Chief Investment Officer Tony Roth and Chief Economist Luke Tilley of Wilmington Trust Investment Advisors discuss the productivity paradox.

  • Forces such as market creation, firm strategy, consumer surplus, and progress all combine to help explain the disconnect between the productivity we see and the fact that it isn’t reflected in the economic data.
  • Despite the paradox, productivity is extending the business cycle, allowing for low inflation and low interest rates, and presenting a number of interesting investment opportunities; it is the foundation of the equity market that we’ve experienced for the last decade and we expect it to continue broadly.
  • Ongoing changes will dominate our future and continue through the next recession—and advances like artificial intelligence, 5G, driverless cars, customized medicine will stay at the forefront of our economy as we go through this radical transformation.

Please listen to important disclosures at the end of the podcast.

 

Wilmington WealthWise with Tony Roth
Episode 2: O Productivity, Where Art Thou?

Tony: Hello, welcome to Wilmington WealthWise, the podcast dedicated to financial literacy, where we take complex ideas from the investment world, and make them accessible to everyone. I’m your host, Tony Roth, Chief Investment Officer of Wilmington Trust. Today, we’ll be discussing in detail the idea of productivity, why are we so hung up on this concept, and why we think the answer to that explains so much of what is going on in the economy now, and as a key dimension of our future.

Today, I’m pleased to welcome our Chief Economist, Luke Tilly.

Luke: Thanks for having me.

Tony: Thanks for being here to talk about this fun topic. So let me set the stage Luke, by talking a bit about our capital market forecast last year and into this year, which is the relationship between technology productivity, inflation and interest rates. And it’s actually a pretty linear relationship. Technology has enabled the world around us to change so much with increased supply chain efficiency, increased efficiency in terms of how we buy things, and that’s all resulted in height and productivity relative to what we’ve experienced in the past.

That higher productivity allows the economy to create more stuff, with less price pressure; therefore, lower inflation. And with lower inflation, we have lower interest rates. Lower interest rates allow the economic cycle to expand for a longer period of time, so the Fed does not have to end the economic expansion by raising interest rates, and everybody’s happy.

So that sounds like a very rosy story, but there’s a paradox. And today’s podcast is focused on what we call the paradox of productivity. So Luke, what’s going on? Why is it that we have all this positive experience around productivity—but the paradox is, it’s not showing up in any of the economic numbers. We see it every day, but we can’t measure it.

Luke: Right, so of course, all of this is really important, as you say. And as the economist, and somebody who studied this stuff in school for a long time, I’m sort of tempted to jump into textbook speak here and start talking about equations. But instead of doing that and getting too wonky, I’ll respond to you just by asking a question. What do self-driving cars, Netflix, and a toilet seat have in common?

Tony: Well, I have a pretty active imagination, so you probably don’t want me to really answer that question, other than to say, what Luke, what do those have in common?

Luke: Well, all three of the things have these things in common. One, they’re really cool. And two, they all explain one aspect of the productivity paradox that you’re asking about.

Tony: Cool, so let’s dig in here. Why don’t we start with self-driving cars? I haven’t seen what happened yet. So what’s that all about here?

Luke: All right, so obviously, these things are very cool when you hear about them in the news report or read about it in a magazine. It makes you think about futuristic movies, or the Jetsons, or something like that. But what’s so cool about them is that companies have been developing these things to get them on the news, but they’re really not, as you said, visible to us in everyday life.

And the way that they play into productivity in this paradox of productivity is over a three-year period from 2014 to 2017, the Brookings Institution estimates that about $80 billion was dumped into studying and researching and developing autonomous vehicles over that three-year period. Despite all of those resources, autonomous vehicles have not really been deployed in a fully commercial way, like you’re talking about. They’re really still in the testing stage, for the most part, so we’re developing these new technologies to be more productive. However, it hasn’t really hit the road yet. So in this way, what we are expecting, even though we read about these technologies, is that they’ll be affecting our productivity in the future, and that’s gonna provide a boon for the economy.

Tony: Okay, so you’re giving me the story around self-driving cars, and the Jetsons, and sounds really cool. You must be telling me this, because there are a lot of other examples like it?

Luke: Yeah, so just within autonomous vehicles, think about the capabilities for this. Trucks move about 71% of U.S. freight by weight, according to the U.S. Trucking Association, 800 billion in gross freight revenues. And there are 3.5 million truck drivers, and another 4.5 million people that are employed by the industry. So it’s an industry that’s facing incredible challenges. And when you get this technology, what you’re gonna have is the ability for an industry to deal with cost pressures. So as you said at the beginning, if we’re thinking about costs, if we’re thinking about productivity, if we’re thinking about interest rates, that’s how it plays into the productivity equation.

Tony: So let me see if I can offer an example that may be along these lines. Virtual reality is something that we hear a lot about. We know Facebook and Apple are all designing virtual reality, or alternative reality, or some kind of different reality glasses. I actually recall seeing a video where people in Boeing that assemble aircraft are actually wearing glasses like that today.

And they have on those glasses, essentially a blueprint of what they’re building, which is extremely complicated, of course, for an airplane. And so they’re able to be much more efficient today, although, that’s just the beginning of what hopefully will be a cascade of new capabilities when virtual reality comes online. Does that sound like I’m on along the right path there?

Luke: Yeah, it’s another example. And if a large company like Boeing is able to invest in these things, just imagine the potential when it’s an economy-wide thing, when you get smaller companies and basically everybody being able to invest in that, and just how much more productive they can make their employees, who can work on something more quickly, as opposed to going back to the manual, and going back to design, and be able to do things much more quickly.

Tony: Okay, so okay, really cool. But like the Jetsons, it hasn’t arrived yet, it’s on the come. So why are we talking about this in terms of the productivity paradox, as an explanation for why the numbers aren’t showing up today, even though the productivity is really there today?

Luke: Right, so this, as we said, as an example of why there we have productivity, and we expect it to come in the future. But let me give you another example. I already referenced Netflix before. Again, another thing that’s really cool, but also is playing into the productivity paradox. So Tony, what’s your favorite Netflix show?

Tony: Well, there’s so many, I spend so much time on the couch watching Netflix. It seems to change every day, cuz I can binge watch a whole series in one night, but probably the most recent one I would say is Happy Valley. British crime drama, love the British crime dramas.

Luke: We’re still stuck on Orange is the New Black. So I’m sure that we could sit here for a long time and talk about the different shows, but let’s think about it from the economist’s point of view. What we have here in Netflix is not just comfort, but also just massive advances in the way that technology can deliver entertainment to human beings into our eyeballs, into our brains, which is incredibly important. If we think back to what’s important for the economy and for companies, it’s that efficiency, it’s that ability to keep costs down. And, that ever-changing technology in the way that’s able to deliver that entertainment to us, as I said. So when we think about the impact here, what we’re thinking about is the experience of the consumer and also cost.

Think back to last year, even less than a year ago, where Netflix actually engaged in a price increase from roughly $9 to about $12 a month for their main streaming service. And most people didn’t even really even think about canceling their Netflix. But what that was, it was a 33% increase in the pricing. What they’re doing right now is actually keeping their price even with that increases relatively low, compared to what they could collect. But what they’re engaging in what we call is market creation and firm strategy. They’re keeping their prices at a point where they really wanna get more and more subscribers before they really engage in any kind of pricing that makes sense for their costs.

Tony: So this is really cool. So for example, when you think about the market creation, it even goes beyond Netflix, right, because you also have Apple and Comcast, Disney. They’re all creating these kinds of services, it’s almost like a whole new industry being created from its infancy.

Luke: Yeah, it’s a whole other industry. And actually, that’s a really important point. All of the other competitors coming in will continue that sort of that price competition and try to keep their companies from keeping their prices down, and really engaging in things that are helpful to the consumer.

Tony: Now I know you have a word for all of this, which is to say, the value that we derive out of the economy now, as these new markets are created without really paying full price.

Luke: Yeah, so a micro-textbook would call it consumer surplus. And this is really just the value that consumers are getting from paying a low price. So for instance, if I was willing to pay $25 a month for Netflix, but I’m only paying 12, that extra money, that extra $13 is referred to as consumer surplus.

Tony: All right, so just to review here to step back, we have two phenomena you’ve talked about. One is, I’m gonna call it time lag, is that fair? When you think about driverless cars, they invest now, and they wait for the benefits in the future.

Luke: That’s true, we refer to that as time lag.

Tony: Okay, and then you’ve got also this market creation. So are those pretty much the two main explanations for the productivity paradox?

Luke: No, we’re gonna focus on another one here that we call progress. And of course, listeners might have noticed that I talked about a toilet when I first asked you about that first question.

Tony: Yeah, I wanted to hear about the toilet seat, right. Is that just watch Netflix watch while you’re in the bathroom? Because some of us might do that already.

Luke: No, this is actually different technology. So researchers at the University of Rochester developed a toilet seat that can monitor your heart health. It has sensors in it that measure your pulse and blood pressure from the patient. And actually can send automatic updates to the doctor, and it alerts the doctor if there’s a need for a visit. So this is pretty amazing, because for the technology, or sorry, for the health care sector using the technology. Cuz one of the biggest challenges with treating patients is that they spend more than 99% of their time away from doctors, and they’re less likely to keep up with monitoring. So what this thing does is it helps monitor patients in the meantime.

Tony: Wow, I never thought that a consumer, I mean, excuse me, that a toilet could keep me out of the hospital. Well, I guess that’s another aspect of it, is not only is it keeping somebody healthier, which is essentially progress, but it’s also saving money for the economy by cutting down on hospital visits.

Luke: Yeah, absolutely, and this is what we think of when we think of as progress, so keeping somebody out of the hospital might actually reduce the amount of money that spent in the health care sector. But when we think about progress, it’s also the quality of life of the individuals and spending less dollar on some of these technologies is actually incredibly beneficial for their quality of life. And that’s why we refer to it as progress.

Tony: So I’m one of these very fortunate individuals that well, I have high cholesterol, it’s genetic, and so no matter how much I diet, it doesn’t really impact my cholesterol. But if I take this little white pill every morning, I can eat cheeseburgers for breakfast, lunch, and dinner every day, and I have a wonderful life, so for me, that’s progress.

Luke: Yeah, it is progress. It actually brings up another point where developers have come up with a pill bottle. Because it turns out that a lot of people could get those same benefits, but they don’t, turns out, if you don’t actually take the pills, then it’s not beneficial to your health. Sounds kind of simple, but as many as 50% of people don’t follow their prescription regimen. So another thing that we’re watching that can help the health care sector is pill bottles that are actually internet-connected. And send text and email reminders to people that have forgotten to open the pillbox that day.

Tony: Wow, but we still can’t actually open the pillbox, because our hands are too weak to open them.

Luke: I’ll leave that to you.

Tony: Okay, so to review, we have time lag, market creation, we have progress, consumer surplus. These are all phenomena that explain productivity, the productivity paradox, and why it’s not showing up in the numbers. We’re convinced, Luke. What do we do with this information going forward? In other words, how can it help us understand the role of going forward? How can we sort of, in a sense, see this play out and verify the thesis as we live our lives?

Luke: Yeah, well, first, continue to be entertained by them, right? These things are really cool, as we said at the onset. But also, watch how it’s affecting your everyday life. So you get these things that affect your daily lives. And what you really should do is pay attention to whether it’s affecting your Interactions with large companies. Something you might have noticed is that it’s getting increasingly hard to get a real human being on the phone if you call a big company.
Another example, voice recognition and artificial intelligence behind those systems just keeps getting better and better. Credit card providers, airline companies, cable companies. What you see in your everyday life is not just the stories about these things on news reports being really cool, but it’s affecting your life in a way that it makes it easier for you to obtain consumer goods. And also, it affects the pricing that you see.

Tony: So fascinating. I need to learn to stop getting upset as well when a computer is talking to me on the other end of the line, and they’re not getting me to a person fast enough. So from an investing standpoint, as the chief investment officer of Wilmington Trust, we do think about this every day. And it’s not just that we’re overweight to technology, which we are, because technology obviously is the provider of all these wonderful things that companies are incorporating into their businesses in order to become more efficient. But it’s really every company in the economy, in some way has become a technology company and/or is using technology to build moats around their business to become more efficient and transforming themselves into the future. And it is central to how we invest and stocks that we pick and companies that we invest in. So let me conclude today with our Productivity Paradox podcast with three takeaways.

One is that, despite the paradox, productivity really is extending the business cycle, and allowing for low inflation, and low interest rates, and presenting lots of interesting investment opportunities.

Number two is that the phenomenon is really the foundation for the equity bull market that we’ve experienced for the last decade. And we expect it to continue broadly, and to continue to benefit the kind of company that we’ve talked about.

And lastly, this is really a structural change that will survive through the next recession. We think it’s gonna dominate our future. And we think that things like AI, 5G, driverless cars, customized medicine, will remain at the forefront of our economy as we go through this radical transformation.

So with that, I wanna thank you Luke, I wanna thank our audience today for listening. And I wanna direct the audience for more information on this topic to our capital market forecast at wilmingtontrust.com/cmf. Thank you very much.

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