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 and far-reaching so the presented views are by no means exhaustive. In future articles, we will refer to the concepts presented in this article and build upon them further.
Entropy and spread of knowledge
The second law of thermodynamics in physics states that entropy tends to increase, which in a broader and metaphorical sense also can be applied to the spread of knowledge and technological development. Not long ago, most technological innovation was heavily concentrated in specific parts of the world, particularly in the Western world and Japan. This had several causes, like the concentration of knowledge, necessary economic conditions and infrastructure in these countries and regions. As we move deeper into the 21st century, this pattern is shifting. Like heat radiating from a heat source in a room, knowledge and people are spreading freely across borders, fostering new technological and economic centers and changing the global balance of power in the process.
As a result, students don’t need to attend one of a select group of universities, often located far away from their homes, to receive a high-quality education. Due to the rise of online courses and research platforms one could even make a case that one doesn’t even have to leave home. This all allows students to develop expertise closer to home 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
Another important, though economic, factor driving the dispersion of economic and technological development across the globe is captured by the flying geese theory in economics. This theory was formulated 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 at first, but is actually well-chosen as the pattern in which industrialization and economic production spreads, within this theory, resembles that of flying geese.
At its core, this theory is about economic progression, specialization and production hierarchy. It 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 manufacturing products lower in the value chain. Consequently, lower segments in the value chain are outsourced towards less developed countries and regions.
This presents in the short-run a win-win situation as all parties involved (seemingly) gain from this. However, in this context it is important to note that the lower segments will have slim margins as industries can rapidly relocate to even cheaper locations in the future, resulting in a race to the bottom with harsh competitive and social consequences. Players at the top of the value chain on the other hand enjoy pricing power and can even be monopolies in their area.
A major lesson within this theoretical context is forward planning and understanding that one eventually needs to move up in the value chain to not fall prey to competition. Another major lesson from the developments we observe 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, a country which was poor not so long ago but in recent decades took on the role of the ‘factory of the world’. However, 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, associated with low-cost, low-quality goods. Today, however, it can be seen that more and more people are turning to high-end Chinese products.
Over the past few decades, Western companies in various sectors have increasingly shifted production to China—a trend significantly accelerated by China’s entry to the World Trade Organization in 2001. In the short term, this brought substantial benefits, including lower production costs, cheaper consumer goods, and record profits. It also provided these companies access to China’s vast and rapidly growing domestic market. Moving supply chains to China was in cases more necessary than desired, as maintaining local production outside China could render a company uncompetitive in terms of cost and scalability. This shift also required companies to share valuable production knowledge and technological know-how with Chinese partners. A natural consequence of this was the gradual emergence of strong domestic competitors within China. The country effectively leveraged this environment, accelerating its industrial development and quickly moving up the value chain. Over time, Chinese firms began producing increasingly advanced and high-quality products—eventually surpassing Western counterparts in several key sectors, although we observe this still hasn’t received sufficient widespread realization in the West.
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. However, it is becoming increasingly clear that Chinese companies can produce vehicles that are notably cheaper than those of their Western counterparts in this regard, while it can no longer be claimed that 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. Revisiting the flying geese theory, we don’t see a natural progression in the hierarchy which means that one is lost in the flock, so to speak. The best outcome is, of course and as again also emphasized in our company slogan, innovation 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 that have driven their success—such as cheap labor—are not sustainable in the long run. 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. In this context, it’s worth referencing the 2003 film The Animatrix, in which machines eventually retreat to a separate region, producing far more sophisticated and cheaper products that humans can not compete with, collapsing the entire human economy.
All in all, the outlined 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. This is highly undesirable as it implies 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. In today’s world, 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 to maintain a competitive edge. 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
From the theory, we can logically conclude that creating an environment that fosters and rewards innovation is essential, as it helps attract and retain the talent necessary for driving such innovation. This is of course not a radical conclusion. However, the question which conditions truly meet the needs of this talent pool is rarely discussed. There is often an unspoken assumption that monetary compensation is the primary motivator. It is important, though, to examine the true value of this compensation and whether it addresses the most pressing needs of people in today’s world. For example, it may be more appealing to work in a location offering a lower but decent salary, where one feels more valued and at ease. Furthermore, 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 aware of, and place greater importance on, non-economic considerations when evaluating how well their needs are met in a particular environment. Therefore, it is essential for countries to prioritize the promotion of the right values, including fair and equal treatment for all, and to create a truly meritocratic and realistic system that addresses people’s non-monetary needs. This, in turn, will foster social cohesion and inevitably drive innovation. However, it is important to note that in today’s Western society, deep polarization on a wide range of issues undermines cohesion and a sense of belonging. This raises the question of whether social and spiritual engineering, rather than technological engineering, should be the most important focus in current society. While this perspective may be unconventional for more rationally oriented nations, we believe it will gain greater recognition and acceptance over time.
Some lessons for investors
Coming back to earth, the lessons for investors are truly profound. We would advise incorporating the insights presented here when making future investment decisions. Some key points to consider include:
- Impact of outlined mechanisms: How will the mechanisms outlined in the flying geese theory and the race to the bottom affect industries and regions? Secondary effects, such as their influence on future consumer spending and real estate prices, should also be carefully evaluated. It’s important to recognize that while the likelihood of adverse outcomes may be small, their potential impact could be significant.
- Investment strategy: The electric automotive sector and demand for electric vehicles are certain to grow. However, betting specifically on European car manufacturers is risky. The conclusion is that it may be wiser to diversify investments globally or focus on companies that are building the infrastructure for electric vehicles.
- Global leadership: It’s valuable to identify early which companies are leading in global markets within certain sectors. Understanding how easily their approaches can be replicated or improved upon can reveal potential future global leaders.
- Employee-centric regions: Consider which regions in the world offer the best conditions to meet the needs of employees. These regions may hold a competitive advantage, not only in economic terms but also through social and spiritual cohesion.
- Stable investments: Certain assets, such as gold and real estate, will remain sound investments regardless of economic scenarios, particularly in turbulent times.
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