Monday, November 24, 2014

Labor’s Digital Displacement

MILAN – Digital technologies are once again transforming global value chains and, with them, the structure of the global economy. What do businesses, citizens, and policymakers need to know as they scramble to keep up?

Digitally enabled supply chains initially increased efficiency and dramatically shortened lead times. Capital was mobile; labor less so. Economic activity (production, research, design, etc.) moved to any accessible country or region that had relatively inexpensive labor and human capital. With only a slight lag, complexity became manageable, and global supply chains’ linear model (something produced in country A is consumed in country B) gave way to a more complex model with more fragmented but more efficient supply networks.

Meanwhile, a dramatic shift occurred on the demand side, as emerging economies grew and became middle-income countries. Developing country producers, who in an earlier era accounted for a relatively small fraction of global demand, became major consumers.

Global supply networks shifted again, accommodating fragmentation and dispersion on both the supply and demand sides of their structure, a process sometimes called technologically enabled atomization: the division of supply networks into finer and finer parts, breaking the bonds of proximity and the resulting transaction-cost constraints that previously prevailed.

For example, many services related to intermediate and final demand require knowledge, expertise, information, and communication for their delivery. What they do not require is geographical nearness or the physical movement of goods. They represent a large share of the global economy, and they are gravitating rapidly toward the tradable sector, with increasingly powerful digital and information technology chasing imperfectly mobile human resources and new rapidly growing markets.

In the course of this transformation, millions of people joined the global economy, with wide-ranging consequences – many of which remain challenging – for poverty, prices, wages, and income distributions.

Now comes a second, potentially even more powerful, wave of digital technology that is replacing labor in increasingly complex tasks. This process of labor substitution and disintermediation has been underway for some time in service sectors – think of ATMs, online banking, enterprise resource planning, customer relationship management, mobile payment systems, and much more. This revolution is spreading to the production of goods, where robots and 3D printing are displacing labor.

It is important to understand the economics of these technologies. The vast majority of the cost comes at the start, in the design of hardware (like sensors) and, more important, in creating the software that produces the capability to carry out various tasks. Once this is achieved, the marginal cost of the hardware is relatively low (and declines as scale rises), and the marginal cost of replicating the software is essentially zero. With a huge potential global market to amortize the upfront fixed costs of design and testing, the incentives to invest are compelling.

In other words, unlike the preceding wave of digital technology, which motivated firms to gain access to and deploy underutilized pools of valuable labor around the world, the driving force in this round is cost reduction via the replacement of labor.

This transformation has important side effects. For physical goods, there are costs associated with logistics and lead times, owing to inventories and poor forecasts of the market. With digital capital-intensive technology, however, production will inevitably move toward the final market, wherever it is. This re-localization constitutes a major shift in the structure of global supply networks.

An extreme form of this may be coming in the form of 3D printing, a technology that makes it possible to produce an astonishingly wide and growing range of products by printing them one layer at a time. Examples include buildings, athletic shoes, designer lamps, aircraft wings, and much more.

As the costs of this technology decline, it is easy to imagine that production will become extremely local and customized. Moreover, production may occur in response to actual demand, not anticipated or forecast demand. In some sense, this represents the ultimate compression of supply chains, as firms produce to final demand with minimal delay.

Meanwhile, the impact of robotics (another technology with digital foundations), is not confined to production. Though self-driving cars and drones are the most attention-getting examples, the impact on logistics is no less transformative. Computers and robotic cranes that schedule and move containers around and load ships now control the Port of Singapore, one of the most efficient in the world.

Developing countries in the early stages of growth need to understand these trends. Labor, no matter how inexpensive, will become a less important asset for growth and employment expansion, with labor-intensive, process-oriented manufacturing becoming a less effective way for early-stage developing countries to enter the global economy.

Re-localization will be seen everywhere, including lower-income countries. Production will not vanish; it will just be less labor intensive. All countries will eventually need to rebuild their growth models around digital technologies and the human capital that supports their deployment and expansion.

The retail sector, too, is being transformed. Online retail and supporting logistics is expanding in a wide range of advanced and developing economies. In China, where the expansion is occurring extremely quickly, estimates suggest that only part of the expansion is at the expense of traditional retail.

In fact, online retail appears to be accelerating the expansion of the overall consumer market. Knowledgeable participants expect the new retail model to be an integrated form of online and physical retail, each modified by the presence of the other. Think again of the 3D printing model, a potential form of demand-driven mass-customization, and its combination with online mobile payments systems and social media. The integration of sourcing with logistics and retail will become the third leg of the stool.

The world we are entering is one in which the most powerful global flows will be ideas and digital capital, not goods, services, and traditional capital. Adapting to this will require shifts in mindsets, policies, investments (especially in human capital), and quite possibly models of employment and distribution. No one knows fully how all of this will play out. But attempting to understand where the technological forces and trends are leading us is a good place to start.

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    1. CommentedGerald Silverberg

      While I can subscribe to Spence's view of the effects of digitization and global networking, 3-D printing strikes me as vastly overhyped. It will never be able to compete on a cost basis with traditional mass production using stamping dies, molds, assembly lines, photolithography, etc. except in niche markets for prototypes and customization. In a sense it is a step backwards even from CNC.

    2. CommentedSteve Metcalf

      Concern of the replacement of man by machine was addressed in the 20th Century by John Maynard Keynes and has been raised by many others since. However, like other authors, Spence remains on the fringe of the issue with the summation "...Adapting to this will require shifts in mindsets, policies, investments (especially in human capital), and quite possibly models of employment and distribution." That people at the low and intermediate skill levels are being replaced by machines and technologies at an increasing rate, while global population continues to burgeon, is a given. It is time for serious attempts to model the world of 2030 and 2050 (or one with contingent percentages of manpower replacement) - a world where there is more liesure time and less essential human work to be performed for survival.

      There is no question that it will demand more effective education of youth to have the best chance to innovate and handle tasks of higher skill levels. It will also increase the degree of socialism to an extent that will make today's debate of a nation's position on the capitalism-socialism spectrum arcane.

      It is time for thinbkers in academia, church and state to begin identifying the most significant challenges man will face in the transition from the world of today to that future era, so debate and the development of solutions can proceed. To continue to ignore the challenge because such issues as restraints on population growth or increases in economic redistribution clash with the current status quo in religion or politics, respectively, will only make the transition to that era harsher. Surely, simple philosophies like "when the going gets tough the tough get going" will increase the probablility of political revolution by those without the intellect or skills to survive.

    3. CommentedNathan Weatherdon

      Does automation of low tech processes bar LDCs from traditional pathways to development?

      While there not still be a need to have humans looking over these processes, I think many processes will be more reliable when monitored by an engineer with a master's degree and 10 years of relevant experience than by a local team of farmers or welders.

    4. CommentedTom Shillock

      Spence is a master of presenting the current state of affairs (from 50,000 feet) as if it were insightful prognostication. One would think that an academic economist especially one with a Nobel would at least have his grad students provide him links to data to quantify his assertions. For example, what does the last paragraph even mean? Perhaps Project Syndicate is just another form of hand waving journalism?

        CommentedNathan Weatherdon

        @ TOM

        If there were readily available numbers geared towards this kind of question perhaps he would have included more. It is relatively new that we are asking such questions. We had figured out that technological advances in manufacturing led to higher wages because human capital was worth more when paired with more capital, but we are talking about very different kinds of dynamics in a very different form of technological advance.

        Broad strokes are required before we can figure out which details are worth picking at.

    5. CommentedEdward Ponderer

      "With only a slight lag, complexity became manageable, and global supply chains’ linear model (something produced in country A is consumed in country B) gave way to a more complex model with more fragmented but more efficient supply networks."

      Herein is articulated the most important statement in Prof. Spence's article. For it is the broad sweep visualized--the future trend. Complexity will ever increase and become evermore, and control with evermore lag -- until we bob in and out of phase as our controls simultaneously turn to sand in the hands of the powers that be, and its effect becomes statistically orthogonal to intent--in short, a "drunkard's walk" -- a statistically guaranteed walk into pure entropy.

      We must recognize that we are falling into a fractal basin of influence and influenced--a fractal orbit into deterministic chaos. Other than its unique global scale, this is the process of evolution--its mathematics repeated over and over in nature as communities entered environmental complexity crises which were resolved by a natural altruism--a voluntary (allegorically in nature, of course) mutual responsibility between members and the community as a whole--leading to a distributed fractal of sense, analysis, and control by a natural neural net. It is such a formation that makes our chaotic heartbeat not a catastrophe, but the central, but central to the homeostasis of life.

      As to say, the electoral goings on in Europe--bad news. This is not the truly whole system mutual responsibility of nature, but a crippling fascism at the organ level. It is as though our bodily organs took a walk to try to make it on their own--is their impending doom even a question mark? We can only hope hear that sense will soon override sensationalism as the masses of Europe begin to sense the writing on the wall about where their reactions are taking them.

      Call me an optimist, but I'm betting on Humanity to make it. I just hope that we will not impose too much suffering upon ourselves and make the process needless long and grinding.

    6. Commenteddavid ursiny

      If goods and services lose out, then local,state, and national governments won't raise enough money to cover their responsibilities, in the future under that model of no growth,

    7. CommentedVelko Simeonov

      Very well written article, but I think something is missing. If we assume that technology advancement far outpaces our ability to transform our way of thinking, in essence way of life, what will be the impact. What will be the potential cost of not making bold and inovative decision to start transforming our society NOW?