Succeeding in low growth markets

It is now more than four years since the financial crisis struck. At the time, the conventional wisdom was that, while the crisis was serious, we would see a similar pattern to previous recessions: a two- to three-year period in which output was below its pre-crisis peak, followed by a return to growth. It hasn’t happened. Andrew Curry and J Walker Smith analyse the barriers to growth and offer advice as to how companies should respond.

The scale of the financial sector’s losses, the level of debt in richer economies and the austerity policies pursued by many governments have combined to create a slowdown that is longer and deeper than anticipated.

Now some economists are suggesting that the growth years before the crisis were a blip rather than a trend, and that the rich economies will have to learn how to live in a world of low growth. They may be wrong: pessimism is also a feature of recessions. But what if they are not? It would mean a fundamental shift in the way that companies do business in the richer world. In this article, we examine the arguments and outline the ways in which businesses need to change their thinking if they are to succeed in a low-growth world.

SEVEN HEADWINDS
The idea that we might be facing a step change towards a lower underlying growth rate has been around for some years, even before the financial crisis. Here we look at the seven headwinds or themes that underpin this expectation.

1 Demographics (ageing)
There are two effects here. The first is history: the post-war ‘demographic dividend’ that saw a surge in young people joining the workforce, with a resulting boost to output, is long gone. So has the economic boost that came in most markets from women coming into labour markets in far greater numbers.
Instead, we now have the flipside, which is more of a demographic payout. Both the demographic dividend and the gender dividend have been spent.

Across Europe and Japan, and even in the US, populations are ageing, and in ageing societies the traffic is the other way: older people leave the workplace faster than young people come into it. The biggest consequence is an increase in the ‘dependency ratio’, or the ratio of retired people to working people, with consequences for public spending directly on pensions and indirectly on health and care costs. While economies are adjusting to this change by encouraging older people to work for longer (the UK abolished its official retirement age in 2011), this may only move the problem around. While there are some complex effects here, the outcomes are likely to reduce productivity and longterm growth rates.

2 The unequal society
Inequality matters because the rich spend their money differently from the rest of us.  In fact, to a significant extent, they don’t spend it at all. In contrast, the less rich (and this includes most middle-income earners as well as poorer households) spend a much greater proportion of their income and they also spend it closer to home, in their own local economies. The very rich, in contrast, are more likely to spend on niche products or assets.

Inequality comes with another cost: it changes patterns of innovation. Instead of innovation for the mass market, which has the potential to be transformative, it chases niche opportunities among the rich. The result of both these factors is simply that growth tends to be lower in more unequal societies, and the US and the UK are as unequal now as they have been for 80 years. This may start to reverse over time – there are patterns in long-term trends – but only slowly.

3 Growth of the service sector
As economies get richer, they tend to spend more on services and less on goods. And as societies get older and expectations change around healthcare, more is spent on care services. But historically, there is less scope for increasing productivity in the services sector in general and the care sector in particular. There are fewer gains to be had from automating production. Customers would worry about going to a hairdresser who planned to use a machine to cut their hair, rather than cutting it themselves; and a patient who needs turning in bed will probably be turned by hand for some years to come.

It’s not impossible to find ways to improve productivity in the service sector, although there are always arguments as to whether such gains are being measured effectively. It is just to say that the opportunity for productivity gains tends to decline in more service-orientated economies, and with it, the opportunity for economic growth.

4 The debt overhang
The scale of debt in richer markets is huge, although in some countries their response to the financial crisis has had the effect of moving the debt around between sectors. Some kind of ‘debt haircut’ or ‘debt jubilee’ seems possible in the longer term if the recession continues, but it will be the last resort of governments captured by their financial markets.

There is a second concern: that some markets are suffering from what has been called a ‘balance sheet recession’ and that the policy tools deployed to address the recession in these markets are not suited to the nature of the problem. Economist
Richard Koo summarises this as follows: “When a debt-financed bubble bursts, asset prices collapse while liabilities remain, leaving millions of private sector balance sheets under water. In order to regain their financial health and credit ratings, households and businesses are forced to repair their balance sheets by increasing savings or paying down debt. This act of deleveraging reduces aggregate demand and throws the economy into a very special type of recession.”

The spectre that sits behind such analyses is that of a Japanese-style ‘lost decade’ in which deleveraging across the private sector leads to both low investment (by the corporate sector) and low demand (by the household sector), and these simply face each other off. Public sector investment is required to break the cycle, but debt-laden governments may be unwilling to intervene in this manner, for a number of reasons.

5 Higher energy prices
As demand continues to climb, and supply plateaus, oil prices are trending upwards. This will continue until global demand starts to decline significantly, energy efficiency increases substantially, or renewables start to provide a significant share of energy, especially for transport. None of these things looks likely to happen soon. At best, they will occur over two decades rather than one. And despite the excitement in some quarters about the emergence of shale gas and oil, there is little reason to believe these will be produced in sufficient quantities over a sustained period of time to make more than a dent in the price of oil.

There’s a larger story here, and a larger controversy, about the extent to which long-run growth in the richer economies has been a product of 200 years of cheap fossil-based energy. That is beyond the scope of this article. But in the short term, some economists now believe that the effect of the relationship between underlying high oil prices and the global economy may be to keep it continually on the edge of recession.

6 The rise of the digital economy
Brian Arthur, who developed the idea of increasing returns to scale, estimates that digital networks account for 60-80% of productivity gains since 1995. As reported by journalist Gillian Tett, the US export credit guarantee agency Exim has seen an export boom, with exports 25% up on last year.
But the number of jobs sitting behind those increased exports has fallen by 12%. Tett notes: “This is jobless growth.”

A broader effect of digital networks has been to expose national economies to much broader competition than previously, effectively suppressing middle-income wages and removing swathes of middleincome jobs. At the same time, it has made nationally-based companies more vulnerable to international competition, even if this sometimes takes the form of gaining competitive advantage through (digitally enabled) tax avoidance.

The digital wave has produced upsides. Falling prices mean greater consumer utility. Arguably, lower prices have acted to offset the lower wages produced by global transparency, although there are limits to the extent of this. As the digital economy reaches saturation, in terms of high levels of penetration, and as wage levels in emerging markets start to rise (in particular in the so-called ‘tradable sectors’ that export), the global impact of digital technology should level off.

7 The problem of scale
As organisations become larger, it is harder to grow at the same rate as before as it becomes more difficult to command the necessary resources – whether people, capital or raw materials. Larger organisations also tend to get layered with bureaucracy and institutional politics that make decision-making slower.

Even in recession there are peaks within the economy that represent areas of growth. But these are not always large enough to represent sufficiently interesting opportunities to companies with shareholder-driven expectations of particular levels of growth or innovation assessment processes which apply aggressive discount rates.

At the other end of the scale, the rate of new business start-ups has been declining in the US since the 1980s and, contrary to received wisdom, this trend has accelerated since the financial crisis. As a result, the share of job creation among young firms (five years old or less) has fallen from 40% of new jobs in the 1980s to around 30% recently. The reasons for this decline are unclear.

Finally, with scale comes greater scrutiny. The period after a financial crash is when governments start worrying about competition law, excessive corporate profits and anti-trust policies.

SOME BIGGER QUESTIONS
There are some further issues that emerge from this analysis that also compound the long-term likelihood that growth will remain low. The first is simply that the global economy is not conforming to the ‘Consensus Future’. As Mark Thirlwell of Australia’s Levy Institute has observed, this is “a view of the future that is shared by international financial institutions, investment banks, consultancy firms and think tanks”.

The Consensus Future model depends on two significant features. The first is that the leading-edge ‘frontier’ economies (such as the US and Germany) continue to move forwards, through a combination of innovation and growth, and that the rest converge on the frontier, largely through being fast followers, and so are quick to catch up. But right now the frontier economies are largely stuck, while the record of middle-income countries succeeding in the transition to high income is actually quite poor (most don’t escape from middle-income status). The combination of population growth and resource pressures that most now face makes this transition even more difficult than before. Beyond that, there is the risk of low growth becoming structured into economies and societies that experience it at a social, cultural and even political level. For low-growth pessimists, Japan and its two decades of stagnation are an awful warning. Charles Hugh Smith argues that in Japan, “the decline of permanent employment has led to the unravelling of social mores and conventions. Many young men now reject the macho work ethic and related values of their fathers… Young women are opting out of the burdens of being, in effect, a single parent who carries the immense responsibility of guaranteeing the academic success of her son(s) and the marriageability of her daughter(s)… it’s no wonder a third of Japanese young women have not married and have no plans to marry”.

And it appears that the political dynamics of an ageing population have helped to lock Japan on to its deflationary path: older voters on fixed incomes have supported economic programmes that promote deflation because this preserves, and even increases, their income.

There are politically-led approaches that could reopen paths to growth. But they require states to become lead actors and also to act against the interests of the financial sector. For example, the geographer David Harvey has argued that previous economic crises have been overcome by significant public and private investment in housing programmes: “To recover from recession, we build houses and then fill them with things.” Even if large-scale housing initiatives are hard to imagine at present, it is possible – at the least – to envisage new infrastructure investment (for example in clean energy or transit systems) as a route from recession.

But in governments and finance departments that are dominated by a view of the world seen through austerity lenses, such a change in policy could be, at best, a slow train coming.

HOW TO PREVAIL AGAINST LOW GROWTH
If the headwinds identify the factors likely to depress growth, they also provide clues for where to look for opportunity. For the headwinds are not evenly distributed. In this final section we look at where opportunities are to be found in low-growth markets.

Look for markets where the headwinds are weaker
In previous Future Perspective reports, we have identified such markets. In The Future of the Eurozone, for example, we wrote about the strong prospects for Poland, which combines low debt levels with a younger population. Equally, some markets – such as Italy, where the economy is currently persistently weak – nonetheless have more scope for growth because the current low economic participation rate by women means it has more headroom to grow if women become economically active.

Follow the money
As demographics shift, so does the money. It is a familiar refrain, but the over-50s – for the foreseeable future – control most of the wealth and a significant proportion of the income, yet few sectors (outside Hollywood) have adjusted to this. Older consumers will also be increasingly visible in the labour market out of both necessity and choice.

The Futures Company has argued elsewhere that older workers will be looking for ‘bridge jobs’ that allow them to make a slow transition to retirement, although their choices in this will be limited by their skills and position in the labour market. Smart businesses will look to redesign human resources structures to attract and utilise such ‘bridge workers’.

Changing debt into running costs
In a world where consumers are trying to avoid debt, business models that depend on debt will come under pressure. This is one of the reasons why consumers have delayed new purchases of ‘big ticket’ items, which are often associated with debt-based purchase models. It will be difficult for businesses to let go of these because they have been supremely profitable (think of the margins in car finance) but competitive advantage is likely to follow those businesses that innovate their business models first. In other sectors, such as the mobile phone market, providers have rolled capital costs into fixed-price service contracts.

Designing costs out of services
One of the benefits of ‘co-produced’ or ‘co-created’ services is that the service user expects to do some of the work and also gains a better or more personalised service as a result. Digital networked technologies provide such opportunities (think of personalised health, for example). In doing so, the provider can reduce costs while focusing more acutely on the needs of the user.

Squeeze energy out of your operations
Most organisations have been actively doing this already through their climate change programmes. In a world of high energy prices and continuing competition for fossil-based energy from emerging economies, organisations that are most aggressive in squeezing out energy costs, and shifting to renewables, will gain competitive advantage.

Rescaling innovation
Conventional innovation approaches can focus too much on incremental improvement. While these are often necessary to maintain market share, they don’t necessarily help to find the peaks in a low-growth world. It is perhaps no coincidence that recent books on innovation emphasise experimentation (and rapid scaling of successes) or the importance of networks, contexts and innovation ecologies, or of learning from low-cost innovation in emerging markets. But traditional assessment frameworks that measure outcomes against high anticipated discount rates will not work.

Making markets
Markets need consumers. It is an obvious point, but one that seems to have been lost in the race to the bottom represented by notions of ‘shareholder value’ and the pursuit of profit at the expense of wages. The economics editor of the Guardian newspaper in the UK, Larry Elliott, made the point this way: “Capital’s victory over labour since the late 1970s has come at a price: workers lack the purchasing power to buy the goods and services they are producing, and are no longer willing or able to borrow the money to do so.”

In other words, wages will have to rise as a share of the overall economy if there is to be long-term growth. This is not so much a question of economics as of political economy. There are already signs of the politics involved in this change in the notion of shared value popularised by Michael Porter and, perhaps, underlined by the corporate tax campaigns in the UK.

CONCLUSION
For many businesses, these are truly disruptive changes. They could require significant shifts in the way businesses organise their marketing, their innovation, their business models, their operational assumption and their human resources approaches. In this article, we have barely scratched the surface of the issues that would affect businesses – almost regardless of sector – if the pessimists are right in seeing a longterm low-growth future for the richer economies.

Of course, the pessimists could be wrong. Although this recession has been longer and deeper than previous ones, good times might be just around the corner. We could be on the verge of a return to business as usual. The new wave of technological investment might be just about to break across these struggling economies. But if they are not, it might at least be worth understanding what plan B looks like. If low growth has settled in for the long haul, then it is worth knowing what your business would need to do differently.

Andrew Curry is a director of The Futures Company [email protected]. J Walker Smith is executive chairman of The Futures Company [email protected].

This is an edited version of a Future Perspectives report. The full report with extensive references is available at here