BNP Paribas Asset Management 2018 Investment Forum: Great instability
Understanding disruptive change and the opportunities it creates
To deepen our understanding of the fundamental drivers of disruptive change and the opportunities it creates, BNP Paribas Asset Management recently held an Investment Forum in Paris. The firm brought together leading academics and policymakers along with the firm’s senior management, research analysts and portfolio managers from around the globe, to share perspectives and insights and to debate how it should drive our investment decisions.
During the one-day Forum, we debated five distinct perspectives on the disruption theme to better understand the multi-faceted nature of the change we are living through as individuals and investors.
But the Forum was not just about enriching our understanding of the forces that are driving markets: It was a statement about who we are as a firm, about our culture of investment rooted in research, debate and challenge and a commitment to be a force for change in financing a more sustainable world.
China: a key driver of economic – and political – transformation
Professor David Autor, Ford Professor of Economics at MIT and co-chair of the university’s Work of the Future Task Force, spoke about Disruption in the Workplace and at the Ballot Box: Globalization, Superstars, and New Work. He highlighted that one of the key drivers of not only the economic, but also the political, transformation we’ve seen recently is China. In particular, the surge in the country’s manufacturing exports following its accession to the WTO in 2001, and the parallel decline in US manufacturing.
While this phenomenon is well known, the political impact is less appreciated. Even though the total number of manufacturing jobs lost has been small relative to the entire US labour market, the job losses have been very concentrated in particular parts of the country. During the US presidential election of 2016, arguably enough people in these regions changed their votes to swing the election results in Donald Trump’s favour. Thus, the consequences of China’s growth have been as much political as economic. The key question Professor Autor posed was whether the shock is over. Given the ongoing trade dispute between the US and China, it seems clear that it is not.
Superstar firms increasing in dominance and control
The rise of “superstar” firms, particular in the technology sector, and their impact on society, is a keenly discussed topic today. A big contributor to their growth has been the ability of these companies to achieve dominant market power. The reasons why “superstar” firms have risen recently are subject to much debate, but it is clear that technological change and globalisation are significant contributory factors. It is also clear that the forces driving the “superstar” firm phenomenon are still increasing, and have spread well beyond the technology sector
Jan De Loecker, Professor of Economics at KU Leuven, explained that the increasing industry concentration and market power enjoyed by “superstar” firms is reflected in rising margins, as successful companies raise prices relative to their costs of production. Where costs are falling sharply, as can be the case in periods of rapid technological change, or where firms can exploit their power – as key customers of their suppliers or as employers of labour – by demanding lower costs (monopsony or oligopsony effects), rising margins may actually be associated with falling, rather than rising, prices.
Either way, the “superstar” company phenomenon, in which capital’s share of added value is on the increase, may help explain the countervailing decline in labour’s share of national income highlighted earlier by David Autor.
Entering the third phase of globalisation
Globalisation is not new. Richard Baldwin, Professor of International Economics at the Graduate Institute in Geneva, took us on a whistle-stop tour of the history of globalisation over the past 1 000 years. For 800 years prior to the industrial revolution, activity was primarily agricultural; production and consumption were clustered together, and there was little difference in the value of output between one part of the world and another. The more people you had, the more aggregate value you produced. China and India dominated global GDP as they accounted for the majority of the world’s population – as they do today.
From the 1820s to 1990, however, as the industrial revolution allowed western Europe and then America to greatly increase production, the share represented by the G7 soared from 20% to over 60%, and the share of China fell commensurately from 50% to 5%. The dramatic economic growth in China over the last thirty years has inevitably rebalanced the scales again, with China and India now accounting for 20% of global income and the G7 less than 40%.
So far, globalisation has unfolded in two waves. The first was driven by a sharp decline in relative transportation costs. This allowed production and consumption to be separated so that goods could be produced where there was the optimum comparative advantage, and consumed where they were most wanted. Trade in goods exploded, global incomes rose and the economic benefits were widely distributed. The second wave of globalisation was driven by developments in information and communication technology, which allowed the separation of intellectual capital and production through outsourcing and offshoring to more efficient, lower cost production centres. The benefits were more narrowly distributed, with companies and capital share gaining most.
Professor Baldwin explained that we are now entering the third stage of globalisation in which digital technologies and robotics allow “face to face” labour services to be provided across borders. The ramifications are far-reaching and unpredictable; sectors such as education, medical services and law may be severely disrupted. Emerging markets are likely to gain more than developed countries. The winners and losers of this next stage of globalisation will be an important subject of research for us in the months and years ahead.
Monetary policy innovation – beyond the control of the people it affects
The revolutions we have seen in politics and in the corporate landscape have coincided with innovation in monetary policy following the global financial crisis. The introduction of initially unconventional monetary policy tools, from quantitative easing to yield curve control, has provoked heated debate among economists about their effectiveness and long-term consequences.
Sir Paul Tucker, Fellow at the Harvard Kennedy School, Chair of Systemic Risk Council, and former Deputy Governor Bank of England, shared his thoughts on what central bankers should be doing (and not doing) now, not only to maintain their legitimacy with the public, but also their ability to react to the next, inevitable, recession. Sir Paul noted the contrast between US President Franklin Roosevelt’s “fireside chats” over the radio in which he explained his measures to combat the Great Depression in a homely way, and US Federal Reserve Chairperson Ben Bernanke outlining the Fed’s response to the global financial crisis on the television programme, “60 Minutes”.
This difference illustrated how it was, in Sir Paul’s opinion, unelected technocrats who led the reaction to the global financial crisis, and not democratically elected politicians as was the case after the Great Depression. This could ultimately prove to be a risk to western societies if citizens feel they have no influence over who makes the final decisions that dramatically affect their lives.
Unconventional monetary policy tools are difficult to explain to the public, and this was one of the reasons why Sir Paul thought that they should only be used when an economy was in a recession, but not as part of normal economic management. His worry was that there will not be enough time to reduce central bank balance sheets to pre-crisis levels, and to move interest rates back closer to historical norms, before the next recession arrives.
Climate change inflexion point being too close for comfort: investment implications
The final disruption we discussed was the revolution in consciousness around climate change, and the need to create a sustainable economic model globally. Mark Lewis, Head of Research at the think tank Carbon Tracker Initiative, explained that dramatic change was coming even sooner than we expected. Most major oil companies expect global fossil fuel demand to peak after 2040, whereas he believes it will come in less than 10 years, from 2023-2025. This means we need to be considering our investments today, as market prices will begin reflecting the decline in demand well ahead of its arrival. As an example, he highlighted the European utilities sector, one that had traditionally been considered the most stable. Since 2010, companies in the sector have written down more than USD 150 billion in assets as they were unprepared for the swift transition that took place away from fossil fuels towards renewable energy.
Beyond the investment implications of climate change, BNP Paribas is committed to establishing a business action plan that will help us to gradually align our investments with the less-than-two-degree global warming limit laid out in the Paris Agreement. We are providing our portfolio managers with the tools to determine the carbon footprint of their portfolios, and to view the physical risk exposure of potential investments. We are a leader in the development of green bonds, and committed to using our proxy voter power to promote sustainability. Moreover, BNP Paribas Asset Management’s commitment to sustainability is not recent: we have just celebrated the 10-year anniversary of our EASY Low Carbon 100 Europe UCITS ETF.
Economic growth or hitting the 1.5°C target isn’t a choice: if we don’t hit the bullseye, there will be no growth to pursue
In his concluding remarks, our CEO Frédéric Janbon emphasised that it is a false dilemma to say one must choose been economic growth and achieving the objective of a less-than-1.5°C increase in global temperatures over the next 20 years: if we do not achieve this goal, the consequences are so dire that there will be no growth to be had.
The Forum is a tangible sign of our determination to understand fully the true nature of disruptive change so that we can help our clients profit from these profound technological, economic, political and societal changes. We are convinced that these themes will continue to drive developments for years to come. We will set our research agenda and investment strategies accordingly. Disruptive change is a reality. We choose to prepare and position for it.
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