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Industrial revolution and dollar dilemma
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The theme of last week’s World Economic Forum Annual Meeting in Davos is the Fourth Industrial Revolution. The argument is that the world has seen three industrial revolutions — mechanical production and steam power, mass production and electricity, and electronics and IT – and is embarking on an additional one in which artificial intelligence is likely to play a much greater role. As WEF founder Klaus Schwab states in his new book on the subject, the velocity, breadth and depth, and systematic impact of these changes have already set the fourth revolution apart from the third.
Some of the potential consequences have already been widely discussed. Inequality may persist as lower-skill jobs become automated. Growing digitization may boost cyber risks. Disruptive technologies like big data and blockchain may revolutionize areas like financial services. However, what has received less attention is the degree to which the Fourth Industrial Revolution will exacerbate the current divide in fortunes between developed and emerging markets.
A key example of this is what we would term ‘the dollar dilemma’. The US possesses many of the key attributes necessary for success in the Fourth Industrial Revolution. It is a hub of technological innovation and remains an attractive destination for investment, company establishment and headquartering. This creates a plausible scenario where the US dollar maintains its structural strength.
Further dollar strength would add to the difficulties of emerging market economies, whose struggles with a strong dollar are already garnering headlines. Countries maintaining dollar pegs would face extra competitive pressures. The cost of debt servicing would also rise for emerging countries and companies that have used the period of low US interest rates and broad dollar weakness since the financial crisis to increase significantly their dollar-denominated borrowing.
Elsewhere, robotics and 3D printing could also materially affect emerging market manufacturing jobs. For some economies on the cusp of joining the global manufacturing and trading system (for example in South Asia, the Middle East, Africa, and parts of Latin America), extreme automation in the US could have short-run negative effects on demographics and employment. Emerging markets that are yet to move from low-income to middle-income status are at risk of squandering their demographic prime.
In addition, the on-shoring of work back to the US from areas with a former labor advantage could be seen as a risk to developing nations. Extreme connectivity may shorten global supply chains. One particular implication will be the role of virtual trade in ideas and intellectual property versus traditional trade in physical goods. Relative advantages in developed market legal protections of intangible ideas may lead to on-shoring from emerging markets to the developed world initially. However, this trend may reverse over the longer term as emerging nations grow and develop their infrastructure to embrace extreme automation and connectivity.
Although cyber security dangers vary between nations, many emerging markets are more exposed. Eurasia Group’s cyber risk index, which rates the threat to businesses from 1 to 100, indicates a relatively elevated risk reading of 88 for Chinese firms, versus a safe score of just 14 for Swiss firms. One caveat is that the United States, despite its relatively robust cyber environment, is considered a prestige target by foreign states and dissidents. As a result, Eurasia Group gives it a rating of 77, putting it at far greater risk than most rich nations.
Overall, however, the Fourth Industrial Revolution is expected to entail fewer headwinds for developed markets than their emerging peers.
Emerging markets have more lower-skilled workers and less flexibility to raise skills than developed markets. We have also noted the nearer-term risks of a higher US dollar due to the US’ current advantage in Fourth Industrial Revolution technologies. Furthermore, the shift from physical to ‘virtual’ trade may impact emerging market growth drivers and labor forces, at least until investment in the relevant infrastructures are made and bear fruit.
The sensitivity of global trade to global growth already seems to have declined since the global financial crisis. This is one of key reason emerging market growth has been so weak in recent times. A further decline in advanced economies propensity towards imports, along with the risk of a structurally stronger US dollar, could hit emerging markets’ earnings and cost of equity at the same time.
Hopefully, this disadvantage will also be a catalyst for emerging markets to invest over time and counteract it. Until then, however, the Fourth Industrial Revolution is likely to favor developed market over emerging market assets.
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