Davis: Economy Experiencing Disruption, not Stagnation

Joe Davis, global chief economist at Vanguard, kicked off the 2017 Morningstar ETF Conference with an optimistic, if guarded, outlook for the future of the economy.

Davis said slow GDP growth might make it tempting to think the economy is stagnating, but under the surface the economy is actually moving very quickly as technology evolves.

He thinks investors should be focused on productivity, progress, and prosperity versus just looking at traditional GDP. And the biggest drivers of productivity won't be the things investors often think about like monetary policy, globalization or even demographics; it will be the intersection of human capital and technology.

Where productivity is going is hardly clear, though. Davis described the world as being at an "inflection point" in the nature of work and that the type of skills needed to compete against machines is changing rapidly. This is likely to lead to an increase in "automation anxiety" and potentially a big shakeout in jobs; some studies go as far as predicting that by 2022, 47% of jobs in the U.S. could be automated away.

These pessimists may be missing some important points though. Chief among them that jobs are made up of more than one task and that those tasks change over time. Yes, basic and repetitive tasks are likely to be replaced in the years to come, but jobs will change (and have been changing) to incorporate more advanced tasks that are uniquely human. Tasks like creativity or developing teams will become more important. Right now, about 50% of the tasks down in the U.S. are advanced, and that is set to move up to 80% in the years to come across all types of positions.

Does that mean there won't be job losses due to automation? No. Davis predicts 20% of jobs could be eliminated, but the losses will be swamped by new jobs that are created as the people adapt and find new ways to use technology.

As this shift happens, Davis expects to see four consequences.

First, there will be more automation but we will still see labor shortages. The number of robots will double, but with aging population and strong demand means we will be short. Unemployment could go into the 3% range next year and even as low as 2% in 2019 if there is no recession.

Second, there will be labor shortages, but still low inflation. We will see some wage growth, but no big rise in inflation because wage pressures will be offset by falling tech prices.

Third, there will be low inflation, yet higher real interest rates. Davis said it is quite possible over three years to have the same growth and same inflation and higher rates due to a slow increase in productivity.

And finally, higher real rates could create some lower short-run market returns. Should we adjust to higher rates there could be some rocky market returns. Davis sees more risk in equity markets than the bond market today.

Overall, he sees the future of the economy as bright and says the changing nature of work will be the single biggest factor to watch.