We are living through disconcerting times. Negative interest rates for bonds while hedge funds, venture capital firms and big technology players return double digits. Stagnating wages for the middle class, at the same time as engineers are hired with six-figure salaries just out of school, and companies claim they can’t find workers to fill positions. Polarization in land values, with San Francisco, London or Hong Kong becoming really expensive, while most areas lose value. What is happening? Is this just a phase?
I will argue this is the new normal, and we need to adapt to it. Knowledge has become a key factor of production and it heavily affects the returns of Capital, Labor and Land. This has been a long time in the making. Peter Drucker already used the term knowledge worker sixty years ago in The Landmarks of Tomorrow (1959) and knowledge economy fifty years ago in The Age of Discontinuity (1969). As Carlota Perez claims in her Technology Revolutions and Financial Capital, the full maturation of both ideas has taken half a century.
Let’s explore how each factor of production has been affected and what are the returns and dynamics of Knowledge itself. Along the way, we will mention Attention, a new type of Labor that is emerging as a factor of production.
Capital: so abundant as to be free
We are facing an apparent contradiction. Bond yields have gone negative for almost half of all bonds issued. My own country, Spain, and our neighbour, Portugal, have almost zero rates for its 10-year bonds. Ten years ago they were facing default and intervention. Danish banks have started offering negative interest mortgages and charging for deposits. At the same time, returns to Capital are higher than ever since the 1920s and they have compressed returns to Labor to all-time lows. Some VCs, PEs and hedge funds create outsize returns for their investors. The large tech monopolies (Amazon, Microsoft, Google, Facebook and Apple) have all averaged huge total returns that have made them the most valuable companies ever. New software unicorns are minted every week.
To reconcile both extremes we have to differentiate based on how much Knowledge is injected with the Capital.
- Plain Capital. Most Capital is deployed requiring little or no Knowledge. Anyone can buy a German bond, invest in a mortgage backed by a good property or deposit cash in a bank that is insured by the government. It has no risk, so it requires no Knowledge. There is more Capital without Knowledge than we can employ, so the new normal is negative interest rates for relatively riskless Capital.
- Knowledge Capital. Some Capital is deployed requiring a very high amount of Knowledge to make it productive. Venture Capital investing, advanced Hedge Fund strategies, high Knowledge companies or successful Private Equity investing, all require high stocks of Knowledge. Thus they can earn very high returns. At the same time, they have very high dispersion. Some Knowledge is right and other is wrong. The challenge is how to differentiate, “good Knowledge” (e.g. Warren Buffet) from “bad Knowledge” (e.g. Bernie Madoff) from the outside and be able to pick the winners.
This new world in which Plain Capital by itself earns negative returns and Knowledge Capital can earn outsized returns breeds inequality. Silicon Valley VCs, New York hedge funds and London PEs can all make a killing. Large pools of capital, like wealthy individuals, family offices or endowments, have access to Knowledge Capital investment opportunities. But the average saver is mostly limited to Plain Capital or to trying to pick Knowledge Capital from limited sources. At the same time, it challenges our financial system which is based on positive interest rates for Plain Capital.
Labor: Knowledge winners and Plain losers
In the Labor front, we are facing a similar situation to Capital. On the one side, life is tough for Labor. Labor share of GDP has been dropping precipitously. Most workers are seeing their jobs automated, shifted off-shore or face so much competition that their wages are deflating. On the other hand, we have a very tight Labor market with firms claiming they have millions of unfilled specialist jobs and that the war for talent is more intense than ever. Engineers and data scientists in Silicon Valley command astronomical starting salaries while clerks and factory workers everywhere are facing wage deflation.
Again, to understand this phenomenon we need to look at the impact of Knowledge on Labor. We will explore the different types of Labor based on how much value they add:
- Attention Labor. A new type of Labor is starting to emerge. Attention is very important for companies like advertisers or software developers. It is used to generate revenue by selling advertisement of products and services, and also to generate information that improves products or feeds AI algorithms. Attention Labor is still very low value at an individual level (maybe in the hundreds of dollars per year in the developed world), however, it has become very important in aggregate. The free Attention Labor Facebook or Google collect from the usage of their products is what constitutes a very important component of their competitive advantage. We pay Facebook, Google, TV channels, and other “free” services with almost 12 hours of media consumption and smartphone use per day, our Attention Labor.
- Plain Labor. Most Labor requires very little widely available Knowledge. Jobs that require high school level or even basic university-level skills are in this category. Inmigration and the ability to globalize work has made Plain Labor widely available at very low prices. The educated billions of China and India have competed away wages from the developed world, and Africa stands ready to step in whenever Asia is exhausted. If globalization was not enough, we are seeing the rise of the Digital Worker that automates the work of Plain Labor. Under these twin pressures, the wages for Plain Labor are plummeting creating inequality and social disruption. Plain Labor can expect their children to have less economic opportunity than they did if they live in the developed world.
- Knowledge Labor. Some Labor is combined with substantial Knowledge. Thus it manages to keep its value and its scarcity allows it to command substantial wages. These are the software engineers, surgeons, M&A bankers, salespeople, coaches, consultants, product managers, data scientists, blockchain experts and many others. They represent the millions of jobs that companies cannot recruit for. However, the advantage is fleeting, these workers are only as valuable as the scarcity of their Knowledge. If the Knowledge becomes widespread (think Excel) or if it becomes embedded in technology (think the London map and cab drivers) they become Plain Labor. So Knowledge Labor manages to capture substantial returns but lives in continuous uncertainty and need for renewal. This renewal might partly come from education, but on-the-job learning is the most important component. So workers face a catch-22 situation as they need to be part of Knowledge Labor in order to develop the skills required to be part of it. At the same time, they are forced to work long hours to keep the Knowledge advantage they have painstakingly built.
- Knowledge Capital Labor. Finally, at the top of the pyramid, we have the people whose Labor infuses Capital with Knowledge. These are the hedge fund managers, private equity partners, startup CEOs, financial derivatives traders and technology executives. They can have such a disproportionate effect on the return on Capital given negative interest rates that they are rewarded for their work at a level never seen before. That is why we see the 0.1% capture an ever-increasing share of income. They are in a privileged position, but not completely immune to automation (think trading rooms substituted by algorithmic trading) or to obsolescence (think Blackberry or Nokia executives). It is a difficult club to join, with the catch-22 situation being even more extreme than with Knowledge Work. The only way to demonstrate relevant Knowledge is by managing Capital, and to manage Capital you need to demonstrate relevant Knowledge or have the Capital available. Getting and staying in the club can be gruelling. Knowledge Capital Labor has a lot of very wealthy members, that work extremely hard to keep their advantage and reputation.
This split of Labor into four different categories, two of them very difficult to enter, is stratifying society at a rapid pace. This increasing inequity is causing substantial tension in all societies, and especially in advanced democracies.
Land: from fertile fields to favourable school districts
Land continues to be valuable for some traditional uses like agriculture or resource extraction. However, a new use has emerged. Some areas, like San Francisco or London, have become Knowledge hubs. They allow people to access better Knowledge and better high-value Labor opportunities. Consequently, these areas have become extremely valuable, as the economic consequences of living in them are momentous. The Knowledge Hub effect can be found in many cities beyond San Francisco or London, even if in most it is to a lesser degree.
This has been a boon to the owners of that Land, which used to be significantly less valuable. They can extract a significant share of the economic value created by the Knowledge hubs in terms of rents. The extra income that Knowledge Labor and even Plain Labor can capture in San Francisco or London mostly goes to pay Land owners directly through rent and indirectly through rent embedded in the prices of services and products.
The death of distance might come one day and undo this effect. But for now, technology has brought an unprecedented windfall for Land owners in Knowledge hubs. It is also concentrating Labor that wants to develop the required Knowledge to play in the two upper categories in special hotspots around the world. Again, this is feeding stratification and inequity and it is creating significant tension between nation-states and regions as Knowledge hubs “hollow up” the rest of the regions.
Knowledge: implicit, explicit and mutable
Knowledge takes many different forms that we are still trying to understand. For sure a large part of it is implicit in the brains of the Knowledge Workers that use it. There is also implicit Knowledge in the processes and culture of organizations. The Apple Way or the Netflix Values or Google’s Knowledge of how modern computing works have demonstrated their capability to generate returns. This implicit Knowledge is turning the balance sheet of most companies increasingly immaterial, with property, plant and equipment representing a diminishing proportion of a company’s assets. There has been explicit Knowledge for more than a century already in the form of patents and copyright-protected content, which allow their owners to earn licensing fees. At the same time, digital technology is allowing Knowledge to be made explicit and codified at a faster rate. Any software product, like Windows, Google search or Salesforce.com, is very valuable Knowledge rendered explicit. Machine Learning models and datasets also represent codified Knowledge, which will be increasingly valuable as AI comes of age.
The other thing we know about Knowledge is that it is mutable and can be rendered obsolete or commonplace very quickly. Digital maps and navigation have substantially lowered the value of the London taxi drivers Knowledge of the city’s complex web of streets. Nokia had extremely valuable Knowledge instantiated in its phones, that was rendered obsolete by the iPhone in less than five years. Traders and Hedge Fund managers have been forced to evolve their algorithms based on human decision making to fully programmed ones that require different skills.
What is clear is that Knowledge is the key production factor in today’s world. It not only creates returns for itself but also heavily skews the returns of the traditional factors of production.
Giving this context, populism is no surprise. The majority of people don’t have access to Knowledge and are capturing a shrinking portion of the pie both from their work and savings. Trends only lead to further stratification. Knowledge Capital favours large pools of Capital, penalizing heavily the returns of small savers. Knowledge Labor and Knowledge Capital Labor are self-reinforcing making it very difficult to join them. Trying to restrict immigration or technology seems the only solution to protect the value of Plain Labor. This has brought radical options like Brexit or the Mexico Wall to mainstream acceptance. Trying to restrict capital flow to protect Plain Capital is more difficult to address because governments are dependent on low interest rates to finance their huge debt piles.
On the other side, Knowledge Capital Labor, and to a lesser extent Knowledge Labor, are very happy with the economic outcomes of the current situation. They see it as a fair consequence of their own Knowledge they work hard to develop and maintain. Becoming a millionaire or even a billionaire is now within the realm of possibility for some regardless of initial wealth. Solutions like the Universal Basic Income and free access to services are a way to secure a minimum return to Plain Labor and Attention Labor. However, they don’t address the deeper problem of meaning, and the human need to meaningful Labor.
At the same time, incredibly we are living in a time of crisis, with problems like climate change, ecological degradation, poverty and a renewed threat of conflict, maybe even nuclear conflict. Living in a world with an abundance of Capital, Labor and Land and not solving the world’s pressing problems seems incredibly stupid. We need to get our act together and mobilize our incredible resources to ensure a sustainable Earth, and maybe even reach beyond Earth. If not, we might see our stocks of Capital, Labor, Land and Knowledge quickly diminish and go back to the starting point very quickly.