The third great wave

October 4th 2014

S P E C I A L R E P O R T

T H E W O R L D E C O N O M Y

The thirdgreat wave

20141004_SR_WorldEcon.indd 1 23/09/2014 14:30

The Economist October 4th 2014 1

THE WORLD ECONOMY

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A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/specialreports

CONTENTS

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MOST PEOPLE ARE discomfited by radical change, and often for goodreason. Both the first Industrial Revolution, starting in the late 18th cen-tury, and the second one, around 100 years later, had their victims wholost their jobs to Cartwright’s power loom and later to Edison’s electriclighting, Benz’s horseless carriage and countless other inventions thatchanged the world. But those inventions also immeasurably improvedmany people’s lives, sweeping away old economic structures and trans-forming society. They created new economic opportunity on a massscale, with plenty ofnew workto replace the old.

A third great wave of invention and economic disruption, set off byadvances in computing and information and communication technol-ogy (ICT) in the late 20th century, promises to deliver a similar mixture ofsocial stress and economic transformation. It is driven by a handful oftechnologies—including machine intelligence, the ubiquitous web andadvanced robotics—capable ofdeliveringmany remarkable innovations:unmanned vehicles; pilotless drones; machines that can instantly trans-late hundreds of languages; mobile technology that eliminates the dis-tance between doctorand patient, teacherand student. Whether the digi-tal revolution will bring mass job creation to make up for its mass jobdestruction remains to be seen.

Powerful, ubiquitous computing was made possible by the de-velopment of the integrated circuit in the 1950s. Under a rough rule ofthumb known as Moore’s law (after Gordon Moore, one of the foundersof Intel, a chipmaker), the number of transistors that could be squeezedonto a chip has been doubling every two years or so. This exponentialgrowth has resulted in ever smaller, better and cheaper electronic de-vices. The smartphones now carried by consumers the world over havevastly more processing power than the supercomputers of the 1960s.

Moore’s law is now approaching the end of its working life. Transis-torshave become so small that shrinking them further is likely to push uptheir cost rather than reduce it. Yet commercially available computingpower continues to get cheaper. Both Google and Amazon are slashingthe price of cloud computing to customers. And firms are getting muchbetter at making use of that computing power. In a book published in

The third great wave

The first two industrial revolutions inflicted plenty of pain butultimately benefited everyone. The digital one may prove far moredivisive, argues Ryan Avent

ACKNOWLEDGMENT S

The author wishes to thank the many

people, both named and unnamed,

who helped in the preparation of

this report.

3 ProductivityTechnology isn’t

working

5 The privileged fewTo those that have

shall be given

6 HousingHome economics

8 Emerging economiesArrested development

10 New opportunitiesSilver lining

12 Easing the transitionMeans and ends

2 The Economist October 4th 2014

SPECIAL REPOR TTHE WORLD ECONOMY

2 2011, “Race Against the Machine”, ErikBrynjolfsson and AndrewMcAfee cite an analysis suggesting that between 1988 and 2003the effectiveness ofcomputers increased 43m-fold. Betterproces-sors accounted for only a minor part of this improvement. Thelion’s share came from more efficient algorithms.

The beneficial effects of this rise in computing power havebeen slow to come through. The reasons are often illustrated by astory about chessboards and rice. A man invents a new game,chess, and presents it to his king. The king likes it so much that heoffers the inventor a reward of his choice. The man asks for onegrain of rice for the first square ofhis chessboard, two for the sec-ond, four for the third and so on to 64. The kingreadily agrees, be-lieving the request to be surprisinglymodest. Theystart countingout the rice, and at first the amounts are tiny. But they keep dou-bling, and soon the next square already requires the output of alarge ricefield. Not long afterwards the king has to concede de-feat: even his vast riches are insufficient to provide a mountain ofrice the size ofEverest. Exponential growth, in otherwords, looksnegligible until it suddenly becomes unmanageable.

Messrs Brynjolfsson and McAfee argue that progress in ICT

has now brought humanity to the start of the second half of thechessboard. Computing problems that looked insoluble a fewyears ago have been cracked. In a book published in 2005 FrankLevyand Richard Murnane, two economists, described driving acar on a busy street as such a complex task that it could not pos-sibly be mastered by a computer��et only a few years later Goo-gle unveiled a small fleet of driverless cars. Most manufacturersare now developing autonomous or near-autonomous vehicles.A critical threshold seems to have been crossed, allowing pro-grammers to use clever algorithms and massive amounts ofcheap processing power to wring a semblance of intelligencefrom circuitry.

Evidence of this is all around. Until recently machines havefound it difficult to “understand” written or spoken language, orto deal with complexvisual images, but now they seem to be get-ting to grips with such things. Apple’s Siri responds accurately tomany voice commands and can take dictation for e-mails andmemos. Google’s translation program is lightning-fast and in-creasingly accurate, and the company’s computers are becomingbetter at understanding just what its cameras (as used, for exam-ple, to compile Google Maps) are looking at.

At the same time hardware, from processors to cameras tosensors, continues to get better, smaller and cheaper, opening upopportunities for drones, robots and wearable computers. Andinnovation is spilling into new areas: in finance, for example,crypto-currencies like Bitcoin hint at new payment technologies,and in education the developmentofnewand more effective on-line offerings may upend the business ofhigher education.

This wave, like its predecessors, is likely to bring vast im-provements in living standards and human welfare, but history

suggests that society’s adjustment to it will be slow and difficult.At the turn of the 20th century writers conjured up visions of adazzling technological future even as some large, rich economieswere limping through a period of disappointing growth in out-put and productivity. Then, as now, economists hailed a new ageof globalisation even as geopolitical tensions rose. Then, as now,political systems struggled to accommodate the demands of

growing numbers ofdissatisfied workers. Some economists are offering radical thoughts on the job-

destroying power of this new technological wave. Carl BenediktFrey and Michael Osborne, of Oxford University, recently ana-lysed over700 differentoccupations to see howeasily they couldbe computerised, and concluded that 47% of employment inAmerica isathigh riskofbeingautomated awayover the nextde-cade or two. Messrs Brynjolfsson and McAfee ask whether hu-man workers will be able to upgrade their skills fast enough tojustify their continued employment. Other authors think thatcapitalism itselfmay be under threat.

The global eclipse of labour

This special report will argue that the digital revolution isopening up a great divide between a skilled and wealthy fewand the rest ofsociety. In the past new technologies have usuallyraised wages by boosting productivity, with the gains being splitbetween skilled and less-skilled workers, and between ownersof capital, workers and consumers. Now technology is empow-ering talented individuals as neverbefore and openingup yawn-ing gaps between the earnings of the skilled and the unskilled,capital-owners and labour. At the same time it is creating a largepool ofunderemployed labour that is depressing investment.

The effect of technological change on trade is also changingthe basisoftried-and-true methodsofeconomicdevelopment inpoorer economies. More manufacturing work can be automat-ed, and skilled design work accounts for a larger share of the val-ue of trade, leading to what economists call “premature dein-dustrialisation” in developing countries. No longer can govern-ments count on a growing industrial sector to absorb unskilled

labour from rural areas. In both the richand the emerging world, technology iscreating opportunities for those previous-ly held back by financial or geographicalconstraints, yet new work for those withmodest skill levels is scarce comparedwith the bonanza created by earlier tech-nological revolutions.

All this is sorely testing governments, beset by new de-mands for intervention, regulation and support. If they get theirresponse right, they will be able to channel technological changein ways that broadly benefit society. If they get it wrong, theycould be under attack from both angry underemployed workersand resentful rich taxpayers. That way lies a bitter and more con-frontational politics. 7

1For richer, for poorer

Sources: Maddison Project; The Economist *To 2010

GDP per person, average annual % change over 25-year periods

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The digital revolution is opening upa great divide between a skilled andwealthy few and the rest of society


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IF THERE IS a technological revolution in progress, richeconomies could be forgiven for wishing it would go away.

Workers in America, Europe and Japan have been through a diffi-cult few decades. In the 1970s the blistering growth after the sec-ond world war vanished in both Europe and America. In the ear-ly 1990s Japan joined the slump, entering a prolonged period ofeconomic stagnation. Brief spells of faster growth in interveningyears quickly petered out. The rich world is still trying to shakeoff the effects of the 2008 financial crisis. And now the digitaleconomy, far from pushing up wages across the board in re-sponse to higherproductivity, is keeping them flat for the mass ofworkers while extravagantly rewarding the most talented ones.

Between 1991 and 2012 the average annual increase in realwages in Britain was1.5% and in America 1%, according to the Or-ganisation for Economic Co-operation and Development, a clubof mostly rich countries. That was less than the rate of economicgrowth over the period and far less than in earlierdecades. Othercountries fared even worse. Real wage growth in Germany from1992 to 2012 was just 0.6%; Italy and Japan saw hardly any in-crease at all. And, critically, those averages conceal plenty of va-riation. Real pay for most workers remained flat or even fell,whereas for the highest earners it soared.

It seems difficult to square this unhappy experience withthe extraordinary technological progress during that period, butthe same thing has happened before. Most economic historiansreckon there was very little improvement in living standards inBritain in the century after the first Industrial Revolution. And inthe early 20th century, as�ictorian inventions such as electriclighting came into their own, productivity growth was every bitas slow as it has been in recent decades.

In July 1987 Robert Solow, an economist who went on towin the Nobel prize for economics just a few months later, wrotea book review for the New York Times. The book in question,“The Myth of the Post-Industrial Economy”, by Stephen Cohenand John Zysman, lamented the shift of the American workforce

into the service sector and explored the reasons why Americanmanufacturing seemed to be losing out to competition fromabroad. One problem, the authors reckoned, was that Americawasfailing to take full advantage ofthe magnificentnew technol-ogies of the computing age, such as increasingly sophisticatedautomation and much-improved robots. Mr Solow commentedthat the authors, “like everyone else, are somewhat embarrassedby the fact that what everyone feels to have been a technologicalrevolution...has been accompanied everywhere...by a slow-down in productivity growth”.

This failure of new technology to boost productivity (apartfrom a brief period between 1996 and 2004) became known asthe Solow paradox. Economists disagree on its causes. RobertGordon ofNorthwestern University suggests that recent innova-tion is simply less impressive than it seems, and certainly notpowerful enough to offset the effects ofdemographic change, in-equality and sovereign indebtedness. Progress in ICT, he argues,is less transformative than anyofthe three major technologies ofthe second Industrial Revolution (electrification, cars and wire-less communications). �

et the timing does not seem to support Mr Gordon’s argu-ment. The big leap in American economic growth took place be-tween 1939 and 2000, when average output per person grew at2.7% a year. Both before and after that period the rate was a lotlower: 1.5% from 1891 to 1939 and 0.9% from 2000 to 2013. And thedramaticdip in productivitygrowth after2000 seems to have co-incided with an apparentacceleration in technological advancesas the web and smartphones spread everywhere and machineintelligence and robotics made rapid progress.

Have patience

A second explanation for the Solow paradox, put forwardby Erik Brynjolfsson and Andrew McAfee (as well as plenty oftechno-optimists in Silic��alley), is that technological ad-vances increase productivity only after a long lag. The past fourdecades have been a period of gestation for ICT during whichprocessing power exploded and costs tumbled, setting the stagefora truly transformational phase that is only just beginning (sig-nalling the start of the second halfof the chessboard).

That sounds plausible, but for now the productivity statis-tics do not bear it out. John Fernald, an economist at the FederalReserve BankofSan Francisco and perhaps the foremost author-ity on American productivity figures, earlier this year publisheda study of productivity growth over the past decade. He foundthat its slowness had nothing to do with the housing boom and

Productivity

Technology isn’tworkingThe digital revolution has yet to fulfil its promise ofhigher productivity and better jobs

Interactive: For more countries and other labour-market indicators see Economist.com/worldecon14 2Get used to it

Sources: OECD; World Top Incomes Database; World Bank; ILO; BLS; The Economist *2004-12 †2002-10 ‡Estimate based on two series §1997-2010 **1990-2008

Real wages, 2002-12, % change Income share of top 10% of earners, % Share of employment by skill level1992-2010, percentage-point change

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India

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bust, the financial crisis or the recession. Instead, it was concen-trated in ICT industries and those that use ICT intensively.

That may be the wrong place to look for improvements inproductivity. The service sector might be more promising. Inhigher education, for example, the development of onlinecoursescould yield a productivitybonanza, allowingone profes-sor to do the work previously done by legions of lecturers. Oncean online course hasbeen developed, it can be offered to unlimit-ed numbers ofextra students at little extra cost.

Similar opportunities to make service-sector workers moreproductive may be found in other fields. For example, new tech-niques and technologies in medical care appear to be slowingthe rise in health-care costs in America. Machine intelligencecould aid diagnosis, allowinga given doctorornurse to diagnosemore patients more effectively at lower cost. The use of mobiletechnology to monitorchronically ill patients at home could alsoproduce huge savings.

Such advances should boost both productivity and pay forthose who continue to work in the industries concerned, usingthe newtechnologies. At the same time those services should be-come cheaper for consumers. Health care and education are ex-pensive, in large part, because expansion involves putting upnew buildings and filling them with costly employees. Risingproductivity in those sectors would probably cut employment.

The world hasmore than enough labour. Between 1980 and2010, according to the McKinsey Global Institute, global nonfarmemployment rose by about1.1billion, of which about 900m wasin developing countries. The integration of large emerging mar-kets into the global economyadded a large pool ofrelatively low-skilled labourwhich many workers in rich countries had to com-pete with. That meant firms were able to keep workers’ pay low.And low pay has had a surprising knock-on effect: when labouris cheap and plentiful, there seems little point in investing in la-bour-saving (and productivity-enhancing) technologies. By cre-ating a labour glut, new technologies have trapped rich econ-omies in a cycle ofself-limiting productivity growth.

Fear of the job-destroying effects of technology is as old asindustrialisation. It is often branded as the lump-of-labour falla-cy: the belief that there is only so much work to go round (thelump), so that if machines (or foreigners) do more of it, less is leftfor others. This is deemed a fallacy because as technology dis-places workers from a particular occupation it enriches others,who spend theirgains on goods and services that create new em-ployment for the workers whose jobs have been automatedaway. A critical cog in the re-employment machine, though, ispay. To clear a glutted market, prices must fall, and that applies tolabour as much as to wheat or cars.

Where labour is cheap, firms use more of it. Carmakers inEurope and Japan, where it is expensive, use many more indus-trial robots than in emerging countries, though China is begin-ning to invest heavily in robots as its labour costs rise. In Britain about ofhigh inflation caused real wages to tumble between 2007and 2013. Some economists see this as an explanation for the un-usual shape of the country’s recovery, with employment hold-ing up well but productivity and GDP performing abysmally.

Productivity growth has always meant cutting down on la-bour. In 1900 some 40% ofAmericans worked in agriculture, andjustover40% ofthe typical household budgetwasspenton food.Over the next century automation reduced agricultural employ-ment in most rich countries to below 5%, and food costs droppedsteeply. But in those days excess labour was relatively easily real-located to new sectors, thanks in large part to investment in edu-cation. That is becoming more difficult. In America the share ofthe population with a university degree has been more or lessflat since the 1990s. In other rich economies the proportion of

young people going into tertiary education has gone up, but fewhave managed to boost it much beyond the American level.

At the same time technological advances are encroachingon tasks that were previously considered too brainy to be auto-mated, includingsome legal and accountingwork. In those fieldspeople at the top of their profession will in future attract manymore clients and higher fees, but white-collar workers with low-er qualifications will find themselves displaced and may in turndisplace others with even lesser skills.

Lift out of order

A new paper by Peter Cappelli, of the University of Penn-sylvania, concludes that in recent years over-education has beena consistent problem in most developed economies, which donot produce enough suitable jobs to absorb the growing numberofcollege-educated workers. Over the next fewdecadesdemandin the top layer of the labour market may well centre on individ-uals with high abstract reasoning, creative, and interpersonalskills that are beyond most workers, including graduates.

Most rich economies have made a poor job offinding lucra-tive jobs for workers displaced by technology, and the resultingglut ofcheap, underemployed labour has given firms little incen-tive to make productivity-boosting investments. Until govern-ments solve that problem, the productivity effects of this techno-logical revolution will remain disappointing. The impact onworkers, by contrast, is already blindingly clear. 7



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JUST ACROSS THE road from Gothenburg’s main railwaystation, at the footofa pairofhotels, a line of taxis iswaitingto pick up passengers. The drivers, all men, many of them

immigrants, chat and lean against their vehicles, mostly Volvos.One of them, an older man with an immaculate cab, ferries yourcorrespondent to Volvo’s headquarters on the other side of theriver. Another car is waiting there, a gleaming new model withunusual antennae perched on two corners of its roof. An engi-neergets in and drives the caronto a main commuter route. Thenhe takes his hands offthe wheel. �

olvo, like many car manufacturers, is putting a lot ofworkinto automated vehicle technology. Such efforts have been goingon for some time and were responsible for the development ofpower steering, automatic transmissions and cruise control. Inthe 2000s carmakers added features such as automated parallelparking and smart cruise, which can maintain a steady distance

between vehicles. In 2011 Google revealed it was developingfully autonomous cars, using its detailed street maps, an array oflaser sensors and smart software. It recently unveiled a new pro-totype that can be configured to have no driver controls at all,save an on/off button. Traditional car manufacturers are takingthings more slowly, but the trend is clear.

In many ways driverless cars would be a great improve-ment on the driven variety. Motoring accidents remain one ofthe leading causes of death in many countries. Automated driv-ing promises huge improvements in both fuel efficiency andjourney times and will give erstwhile drivers the chance to doother things, or nothing, during their trip. �

et its effect on the labour market would be problematic.Only ten years ago driving a car was seen as the sort of complextask that was easy for humans but impossible for computers.Driving taxis, delivery vans or lorries has been one of the few oc-cupations in which people without qualifications could earn adecent wage. Driverless vehicles could put an end to such work.

The apocalypse of the horsemen

Before the horseless carriage, drivers presided over horse-drawn vehicles. When cars became cheap enough, the horsesand carriages had to go, which eliminated jobs such as breedingand tendinghorses and makingcarriages. But cars raised the pro-ductivity of the drivers, for whom the shift in technology waswhat economists call “labour-augmenting”. They were able toserve more customers, faster and over greater distances. The eco-nomic gains from the car were broadly shared by workers, con-sumers and owners of capit��et the economy no longer seemsto workthatway. The big losershave been workerswithout high-ly specialised skills.

The squeeze on workers has come from several directions,as the car industry clearly shows. Its territory is increasingly en-croached upon by machines, including computers, which aregetting cheaper and more versatile all the time. Ifcars and lorriesdo not need drivers, then both personal transport and shippingare likely to become more efficient. Motor vehicles can spendmore time in use, with less human error, but there will be no hu-man operator to share in the gains.

At the same time labour markets are hollowing out, polar-ising into high- and low-skill occupations, with very little em-ployment in the middle. The engineers who design and test newvehicles are benefiting from technological change, but they arehighly skilled and it takes remarkably few of them to do the job.At�

olvo much of the development work is done virtually, fromthe design of the cars to the layout of the production line. Otherworkers, like the large numbers of modestly skilled labourersthat might once have worked on the factory floor, are beingsqueezed out of such work and are now having to compete forlow-skill and low-wage jobs.

Labour has been on the losing end of technological changefor several decades. In 1957 Nicholas Kaldor, a renowned econo-mist, set out sixbasic facts about economic growth, one ofwhichwas that the shares of national income flowing to labour andcapital held roughly constant over time. Later research indicatedthat the respective shares of labour and capital fluctuate, but sta-bility in the long run was seen as a good enough assumption tokeep it in growth modelsand textbooks. Over the past30 yearsorso, though, that has become ever harder to maintain as the shareof income going to labour has fallen steadily the world over.

Recent work by Loukas Karabarbounis and Brent Neiman,of the University of Chicago, puts the global decline in labour’sshare since the early 1980s at roughly five percentage points, tojustoverhalfofnational income. This seemsto hold good withinsectors and across many countries, including fast-growing de

The privileged few

To those that have shallbe given

Labour is steadily losing out to capital

SPECIAL REPOR T



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veloping economies like China, suggesting that neither trade noroffshoring are primarily responsible. Instead, the two scholarsargue, at least half of the global decline in the share of labour isdue to the plummeting cost of capital goods, particularly thoseassociated with computing and information technology.

By one reckoning the price of cloud-computing poweravailable through Amazon’s web services has fallen by about50% every three years since 2006. Google officials have said thatthe price of the hardware used to build the cloud is falling evenfaster, with some of the cost savings going to cloud providers’bottom lines rather than to consumers—for now, at any rate. Thefalling cost of computing power does not translate directly intosubstitution of capital for labour, but as the ICT industry has de-veloped software capable of harnessing these technologies, theautomation of routine tasks is becoming irresistible.

From the end of the second world war to the mid-1970s pro-

ductivity in America, measured by output per person, and infla-tion-adjusted average pay rose more or less in tandem, eachroughlydoublingover the period. Since then, and despite a slow-down in productivity growth, pay has lagged badly behind pro-ductivity growth. From 2000 to 2011, according to America’s Bu-reau of Labour Statistics, real output per person rose by nearly2.5% a year, whereas real pay increased by less than 1% per year.

The counterpart to this eclipse of labour is the rise and riseofcapital. In a landmarkbookthatbecame an unlikelybestseller,Thomas Piketty, an economist at the Paris School of Economicsand an authority on inequality, argues that economics shouldonce again focus on distribution, as it did in the 19th and early20th centuries. In those days the level of wealth in rich econo-mies often approached seven times annual national income, soincome earned from wealth played an enormous part in theeconomy and caused social strains that sometimes threatened

A LARGE PART of the recent growth inwealth—in some economies nearly all ofit—consists of rising property values, accord-ing to Thomas Piketty’s analysis. House pricesin many parts of the world have been boom-ing for the better part of two decades. Thebiggest increases have been in rich cities suchas London, New York and San Francisco.

Rising house prices are a response to animbalance between supply and demand.Demand has been affected by the global-isation of economies. As transport costsstarted to fall at the beginning of the 20thcentury, many of the manufacturing firmsclustered in cities in developed countries leftin search of cheaper land and labour. Thisthrew many of those cities into crisis as theirtax base crumbled and their public servicesdeteriorated, hastening the exodus. Yetstarting in the 1980s cities that had retaineda core of highly skilled workers enjoyed arebound. Population decline slowed andeventually halted, and local economic growthand property prices picked up.

Ed Glaeser, an economist at HarvardUniversity, links this turnaround to the ICTrevolution. Cities enjoy a number of benefitsthat encourage people to live in them despitehigher costs, crowds and congestion. Ashorter distance between customers andsuppliers (and indeed friends and lovers) isone. The ease with which ideas seems tospread within cities is another.

The Bay Area of California is a primeexample: a place in which ideas seem toreverberate from person to person and firm tofirm, and in which those with good ideas caneasily tap into networks of engineers, design-ers and financiers. Similar forces are at workin other large cities around the world. In a

paper written with Matthew Resseger, also ofHarvard, Mr Glaeser finds a strong relation-ship between city size and productivity perworker, but only in places with highly skilledworkforces. Carl Benedikt Frey and ThorBerger of Lund University note that since the1980s new work has been getting much morecognitive in nature. They link this to the ICTrevolution and to the rapid growth of citieswith a core of highly skilled workers.

Yet since the 19th century a densethicket of zoning regulations has grown up inmany of those cities, sending the cost ofhousing skywards in attractive cities. A gen-eration ago only a handful of cities on Ameri-can coasts had housing costs much above thecost of new construction. Today most largecities suffer from such an excess, whichrepresents a regulatory “shadow tax” on newconstruction. Indeed, most of the value ofproperties in places like London and New Yorkreflects the difficulty of building new homes.

So even as large, high-skill metropol-itan economies are becoming more impor-tant, they are getting less affordable foranybody but the rich, prompting migrationaway from the most economically dynamicplaces towards those that offer good jobs andallow lots of construction. The maths areclearest in America. In Harris County in Texas,which takes in most of the fast-growingHouston metropolitan area, the medianhousehold income is about $53,000 and themedian value of an owner-occupied home is$128,000. In California’s Santa Clara County,which includes the hear�� alley, themedian household income is over $90,000and the median price of a home is $657,000. ACalifornian moving to Texas will almostcertainly take a pay cut but nonetheless enjoy

Home economics

Sky-high house prices in the most desirable cities are holding back growth and jobs

a higher disposable income. The difference in housing costs is

mostly due to different attitudes to building.Freewheeling Houston approved more than51,000 new dwellings in 2013 whereas SanJose, home to some of the nation’s worstNIMBYs, approved just under 8,000.

The economic effect of keeping a tightlid on housebuilding is stunning. EnricoMoretti, an economist at the University ofCalifornia, Berkeley, estimated the employ-ment multiplier of different sorts of work inhis book “The New Geography of Jobs”,published in 2012. A new manufacturing job,he suggested, typically creates 1.6 new jobsin the local service economy. In innovativeindustries, one new position might yield fourto five new service-sector jobs within ametropolitan area. But vertiginous houseprices stunt this effect. Rich Googlers in SanFrancisco spend money on homes that mightotherwise go to local restaurants or gyms.

In developed economies, all this ishaving a negative effect on employment,productivity and output. A new paper by MrMoretti and Chang-Tai Hsieh, of the Universi-ty of Chicago, estimates that between 1964and 2009 output in America was 13% lowerthan it might have been because high hous-ing costs encouraged people to move away.

For homeowners in London, New Yorkor San Francisco, this is all excellent news aslong as they plan to sell up some day. Sky-high housing costs mean that more of thegain of new job creation is captured by land-lords (or homeowners who get out) than byemployers or workers. Technology has raisedthe return to living in high-skill cities, buthas done nothing to make it easier to find ahome there.


THE WORLD ECONOMY

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the capitalist system. In the decades following the first world warold fortuneswere wiped outby taxation, inflation and economiccollapse, so by1950 wealth in rich economieshad typically fallento just two or three times the level of annual national income.But since then it has begun to creep up again.

Mr Piketty acknowledges that inequality today is differentfrom what it was100 years ago. Today’s great fortunes are largelyin the hands of the working rich—entrepreneurs who earned bil-lions by coming up with products and services people wanted—rather than the idle gentry of the early industrial era. Yet even ifthe source ofthe new wealth is less offensive than that of the old,the eclipse of labour could still become a disruptive social force.Wealth is generally distributed less equally than capital; many ofthose getting an income from work own little or no wealth. AndMr Piketty reckons that as wealth plays a bigger part in an econ-omy, it will tend to become more concentrated.

The decline in the role ofwealth in the early part ofthe 20thcentury, Mr Piketty observes, coincided with a levelling out ofthe wealth distribution, as for the first time in modern economichistory a broad, property-owning middle class emerged. Thatmiddle class has been a stabilising force in politics and societyover the past 70 years, he reckons. If it were to disappear, politicscould become more contentious again.

Labour in America would have lost out to capital evenmore dismally except for soaring pay among a small group ofhigh earners, according to a study in 2013 by Michael Elsby, of theUniversity of Edinburgh, Bart Hobijn, of the Federal ReserveBankofSan Francisco, and Aysegul Sahin, of the Federal ReserveBank of New York. The typical worker has fallen behind evenmore than a straightforward look at the respective shares of la-bour and capital suggests.

One explanation for that is the changing nature of manyjobs. In recent years economists such as David Autor and DaronAcemoglu of the Massachusetts Institute of Technology havepioneered a new way of looking at work: analysing occupationsin terms of the tasks they involve. These can be manual or cogni-tive, routine or complex. The task content determines howskilled a worker must be to qualify for work in a particular occu-pation. Mr Autor argues that rapid improvement in ICT has en-abled firms to reduce the number of workers engaged in routinetasks, both cognitive and manual, which are comparatively easyto programme and automate.

Amanufacturingworkerwhose job consistsofa clear setofsteps—say, joining two sheets of metal with a series of welds—ishighly vulnerable to being displaced by robots who can do thejob faster, more precisely and at lower cost. So, too, is a book-keeperwho enters standard data setsand performssimple calcu-

lations. Such routine work used to be done by people with mid-level skills for mid-range pay. Over the past generation, however,technology has destroyed large swathes ofwork in the middle ofthe skill and wage distribution, in a process economists call la-bour-force polarisation.

The hole in the middle

As recently as the 1980s demand from employers in richcountries was most buoyant for workers with a college educa-tion, less so for those with fewer qualifications and least so forthose who had at best attended high school. But from the early1990s that pattern changed. Demand still grew fastest for skilledworkers and more slowly for less-skilled workers, but the shareof employment in the middle actually shrank. In the 2000s thechange became more pronounced: employment among theleast-skilled workers soared whereas the share of jobs held bymiddle- and high-skill workers declined. Work involving com-plex but manual tasks, like cleaning offices or driving trucks, be-came more plentiful. Both in America and in Europe, since 2000low-skill, low-productivity and low-wage service occupationshave gained ground.

3

Sources: University of Chicago Booth; “Capital in the Twenty-First Century”, by Thomas Piketty, 2014

Wealth as % of national incomeLabour’s share of national income, %

Workers of the world, despair

45

50

55

60

65

1980 85 90 95 2000 05 10 12

China

Japan

Sweden

Britain

United States

0

200

400

600

800

1700 20 40 60 80 1800 20 40 60 80 1900 20 40 60 80 2010

124

300

Britain

96

371

France

83

231

Germany83

182

United States

of which: housing

2

1



1

THIRTY-FIVE YEARS ago Shenzhen was a tiny fishing vil-lage just over the river from British Hong Kong. Its inhabit-

ants, like most Chinese, lived in poverty. In 1978 the average in-come in America was about 21 times that in China. But in 1979China’s leader, Deng Xiaoping, chose Shenzhen as the country’sfirst special economic zone, free to experiment with market ac-tivity and trade with the outside world. Shenzhen quickly founditself at the leading edge of Chinese economic development, us-ing the same model as Japan, South Korea and Hong Kong itselfhad done at earlier stages. In the late 1970s China was burstingwith cheap, unskilled labour. It opened its doors (a crack, inlucky places like Shenzhen) to foreign manufacturers waiting totake advantage of these low labour costs. Even though wageswere at rock bottom, both productivity and pay in urban fac-tories were dramatically higher than in agriculture, so China’sfledgling industrialisation attracted a steady flow of migrantsfrom the countryside.

Over time local production became more sophisticatedand wages went up. Industrial cities served as escalators for de-velopment, linking the Chinese economy with global marketsand allowing incomes to rise steadily. The fruits of this processare clearlyvisible. Asvisitorsapproach the checkpoints betweenHong Kong and the mainland, a modern skyline rises on the ho-rizon. Great glass-sheathed skyscrapers reach upwards in centralShenzhen, which boasts some of the world’s tallest buildings. Atstreet level Chinese workers stroll past shopfronts displayingWestern luxury brands: Ferrari, Bulgari, Louis Vuitton.

Governments across the emerging world dream of repeat-ing China’s success, but the technological transformation nowunder way appears to be permanently changing the economicsof development. China may be among the last economies to beable to ride industrialisation to middle-income status. Much ofthe emerging world is facing a problem that Dani Rodrik, of theInstitute for Advanced Study in Princeton, New Jersey, calls “pre-mature deindustrialisation”.

For most of recent economic history, “industrialised”meant rich. And indeed mostcountries thatwere highly industri-alised were rich, and were rich because theywere industrialised.Yet this relationship has broken down. Arvind Subramanian, ofthe Peterson Institute for International Economics and reported-ly soon to become chief economic adviser to the Indian govern-ment, notes that, at any given level of income, countries todayare less reliant on manufacturing, in terms of both output andemployment, than they were in the past, and that the level of in-come per person at which reliance on manufacturing peaks hasalso declined steadily (see chart 4). When South Korea reachedthat point in 1988, its workers’ earnings averaged just over$10,000 (in PPP-adjusted 2011dollars) per person. When Indone-sia got there in 2002, average income was just under $6,000, andfor India in 2008 it was just over $3,000.

Premature non-industrialisation

Early loss of industry (or, in India’s case, what Mr Subrama-nian calls “premature non-industrialisation”) is a distressingtrend, given the role that exports of goods have historicallyplayed in economic development. Productivity in export indus-tries is generally high, otherwise they could not compete in glo-bal markets. Over time, productivity in making traded goodstends to rise as firms and workers in the industry become famil-iar with the technologies involved. Past developmental successstories such as the Asian tigers moved from low-margin, labour-intensive goods such as clothing and toys to electronics assem-bly, then on to component manufacture and, in the textbookcases of Japan and South Korea, to advanced manufacturing, de-sign and management.

Export success trickles down to the rest ofdeveloping econ-omies. Since producers of non-traded goods and services, suchas housebuilders and lawyers, must compete with exporters forlabour, they need to pay attractive wages. At the same time thechance of well-paid work in manufacturing creates an incentivefor workers to move to cities and invest in education. An indus-trialisingexport sector is like a speedboat thatpulls the restof theeconomy out ofpoverty.

Loss of industry at low income levels, by contrast, caps thecontribution that manufacturing can make to domestic livingstandards. That is no small problem: there is no obvious alterna-tive strategy for turning poor countries into rich ones.

The change in technology’s role in development began inthe 1980s. Richard Baldwin, an economist at the Graduate Insti-tute of International and Development Studies in Geneva, ex-

Emerging economies

Arrested development

The model of development through industrialisationis on its way out

4Off peak

Sources: Amrit Amirapu & ArvindSubramanian; World Bank * Highest share of people employed in industry

Share of employment in industryat peak industrialisation*, %

0

10

20

30

40

1980 85 90 95 2000 05 10

Singapore

Turkey

Brazil

Bangladesh

Mexico

SouthKorea

ArgentinaMalaysia

Philippines

ChileSouthAfrica Pakistan

Sri Lanka

20

GDP per personAs % of United States’

100

Highly skilled work, on the other hand, has become in-creasingly concentrated in jobs requiring complex cognitive orinterpersonal tasks: managinga business, developinga new pro-ductoradvisingpatients. Asnon-routine workhasbecome moreprized, supply and demand in the labour market have becomeincreasingly unbalanced. Many cognitively complex jobs are be-yond the abilities even ofpeople with reasonable qualifications.The wage premium for college graduates has held steady in re-cent decades, but that is mainly because of the rising premiumearned by holders of advanced degrees. The resulting competi-tion for lower-level workhas depressed wage growth, leading tostagnant pay for typical workers.

Technology has created a growing reservoir of less-skilledlabour while simultaneously expanding the range of tasks thatcan be automated. Most workers are therefore being forced intocompetition both against each other and against machines. Nowonder their share of the economic pie has got smaller, in devel-oping economies as well as in the rich world. 7

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THE WORLD ECONOMY

SPECIAL REPOR T

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1

plains that for much of modern economic history the drivingforce behind globalisation was the falling cost of transport. Pow-ered shipping in the 19th century and containerisation in the20th brought down freight charges, in effect shrinking the world.Yet since the 1980s, he says, cheap and powerful ICT has played abigger role, allowing firms to co-ordinate production across greatdistances and national borders. Manufacturing “unbundled” assupply chains scattered across the world.

According to Mr Baldwin, this meant a profound change inwhat it is to be industrialised. The development of an industrialbase in Japan and South Korea wasa longand arduousprocess inwhich each economy needed to build capabilities along thewhole of a supply chain to manufacture finished goods. Thatmeant few economies managed the trick, but those that did wererewarded with a rich and diverse economy.

In the era of supply-chain trade, by contrast, industrialisa-tion means little more than opening labour markets to globalmanufacturers. Countries that can grab pieces of global supplychains are quickly rewarded with lots ofmanufacturingemploy-ment. But development that is easy-come may also be easy-go.Unless the economies concerned quickly build up theirworkers’skills and infrastructure, wage increases will soon lead manufac-turers to up sticks for cheaper locations.

From stuff to fluff

Another mechanism through which new technology ischanging the process of development is the dematerialisation ofeconomic activity. Consumption the world over is shifting from“stuff to fluff”, reckons Mr Subramanian. People everywhere arespending a larger share of their income on services such ashealth care, education and telecommunications. This shift is re-flected in trade. Messrs Subramanian and Kessler note that, mea-sured in gross terms, goods shipments dominate trade as muchas ever. They accounted for 80% of world exports in 2008 (themost recent figure available), down only slightly from 83% in1980. Measured in value-added terms, however, the importanceof goods trade tumbled, from 71% of world exports in 1980 to just57% in 2008, because of the increasing weight of services in theproduction of traded goods. Much of the value of an iPhone, forexample, derives from the original design and engineering oftheproduct rather than from its components and assembly.

A recent report by the McKinsey Global Institute put thevalue in 2012 of “knowledge-intensive” trade—meaning flows ofgoods or services in which research and development or skilledlabourcontribute a large share ofvalue—at$12.6 trillion, ornearly

half the total value of trade in goods, ser-vices and finance. Physical assembly ac-counts for a declining share of the valueof finished goods. The knowledge-inten-sive component of trade is also growingmore quickly than trade in labour-, capi-tal- or resource-intensive products andservices. At the same time the dramaticdecline in the cost of information andcommunications technologies has open-ed up trade in some high-value services.Skilled programmers in India, for exam-ple, can sell IT services around the worlddespite the low overall level of develop-ment of the Indian economy.

India has masses ofcheap, unskilledlabour that ought to be attractive to firmswanting to set up low-cost manufacturingfacilities. Yet operating them would re-quire at least some skilled workers, and

the rising premium on these created by trade in ICT servicesmakes it uneconomic for many would-be manufacturers to hirethe necessary talent. Mr Subramanian and Raghuram Rajan, an-other Indian economist, have dubbed this the “Bangalore bug”, areference to the extraordinarily successful ICT cluster in thesouthern Indian city of Bangalore. But other emerging econo-mies are similarly affected.

Other advances are eliminating the need for human labouraltogether. Walking through an electronics production line atFoxconn’s Longhua campus in Shenzhen, a worker points outplaces where people have already been replaced by machin-ery—“to reduce injuries to workers”, he says. Elsewhere on theline he indicates a place where a robot is being tested to take overa range oftasks from humans. Perhaps10% ofthe staffatLonghuanow consists ofengineers working on such automation.

Successful solutions will be rolled out to other Foxconn fa-cilities, says Louis Woo, a special adviser to Foxconn’s chairman,TerryGou. And Foxconn haseven greaterambitions. In Chengduit is working on a “lights out”, entirely automated, facility whichserves a single, as yet unnamed, customer. In fast-developingand rapidly ageing China workers are becoming increasingly ex-pensive, as well as hard to find. Automation provides a means tohold on to work that might otherwise pack up and move to an-other country.

It also saves a lot of trouble��ast areas of Foxconn’s Long-hua campus are given over to support services for the roughlyquarter of a million workers employed there: shops and restau-rants, a massive central kitchen with automated rice-cookingequipment, dormitories that house about half the staff, schoolsfor workers’ children and counselling services for distressed em-ployees. Foxconn’sdormitoriesare ringed with netting, a precau-tion prompted by an epidemic ofsuicides by workers that set offa torrent ofbad press for the company and its customers. Indeed,notes Mr Woo, it is often customers that are behind the push forgreater automation ofFoxconn’s facilities.

The falling cost of automation makes the use of robots at-tractive even in India, where cities are swarming with under-employed young workers. The main reason for that is the coun-try’s thicket of red tape. Mr Subramanian thinks India’s besthope now may be to concentrate on churning out more highlyskilled workers, rather than count on manufacturing to mop upits jobless millions.

The rapid growth in emerging economies over the past 15years was good for many very poor countries in Africa and Cen-tral America, but most still grew more slowly than richer de



2

1

NOT FAR INLAND from where India’s west coast meets theArabian Sea, a modern high-rise building that looks a bit

like a stack of hastily piled-up boxes grows from the streets ofMumbai. Called Antilia, it is the private residence of MukeshAmbani, the chairman ofReliance Industries and reportedly therichest man in India. On a clear day, from the higher floors of hishome, MrAmbani can see the neighbourhood ofDharavi, aboutsix miles to the north-east. The area, made famous by the film“Slumdog Millionaire”, is one of the world’s largest slums, apatchworkofblue tarpaulin, corrugated tin and teeming human-ity. Few other places in the world display such a stark contrast inwealth and living conditions in such a small space.

Many of Dharavi’s people have shown extraordinary am-bition and entrepreneurial verve, but until recently they werelimited to light industry, such as pottery or leather processing.Everything they made was sold in the immediate neighbour-hood, to people of broadly the same income and prospects asthose who made them.

That is beginning to change. A recent story published in theFinancial Times featured a Dharavi resident, MohammedTaushif Ansari, who earns nearly $20,000 a year selling leathergoods through eBay to customers around the world. The spreadof e-commerce around the globe opens up a huge new reservoirof purchasing power to those motivated enough to seek it. Andthat is just one of the ways technology is creating economic op-portunities to replace at least some of the work it destroys. Thecritical question is justhowmuch ofthe world’savailable labourwill find productive work in this supercharged new economy.

One hope restson the creation ofnewkindsofjobs. In NewYork the old industrial warehouses and factories along Brook-lyn’s waterfront are being turned into a thriving tech-industryhub. One of its star companies, Etsy, recently signed a deal tomove to a new office twice the size of its previous one, to makeroom for its growing workforce.

Or some of it, anyway. Apart from the 750 or so peopleworking directly for the company from its offices in Brooklynand elsewhere, there is a second labour force, consisting of

roughly 1m independent sellers the world over: craft-based en-trepreneurs offering housewares, artwork, clothing and manyother creative items. Sales last year were reported to be $1.35 bil-lion, half as much again as the year before. The company saysthat for18% of its sellers this business is a full-time job. Many oth-ers use income from Etsy to supplement pay from other work.

The global artisan

Etsy is part of a broad movement that represents one possi-ble entrepreneurial response to a new and different economy.This began more than a decade ago when the sort of privatetransactions previously conducted through classified ads, car-boot sales and flea markets moved online, courtesy of compa-nies like Craigslist and eBay. That move dramatically increasedthe value of the market for such goods by increasing its scale andraising the oddsofachievinga match between a buyerand a sell-er. This market has since grown dramatically, powered by thepull of new opportunities and the push of economic strainacross the rest of the labour market.

E-entrepreneurship received a boost in 2008 when Applelaunched its app store, through which third-party software de-signers could market their own iPhone applications. The “appeconomy” has since grown by leaps and bounds. According toan estimate by the Progressive Policy Institute, a think-tank, in2013 it provided work for more than 750,000 people in Americaalone. Many more take part in it from elsewhere in the world, in-cluding employees at Rovio, the Finnish firm behind the wildlypopular “Angry Birds” line of mobile games, and people likeDong Nguyen, a young programmer��ietnam who scored anunlikely app hit with “Flappy Bird”, a simple but addictive gamethat was at one point earning him $50,000 a day.

Amazon and other e-tailers allow authors and artists toself-publish and market their work around the worl��ouTubeoffers a platform to a cast ofphenomenally successful video pro-ducers, makers of comedy clips or video-game reviewers whocan rack up billions of views. Odd genres flourish, like “unbox-

New opportunities

Silver lining

How the digital revolution can help some of theworkers it displaces

veloping countries in Asia and South America. Given the institu-tional weakness, inadequate infrastructure and modest skillsbase in many of the world’s poorest places, even rock-bottomwages there may be insufficient to attract much manufacturing.

That is a distressingprospect. The United Nations estimatesthat sub-Saharan Africa’s population will roughly triple over thenext half-century, to about 2.7 billion. A development model inwhich rapidly rising incomes are limited to a highly skilled few isunlikely to be sustainable. Many talented workers are alreadythinking about emigrating, yet rich economies trapped by grow-ing social spending and shrinking tax bases are more likely toslam their borders shut. Over the past decade or two inequality,despite rising within many economies, has shrunk at the globallevel, thanks to rapid growth in large emerging markets. But inthe absence ofa new development model, that happy state ofaf-fairs may soon be reversed. 7


THE WORLD ECONOMY

2 ing clips” in which the star buys various trinkets and opens anddescribes them on camera. “DisneyCollectorBR”, an unboxingproducer called Melissa Lima, specialises in unwrapping cheaptoys. These clips, generally a few minutes long, apparently en-trance small children. The advertising revenue from her videosmay be earning Ms Lima up to $5m a year. Social networks oftencontribute to such hits by drawing attention to particular apps orproducts. In the future, to paraphrase Andy Warhol, everyonemay trend on social media for15 minutes—and earn a bit of extraincome as they do so.

Mobile apps and networks are also democratising capitalownership in some sectors of the economy, including accommo-dation and passenger travel. Airbnb, for instance, allows house-holders to earn moneyby letting theirhome while theyare away.Uber and Lyft blur the line between professional drivers andthose with a spare seat in their private car. The “sharing econ-omy” is increasingly indistinguishable from the mainstreameconomy; things that can now be borrowed via online apps in-clude server space, home appliances, bicycles and tools. Otherservices connect people who own pets with those willing tolookafter them while the owners are away.

The logistical hurdles to entrepreneurship are quicklyshrinking. Selling surplus goods or putting underused capital towork is as easy as creating an online profile. Startups are benefit-ing as well. New firms can rent computing power from Amazonthrough the cloud rather than having to buy expensive servers.Office space and support services are becoming ever easier tofind, as is finance, thanks to peer-to-peer lenders and crowdfund-ing platforms like Kickstarter. Easy and cheap access to all the off-the-shelf components needed for a startup is fuelling the rise of“weightless companies”, firms that can attain extraordinary val-uations with minimal staffand capital.

That is a very good thing in the eyes of those who see therich world’s problems as a matter of too little innovation ratherthan too much. Michael Mandel, a technology expert at the Pro-gressive Policy Institute, reckons that innovation is generally fol-

lowed by growth in employment. That is most obviously true inICT, butalso in sectors like energy, where fracking technology hasgenerated an oil boom and a jobs bonanza in states such as NorthDakota and Texas. Mr Mandel invites sceptics to imagine a futurein which doctors can 3D-print livers (and other organs) on de-mand—a technology that looks increasingly realistic. In additionto the significant health benefits that would result, organ printingwould create new jobs, from workers to monitor the printers tonurses for the patients receiving transplants.

As innovation expandsoutward from ICT, so too should thejobs. Success in many of the newly available niches will often re-main a matter of skill, whether the product on offer is a leatherbag or a fancy app. But at least technology is making it easier andcheaper than ever to obtain new skills.

Beyond MOOCs

Informal online education is already a widespread andunderappreciated aspect of modern economic life��ouTube is atreasury of how-tos, from making the perfect Bolognese to pro-nouncing words in an unfamiliar language. More important,teachers around the world have been putting academic course-work online for more than a decade, including reading material,syllabuses, video lectures and practice exams. For the price of acomputer and an internet connection, motivated learners couldwork their way through several lifetimes’ worth ofuniversity de-grees and save millions ofdollars.

The online education market is now maturing. MassiveOpen Online Courses, or MOOCs, have struggled to live up to ex-pectations, but online offerings are improving and expanding.America’s three largest providers of online education—edX, anon-profit service run by Harvard University and the Massachu-setts Institute of Technology (MIT); Coursera, a for-profit serviceset up with academics from Stanford University; and Udacity, an-otherfor-profitwith Stanford roots—have provided courses foranestimated 12m students so far. Other individuals and universitiesare also getting into the game. Some of them will offer complete

online degrees. Online education programmes have

several big advantages over traditionalmodels. These probably weigh mostheavily with people living in developingeconomies who have few other options.MOOC enthusiasts like to tell the story ofBattushig Myanganbayar, a Mongolianteenager who performed brilliantly in anonline computer-science course offeredby MIT. His story is no longer exceptional.EdX, which had nearly 400,000 studentsin 2012-13, reckons that almost halfof themlive outside the rich world.

Online education offers flexibilitythat the bricks-and-mortar sort cannotmatch. Busystudentscan fit it around theirjob or family schedule, work at their ownpace and sample courses from universi-ties the world over without leaving theirhomes. And, critically, online courses aresignificantly cheaper than the in-personkind. Many are offered free, though pro-viders sometimes charge to certify examresults. Fees at Minerva Schools, an onlineinstitution that aims for top-notch stu-dents, are half of those at Ivy League uni-versities. A new online master’s degree incomputing at Georgia Tech costs just 1

SPECIAL REPOR T



1

$7,000, compared with $25,000 for the on-campus alternative. Lower costs not only make courses more accessible, they

also encourage experimentation. Students can start work on adegree with little financial risk. This freedom to experiment hasboosted drop-out rates, increasing scepticism about the courses’viability. Yet the ease of dipping in and out is a virtue, improvingthe chances that students will take up on-line education in the first place and that ifthey keep trying they will hit on the rightsubject eventually.

Areduced price forhighereducationwould be a boon to many families inAmerica, where university can take alarge bite out of household budgets (orsaddle students with loads of debt). Andeducation is just one of many things that

new technology could deliver more cheaply. Over the past cou-ple of decades prices of many physical goods, including televi-sions, computers and household appliances, have tumbled, par-ticularly allowing for improvements in quality. The cost ofcommunicating with friends and family, watching many videosand listening to many kinds ofmusic is now close to zero.

Yet the costofother items justkeepsgoingup. In 1990 Amer-icans on average spent 38% of their income on housing, healthcare and education. By 2010 that share had risen to 43%. In recentdecades prices for all three of those categories have risen fasterthan for goods and services as a whole. Even if technology doesnot create many new jobs, if it brings down the cost of educationand medical care as well as that of other goods and services,workers may nonetheless breathe a sight of relief.

Drops in the bucket

For many workers, those cheaper goods and services maybe the onlypecuniarygain theysee from newtechnologies. Newjob and self-employmentopportunitieswill provide some coun-terweight to the disruptive power of the digital revolution, butthey are unlikely to offset it entirely. Tyler Cowen, an economistat George Mason University��irginia, agrees that such innova-tions will allow highly motivated, talented and conscientious in-dividuals to claw their way into a small elite of very well-paidworkers, but fears that the remaining 85-90% of the populationmay find little to do in the new economy.

In the past, industrialisation often involved a loss ofskills: asmall group offirst-class artisans was replaced by factories full ofless-skilled workers producing goods at a much lower cost. Simi-larly, future advances in education and health care could reducethe earning power of many highly paid academics and doctorswhile creating jobs for more workaday tutors to help the lag-gards, or nurses enabled by technology to do much of the worknow reserved for expensive physicians. Yet even these moremundane new jobs will still require specialised training and acombination of social and cognitive skills that will elude a largepart of the labour force. And at the very top of these professions,“superstar” teachers or doctors using technology to reach manymore people will do better than ever.

Expansion of online education and mobile health caremightalso give a boost to global trade in services, which could of-fer an alternative route to economic development in countries

like India. People there might find work monitoring the vitalsigns of patients or marking essays from students across theglobe. But first they would have to obtain the necessary skills, sothis is unlikely to provide jobs for the masses. It might also provecontroversial in some rich economies, where people who arecurrentlydoingsuch jobscould face downward pressure on their

pay or lose them altogether. Likewise, the employment effects of

the sharing economy are not obviouslyegalitarian, since many drivers and hotelstaff affected by it are relatively low-skilled and poorly paid and have few oc-cupational options. New online labourservices could help match former hotelstaff with new jobs, perhaps cleaninghomes let through schemes like Airbnb.Yet that begins to sound like a more effi-cient version of the domestic-serviceeconomy of the 19th century. America isalready well on its way to that. A servicecalled Taskrabbit allows well-off busypeople to hire poorer and less busy onesfor errands such as doing the shopping or

queuing for theatre tickets on their behalf. Meanwhile much of the work that can easily be done by

those with minimal training—in retailing, for instance, or whole-sale warehouses—is gradually being automated away. And thecrowds of underemployed workers competing for jobs that ro-bots still cannot do—such as caretaking—will ensure that pay forsuch workremains low.

This technological revolution could still hold many sur-prises. It may create vast numbers of jobs nobody has yet imag-ined, or boost the productivity of less-skilled workers in entirelynovel ways, perhaps through robotic exoskeletons or brain im-plants. But for now, and despite the opportunities opened up bysome new tech-based ventures, a generation of workers theworld over is facing underemployment and stagnant pay. Gov-ernments will be sorely tested to deal with that. 7

For many workers, cheaper goods and services may bethe only pecuniary gain they see from new technologies

IF THE WORLD is thought to be suffering from both too lit-tle innovation and too much at the same time, itmay be rea-

sonable to think that the future will look a lot like the past. Thatstrategy offers some room foroptimism. Thanks to technologicalchange and the resulting economic growth, many countries arenow vastly richer than they were 300 years ago, and rich in wayspre-industrial societies could not have conceived of. Fears ofmass unemployment raised by earlier technological leaps nevercame to pass. Instead, technology allowed people to live longer,fuller lives. Quite possibly this time will be no different. Hu-mans’ greatest advantage over machines has always been theirflexibility, which should help them adapt to the new worldaround them. A generation from now people everywhere willalmost certainly be richer and live longer, and most of thoselooking for workwill probably still be able to find it.

Easing the transition

Means and ends

How governments can deal with the labour imbalance

2


THE WORLD ECONOMY

1

Yet history also offers plenty of reason to worry. Humansmay be flexible, but their governments typically are not: they actonly when forced to do so. In past economic revolutions it took ashift in the balance of political power, sometimes achieved onlyafter violent conflict, to ensure that the gains from growth werebroadly shared. The necessary investment in education and in-frastructure and the provision ofa social safety net proceeded infits and starts and did not always go right.

Over the past few decades technology has hollowed outworkforces, leaving too many people competing for jobs that re-quire minimal skills and offer minimal pay. Rising inequalityand stagnant wages are eating away at the legitimacy of existingtax and redistribution systems. Governments’ responses so farhave ranged from the uninspiring to the negligent.

Broadly speaking, there are three ways of dealing with thelabour imbalance: raising the productivity of less-skilled work-ers; turning less-skilled workers into more-skilled workers; andproviding income support for those who find it hard to earn a liv-ing in this new world.

Raising the productivity of less-skilled workers may not beas hard as it sounds, but it requires governments to get their eco-nomic policies right. Often they simply need to get out of theway. A prime example is occupational licensing. Between the1950s and 2008 the share of employment in America covered byoccupational regulation rose from roughly 5% to nearly a third. Itnow includes not only professions like nursing and teaching butjobs in interior design and even in nail salons. Excessive regula-tion reduces mobility and makes it harder for workers to changecareers or earn extra income. In Europe non-transferability ofprofessional qualifications restricts migration. In parts of theemerging world jobs involve so much red tape that many globalfirms would rather automate than employ more people.

Having workers in the right places is critically important togenerating more and better jobs. In both the rich and the emerg-ing world unmet demand for housing is a significant constrainton growth. In developing economies many large cities have out-grown their capacity to house their populations, resulting insprawling slums that harbour crime and disease. India’s govern-ment, for example, tightly restricts land use, making new con-struction costly and modern housing extremely expensive.

In rich countries restrictions on the supply of housing canbe just as pernicious. In economically dynamic places such asNew York and London the shortage of housing is a serious con-straint on growth in output and highly paid jobs. Inadequate in-vestment in infrastructure exacerbates the problem. As roadsand trains become more crowded, residents grow wary ofagree-ing to new developments, and so it goes on.

Back to school

The best hope for reducing the glut of less-skilled labour isto transform some of it into the more-skilled sort through higherspending on education. In the 19th and 20th centuries it took sig-nificant public investment to ensure that newly industrialisedeconomies had a supply of labour with the right qualifications.Something similar is needed today. Rich countries are short ofhighly skilled workers, and many developing economies lackthe basic educational infrastructure to produce a more effectivelabourforce. Immigration from poorcountries to rich ones mighthelp adjust that global imbalance, but is too politically conten-tious to make a big difference. Across the world more effort isneeded to improve primary and secondary education.

A good standard of literacy and numeracy across popula-tions in emerging countries will be critical if large numbers ofworkers there are to take part in trading global services. Govern-ments need not turn every student into a PhD candidate to boost

his or her earnings prospects. Demand for skilled tradespeoplesuch as plumbers and electricians remains high. Recent studiesof the long-term effect of good teaching indicate that improvingthe quality of teachers just from poor to middling has a signifi-cant effect on the lifetime earnings potential of a typical schoolclass. Long-run analyses of intensive pre-school programmessuggest that they achieve annual social returns on investment(allowing for expected cost savings from reduced crime and wel-fare spending) of7-10%.

But providing better opportunities through education andderegulation may not be enough to ensure that the benefits oftechnology-based growth are sufficiently widely spread. As inpast economic revolutions, the social safety net will also need tobe strengthened. That might include measures such as introduc-ing or extending minimum wages. This time, however, govern-ments face a sticky problem. If such policies make workers moreexpensive, firms will hire fewer of them. If on the other handwages are kept very low and benefits are reasonably generous,workers may be dissuaded from looking for jobs. And at a timewhen fiscal demands on taxpayers are rising, governments can-not afford to allow labour-market participation to fall and thusreduce their tax base.

Some research suggests that modest increases in minimumwages can lead to productivity improvements. That may be be-cause they reduce worker turnover, or because they promptfirms to invest in their workers or get them to workharder !et al-though higher minimum wages can be politically appealing,their use will need to remain limited. The easier it becomes toautomate basic work, the less ofa nudge firms will need to swapworkers for machines when wages rise.

One way of squaring that circle would be for governmentsto provide wage subsidies. Such payments encourage participa-tion in the labour force by making work more worthwhile forlow-paid workers without discouraging firms from recruiting.America’s earned-income tax credit and Britain’s working taxcredit both use the taxsystem to help families with low incomes.In America the subsidy available to poor families with childrenis relatively generous, but the maximum paid to the childless is amiserly $496 a year.

Economists frown on the idea of sharing out work to makeit go further, but as a temporary measure it has been used withsome success. The best-known example is that of the Kurzarbeit

programmes used in Germany during the recession followingthe 2008 financial crisis. Workers accepted a shorter workingweek in lieu of lay-offs, and the government helped make up theresulting shortfall in income.

If the dislocating effect of technology turns out to be really

5Plucking the goose

Sources: ILO; IMF; OECD; The Economist

General government tax revenue per employee, $’000

0

10

20

30

40

50

60

1980 85 90 95 2000 05 10 12

Japan

Sweden

Britain

India China

UnitedStates

2

SPECIAL REPOR T

fits at home. Governments mayneed to tighten up their resi-dence rules to prevent the richfrom pretending to live in a low-tax country to minimise theirtax bill, and tax regimes mayneed to be co-ordinated to dis-courage avoidance and evasion.

Preventing fiscal disastermay also require comprehen-sive reforms to make tax sys-tems more efficient, so that a giv-en tax burden is more difficult tododge and less disruptive to theeconomy. One wayofdoing thatwould be to tax immobile fac-tors such as land more heavily.Land taxes within cities, if com-bined with a loosening of zon-ing restrictions, should encour-age denser construction, whichcould help alleviate housingshortages in some of the mostexpensive places.

Taxing undesirable activi-ties such as emitting carbon andcausing pollution would alsoraise revenues at minimal eco-nomic cost. Shifting the brunt oftaxation from income to con-sumption in America couldhelp the country resolve its fis-cal and inequality problems at the same time—provided themoney isused to boost sagging incomes. In Europe the use ofval-ue-added taxes has allowed governments to maintain high pub-lic expenditure at relatively low economic cost. America, whichcurrently has a progressive taxsystem but spends less on helpingthe poor, might need to review its system.

The first two industrial revolutions fundamentallychanged the relationship between the individual and the state.The digital revolution now in progress will inevitably bringabout yet another such change. Governments may need to de-velop new economic approaches, giving technology freer rein to

transform production while providingworkers with more of a cushion againstthe painful effects of that creative destruc-tion. Some might instead tolerate theemergence ofa growing underclass that ishard to escape from while continuing tosearch for a technological solution to un-deremployment. Governments them-selvesmightbe transformed bynewpolit-ical movements emerging in response tothe dissatisfaction generated by techno-logical change: in benign ways, throughpolitical reform and realignment, or in ug-lier fashion.

Technologies are tools without anagenda of their own, but their influenceon society is never neutral. They blindlysweep aside the livelihoods of some peo-ple and enrich others. Politics must craftrules and institutions that harness tech-nology to suit society’s values and visionof itself. 7



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2 severe this time, governments might consider offering a univer-sal basic income, just sufficient to live on, to which all working-age adults would be entitled. A basic income for all is an old ideareceiving new attention because of the recent labour-market up-sets. Switzerland is gettingclosest to trying this out: last yearcam-paigners there obtained enough signatures to force a referen-dum, to take place in the next couple of years, on introducing abasic income ofSFr30,000 ($32,000).

The idea of a guaranteed income runs smack against corebeliefs regarding the meaning and importance of work. Allow-ing people to become full-time couch potatoes at public expenseis abhorrent to those who reckon that healthy adults should con-tribute to society in order to benefit from its economic output, aswell as to those who see workas a source ofpersonal dignity orameans to maintain mental balance, to say nothing of the major-ity who would still be working for their livingand generating thetax income that would fund such a scheme.

What would you do if you didn’t have to work?

Entitlement to a basic income might be linked to a require-ment to seeka regular job, take part in make-workschemes oren-gage in volunteering"#et economic liberals might argue that suchpaternalism is unlikely to make anyone better off. And freedomfrom want might create scope for other socially benign activities,such as work or self-employment that generates some income,just not enough to live on. Given a basic income, many morebudding entrepreneurs might launch businesses doing some-thing they feel passionate about.

Whicheverwaygovernments respond, budgetswill be test-ed. Even modest increases in income subsidies imply both a risein government spending as a share of GDP and a concentrationof the tax burden on a smaller share of the population. A highertax burden will encourage tax avoidance among the very richand distort economic decisions. In America and Britain the top1% of earners already contribute 46% and 28% respectively of alltaxrevenues. If theyare squeezed too much, some ofthem mighttake their money and move elsewhere. Governments got muchbigger after previous technological revolutions. They cannot ex-pand much more without running into serious fiscal constraints.

Tax competition may become an increasingly divisive in-ternational issue. Some of the highly mobile rich will be attract-ed by countries with low-tax, low-spending regimes, whereasthe relatively immobile poor will hope for generous state bene-

Politicsmust craftrules andinstitutionsthatharnesstechnologyto suitsociety’svalues

The third great wave

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