Capital Income
Capital Income
for the second
machine age
2
Capital income
Content
4 Capital income for the second machine age
5 Demographics
6 Machine age
7 Capital income & earned income
7 Machines working for humans
9 Dividends as a source of investment
income
9 Understand. Act.
Imprint
Allianz Global Investors GmbH
Bockenheimer Landstr. 42 – 44
60323 Frankfurt am Main
Global Capital Markets & Thematic Research
Hans-Jörg Naumer (hjn)
Ann-Katrin Petersen (akp)
Stefan Scheurer (st)
Data origin – if not otherwise noted:
Thomson Reuters Datastream
Allianz Global Investors
www.twitter.com/AllianzGI_VIEW
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Capital income
Capital income for the second
machine age
We are heading towards major technological changes, driven
by digitalisation, self-learning machines and information
platforms. Brynjolfsson and McAfee forecast that, while
human labour may not become superfluous, it will probably
change profoundly. The “second machine age”, which they
see on the horizon, will not increase labour productivity by a
combination of labour and capital (i. e. machines) as the first
machine age did. Instead, labour will be replaced by capital
in their scenario. Why not have machines work for humans?
If capital formation among workers were increased, they
might expect higher returns on their investment than on
bond investments. Capital income would supplement labour
income – a development which would become particularly
important in retirement.
cp. for this our study:
„Financial Repression –
It is happening already“.
Large segments of the government bond
market in the Eurozone are yielding negative
returns. And there is little solace to be gained
from the fact that, to date, not all of the bond
segments in industrialized countries have
joined the “Negative-interest-rate club”.
Although returns in the USA are positive in
nominal terms, they are still being impacted
by the flood of liquidity from the major
central banks and are unusually low. Despite
the fact that the Fed may be about to raise
its base rate, there are so far no signs of any
comprehensive exit strategy, i. e. how the Fed
intends to reduce the government bonds on
its balance sheet. At the same time, European
Central Bank (ECB) policy is heading in the
other direction, for the time being anyway.
The policy adopted by the Bank of Japan also
remains ultra-expansionary.
4
So financial repression is likely to continue,
and even gain new momentum. These are
hard times for government bond holders.
Especially since adequate capital returns are
urgently needed in times of technological
and demographic change. Most of the world’s
economies are facing two challenges at once:
1.
While technological and demographic
trends are changing the labour markets,
2.
the flow of income from bank deposits
and government bonds that is urgently
needed for old age is drying up.
Below, we examine in greater detail the
relationships between low interest rates,
demographics and technology and offer a
solution for ensuring a sustainable flow of
income.
Demographics
The demographic changes that are already
underway do not bode well. Although the
world economy is continuing to grow 1 –
albeit at a reduced pace as fertility rates
decline – it is also growing older, with an
increasing share of the population reaching
retirement age. Birth rates around the globe
are declining and with them, the potential
working-age population is shrinking. At the
same time, the percentage of people in
employment is decreasing. In North America,
the share of 60+ year olds is going to rise
from 30 % currently to around 37 % by 2025.
In Europe, this age group is likely to increase
from 32 % to 39 %. Asia expects the number
of people 60 and older to grow by six percent,
from 17 % to 23 %. Africa will probably witness
the lowest share of 60+ year olds, with only
slight growth of one percent, from 12 % to
13 %.
According to figures published by the
United Nations, the share of the workingage population started declining in the
industrialized world as a whole, excluding
Japan 2, back in 2013. This trend is irreversible.
UN population estimates assume that this
population cohort will decline by between
0.2 % and 0.3 % each year between now
and 2025. The trend will probably be
comparatively uneven from country to
country. A decline of more than one percent
is expected in Russia and Eastern Europe,
while the remainder of Europe should witness
a decrease of less than one percent. Slight
growth is actually assumed for North America
and parts of Latin America, while large parts
of Africa are expected to witness growth of
two percent.
1
UN Population Division,
Department of Economic
and Social Affairs, “World
Population Prospects: The
2012 Revision”
Admittedly, the trend in the size of the
working-age population does not allow any
direct conclusions about the actual working
population since the participation rate may
change, as people retire later or the share
of women in employment grows, and thus
the potential workforce as a whole may also
change. The underlying trend does, however,
indicate that demographic developments will
reduce the potential workforce.
3
HSBC, “The deflating
consequences of Europe’s
swelling workforce … and
comparison with the US”,
September 2014
2
Japan is far ahead of the
demographic trend and
would distort the overall
picture for the other
industrialized nations.
4
ILOSTAT Database der
International Labour
Organisation (ILO)
According to calculations by HSBC 3, the first
signs are already visible, indicating that the
people retiring from working life are clearly
not being replaced in sufficient number by
changes in employment behaviour. If, in our
simulations, we calculate the demographic
trend separately for the participation rates
obtained from the International Labour
Organisation 4 (ILO) for various countries, we
can see a resulting lower participation rate
due to ageing in a whole series of countries.
So the demographic trend is already
influencing participation in working life.
5
Kapitaleinkommen
5
Rifkin, Jeremy, “The End
of Work: Decline of the
Global Labor Force and the
Dawn of the Post-market
Era”, 1995
6
Rifkin, Jeremy, “The Zero
Marginal Cost Society: The
Internet of Things, the
Collaborative Commons,
and the Eclipse of
Capitalism”; 2014
7
Brynjolfsson, Erik; McAfee
Andrew; “The Second
Machine Age”, New York
2014
8
Frey, Carl Benedikt &
Osborne, Michael A.; “The
Future of Employment:
How Susceptible are Jobs
to Computerisation?” 2013
9
Philosopher Karl Popper
criticized the idea of
the historical necessity
of laws as a fallacy. See:
Popper, Karl; “The Poverty
of Historicism” 2003 and
“The Open Society and its
Enemies”, 1945.
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Machine age
Demographic developments are
accompanied by technological trends.
As technology increasingly gains ground,
radical changes will become visible in the
labour markets; indeed, some are already
discernible. Digitization, adaptive machinery
and information platforms are driving trends
simultaneously around the globe.
And we don’t need to go as far as Jeremy
Rifkin 5 to identify the changes. As far back as
1995, in his eponymous book, Rifkin voiced
the theory of “The End of Work”, which he
later revisited in another book, “The Zero
Marginal Cost Society 6“. Brynjolfsson and
McAfee 7 further developed the prediction
that, although human labour may not come
to an end, there will be radical changes in the
working environment. The “Second Machine
Age” that they are presaging will – unlike the
first age – no longer raise the productivity of
labour through a combination of labour and
capital (i. e. machines). Instead, they predict
that labour will be replaced by capital. This
theory is based on the increasing cognitive
skills of machinery that even extend as far as
first signs of artificial intelligence and enable
both machines and programs to advance into
territory requiring extremely sophisticated
tasks that, so far, can only be performed by
humans. Driverless cars and pilotless aircraft
or software that helps lawyers and doctors to
assess cases are just some examples. Robots
are increasingly able to perform tasks that
are not pre-structured, understand spoken
instructions and – to a certain degree – even
make their own decisions. At the same time,
these skills can produce infinite economies of
scale with the aid of platforms and machineto-machine communication.
Frey and Osborne 8 examined the impacts
on more than 700 occupations in the US
economy and concluded that more than
47 % of all jobs are exposed to a high risk, and
19 % to a medium risk, of computerization.
That being said, the model does exhibit some
weaknesses, as it only reveals percentage
shares but not absolute employment
figures and does not make any statements
with regard to the period over which these
changes will take place.
Beware of “historicism” 9: neither
technological developments nor changes
in preferences can be predicted. Financial
repression, demographics and technological
advancement prompt us to revisit two central
challenges:
1.
In order to accumulate wealth and
pension capital, a substitute must be
found for unprofitable government
bonds.
2.
If labor and – coming along with
it – earned income as a share of total
economic value is likely to decline, a
further source of income must be found
that is immune to, or even benefits
from, developments in the labour
market.
Capital & labour income
So why not take advantage of these trends
and combine them? If the signs point towards
an increasingly smaller workforce, it may
be a stroke of luck if jobs can be replaced by
technology and hard manual labour can be
performed by robots. So why not let machines
do the work for humans and, consequently,
replace or supplement wages and pensions
with investment income? This would counter
the prolonged period of low or negative
interest rates. Instead of using government
bonds – which yield no, or even negative,
nominal returns – to save up or generate
an income directly or indirectly for old age,
equity investments would allow people to
share in company earnings, including the risk
premium. Equally: Is the criticism voiced by
Thomas Piketty 10 ultimately not also criticism
of the fact that too few people have a stake in
business capital and thus in the resulting risk
premium?
Machines working for humans
Our following analysis of several European
countries clearly shows the significance of
income and wealth accumulation through
„If the workforce declines, it may be a happy
circumstance that human labour is replaced
by technology and that robots can do the
heavy work. Why not have machines work
for humans – also in the sense that wages
and pensions are replaced or supplemented
by capital income?“
Hans-Jörg Naumer
Global Head of Capital Markets
& Thematic Research Allianz GI
equity investment. The analysis assumes
that gainfully employed people in Germany,
Italy, Spain, France and the UK participated in
their local equity markets by saving EUR 50
each month between 1992 and end of 2015.
In this respect, the equity market represents
the national stock of capital as it comprises
at least a representative, if not exhaustive,
portion of business risk capital. MSCI
benchmark indices were used as examples
as they are all compiled on the same basis,
unlike the better known indices such as the
DAX 30 or CAC 40, and track up to at least
85 % of the actual market capitalization in the
respective equity markets.
10
Piketty, Thomas; “Capital
in the 21st Century”; 2013
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As the progression of
the benchmarks for each
country shows, the equity
markets in question have
clearly recovered from
the Euro debt crisis to very
differing degrees.
The result is impressive: if this savings plan
had been put in place more than 24 years
ago, gainfully employed people in these
five countries would nowadays own around
49 % of the market capitalization of the MSCI
Europe (equivalent to some EUR 4 trillion)
and would have earned an average return
(in terms of the MSCI-Europe) of more than
10.5 % p. a. on their savings. And all in spite
of the crises that occurred during this period,
such as the burst of the dotcom bubble at the
start of the millennium or the financial crisis
triggered by the US real-estate market that
spilled over to become the European debt
crisis.
The average total cost effect, the basis of each
savings plan, becomes noticeable in here.
The results are also interesting from an
individual perspective. Depending on the
choice of benchmark, the investment
would have earned 8.3 % (Italy) and 10.2 %
(Germany) (see table) 11. Over the period in
question, this would have equated to total
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Capital income
earnings of more than EUR 11,500 (Italy)
or around EUR 28,500 (Germany) on the
EUR 14,400 paid in by each investor. The
contribution from dividends would have been
considerable, and much more consistent than
the equity-price gains. Another conclusion
from the study: a well-diversified investment
in the MSCI Europe would generally have
been a much more attractive proposition than
just investing in the respective national equity
markets. Broader diversification also supports
this argument.
See also our report: “Dividends instead of
low interest rates”
Table 1: (Employee) Equity Investment in the 21st Century Results
Savings plan: EUR 50 per person per month from 1992 – 2014
Avg. return p. a.
Total earnings
of which:
Dividends
Share in MSCI
Europe
10.16 %
28,649 €
14,411 €
14.55 %
Italy
8.34 %
11,664 €
10,575 €
8.18 %
Spain
12.49 %
37,929 €
24,665 €
5.75 %
France
9.70 %
23,610 €
13,485 €
9.23 %
UK
9.12 %
21,793 €
14,735 €
10.70 %
10.42 %
27,517 €
16,052 €
48.40 %
Germany
Europe
Source: OECD, as of 30. November 2015. Allianz Global Investors Global Capital Markets & Thematic Research.
Past performance is not indicative of future results. The savings plan is an illustration derived from historical data.
Table 2: Dividends as a Source of Additional Investment Income
Saved capital
Dividend yield
20,000
Dividend payment
p. a.
p. m.
0.03
600
50.00
30,000
0.03
900
75.00
40,000
0.03
1,200
100.00
50,000
0.03
1,500
125.00
Source: Allianz Global Investors Global Capital & Thematic Research.
Past performance is not indicative of future results. The savings plan is an illustration derived from historical data.
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Dividends as a source of
investment income
Assuming the investor would have
accumulated equity assets valued at
EUR 40,000 – at a dividend yield of 3 % p. a.,
that investor could rely on EUR 1,200 worth
of dividend income each year (= EUR 100
per month). Which just goes to show: when
accumulating wealth based on equities,
dividends can potentially play the decisive
role when it comes to generating additional
(investment) income.
Understand. Act.
Financial repression, demographics and
technology indicate that more income should
be generated from equity investments in
the future than has been the case so far. The
time has come to build the bridge between
capital and labour and to spread the equity
investment over a wide base (not just) in
light of the anticipated radical technological
changes. Such an equity investment would
be easy to set up with a fund solution.
Accumulating wealth and generating
investment income – in the face of change,
these must be the goals.
Hans-Jörg Naumer
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Capital income
Further Publications of Global Capital Markets & Thematic Research
Active Management
→→ “It‘s the economy, stupid!”
Alternatives
→→ Volatility as an Asset Class
→→ The Changing Nature of Equity Markets
and the Need for More Active Management
→→ The Case for Alternatives
→→ Harvesting risk premium in equity investing
→→ Active Management
→→ Market-neutral equity strategies – Generating returns
throughout the market cycle
→→ Active Share: The Parts Are Worth More Than The Whole
→→ Benefiting from Merger Arbitrage
Financial Repression
→→ Shrinking mountains of debt
Capital Accumulation – Riskmanagement – Multi Asset
→→ Smart risk with multi-asset solutions
→→ QE Monitor
→→ Strategic Asset Allocation in Times of Financial
Repression
→→ Between a flood of liquidity and a drought
on the government bond markets
→→ The Long and Short of Volatility Investing
→→ Sustainably accumulating wealth and capital income
→→ Macroprudential policy – necessary, but not a panacea
→→ Strategic Asset Allocation in Times
of Financial Repression
Strategy and Investment
→→ Equities – the “new safe option“ for portfolios?
Behavioral Finance
→→ Behavioral Risk – Outsmart yourself!
→→ Capital Markets Monthly
→→ Reining in Lack of Investor Discipline:
The Ulysses Strategy
→→ Liquidity – The Underestimated Risk
→→ Dividends instead of low interest rates
→→ Is easy monetary policy fuelling new economic
imbalances and credit bubbles?
→→ Behavioral Finance – Two Minds at work
→→ Behavioral Finance and the Post-Retirement Crisis
All our publications, analysis and studies
can be found on the following webpage:
http://www.allianzglobalinvestors.com
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