When Joe Davis’ 13-year-old daughter came to him with the question, “Is the world getting better?” he hesitated answering because he wasn’t sure. As Davis is the global chief economist of Vanguard and heads up its investment strategy group, having an eye to the future is what he does. But this question, part of his daughter’s school project, stumped him.
Speaking at the Financial Planning Association conference in Chicago this week, Davis said, “how would you answer this question? In many ways you could say yes, we have a job market today that hasn’t been this healthy or robust in many ways in over a generation. And if you look at our client portfolios, or our own portfolios, clearly it’s been a stellar investment environment,” especially with a bull market in stocks.
However, at the same time, when Davis watches the evening news, “it doesn’t always seem that way. We have rising risk of trade wars, increased tension between United States and China, which is a new economic cold war, and periods of economic softness and political tensions around the world,” he said. He also had to explain to his daughter the concept of income inequality.
He proceeded to show what is called the global economic potential, an indicator that is a “trend growth rate for the economy,” and which has been falling for more than 15 years. Davis sees it as the rate of innovation, and it can show how standards of living improve. It dictates the level of expected returns for portfolios, or even how high interest rates go. “This is the most meaningful trend in my judgement of all economic issues that face the world,” he said.
It was just before 2000 when a game-changing idea took hold with the public: the internet. “Since that time the growth of meaningful ideas in the world has ground to a halt, which is why the [indicator’s] line has kept falling,” he said.
“Will this line go back up?” he asked. “Most of the leading economists in the world say it won’t. Today’s ideas are just less innovative.”
He added that some believe this is the new normal, and “the low-hanging fruit of human creativity has already been picked, so going forward, innovation will not be as powerful.”
If true, this has impacts, Davis explained. For example, for the next generation, the average American family will take three generations to see meaningful improvement in standard of living, whereas “it used to take just one.”
“Ultimately, rate of innovation for the world aggregate is ultimately a summation of individual invention and individual creativity.”
This led he and his Vanguard team to do an in-depth research project to “find a formula to not only determine what drives innovation in the world, but also what drives human creativity,” a so-called “ideas multiplier.”
Over the past several months, reading hundreds of books and crunching “billions” of data points, “we made an unexpected but pleasant discovery that we found what we believe is the world’s first leading indicator in the rate of innovation.”
Based on this study and resulting indicator, he noted they see a “major upturn” in innovation. The study also suggested what sectors will see the most innovation: telecommunications, polymers and materials, agriculture and plant science, oncology and genetics. In fact, he said they found that genetics will have the most innovation.
Davis discussed how the team pored over articles with (adopted) ideas, conference presentations and books from the past 20 years to find out what pushes innovation. The answer? Globalization — not what is commonly linked with global trade, but the “trade of ideas and knowledge, across firms and societies and cultures,” he said. “This is 10 times more powerful than the trade definition of globalization.”
A couple of examples he provided included a story of 15th century China, which had been open to trade, was the top economy of the world, and even had a navy that was larger than the British navy that came three centuries later, he said. But after the later-period Ming Dynasty closed off the country, there was a 500-year decline in China’s innovation. “Censorship blocks the exchange of ideas,” he said.
Inventions are built upon other ideas, he said, showing how one great inventor, Ben Franklin, was not just smart, but had a “knowledge network.” Franklin had as many as 5,000 letters with people from around the world on different scientific advances. “This exchange of knowledge was a secret driver of his creativity,” Davis said.
Global collaboration is key to this growth, and Davis said it is accelerating now because of 1) the rise of China’s intelligence economy, and 2) the building blocks across fields that lead to cross-pollination.
Davis said that the “ideas multiplier” had of a ratio of 40:1 in 1980, but flatlined in 2000 at 200:1. But due to the exchange of ideas between the United States and China today, the trend will jump to 400:1, he projects. He said that today’s innovations will mean an upturn in 2020. In conclusion, he said, yes, “the world is getting better.”
— Related on ThinkAdvisor: