The Difference between Productivity and Innovation – and the Implications for Growth and Equity Markets
Official productivity measurements have been falling for decades – a puzzling
development given the rapid pace of high-tech innovations. But rather than
functioning as productivity-enhancers, many of these innovations disrupt
economies and markets. This could have major implications for jobs and
productivity, and trigger unforeseen amounts of social and political change.
1 WELCOME TO THE FOURTH INDUSTRIAL REVOLUTION
Technological innovations are taking place at a rapid and
accelerating pace. Apps on our mobile phones enable us to search
and find information to an extent that was unimaginable only a
few years ago. The digital footprints we leave on the internet allow
companies to use vast amounts of data to provide tailor-made
advertisements. Self-driving cars will probably become
commonplace in the not-too-distant future, while self-learning
machines are already taking over functions that were once carried
out by highly trained specialists. And these are just a few examples.
Innovations in the digital world, notably artificial intelligence (AI),
are likely to have an even more profound effect on a range of
industries in the future – energy, manufacturing, retail, finance,
legal and even healthcare are all expected to change significantly.
In fact, the scale and scope of these technological changes have
been described as a new industrial revolution – one that may be
taking place right under our noses.
The First Industrial Revolution – from the late 18th to mid-19th
centuries – was all about the introduction of mechanical
production processes, steam power and railways.
The Second Industrial Revolution – from the late 19th century to
the early 1930s – was characterised by major breakthroughs in
the use of electricity, and by the invention of telephones,
automobiles, the radio and plastics.
The Third Industrial Revolution – from around 1950 to the early
2000s – saw the development of mainframe computers,
personal computers (PCs), mobile phones and the internet.
Since the beginning of this decade, some argue, we have been
in the midst of a Fourth Industrial Revolution – one in which we
can observe the fusing of the digital, physical and biological
One of the earliest champions of this theory was Klaus Schwab, the
founder of the Davos World Economic Forum. He has described
the changes presented by the Fourth Industrial Revolution as “so
profound … there has never been a time of greater promise or
2 WHERE HAS ALL THE PRODUCTIVITY GONE?
The promise and perils of the Fourth Industrial Revolution can be
applied first-hand to the concept of productivity. In other words,
while today’s technological innovations may lead to significantly
higher productivity – that is, much higher output per unit of input,
often measured as output per hour worked – many of these
technologies could also disrupt existing business processes. This
could have major implications on labour markets, and trigger
unforeseen amounts of social and political change.
When we think about productivity in a traditional sense, we expect
it to respond positively to the major technological innovations of
the last few years. However, when analysing official productivity
numbers, both in developed markets and in the emerging-market
world, this does not seem to be the case. One is even tempted to
repeat the famous Robert Solow quote from 1987: “You can see
the computer age everywhere but in the productivity statistics”.
According to Robert Gordon, one of the godfathers of productivity
research, US labour productivity was around 2 1/3 per cent per year
from the late 19th century onwards – that is, until the early 1970s.
Since then, labour productivity has fallen to around 1 1/3 per cent per
year, with the exception of a few years around 2000. Data provided
by the Conference Board confirm these conclusions (see Figure A).
Labour-productivity growth has been trending down in the
developed markets for many years already – a trend that started well
before the global financial crisis of 2007/2008. Even in China, the
biggest emerging economy in the world, labour-productivity growth
peaked in 2006.
A: YEAR-OVER-YEAR PERCENTAGE CHANGE IN LABOUR PRODUCTIVITY, 3-YEAR CENTRED AVERAGE
Source: Allianz Global Investors Global Economics & Strategy, The Conference Board. Data as at 2017.
So how can we explain this perceived disconnect between
technological innovation and low productivity numbers – and
where has all the productivity gone? Unfortunately, as is often
the case in the field of economics, there is no definite answer.
Optimists would argue that we are still early in the multi-phase
technological revolution cycle. During the current instalment
phase – which is marked by the introduction of new innovations
– aggregate productivity numbers still tend to be rather low.
However, once we enter the deployment phase, new technologies
are likely to be widely used. And once the labour force learns
how to best use and apply these technologies, the argument goes,
productivity is likely to pick up.
In other words, optimists believe that it is only a question of
when – and not if – the economy-wide productivity numbers will
ultimately rise. The sectors that are likely to contribute most to
productivity growth should be the most intensive digital-using
sectors, rather than the tech sectors themselves. Seen through this
lens, the problems presented by the potential mismeasurement
of productivity are of negligible relevance, as various studies have
Robert Gordon1 and others take a much more pessimistic view of
the long-term trend in productivity. To those in this camp, it is
the lack of a “new general-purpose technology” that explains the
structural decline we are seeing in productivity growth. Case in
point: electricity, the major technological advance of the Second
Industrial Revolution, is a technology sine qua non – one that
drastically altered production processes across the board and had
a massive impact on consumer behaviour. For evidence of how
dependent we are on electricity, consider what happens during
power outages: only a few hours after the lights go out, the
world seems to come to a standstill. On the contrary, today’s
technological innovations are potentially much less far-reaching
– or so the argument goes. Moreover, Robert Gordon points to
the overall declining trend of educational attainment – which is
not only happening in the US – as an additional explanation for
relatively weak productivity growth.
There is another argument – and a very different one – for why the
productivity trend has been declining, and it relates to monetary
policy. According to this view, easy monetary conditions from
central banks have lasted for too long, depressing the costs of
capital and contributing to the misallocation of resources. With
an artificially reduced hurdle rate for investment, there is an
increasing likelihood that investments that deliver little or no boost
to productivity growth will be implemented. Overinvestment in
real estate during the “noughties” – which directly followed the
popping of the tech bubble in 2000 – provides a classic example.
The low interest rates in effect at that time pushed capital into the
real-estate market, which is not a sector that has traditionally
contributed a significant amount to productivity growth. In this
context, one could even make the argument that monetary policy
in the US and Europe since the mid-1980s has been asymmetric:
expansionary in times of actual or expected economic downturns
and crisis, but not sufficiently restrictive in boom times. As a result,
this asymmetric monetary policy has contributed to the secular
decline in productivity growth rates. The long-term solution is
for central banks to normalise monetary policy, rather than to
maintain or extend their ultra-easy stance.
The jury is still out on which argument – the optimistic or
pessimistic view – will answer the question of why productivity
is falling, even as technological advancement is growing. Yet the
facts are clear: the most recent wave of technological innovations
has not yet led to a more efficient economy.
It also seems that today’s technological revolution is likely to
exacerbate labour-market trends that have been in place since
the 1980s, as a consequence of the move towards automation
In the middle-income segment of the population, there has
been a decline in the demand for routine jobs such as clerking
and manufacturing (seeFigure B).
In the high-wage bracket, the share of labour has been growing
in all major developed economies, due to rising demand for
highly skilled employees.
Interestingly, in the low-wage segment, the share of labour in
most economies has been stable to rising – albeit accompanied
by falling real wages.
"THE MOST RECENT WAVE OF TECHNOLOGICAL INNOVATIONS
HAS NOT YET LED TO A MORE EFFICIENT ECONOMY."
B: ROUTINE JOBS ARE IN LESS DEMAND
Source: C. B. Frey, T. Berger, C.Che, Political Machinery: Automation Anxiety and the 2016 U. S. Presidential Election, 2017
This trend seems likely to continue as new technologies make
routine and manual jobs increasingly obsolete, while making
highly skilled jobs harder to fill. For example, consider the skills
that are in high demand in a technology-driven work
Strong IT and analytical skills (eg, data scientists)
Soft skills such as creativity and communication
(eg, public relations)
Complex perception and refined manipulation tasks
Contrast these professions with, for example, the taxi or lorry
drivers whose jobs might eventually be replaced by driverless
vehicles. While there is a wide range of estimates on how many
jobs will be affected by the introduction of new technologies –
from less than 10 per cent to almost 50 per cent – the majority
of recent studies seem to agree that highly skilled, highly paid
labour will be in rising demand, and low-skilled labour carrying
out routine jobs will see a marked decline.
This shift in the labour share increases the risk of greater wage
inequality – which we believe is a significant issue.
Since the 1980s, and particularly since the end of the global
financial crisis, rising inequality has fuelled the rise of populist
parties and politicians in Europe and the US. We believe that if
these populist trends turn into policy, we could see an increasing
number of negative economic and market implications – which
we detail more extensively in our paper entitled “The Economics
of Populism” (2017). The problem with this development is that
the kind of economic nationalism that populists stand for results
in less economic integration, less international trade and less
international migration, all of which tend to hurt productivity
Free trade, on the contrary, enhances productivity because it
contributes to a better division of labour on an international level,
and encourages the transfer of know-how. Migration also has
productivity-boosting effects, in particular when it results in a
foreign labour force with different skills being added to a local
3 HOW DOES PRODUCTIVITY AFFECT CAPITAL MARKETS?
Clearly, even if today’s technological advances were to generate
higher productivity growth, their disruptive impact on the labour
market could set in motion political dynamics that are – quite
literally – counter-productive.
However, if technological innovations were to lift productivity,
then potential economic growth would move higher, and inflation
would move lower. At least in theory, equities should – in such an
ideal world – benefit from high-tech innovations over the long
run. Yet this theory fails to stand the empirical test.
Our research (see Figure C) demonstrates that periods of
superior long-term equity returns occasionally, but not
systematically, coincided with major technological innovations.2
In this example, superior long-term equity returns would have
been produced on a few occasions if one were to have invested
at the right time – for instance:
In the 1950s, when mainframe computers and nuclear energy
In the mid-1970s, shortly after the development of the PC.
In the early 1990s, after the introduction of the world wide web
and a new generation of mobile phones.
However, our research also shows that long-term equity
returns were below average after several major technological
innovations – for example:
The invention of the telephone (1876).
The roll-out of electricity in Western cities (1882).
The invention of autos (1886), radios (1920) and plastics
In the same vein, the invention of the steam engine (1781), the
introduction of railways (1825) and the advent of modern steel
production (1850s) only opened up short windows of opportunity
during which long-term equity investors could benefit. Those
who came in a bit late experienced low, and sometimes even
negative, real returns – similar to the late 1990s, when
technology investors learned their lessons the hard way. Despite
the evidence, it may still seem surprising that periods of major
technological innovation don’t consistently coincide with
superior long-term equity returns. So how can this be
First, it is important to reiterate that innovation and productivity are
not identical. Any new technological breakthrough can lead to
higher productivity, but it might be accompanied by a substantial
time lag. This was Robert Solow’s experience when he delivered
his famous quote in the 1980s – just as personal computers were
beginning to move into the mainstream.
Secondly, other, negative factors can more than offset the positive
impact of a new technology on productivity. For example, it took
until the beginning of the 20th century for the global economy to
feel a sustainable rise in productivity from the major innovations of
the late-19th-century Second Industrial Revolution. Several factors
contributed to this lag during the period often called the “Long
Depression” (1873-1896), which was characterised by relatively
moderate economic growth: productivity and economic growth
were dragged down following overinvestment in the 1860s and
early 1870s; the economy experienced a build-up of private-sector
debt; and in 1873, the United States switched to a gold standard,
which implied a de facto tightening of monetary conditions.
Moreover, World War I and World War II were major global events
that held back productivity in the 1910s and 1940s, respectively.
Third, and most important from an investment perspective,
valuations matter. The S&P 500 index’s cyclically adjusted price-toearnings
(CAPE) ratio was particularly high during many previous
periods of high-tech innovation:
At the beginning of the 20th century, which came after many
years of major late-19th-century technological innovations.
At the end of the “Roaring Twenties”, which were accompanied
by a dizzying array of technological advancements (especially
During the “go-go years” of the mid-1960s, a period that lifted
technology stocks in particular.
In the late 1990s and early 2000s, a time characterised by the
blowing and bursting of the “dot-com” or “TMT” (technology,
media and telecom) bubble.
In the mid 2000s, a period that culminated in the global financial
crisis in 2007.
During all of these time frames, valuations were high because
investors simply overpaid for the chance to enjoy future growth
potential. Consequently, ensuing market returns were low –
frequently (but not always) exacerbated by the appearance of
major market shocks or financial crises soon thereafter, such as in
1901, 1929 and 2000.
It is important to note that today the S&P 500’s CAPE is again at
a stretched level of around two times the long-term average – similar
to the level seen in 1929 – which suggests that overall US equity
returns in the coming decade are likely to be low compared to
their long-term average. Some of the biggest drivers of the recent
stockmarket boom have been high-tech innovators such as the FANG
stocks: Facebook, Amazon, Netflix and Google. Moreover, our
research highlighted several periods – such as the 1940s and 1980s –
that were not characterised by major technological innovations,
yet that still resulted in strong equity-market returns, as contrarian
investors benefited from the low valuations seen at the time.
"ANY NEW TECHNOLOGICAL BREAKTHROUGH CAN LEAD TO HIGHER
BUT IT MIGHT BE ACCOMPANIED BY A SUBSTANTIAL TIME LAG."
UK/GLOBAL 10-YEAR REAL EQUITY RETURNS INVESTED EACH YEAR FROM 1780 TO 2007
Source3: Allianz Global Investors, Bloomberg, Wikipedia, Federal Reserve Bank of St. Louis. Òscar Jordà, Moritz Schularick, and Alan M. Taylor (2017). “Macrofinancial History and the New Business
Cycle Facts.” NBER Macroeconomics Annual 2016, volume 31, edited by Martin Eichenbaum and Jonathan A. Parker. Chicago: University of Chicago Press. Macrohistory Lab, University of Bonn;
S.Nairn (2002) “Engines that Move Markets”.
Legend: Year end data used, except for 2017 (21/9/2017). All other data as at 9/2017. Global returns: simple average of AUS, BEL, CAN, CHE, DEU, ESP, FIN, FRA, GBR, ITA, JPN, NLD, PRT, SWE, USA.
Major innovations (approximation or year of first commercial use): steam engine (1775), railway (1812), modern steelmaking (1855), telephone (1876), electric illumination (1879), autos (1886),
aircafts (1903), radio (1920), plastics (early 1930s), mainframe computer (1950s), nuclear energy (1954), PC (1974), digital mobile phone (1991), internet (1991), AI (~2010).
Financial crisis or major market downturns: UK, US 1796/97, US 1819, UK 1825, US 1837, UK 1847, US 1857, US 1873 and Long Depression 1873-1896, Paris 1882, Norway 1899, US 1901, US 1907,
US 1929 and Great Depression, US 1937/38, Japan 1989, Nordics ~ 1990, Asia/ Russia 1997/98, World IT bubble 2000, global financial crisis 2007.
Even though technological innovations by themselves do not
necessarily bode well for broad equity market returns, investors
can still capitalise on innovation in a broader sense. Our research4
(see Figure D) demonstrates that “disrupting” sectors – those
representing technological innovations – tended to outperform
the broad market during the ensuing three, five, 10 and even
20-year periods after the technological innovation was made.
Clearly, this rather positive conclusion does not hold for every
sector, nor for every sub-sector – and in fact our research
uncovered a wide range of results. For instance:
After the development of the first commercial PC in the mid-
1970s, software stocks outperformed by a wide margin, while
hardware producers did not.
Likewise, information-technology (IT) stocks performed well
after the development of the world wide web and digital
telephony in 1991, while telecom stocks only outperformed for
a short time – notably during the years of the TMT bubble.
Moreover, the outperformance we uncovered in our research
never occurred in a straight line. In particular, investors’
expectations about future earnings growth often became
exaggerated within a few years of the debut of a particular
innovation. Subsequently, returns suffered in “hot sectors” where
lofty initial valuations were followed by stock-price setbacks.
Nevertheless, if the past is any guide to the future, sectors and
companies in businesses related to certain high-tech innovations
– particularly artificial intelligence – have a good chance to
continue outperforming, on average, as long as valuations are
not excessive. We are thinking in particular of stocks related to
AI infrastructure (big data, the “internet of things” and cloud
computing), AI applications (robotics and deep learning) and
AI-enabled industries (the health care, transportation and
automotive sectors are just a few).
It is true that with technology stocks in the US currently trading at
an average P/E of around 30, valuations may no longer look cheap,
but they don’t look overly stretched compared with historical levels.
And today’s rich US equity valuations can primarily be explained by
other sectors, notably staples and industrials.
There is a second market implication we want to highlight –
namely the speed at which today’s changes are unfolding.
D: PERFORMANCE OF US EQUITY SECTORS REPRESENTING NEW TECHNOLOGIES IN THE YEARS AFTER A MAJOR TECHNOLOGICAL
Source: AllianzGI, Fama, Cowles, Datastream. Data as at 12/ 2017
Legend: Chart shows median, average, minimum and maximum annual nominal excess returns of sectors representing major technological innovation relative to the broad US equity markets in 1,3, 5,
10, 20 years after the year of a major technological breakthrough. Overall, 13 technological innovations since the late 19th century were analysed. Data as at 12/2017.3
This is a critical factor for investors to consider. As Figure E shows,
the innovation cycle is getting ever faster: it took around 100 years
until railways were used by half of the countries worldwide, but
less than 10 years for the internet to be adopted by a similar
number of nations. The speed of these changes shows that
investors have increasingly less time to assess the impact of
innovations and to identify winning sectors, let alone the most
attractive individual companies within those sectors. Joseph
Schumpeter’s “creative force of destruction” – which these days
is called “disruption” – seems to be growing ever stronger. This
clearly strengthens the case for active investment management.
Only time will tell whether new technological innovations will
help the global economy become structurally more productive.
Nevertheless, innovation clearly matters for investors, and we
advise them to be active in identifying the future winners, to not
overpay for growth potential and, most importantly, to be patient.
E: HIGH-TECH INNOVATIONS ARE BEING ADOPTED QUICKLY
Source: D. Comin and B. Hobijn (2010): “An Exploration of Technology Diffusion” (2010).
Legend: The y-axis shows the amount of time that it took in years for the new technology to be introduced in 50% of all countries.
Topic in focus: Answers at a glance
Global Head of Economics
Allianz Global Investors
1) See Robert Gordon’s Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War.
2) We looked at rolling ten-year real UK equity returns since the late 18th century and at rolling ten-year simple average returns of 15
global equity markets from 1870 onwards until 2017. We chose the UK because it was the world’s dominant economy and super-power until
World War I.
3) Past performance is not a reliable indicator of future results.
4) We analysed the performance of US sectors representing major technological innovations since the late 19th century: telephone,
electricity, autos, assembly line, planes, radio, plastics, TV, computers, PC, digital mobile telephony, the world wide web and artificial
intelligence. Special thanks for running the numbers to my colleague Katharina Sänger.
Literature and data used:
Allianz Global Investors (2017): “The Economics of Populism”
D. Comin and B. Hobijn (2010): “An Exploration of Technology Diffusion”
The Conference Board (2014): “Prioritizing Productivity”
The Conference Board (2016): “Navigating the Digital Economy”
Robert Gordon (2012): “Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds”
E. Brynjolfsson, A. McAfee (2016): The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies
C. B. Frey, T. Berger, C. Chen (2017): “Political Machinery: Automation Anxiety and the 2016 U.S. Presidential Election”
C. B. Frey & M. Osborne (2017): “The Future of Employment”
Òscar Jordà, Moritz Schularick, and Alan M. Taylor (2017): “Macrofinancial History and the New Business Cycle Facts”, published in NBER
Macroeconomics Annual 2016, volume 31, edited by Martin Eichenbaum and Jonathan A. Parker (Chicago: University of Chicago Press.
Macrohistory Lab, University of Bonn)
S. Nairn (2002): “Engines that Move Markets”
The Conference Board productivity database
Cowles Data, Yale School of Management: Common stock indices
Fama/French data library
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