This Week in Geopolitics

Productivity, Microchips, and War

October 10, 2016

Before we begin this week, I have a quick language lesson for you.

There is a word in German—Schilderwald—which has no direct equivalent in English but literally means “forest of road signs.”

For me, it perfectly describes how the mainstream media cover geopolitical issues—a paper forest of contradictory signs that confuse you about where the road ahead leads.

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And now, let’s return to This Week in Geopolitics.

In recent weeks, I have been focused on the intensifying instability in Europe and Asia, and the similarities between this decade and the decade before World War II. Conflict has many origins, and the desire of soldiers, politicians, and economists to believe that their field holds the key to war and peace is both natural and wrong.

The origins of conflicts are complex, and all of those fields contribute. I have spent a great deal of time writing about the global exporters’ crisis, which was triggered by 2008 and is still underway. It has created instability from China to Saudi Arabia, Russia, and Europe. This crisis has contributed greatly to the chaos, but it is not the sole cause.

Classical economics argues that as capitalism matures, competition causes both wages and profits to decline. Wages decline because the early successes of capitalism cause more workers to compete for jobs in growing industries, and profits decline because the increasing entries of businesses into markets cause business failure. Each economist puts it differently, but this is the essence.

Why hasn’t that happened?

Karl Marx gave the answer… but he didn’t see that it negated his theory. He argued that under capitalism, the means of production are constantly revolutionized—technology is constantly improving. As old industries decline and workers become unemployed, new technologies arise, rates of return on capital surge, and workers’ wages rise.

In other words, the idea of a single economy is an illusion. The economy is segmented. While some industries decline, new industries emerge, and those new industries begin with much higher wages and rates of return on capital. So there’s no revolution, just the constant ferment of innovation.

What makes this possible? Improvements in technology, coupled with the new methods of production, distribution, and organization that they trigger, lead to increased productivity per worker. As productivity rises, profit margins increase and wages increase as well. There are always emerging and declining industries in capitalism. Without this rotation between the two, I suspect capitalism would fail. But that rotation does take place. So periods of stagnation, declining wages, and weakening profits occur, but innovation (normally, a set of innovations) increases productivity.

That is why this chart is so worrisome.

Since just after the 2008 financial crisis, US productivity growth has diminished, and this year it will fall. According to The Conference Board, there is a worldwide decline in the rate of productivity growth. In economics, causation is a subject of endless debate. I will settle for correlation. When productivity growth flattens, so does economic activity.

In this particular case, I would argue that the productivity crisis has a great deal to do with the aging of the microchip industry. The introduction of the microchip into all aspects of the economy had a revolutionary effect, like that of electricity or the combustion engine. All of these were technologies that revolutionized the way things were produced and distributed, and had a range of unintended consequences that gave them a logarithmic effect on the economy.

Starting in the early 1980s until the early 2010s, the microchip was a prime factor in reversing the global stagnation of the 1970s. In the 1970s, the technologies spawned in World War II had reached maturation. That and a range of other factors created a period of economic dysfunction. We are reaching that point with the microchip and attendant technologies.

Let’s take 1910 as the point at which Henry Ford’s production innovations introduced the automobile as a revolutionary technology. In 1950 (40 years later), the automobile had become a norm in industry. It had ceased to be transformative and had transformed the culture.

From 1950 onward, the focus was less on improvements in performance than on design and marketing. Wages and returns remained high for about 20 more years, until about 1970, but it did not radically improve productivity in other industries. The innovation had been absorbed. And then an inexorable decline set in.

The Microchip Revolution

IBM introduced the first PC in 1981, which I’ll use as the point where the concept became a product. That was 35 years ago. There is no mechanical time frame for maturity, but it is time to stop thinking of microchip-based systems as cutting edge. The microchip-based product is nearing the point where automobiles were in 1950—a commodity with more attractive design and some innovation left, but nothing fundamental.

In 35 years, the microchip has revolutionized all aspects of life and business. But when the new iPhone was introduced, the focus was on the lack of a headphone jack. It is reminiscent of the features introduced for cars in the 1950s. Consumers were still excited, and the auto companies made the best of it, but the heroic days of auto development were done. Now, there are still new applications to be found, but the heroic age of computing is over. And the amount to which it can surge productivity is as well.

Historically, there has been a pause between what I will call socially transformative technologies during which there is a period of economic malaise. But there has always been an emergent new technology that revolutionizes society and economic performance. Historically, most people were wrong about what it would be. I will leave it to my friend John Mauldin to consider the possible new transformative technology. I do not see any indication that there won’t be one, although I don’t know what it is. Nor do I doubt that new applications will be found for the microchip. The self-driving car would certainly be such an innovation.

What I do know is that economic problems are compounding the instability in Eurasia. And within economics, the maturation of the microchip industry is critical because it has decreased productivity growth. That negative growth puts in place the decline in wages and pressure on profitability that classical economists predicted. In turn, that puts pressure on a fragile region of the world.

The internal combustion engine was the foundation of warfare in World War II. Since the 1980s, militaries around the world have shifted to microchip-based warfare… from precision-guided munitions to field hospitals. Just as the World War II model of war was made obsolete by the microchip, so too, the nations that develop the next transformative technology will have an advantage in applying it to warfighting. Since war is the most human of things, any transformative technology will transform this sphere. It always does.

Therefore, productivity and technology are foundations of the Eurasian crisis, and whatever comes next will be a foundation of war.

And Finally…

The analysis continues over at Geopolitical Futures where we’re currently discussing the future of Mexico’s economy, the legacy of the 1973 Arab-Israeli War, and the machinations behind the OPEC agreement.

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George Friedman
George Friedman

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