Labor markets in the new digital age

Columbia Management, Investment Team | April 14, 2014

  • The downside to technological progress is short-term dislocations and job loss for those displaced by automation.
  • Workers with high skills and advanced education command a wage premium while unskilled and lower-skilled workers are displaced which aggravates income inequality.
  • The winners will be those who have skills complementary to the new emerging technologies and those who discern how best to adapt and gain competitive advantage.

By Marie Schofield, Chief Economist and Toby Nangle, Head of Multi Asset Allocation

A theme not touched on so far in our series on income inequality and secular stagnation is the impact of innovation and technology on economic growth and income. Technological progress carries long-term benefits raising standards of living and boosting productivity; however, it also causes short-term dislocations and job loss for those displaced by automation. Turnover and churn in the labor market is a normal response to the disruptive change inherent in innovation—killing some jobs but also creating new ones in the process. But the effects of the new machine age have put downward pressure on wages at the bottom and now middle-income workforce. A recent study by Oxford University economists Frey and Osborne* suggests 47% of U.S. jobs could be automated in the next 20 years, with less impact on those with a higher education and in certain industries that are less vulnerable (Exhibit 1). It is noteworthy that impacts will be felt across many service industries going forward. McKinsey & Company consultants believe future productivity gains will significantly disrupt clerical and professional service jobs.

Exhibit 1

Chart: Jobs lost to automation

Source: The Future of Employment: How Susceptible Are Jobs to Computerisation?, Carl Frey and Michael Osborne, September 2013

The rewards of this innovation fall disproportionately to business at first, as capital is substituted for labor particularly in low and middle-skill industries. In the last few decades, labor’s share of national income has continued to fall while the business share is rising—now at 13% a 60-year high. Exhibit 2 shows the income share of both wages and salaries, as well as the larger total employee compensation (which includes non-cash benefits like health insurance). The latter has seen steady erosion since 1980 and is now at 60.7%, the lowest level since 1952. The last time labor’s income share was rising was when the economy experienced near full employment. Since then, the rise in unemployment and the expanding output gap during the recession undermined the bargaining power of workers and automation made some expendable. High profit margins are (and will remain) a continuing theme as businesses directs capital to technology which substitutes for (low-skilled) labor. This affords the benefits of lower costs and higher productivity which can keep earnings high.

Exhibit 2

schofield2

Source: BEA, December 2013

The benefits of productivity gains usually come first to capital, and income gaps tend to widen and persist. The benefits to labor come much later—a normal sequence in the evolutionary march of technology. Of course, this usually results in increasing social tensions and political risks if left unaddressed. As technology replaces labor with robotics, it also empowers those with high skills and advanced education who can command a wage premium. At the same time, unskilled and lower-skilled workers are displaced which aggravates income inequality. Governments can soften the blow temporarily via benefit stabilizers and income transfers, but these cannot continue indefinitely. Politicians are hard-pressed to craft solutions, but governments can play an important role initiating re-training programs and refocusing our educational priorities.

In the past, technology and innovation mainly impacted goods producing industries like manufacturing, which saw with widespread job losses during recessions and mediocre gains during recoveries. However, the impacts are now broadening to include many industries that were never before regarded as technology intensive, particularly in service sectors. Most at risk are those who perform routine knowledge work and cognitive tasks. This touches on diverse industries such as publishing, wholesale/retail trade, finance and bookkeeping, office and administrative, and law—even healthcare and transportation will not be immune. From pattern recognition software to driverless cars and artificial intelligence, this new industrial revolution is more digital and less mechanical, likely requiring fewer capital outlays but more workers with high skills. So, while technological innovation has decimated demand for low-skilled workers, it will increasingly impact a broader number of domains and move up the income ladder. This creative destruction is healthy in the long run only if it creates as many (or more) new jobs as it trashes. There may be dislocation in the short term, but it will not permanently reduce the demand for labor. It will simply shift the demand to different kinds of work.

The transition will not be smooth, but it will lead to increasing demand for new workers and probably create new industries. Advanced education and training is imperative in this new order, as these are unremitting forces that are changing labor markets worldwide. The winners will be those who have advanced skills complementary to the new emerging technologies and also those who discern how best to adapt and gain competitive advantage. This does not argue for secular stagnation per se, as productivity gains can support improved growth. But these forces can suppress job gains in low-to-middle skill industries and, as a result, keep income inequality metrics weak at least over the medium term.

 

*Source: The Future of Employment: How Susceptible Are Jobs to Computerisation?, Carl Frey and Michael Osborne, September 2013