The Challenges of Innovation in the Last Five Years

With the trend toward a multipolar world accelerating, companies are finding that investing in productivity may help protect margins. Ravi Shanker and Diego Anzoategui discuss.

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Ravi Shanker: Welcome to Thoughts on the Market. I'm Ravi Shanker, Morgan Stanley's North American Freight Transportation Analyst. 

Diego Anzoategui: And I'm Diego Anzoategui from the U.S. Economics Team. 

Ravi Shanker: And on this special episode of the podcast, we discuss what we see as The Great Productivity Race, that's poised to accelerate. It's Tuesday, May 2nd at 10 a.m. in New York. 

Ravi Shanker: The transition away from globalization to a decentralized multipolar world means companies' ability to source labor globally is contracting. This narrowing of geographical options for companies is making cheap labor, particularly for skilled manufacturing, harder to find. But there is a potential positive, a rebound in productivity which has been anemic for more than a decade.

Ravi Shanker: So Diego, what's the connection that you see between the slowing or even reversal of globalization and productivity trends? 

Diego Anzoategui: If you think about it, the decision to upgrade technologies and increase productivity is like any other type of capital investment. Firms decide to improve their production technologies, either to deal with scarce  factors of production or to meet increasing demand. COVID 19 was a negative shock to the labor supply in the U.S., and there is still a long road ahead to reach pre-pandemic levels. On top of that, we think that slowing globalization trends will likely limit labor supply further, causing real wages to increase, and keeping firms under pressure to improve productivity to protect margins. But we think firms will boost productivity investment in the medium term once business sentiment picks up again. And we are past the slowdown in economic activity that we expect in 2023 and into 2024. Expectations are key because the decision to innovate is forward looking, adopting new technologies takes time and the benefits of innovation come with a lag. 

Diego Anzoategui: Ravi, as a result of COVID and the geopolitical uncertainties from the war in Ukraine, companies have been dealing with a number of significant challenges recently, from supply chain disruptions to worker shortages and energy security. How are companies addressing these hurdles and what kinds of investments do they need to make in order to boost productivity? 

Ravi Shanker: Look, it's a good question and certainly a focus area for virtually every company anywhere in the world. The last five years have been very challenging and a lot of those challenges have revolved around labor availability and labor cost in particular. So I think companies are approaching this with two broad buckets or two broad focus areas. One is, I think they are trying to reinvest in their labor force. I think for too long companies' labor force was viewed as sort of a source of free money, if you will, an area to cut costs and gain efficiency. But I think companies have realized that, hey, we need to reinvest in our workforce, we need to raise their wages, improve their benefits, give them better working conditions, and make them a true resource that will obviously contribute to the success of the company over time. And the second bucket they're looking at is just broader long term investments in things like automation and productivity technologies, because many of these labor trends are structural, that are demographic issues, that are geopolitical issues, that are not going to reverse anytime soon. So you do need to look for an alternative, particularly in areas where, you know, jobs that people don't want to take on or where the value added from a labor is not as good as automating it. That's where companies are highly focused on the next generation of tools, whether that's automation or A.I. and machine learning. 

Diego Anzoategui: It seems that A.I. technology holds great promise when it comes to raising productivity growth. In fact, our analysts here at Morgan Stanley believe that A.I. focused productivity revolution could be more global than the PC revolution. What is your thinking around this? 

Ravi Shanker: Look, I think it's still too early to tell what impact A.I. will have on labor productivity as a whole and the impact of labor at corporations around the world. Take, for example, my sector of freight transportation. We don't make anything, but we move everybody else's stuff. And so by nature of freight transportation, is a very process driven industry and process driven industries by nature kind of iterate to find more efficiency and better ways of doing things, and that's where a lot of these new productivity tools can be very helpful. At the same time, it is also a very labor intensive industry that has some significant demographic challenges, whether it's a truck driver shortage, the inability to find rail workers, warehouse workers on the airline side of the house, the inability to find pilots and so the training and the desire of people to do this job over time may be changing. And that's where something like, you know, automation or A.I. tools can be very, very helpful going forward. However, I think this is still very early innings and we will see how this evolves in the coming years.

Ravi Shanker: So finally, Diego, what is your outlook for the US labor market and wages over the next 5 to 10 years and how persistent do you think this productivity race is going to be? 

Diego Anzoategui: We think that a persistently lower labor supply should gradually boost wages. So far nominal wages have increased less than inflation, but we believe the modest increase in nominal wages is simply evidence of typically sluggish response of wages to price shocks. We expect real wages to pick up ahead and regain lost ground, and without this catch up in wages we leave firms to raise prices rather than upgrade their technologies. Evidence of strong price passthrough in the U.S. is limited and structural changes have made wage price spirals less relevant. 

Ravi Shanker: Diego, thanks so much for taking the time to talk. 

Diego Anzoategui: Great speaking with you Ravi.