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    Replaced by Robots

    Human capital is under threat.

    Hal Ratner, 07/29/2016

    Technological revolutions have long animated economic history. The concept of “creative destruction”—in which technological advancement destroys certain sectors of the economy while giving rise to new ones—has roots in some of the earliest economic thought.1 This process hinges on the idea that machines serve to supplement human labor, primarily labor dedicated to repetitive physical and cognitive tasks. At the moment, machines can solve intensive well-defined tasks but for the most part cannot be expected to define problems nor identify and traverse particularly complex systems without human oversight.

    However, stunning advances in artificial intelligence, or AI, are beginning to allow computers to do things considered impossible just a few years ago. The upshot is that this time it may be different. There’s now no logical reason why—at some point in the future—machines cannot do everything humans can and with greater efficiency. This idea, carried to its logical, frictionless conclusion, shows a world in which virtually all labor productivity has been transmitted to capital, and the labor market, as it were, is transformed to a preindustrial, artisan-based economy. The potential impact on wages, returns to education, and the composition of the labor market is profound.

    In the meantime, the encroachment of machines on the professional class (e.g., accounting, legal, software development, finance) will significantly have an impact on society and gradually change the composition of the labor market. While the march of technology clearly points in this direction, social and political factors—as always—could act to moderate or derail this altogether. The future, of course, is unknown. But trying to project the future is the key to successfully confronting it.

    Initial Conditions
    A central theme of the U.S. presidential election is the displacement of American workers. Fear that the U.S. economy may no longer be able to support a large middle class2 has energized voters. Indeed, a cursory examination ( EXHIBIT 1 ) shows that real wages for men are lower than they were in 1979 and that average wages have increased only slightly since then. In fact, this mild increase in average wages is largely a function of greater labor force participation of women, who in aggregate are starting out at a much lower base. If and when the two catch up, it will likely be a function of male wages falling as female wages rise.

    A good deal of real wage stagnation for men is due to the decline in the U.S. manufacturing sector, which has been particularly hard-hit by outsourcing and automation. The effect has been dubbed the “hollowing out” of the middle class and has led to increases in wage growth at the tails of the skill distribution continuum— those in the lowest- and highest-skilled groups seeing increases in real wages, with those in the middle, a decrease, for the 1980–2005 period (Autor and Dorn, 2013).

    Presidential hopefuls Democrat Bernie Sanders and Republican Donald Trump have focused rather successfully on this populist message, citing globalization—exporting jobs and excessive immigration—as the primary culprit of this hollowing out. There’s little doubt that globalization has created significant dislocation, particularly in the manufacturing sector, and this trend looks unlikely to reverse. However, globalization can mean a repurposing of labor. Workers in the developed economies move from manufacturing- based jobs such as assembly-line workers and factory workers to jobs requiring more administrative skills needed to power a service-based economy. This isn’t costless, as the service-based jobs typically pay far less (in wages and benefits) than those in manufacturing, but it does offer respite from the far worse possibility of mass unemployment with its attendant intermediate- term economic, and long-term social, costs.

    To a very large degree, however, the debate over globalization has obscured a much more disruptive cause of worker displacement, as well as declining job and wage security—the increasing substitution of capital for labor. For various reasons, this hasn’t really entered the debate. It’s difficult to imagine a candidate recommending manufacturers ditch automation for the more labor-intensive methods of yesteryear or that software firms stop developing technology that could replace humans. But this has clearly played a major part in weakening the pricing power and employment opportunities most obviously, though not solely, for blue-collar workers.

    Hal Ratner is the chief investment officer, Europe, with the Morningstar Investment Management division.