the developed ones; and to super-wealthy individuals and away from everyone else. The political effects of this redistribution have become evident in recent years, leading to a dramatic corruption crack-down in China and the rise of populism in the West in the shape of Brexit and Donald Trump.

The clear beneficiaries of globalization were those manufacturing countries that integrated themselves in global value chains. These were mainly in Asia, though countries like Mexico and Turkey also participated. Some small, highly competitive countries also benefitted from better access for their exported goods. And, of course, consumers in developed economies benefitted from cheaper imports.

The relative losers were those countries that fought the trend (Brazil, India, South Africa, Venezuela, Indonesia, Russia) or were too small or uncompetitive to participate.

Unfortunately, those countries that did everything right during this cycle and participated fully in the upside of globalization may now have more to lose. Those countries highly integrated into global value chains and highly dependent on exports may now suffer relative underperformance unless they can find other sources of growth.

On the other hand, those countries that never embraced globalization –Brazil and India for example — may now be well positioned. Given the size of their domestic markets and ample growth opportunities that are unlinked to the global economy, they could still attract investments and thrive in a world where country-to-country trade deals based on reciprocal market access become more the norm.

China also seems well positioned. Given the size of its economy, further export-led growth was never going to be plausible. Moreover, the Chinese economy is coincidentally entering into a phase where it will be driven by domestic consumption and improvements to the “quality” of life.

Developed economies also are generally well positioned. Protectionism may lead initially to a welcomed increase in wages. Over time, it will trigger investments in automation technologies and accelerate the opportunities for “on-shoring,” the relocation of manufacturing closer to the customer in the developed countries. Two examples of this are: Adidas operating highly automated sneaker plants in Germany, and cloud computing and artificial intelligence undermining the low-value-added services of the Indian information technology industry.

Technology

There are two main thrusts of technological innovation that will dramatically impact emerging markets in coming years: 1. Artificial intelligence and robotics; and 2. Renewable energy.

With regards to technology, there are two factors to consider; whether a country can benefit as a developer of new technologies; and whether a country can successfully embrace the adoption of new technologies.

In terms of participating in the benefits of the development and commercialization of new technologies, it seems today that only East-Asian emerging markets (China, Korea, Taiwan) are well positioned to do so. China, following the path of its East-Asian neighbors and committing huge government support, is already becoming a leader in many technologies (internet, mobile telephony/5g, drones, high-speed trains, electric vehicles, solar and wind, among others).

In terms of the potential for countries to embrace new technologies, the path is much less clear.

New technologies offer enormous opportunities for emerging markets to leapfrog to state-of-the art conditions with much lower costs and vastly better productivity. For example, China has built a world class telecommunications network based on mobile technology without having had to make huge investments in fixed telephony networks. In Brazil, fixed lines are likely to become nothing more than a bad memory for people over 50 years of age. In Vietnam and India, the average person will have never experienced a fixed line. The potential for leap-frogging is the greatest in the poorer countries which have no attachment to legacy technologies, such as Africa, India and China.

A multitude of new technologies now being deployed will ramp-up dramatically in coming years, including cloud computing, artificial intelligence, drones, electric and autonomous vehicles, e.commerce, fintech, and battery-centric renewable energy. Many of these technologies will be very disruptive to businesses, that will lobby hard to protect legacy markets. Every country will deal differently with these disruptive forces, depending on the vision of policy makers and the power of entrenched interests to block change.

China has embraced technology for idiosyncratic reasons. China started from so low a level of economic development and the pace of change has been so fast that entrenched interests did not oppose new technologies. But that is not the case in most places, particularly the stagnant middle-income countries with powerful entrenched interests and rent-seeking politicians.

Take a country like Brazil. New technologies may face a phalanx of opposition from manufacturers, unions and local politicians, aimed at discouraging entrepreneurs. While in China, multinational automobile firms have quickly toed the Party line and committed to electricity vehicle investments, in Brazil they are likely to resist for as long as possible.

India is probably the country with most to gain from disruptive changes. It has a tech-savvy elite which has been instrumental in pushing for digitalization, such as the recently implemented AADHAAR national biometric digital identification program, which opens huge opportunities for digital commerce and fintech. With a very large proportion of its population with no access to basic public, financial and commercial services, AADHAAR provides significant opportunities for the Indian masses to gain access to state-of-the art technologies. This is now happening with smart-phones and will soon ramp up with battery-centric renewable energy and fintech services, giving countless isolated villagers access to modernity for the first time. Also, with only a fraction of the population currently with access to automobiles, in India there is no legacy infrastructure standing in the way of electric vehicles.

Though it is difficult to predict how things will play out, the following chart attempts to map-out how de-globalization and technological disruption may affect the major countries in emerging markets.

 

 

Fed Watch:

India Watch:

China Watch:

  • China’s commodity demand (Treasury)
  • Ground broken on China-Thai railroad (Caixing)
  • China’s new winter sports resort ( WIC)
  • China cannot be a global leader (China File)

China Technology Watch:

EM Investor Watch:

Technology Watch:

Investor Watch:

 

Energy Disruption Will Benefit Emerging Markets

The ongoing technological disruption of the energy sector is a net positive for emerging markets. The economic importance and market weight of those countries negatively affected by low oil prices (Russia, Mexico, Indonesia, Venezuela) is dwarfed by those that stand to benefit (India, China, Turkey). The rapidly declining cost of wind and solar power as well as the batteries needed to store it will provide huge opportunities for many emerging markets to improve their balance of payments, optimize electric grid efficiency and also make it easier to provide cheap power for hundreds of millions of poor people living in remote areas.

The latest report from the International Energy Agency  (IEA)  makes it clear that we have entered the age of renewable power. According to the IEA, in 2016 two thirds of new net power capacity added around the world came from renewable sources of energy.  In 2016, record-low auction prices were recorded for solar in India, the Middle East, Chile and Mexico, with prices reaching below USD 3 cents per KW. The IEA sees another 920 GW of renewable capacity added by 2022, with solar for the first time contributing more than hydro and wind. The main drivers of future growth continue to be technology-induced cost reductions and China’s policy initiatives, but India has also become a primary source of growth. India is expected to add more capacity than Europe and is on track to pass the United States as the second largest contributor to growth in capacity.

By 2021, according to forecasts from Bloomberg New Energy Finance, wind and solar will have become cheaper than coal in both China and India, two countries that have an enormous incentive to reduce coal combustion to address horrific air pollution problems. As the cost of renewables continues to decline over the next two decades coal power will become increasingly uneconomical.

The growth of solar will accelerate even more if battery costs continue to decline as they have over the past decade. Tony Seba, an expert on energy disruption who teaches at Stanford University, believes that an enormous wave of mega-investments in battery plants currently being made by Samsung SDI, LG Chem, BYD, Tesla, Foxconn and others, will drive down battery costs by over 20% annually for the next five years, to below $100/KW by 2022-23. At this price point, disruption will accelerate and battery storage will become prevalent across all points of the electricity grid (from the plant to the home). Seba believes cheap battery capacity will mean that the electricity grids in most countries will have to convert from the current “just-in-time” framework to one based “on demand,” which will eliminate the need for very expensive “peak” capacity. The average American home will spend less than a dollar a day to store energy for use in peak hours, resulting in much lower electricity bills.

Chile provides a prime example of the transformational impact renewables are having have on a developing economy. Chile has been dubbed “the solar Saudi Arabia,” because of the extraordinary potential for generating solar power in the Atacama Desert situated in the north of the country. Because of ideal direct normal sun irradiation and the dryness of the air, the Atacama is considered the best place on the planet to generate solar energy.

With scarce hydrocarbon resources, Chile has always depended on imports for most of its energy needs, and has suffered acutely from surges in oil prices. As recently as 2007, the country went through a severe crisis when Argentina reneged on contracts to pipe natural gas across the Andes, which forced massive investments in costly emergency diesel generators and LNG plants.

Compounding Chile ‘s energy woes, in recent years it has become increasingly difficult and time-consuming to build hydroelectric dams or coal-fired plants, as these face opposition from local communities and environmentalists.  However, the Atacama now promises a future of abundant and cheap energy.

In contrast to the difficulties faced in building “dirty” capacity, in the uninhabited Atacama desert environmentally-friendly  solar investments can be brought to market in less than a year, and recent advances in technology have made these projects very attractive to private investors.

Benefitting from clear regulation and investment rules, solar production has taken off over the past four years, putting Chile near the top in global tables. Solar producers have come to dominate public auctions,  offering to supply electricity at less than half the cost of coal-fired plants. In recent auctions in Chile, concentrated solar power (CSP) plants also have underbid gas plants. CSP technology combines solar generation with giant molten salt battery towers, allowing the plant to dispatch during the night. In Chile’s last auction for power, Solar Reserve, a U.S. firm,  bid a world-record-breaking low price at just 6.3 cents per kWh ($63/MWh) for dispatchable 24-hour solar.

The speed with which Chile has developed its solar potential is reflected in the generation of over 850 MW from solar panels in 2015, up from 11 MW in 2013. Current investments will bring installed capacity to 1,800 MW.

Solar also improves the potential optimization of the national electricity grid, as solar can be maximized during the day, allowing water accumulation at the hydroelectric dams in the Andes. As the cost of storage batteries decrease in coming years, it will make more and more sense to maximize production in the Atacama.

India is another country that stands to be a major beneficiary of disruptive energy technologies. First, India is a large importer of oil, which makes the economy vulnerable to surges in prices; second, it generates most of its electricity with dirty coal, which contributes greatly to horrendous pollution; and third, solar panels combined with batteries will provide the most cost-effective way to provide power to the nearly 250 million Indians, mainly in remote areas, that do not have access to power.

Prime minister Modi has announced bold plans to promote solar energy. The government aims to add 175 GW of renewable power by 2022, of which 100 GW would come from solar. As the cost of solar goes below coal generation over the next five years and battery storage becomes cheap, India’s is likely to rely on clean solar power for more and more of its needs.

Fed Watch:

India Watch:

  • India on the wings of digitization (Wisdom Tree)
  • India’s electrical vehicle dreams (CSIS)

China Watch:

  • The internationalization of China’s capital markets (Bloomberg)
  • Xi’s conservative, greener speech (CSIS)
  • China’s influence on global markets grows (Bloomberg
  • China’s economy is already the biggest and growing fast (Bloomberg)
  • Riding China’s huge high-flying car market (Mckinsey)
  • China, a strategy born of weakness (Geopolitical Futures)
  • 7 things we learned from China in September (WEF)
  • Buffett’s bet on BYD is working (QZ)
  • Meet China’s evolving car buyer (McKinsey)

China Technology Watch:

EM Investor Watch:

  • Five books on globalization and inequality (Five Books)
  • Investment anomalies (Wisdom Tree)
  • Anchoring Value Investing in EM (Eastspring)
  • EM Index without SOEs (Wisdom Tree)
  • Asia leading in (KKR)
  • Latin America’s slow recovery is on track (IMF)
  • Amazon expands in Brazil (Bloomberg)
  • Increasing pressure on Venezuela’s dictatorship (CSISAsia leads global recovery (IMF)
  • EM; doom to boom (Seeking Alpha)
  • Why you should care about Brazil’s stock market (Seeking Alpha)
  • Gazprom knocks Exxon off its pedestal (Forbes)

Technology Watch:

Commodity Watch:

Investor Watch:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Energy Market Disruption and Global Multi-polarity

 

Around the world, energy markets are being disrupted by a combination of technology and geopolitics. On the one hand, technology is having a huge impact on supply, with shale production exploding in the United States and alternative energies (solar and wind) becoming increasingly competitive everywhere. On the other hand, growing energy self-sufficiency in the U.S. is occurring at a time when demand for oil imports is still growing quickly in emerging markets, particularly in China. As the major importer of oil in the world, China’s future economic stability will depend on secure supplies, which is forcing it to become much more pro-active in global diplomacy. China also will become uncomfortable paying for oil imports in U.S. dollars, as has been the global custom for the past 50 years. China will increasingly insist on being paid in Chinese yuan, a trend that will slowly undermine the “petrodollar system” and U.S. financial hegemony.

Over the past decade, technological innovation has permitted the exploitation of enormous U.S. shale oil and gas deposits, leading to a renaissance for the American oil industry. This, jointly with growing output of renewable energy and higher fuel efficiency, is driving the U.S. towards energy self-sufficiency. BP in its BP 2017 Energy Outlook estimates this will happen in 2023.  U.S. net imports of oil have already fallen from 13 million b/d in 2007 to 3.7 million today.

The decline in U.S. oil imports will have important consequences for global financial markets, because the U.S. pays for imported oil in dollars and the trade receipts accumulate in the world’s Central Banks and sovereign funds and is redistributed into T-bills, bank loans and other investments. Since the 1970s the global economy has been frequently buffeted by violent changes in the price of oil, leading each time to financial instability and a sharp redistribution of wealth between exporters and importers.

U.S. oil production peaked in 1970 at 10 million barrels per day and then began a precipitous decline, reaching a low of 5 million b/d in 2008. The decline in U.S. production, coming at a time of steady increases in global demand, strengthened the hand of OPEC and led to price surges in 1974 and 1980, causing stagflation in the U.S. and eventually the emerging market debt crisis of 1981. The rise of Chinese demand during the past decade created another huge surge in oil prices, with a peak in 2008 and a rebound in 2011, with enormous consequences on global liquidity and financial markets.

Oil imports have been the primary component of chronic U.S. current account deficits, representing 40.5% of cumulative deficits between 2000 and 2012, and 55% in 2012 alone. In the early 1970’s, as the major importer of oil and the global hegemon, the United States was able to convince the Saudis to price their oil in dollars, which they have done along with other OPEC members since the early 1970s. This created the “petrodollar system” as a partial substitute for the gold standard abandoned by President Nixon in 1971, guaranteeing that the dollar would remain dominant in global trade and finance.

 

However, the conditions that led to the replacement of the gold standard by the petrodollar system no longer exist in 2017. The U.S. is approaching energy self-sufficiency, while China is now the dominant oil importer in the world, with demand for imports expected to reach nearly 10 million b/d in 2018.

This is happening at a time when U.S. hegemony is on the decline, and the world is seeing multi-polar leadership, with growing Chinese and European importance.

One of the Chinese government’s expressed objectives is to increase the international influence of the yuan. In a direct challenge to American economic hegemony, China has already started using oil imports to propagate the yuan. Breaking ranks with OPEC, Nigeria in 2011 and Iran in 2012,  both started accepting yuan for oil and gas payments and accumulating yuan Central Bank reserves. Russia did the same in 2015. For both Russia and Iran, the yuan payments allow them to skirt U.S. sanctions, and for Russia this also achieves the objective of undermining U.S. dollar hegemony. Moreover, last month, Venezuela, which owes China $60 billion, announced it will price its oil in yuan.

Also, in September the Nikkei Asian Review reported that China is on the verge of launching a crude oil futures contract denominated in yuan and linked to gold. This contract would be settled in Hong Kong and Shanghai and allow Asian importers to bypass USD denominated benchmarks and could greatly strengthen the financial infrastructure necessary to promote the yuan in Asian trade.

In another interesting development, China appears to be intent on solidifying diplomatic ties with Saudi Arabia. This is of critical importance, given the crucial role the Saudi’s have in maintaining the petrodollar system. As reported by Bloomberg,  the Saudi’s are looking to tighten energy ties with China by investing $2 billion in Chinese refinery assets in exchange for China taking a major stake in the upcoming ARAMCO IPO.

All of this oil diplomacy, comes at a time when China is already achieving success in expanding the role of the yuan in global financial markets. One years ago, the International Monetary Fund agreed to a long-standing Chinese request to give the yuan official Special Drawing Rights status, joining the U.S. dollar, euro, yen, and British pound in the SDR basket. China has also successfully lobbied the MSCI to increase the weighting of Chinese stocks in its Emerging Market Index by including locally traded “A” shares, a first step towards a major integration of China’s financial market into global financial markets which will further the propagation of yuan assets in global portfolios.

Fed Watch:

  • Rajan’s view on unconventional monetary policy (Chicago Booth)
  • Low returns expected long term for U.S. stocks (Macrovoices)

India Watch:

  • Tencent wants its share in India (Caixing)
  • India’s electrical vehicle dreams (CSIS)

China Watch:

  • 7 things we learned from China in September (WEF)
  • Buffett’s bet on BYD is working (QZ)
  • Meet China’s evolving car buyer (McKinsey)

China Technology Watch:

  • China’s airplane delivery drones (China Daily)
  • China, from imitator to innovator (Forbes)
  • China leads the world in digital economy (McKinsey)

EM Investor Watch:

Technology Watch:

  • Adidas robots (Wired)
  • Acemoglu on robots (AEI)
  • Germany has more robots and stable jobs (VOX EU

Commodity Watch:

Investor Watch:

 

 

 

 

 

 

 

 

The Rise of Robots in Emerging Markets

 

The relentless rise of robotics in manufacturing around the world that is expected for the next decade will affect the development of emerging market economies in different ways. The “East-Asian Tigers,” including China, are embracing robotics full-heartedly as the way to preserve the manufacturing intensity of their economies and build global market share in medium and high-value added industries, like automobiles, electronics, semiconductors and batteries. Germany and Japan are also manufacturing powers determined to maintain their manufacturing base through innovative engineering.

Most middle-income countries throughout South-east Asia and Latin America are lagging seriously behind in the robotics race and may find it increasingly difficult to move up the value chain to compete for market share in many highly-automated industries. These middle-income countries also face rising competition in low-value-added manufacturing from the new wave of industrializing countries with significantly lower labor costs, such as Vietnam, Bangladesh, India, Pakistan  and Indonesia.

Until today, robot deployment has been highly concentrated in a few industries, namely motor vehicles, electronics and metal-working.

However, accelerating trends in robotics technology is changing this focus in important ways. For example, robot suppliers are beginning to offer automation solutions for clothing and shoe manufacturing, industries that today are highly dominated by low-income economies. This trend may allow for the preservation of these industries in current high-cost producers like China, and even relocation to Europe and North America, in a process dubbed “robot-shoring.”  Moreover,  teamed with computer-aided-design (CAD) and 3D printing, which dramatically accelerate product design, automated manufacturing in developed countries will permit much shorter production chains and give producers  greater ability to react quickly to consumer trends. This is particularly true for high fashion-content clothing and shoe-wear, so it should not be a surprise that Nike and Adidas are leading the “robot-shoring” trend.

Both Nike and Adidas are working with tech partners on solutions for automating the most labor-intensive part of the sneaker manufacturing process, the fusion of the many parts and layers that make up the upper part of the sneaker. Nike invested in 2013 in a company called Grabit that uses a process called eletroadhesion to use static electricity to manipulate soft materials like leather and cloth, and this year Grabit commissioned upper-assembling robots in Nike plants in Mexico and China that work at 20 times the pace of human workers. This is a significant step towards bringing back production closer to consumers in developed markets.

Adidas’s Speedfactory in Ansbach, Germany is another experiment towards using 3D Printing and robotics to bring back sneaker production home. Adidas has partnered with Oechsler Motion, a German machinery supplier, and plans to produce 500,000 units a year in 2018. A second plant is under construction in Atlanta. Adidas believes technology can solve a huge mismatch between the typical 18-month production chain with Asia and the 12-month “fashion-life” of a sneaker.

Another company, Softwear Automation of Atlanta, Georgia, is intent on using its “Sewbot” technology to disrupt the world apparel-making process and the lives of millions of $5/day sweatshop employees scattered around South-East Asia and Central America.. Sewbot has solved the difficult task of robot manipulation of fabric, and Softwear Automation claims to have dominated the automated production of T-shirts and denim bluejeans. The company estimates that its process is 17 times more productive than human labor. Tianyuan Garments, a large Chinese firm that supplies Adidas, is building a plant in Arkansas that will have 20 Sewbot production lines and aims to produce 1.2 million T-shirts a year. Tianyuan estimates human labor will amount to $0.33/shirt on its completely automated production line, which compares to about $0.33/shirt in Bangladesh, the current low-cost producer.

China has made robotics a key part of its government supported “Made in China 2025” plan, both in terms of usage and domestic supply. The goal is to make China one of the world’s top 10 most intensively automated nations by 2020, with 150 industrial robots per 10,000 employees, which compares to today’s leader South Korea, with 531 robot units, the USA with 176 robot units and Germany with 301 robot units.

In 2016 China led the world in terms of both the amount of new robots installed (87,000 units, of which 27,000 came from Chinese firms) and for the total stock of operational robots (340,000, +33% over 2015).

The deployment of manufacturing robots around the world is extreme in its geographic concentration. As the data from the International Federation of Robotics shows,  the great majority of robots are being deployed in East Asia, North America and Germany. Middle-income countries with significant manufacturing bases, such as Brazil, Thailand, Malaysia, Turkey and South Africa, and European powers like France and the U.K, are being left far behind. The positive exceptions are Italy and  Eastern Europe, perhaps because of the latter’s close integration with the German supply chain.

Us Fed watch:

India Watch:

  • India’s stock market is set for a huge bull run (Wisdom Tree)
  • Is India like East Asia or Latin America? (Livemint)

China Watch:

  • China’s  Anyuang to make T-shirts with robots in Arkansas (Bloomberg)
  • China’ luxury consumer opportunity (McKinsey)
  • China bans ICOs (Bloomberg)
  • Seven reasons China banned ICOs (Fortune)
  • Michael Pettis on China’s slowing growth (Carnegie)
  • China bear turns bullish (Bloomberg)
  • The coming collapse of China’s Ponzi scheme  economy (SCMP)
  • China is going to hit a wall (FUW)
  • The global economy’s new rule maker (Project Syndicate)
  • Chinese millenials will drive global growth (SCMP)

China Technology Watch:

  • How Baidu will win the global AI race (Wired)
  • China leads the world in digital economy (McKinsey)
  • Chinese firms eyeing passenger drones (WIC)
  • Alibaba wants to bring big data to 1 million small shops (Caixing)
  • China’s  Anyuang to make T-shirts with robots in Arkansas (Bloomberg)

EM Investor Watch:

Technology Watch:

  • Nike’s Static-Electricity robots (Bloomberg)
  • Government Investment was key to US success (Teasri)

Investor Watch:

 

 

 

 

 

 

Russia is becoming a food superpower (Bloomberg)

Norway’s sovereign fund drops EM bonds (Bloomberg)

Bull and bear markets and capital allocation (Absolute Returns)

Profit margins and mean reversion (Philosophical Econ)