A good sense for investing and advisory needs to be based on keen observation and ability to make sense of a rapidly changing world and its implications. It was not so long ago that the world was indisputably unilateral and the sense of situational awareness of people was tested to a much lesser extent, as changes were more gradual and easier to comprehend and accept. In this article we therefore want to present more conceptual views that we think drive many major changes that are occurring and about to come. As always we will present concrete implications for industries and investors.
The processes described in this short article are in practice highly complex so the presented views are by no means exhaustive. As this is an important and far-reaching topic we have split this topic into two parts, in the second part we approach more indirect implications we observe at the micro level.
Entropy and spread of knowledge
The second law of thermodynamics states that entropy tends to increase, which in a watered down version also can be applied to spread of knowledge and technological production. It was quite recently that technological companies were mainly concentrated in certain areas of the world, the Western world and Japan. This had several causes, like the concentration of knowledge, necessary economic conditions and infrastructure in these countries. In 2024 we see a different picture however. Also driven largely by the internet knowledge is globally spreading, like heat from a heat source in a room.
This all means for example that, unless for advanced specializations, students don’t necessarily need to go to a select group of prestigious universities located far away from where they grew up and live, to have a good educational development. This makes it more likely for people to study and practice their profession locally. Combined with the trend for companies in these segments to open up to remote workers post-COVID, this further adds to the formation of centers of knowledge dispersed over the globe.
Flying geese
There is another but economic factor for spread of economic and technological development across the globe for which we have to talk a little bit about the flying geese theory in economics. This theory was developed by Japanese economist Kaname Akamatsu already in the 1930s, initially intended in the context of the Japan’s industrialization dynamics but was later further developed in the broader context of East Asia and even broader. The name might sound strange or unfitting but is actually well-chosen as the pattern in which industrialization and economic production spreads, within this theory, resembles that of flying geese.
This theory is actually about economic progression, specialization and production hierarchy. This theory states that leading economies develop increasingly sophisticated products and technologies and as a result move up in the value chain. Also confronted by increasing labour expenses they become less interested in producing products lower in the value chain. As a result lower segments in the value chain move towards less developed countries and regions. This presents in the short-run a win-win situation as all parties involved (seemingly) gain from this. But in this context it is important to note however that the lower segments will have slim margins as industries can quickly move to even cheaper locations in the future. This creates a harsh competitive state, with all its drawbacks and negative consequences. Players at the top of the value chain on the other hand have more pricing power and can even be monopolies in their area.
A major lesson within this theoretical context it is therefore that it is crucial to think ahead and understand that one eventually needs to move up in the value chain to not fall prey to competition. Another major lesson from the developments we have observed and studied is the undeniable power of cheap and organized labour, as it is a precondition for economic progress. Countries that can provide this can attract industries with all the knowledge and expertise that they bring. This all of course with the prospect and hopes of moving up on the value chain towards the production of more sophisticated products in the long run.
Germany, China and electrical cars
In reading about the flying geese theory it is almost impossible to not think about China which was a poor country not so long ago that in recent decades took on the role of the ‘factory of the world’. But China is a very interesting case in which the traditional theory partially breaks down or is rather shown to be incomplete on points, due to new and unprecedented developments which were not accounted for.
It was not that long ago that the label ‘made in China’ had largely negative connotations, but it can be seen currently that many people increasingly started using Chinese high-end products. Western companies in certain sectors have moved production largely to China which was mainly accelerated with the entrance of China to the World Trade Organization in 2001. In the short run this had tremendous benefits as it led to cheaper products and record profits for these companies. It additionally meant that these companies could benefit from the massive Chinese market by selling their products there.
Moving supply chains to China was in cases more necessary than desired as in a certain sense it could even mean that local production outside China might make a company non-competitive. This all also entailed that knowledge for the production of goods needed to be shared with China with the logical consequence of the rise of competitors in China in time. China indeed used this environment to its advantage to an extent that it quickly started producing more and more sophisticated products to the point that it overtook the West on major areas, although we observe this still hasn’t received widespread realization.
Anno 2024 a major problematic area for Germany/Europe is that of electrical cars, as it is clear that the future of the automotive industry lies in electrical vehicles. Together with challenges, this transition presents tremendous opportunities to car manufacturers. It is however becoming increasingly clear that Chinese companies can produce notably cheaper vehicles than Western competitors in this regard, while we can also not say anymore they are of (noticeably) lower quality. This has two major problematic implications:
- The significance of the European electric vehicle industry receives a major blow, also further bolstered by the further challenges of expensive energy prices caused due to ongoing wars. The governments could use protectionism and tariffs to protect the internal market. This is however not a viable solution as external markets in their turn will also retaliate and it will be practically impossible to sell cars outside one’s own market. This also doesn’t solve the issue under point 2.
- Advantages of cheaper vehicles percolate into the wider economy. Companies that have access to cheaper vehicles will have lower expenses which will be translated into cheaper products. Additionally consumers will have more money to spend on other products produced within the economy.
There doesn’t seem to be a straightforward solution to this bleak situation and one therefore needs to assume bad outcomes. If we again return to the classic flying geese theory, we don’t see a natural progression in the hierarchy which means that one is lost in the flock, so to say. The best outcome is of course innovation, as again also emphasized in our company slogan, as otherwise the consequence might be to largely abandon this industry or make some sort of major concessions.
This all doesn’t mean of course that Chinese companies are here to permanently dominate the market, as the same mechanisms like cheap labour becoming more expensive impacts them. Also it needs to be seen what the impact will be of factors like the fertility rate, aging of the population and of the development of AI. Regarding the second, in this context it is interesting to make a reference to the movie Animatrix (2003). In this movie machines eventually retreat to an own region and make much more sophisticated and cheaper products that humans can not compete with, wrecking the entire human economy.
All in all this entire process leads to a more multi-polar world with difference bases of power. A term which has been used also more frequently in the context of ongoing wars.
Lack of innovation and race to the bottom
In an increasingly multi-polar world innovation is essential. Lack of innovation and inability to make and execute the right decisions can namely eventually entail a race to the bottom: If one loses the race in the higher segments of the value chain it means one needs to find new markets or shift down in the hierarchy which means more and more competition on prices and margins.
Innovation is also however merely a word and it doesn’t mean that in all cases rapid innovation can be compelled or is feasible. We can also see in the current world that highly impactful innovations are rarer than say 20 years ago. Additionally new developments can and in many cases will be copied, which means that innovation needs to be structural and continuous. Given such an economical environment with a diminishing rate of impactful innovations, the question arises whether hard economic innovation should be the primary point of focus.
Retrospection
We can logically conclude from the theory that it is essential to create an environment that promotes and rewards innovation and therefore attracts and retains talent that can contribute to this innovation. This is of course not a radical conclusion. The questions on what conditions truly address the need of this talent pool is however rarely discussed. The silent assumption is that monetary compensation is leading, while one needs to examine what the true value is of the monetary compensation and whether it addresses the biggest needs of people in the current world. It can for example make sense to work in a location with a lower but decent pay, where one feels more appreciated and at ease. Also despite the high wages in certain parts of the world, they might still not be proportional in the face of increasing living expenses.
Having focused on economic considerations, we belief that employees will increasingly become conscious for and attach importance to non-economic considerations and will judge how much their needs are met in a certain environment. It is therefore essential that countries prioritize above all promoting the right values, which includes fair and equal treatment of all and a truly meritocratic and realistic system that helps people with their non-monetary needs. This in turn will lead to a cohesion and inevitably to an urge for innovation. In this context however it should be noted that in current Western society there is a lot of polarization on a wide area of views, which actually undermines cohesion and a feeling of belonging. This all raises the point whether not the most important in current society is social and spiritual engineering, rather than technological engineering. This is however a consideration atypical of countries with a more rational nature, but we are sure is something that will gain more realization and acceptance with time.
Some lessons for investors
Coming back to earth, the lessons for investors are truly profound. We would advise to also take the presented views in making future investments. This includes the following points:
- How can/will the outlined mechanisms in the flying geese theory and race to the bottom affect industries and regions. Also secondary effects like on future consumer spending and real estate prices should be considered seriously. Additionally one needs to realize that likelihood of adverse outcomes can be small but with a big impact;
- One should evaluate how to invest: It is inevitable that the electric automotive sector and demand for electric vehicles will grow, but it is risky to bet on European car manufacturers in this in particular. The conclusion therefore can be it is better to diversify globally or more in companies that build the infrastructure for electric vehicles;
- It can be good to realize at an early stage what companies won the global race in certain sectors and evaluate how easy it is to copy their approach or improve it. These companies can become global leaders in near future;
- Evaluate what regions in the world can offer the best conditions that truly address the needs of employees. These regions can have the most competitive advantage based on this and considerations like social and spiritual cohesion;
- Stable investments: Certain assets like gold and property will remain good investments no matter outcome of scenarios, even more so in hectic times.
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