Beyond the significant short-term challenges facing investors, there are other essential megatrends set to transform the economic paradigm for the rest of the 21st century.
Focusing too closely on the short term is an easy trap to fall into. Particularly given the current economic and geopolitical climate, it is tempting to focus on the past few years and feel uneasy about the key trends and challenges driving markets.
At the same time, there is an evolving group of megatrends that are simply too big for long-term investors to ignore – and these, more than any current macro headwinds, could fundamentally transform the global economy. They won’t just dictate opportunities for the next few years, but in fact the next 70-80 as well.
Today, we see four such megatrends with the potential to create long-term transformational changes.
Artificial intelligence (AI) & automation
Much has been written about how early adopters who effectively implement AI within their organisation could gain a competitive edge over their peers who are struggling or less willing to adapt. If implementation, albeit with varying impact, leads to increased efficiency and the automation of laborious tasks, this is likely to have a positive impact on global productivity.
However, as we expect that most companies are still only beginning to explore AI’s potential, it is likely to only produce incremental productivity gains – and therefore minor GDP growth – in the short term.
Nevertheless, in a rapidly changing economy with increased focus on cost competitiveness, sustainability and mental well-being, we believe that AI and advanced workplace automation may become an integral part of society in the long term. As businesses become increasingly familiar with AI capabilities and workplace automation, we foresee more profound effects on the real economy taking shape.
For example, a full AI integration scenario may be accompanied by significant changes in the labour market. The number of new occupations resulting from AI integration may be outpaced by the number of redundant jobs.
Despite valid concerns surrounding AI safety, regulation and risks, there is a consensus that these technologies could eventually significantly impact productivity and the economy in a positive way. Once again, the companies and economies that adapt most smoothly and effectively will be best positioned to reap a competitive advantage.
Climate change
To meet the goals of the Paris Agreement, there is a need for immediate policy commitment, technological change, carbon removal, and a coordinated global approach. These are transition risks for the economy and financial markets too. And all of this might not be enough to stop current trends in weather changes.
The physical risks caused by climate change arise due to real-world environmental hazards, such as an increase in extreme weather events. These physical risks have both real-world and financial implications, including supply chain disruptions, changes in commodity prices and physical damage to assets.
We use carbon pricing as a key policy measure and a factor in modelling transition risk scenarios. Carbon pricing may have positive economic impacts by driving investment and spurring innovation. A key question is whether government investment can stimulate technological change and offset the potential negative impact of stranded assets and the crowding out of private investments.
In addition to having a major impact on the global environment and economy, climate change has a direct or indirect relationship with many other megatrends.
Water scarcity
Climate change and water scarcity are closely intertwined and together could create a self-reinforcing feedback loop, exacerbating both issues. Investors should perceive water management as a distinct and crucial component in a climate change mitigation and adaptation strategy.
Sectors that would be most impacted by water shortages include agriculture, energy, and manufacturing. Water-related losses in agriculture, health, income and property could result in a decline of as much as 6% of GDP by 2050 and lead to sustained negative growth in some regions of the world.
By the same token, effective water management – such as preservation of water resources and more efficient use – can help to mitigate and adapt to the impacts of climate change and provide resilience against future water shortages. From an investors’ perspective, supporting technologies aimed at efficient water management can yield both financial returns and environmental and social benefits.
Demographics
Demographic changes have the potential to affect regions’ populations and consequently their economic environments in the upcoming years. In particular, population growth and changing age structures are likely to have implications on spending trends, labour markets and overall economic growth.
The focus of recent studies, and of policymakers’ attention, has been the population dynamics in the developed world, which has been undergoing a shift in population age distribution for quite some time. However, it should be noted that many emerging markets have already started their demographic transition, with various degrees of advancement.
The sharp decline in fertility rates and the pressure from a changing age structure on investment rates represent challenges for several emerging countries’ economies. In turn, these dynamics could also lower expectations for bonds and equities in countries that will increasingly dominate the emerging markets landscape, thanks largely to changes in real interest rates.
Real interest rates are driven by both cyclical and structural factors. Demographics are widely recognized as an unobservable slow-moving secular force and one of the key explanatory factors for the trend in real rates. Interest rate projections can serve as the baseline for longer-term expected returns of riskier bonds and equities through the addition of various risk premia, and so long-term investors should be attentive to the trends that are driving such changes in populations globally.
Gertjan Medendorp is an investment strategist at Aegon Asset Management. The views expressed above should not be taken as investment advice.