Clarification on what revolutionary Industry 4.0 might bring

The worldwide active Swiss bank UBS has released at WEF, the World Economic Forum staged at Davos, Switzerland from January 20 – 23, 2016, a white paper on Industry 4.0 to make many aspects clear. TextileFuture has been reporting already in the past at four occasions on the latest development of Industrie 4.0 (Industry 4.0). Since the white paper is brand new, and as it offers some very valuable aspects, we present the major findings to you

The basics

The fourth industrial revolution is already taking shape, seeing the rise of robots and dehumanised smart systems. The World Economic Forum warns Industry 4.0 will likely lead to millions of jobs being lost.

The fourth industrial revolution will “cause widespread disruptions not only to conventional business models, but also to labour markets over the next five years,” The World Economic Forum says in a study.

With electronics and robotics taking over the bulk of work processes in many future-oriented enterprises, smart systems will certainly transform the economy, but will not be smart enough to prevent millions of jobs going down the drain, the study suggests.

It says the transformation will lead “to a net loss of over 5 million jobs in 15 major developed and emerging economies.” Researchers looked at the potential impact of Industry 4.0 on the US, Germany, France, China, Brazil and other nations.

They see as many as 7.1 million jobs being lost in those countries, mostly in white-collar office and administrative jobs, while 2.1 million jobs will be created in computer engineering and mathematics, the study argues.

“Without urgent and targeted action today to manage the near-term transition and build a workforce with futureproof skills, governments will have to cope with ever-growing unemployment and inequality, and businesses with a shrinking consumer base,” the World Economic Forum says.

It warns that women will be in the firing line of the changes, one of the reasons being that they are under-represented in the technical fields where new positions are to be created.

An introduction

The global economy is on the cusp of profound changes that are comparable in magnitude to the advent of the first industrial revolution, the development of assembly line production, or the invention of the microchip. Technological advances are permitting ever greater levels of automation. Meanwhile, the near universal ownership of smart devices in many parts of the world is leading to a degree of interconnectedness that was previously unimaginable.

These developments, which the UBS authors believe are part of a technology-driven Fourth Industrial Revolution, have significant implications for investors, the global economy and the relative competitiveness of developed and emerging nations. Thus, these changes are an interesting and important topic for discussion at the World Economic Forum.

In this White Paper, the authors tried to put recent technological shifts in a broader historical context. Previous industrial revolutions have been driven by rapid advances in automation and connectivity, starting with the technologies that launched the First Industrial Revolution in 18th century England through to the exponential increases in computing power of recent decades. The Fourth Industrial Revolution is based on the same two forces. The first is extreme automation, the product of a growing role for robotics and artificial intelligence in business, government and private life. The second, extreme connectivity, annihilates distance and time as obstacles to ever deeper, faster communication between and among humans and (intelligent and sophisticated) machines.

These changes will have very different effects on nations, businesses and individuals. Automation will continue to put downward pressure on the wages of the low skilled, and it is starting to impinge on the employment prospects of middle skilled workers. By contrast, the potential returns to highly skilled and more adaptable workers are increasing.

Among corporations, a wide range of traditional businesses – especially those that act as intermediaries – can be expected to suffer. Many labour intensive firms should be able to boost profit margins as they substitute costly workers for cheaper robots or intelligent software. A range of entirely new companies and sectors will spring into existence. For nations, the largest gains from the Fourth Industrial Revolution are likely to be captured by those with the most flexible economies, adding a further incentive for governments to trim red tape and barriers to business.

At UBS, Axel Weber, Chairman of the Board of Directors and Sergio P. Ermotti, Group CEO, express in the foreword of the white paper that they believe in embracing change, rather than fighting it. UBS technology lab in London, established in early 2015, is already exploring a range of innovations. These include blockchain, the shared ledger system that underpins Bitcoin and offers the potential to enhance transparency and trust, while reducing transaction costs. In addition, the UBS Future of

Finance Challenge aims to identify disruptive ideas and support their commercialisation.

Last year’s competition drew 600 participants from 52 countries. In the same vein, the two hope this White Paper will stimulate debate as well as offering useful insights into the forces that are reshaping global business.

The authors of the UBS White Paper are: Bhanu Baweja, Head of Emerging Market Cross­Asset Strategy, UBS Investment Bank Paul Donovan, Deputy Head of Global Economics, UBS Investment Bank, Mark Haefele, Global Chief Investment Officer, UBS Wealth Management & UBS Wealth Management America, Lutfey Siddiqi, Global Head, Emerging Markets FX, Rates, and Credit, UBS Investment Bank, Simon Smiles, Chief Investment Officer – UHNW, UBS Wealth Management. Further contributors are: Matthew Carter, Kiran Ganesh, Josh Holcroft, Marco Spinelli, and Christopher Swann.

A brief history of industrial revolutions

Prior industrial revolutions  have  centred around improvements in automation and connectivity.

The First Industrial Revolution introduced early automation through machinery and boosted intra-national connections through the building of bridges and railways.

The Second Industrial Revolution began when automation enabled mass production and fostered more efficient, productive connectivity via the division of labour.

The authors have characterized the prior three industrial revolutions using the timeline proposed by Nicholas Davis, the World Economic Forum’s Head of Society and Innovation. Our central view is that all industrial revolutions involve advances in two fields – automation and connectivity.

The First Industrial Revolution

The First Industrial Revolution ushered in early automation via machinery, in lieu of agricultural inputs. 1784 saw Henry Cort’s invention in England of the “puddling” process that turned pig iron into wrought iron. This was seen by economic historians as a key inflexion point of the First Industrial Revolution, marking the beginnings of automation. Mechanisation became a key element of economic development, leading to a profound split between the East and West that has only recently started to converge.

Manufacturing progress and the nascent use of higher energy intensive fuels such as coal and petrol followed, paving the way for steam power and locomotives. This in turn spurred both a connectivity revolution via wider travel, and a surge in the construction of infrastructure projects, including bridges, tunnels, aqueducts, and ports. We also note that an agricultural revolution supported by the inclusion of crop rotation and selective breeding boosted farm productivity and helped contain the costs of labor-intensive foodstuffs.

The Second Industrial Revolution

The Second Industrial Revolution (typically seen by historians as beginning around 1870, the second half of the “long 19th century”) was characterized by three factors: higher levels of automation via the development of mass produ tion; more efficient connectivity in production via the division of labour; and further progress in the use of energy sources such as electricity and petroleum.

While at first the Second Industrial Revolution was limited to “within company” supply chains, automation and connectivity gains allowed supply chains to evolve into the complex systems we know today. These supply chains rapidly expanded across different firms and, increasingly, between different nations. Automation also contributed to a second agricultural revolution by boosting agricultural yields via industrial fertilizer production, and by introducing more productive food storage methods through refrigeration.

Standardisation was one of the key drivers of these achievements, including of quality standards (for example, within trade blocks) and transportation systems (for instance, the shipping container). Legal and trade protections were also needed to assure innovators that they would be able to enjoy the financial rewards of their creativity, without being exposed to early competition from rivals copying their technologies.

The Third Industrial Revolution

The Third Industrial Revolution was propelled by the rise of the digital age, of more sophisticated automation, and of increasing connectivity between and within humanity and the natural world.

The concept of the corporation was key to this. In the absence of this integrated entity, the high transaction costs involved in individuals contracting every single economic interaction would have restrained profit growth, and heavy capital goods could never have achieved economies of scale.

The rise of the digital age characterized the Third Industrial Revolution. 1969 was the year in which connectivity took a leap forward, with the first message sent over ARPANET, the forebear of today’s Internet. Equally, the scope for automation was vastly enhanced by the implications of Moore’s Law – the observation that the number of transistors on an integrated circuit has doubled approximately every two years. This advancing automation, coupled with the growing appreciation of the environmental damage caused by more intensive farming, led from an agricultural revolution perspective, to the rise of a “green revolution.”

Moore’s Law generally refers directly to electronic circuitry, the foundational technology of this era. It captures the wider phenomenon of output growing as an exponential function of input. Moore’s Law resulted in greater computing power and the ability to automate ever more complex tasks. In some areas, such as biotechnology, the pace of progress has even exceeded Moore’s Law.

The Forth Industrial Revolution

The Fourth Industrial Revolution is being driven by extreme automation and connectivity. A special feature of the Fourth Industrial Revolution will be the wider implementation of artificial intelligence.

Take, for example, the cost of sequencing a genome, which has fallen from as high as USD 100000 in 2001 to USD 5000 last year to USD 1400 today. Moore also introduced the theory of “crossing the chasm.” This concept recognises the gap between the early adopters of new technology and an early majority who play “catch­up” as later adopters.

This chasm is most easily bridged by continuous innovation, allowing minimal disruption to the consumer. Advances in computing were setting the stage for the Fourth Industrial Revolution, and in three broad areas, according to the WEF’s Davis: the “technosphere” or digital world; the natural world that technology now allows us to monitor, analyse and digitise; and the human world, as technology impacts the way in which we connect and with whom we connect (human & machine, human & human, machine & machine).

The Fourth Industrial Revolution is being driven by extreme automation and extreme connectivity. Extreme automation will, as a first step, expand the range of jobs it is possible to automate, to include not only highly repetitive low­skill jobs, but also highly routine medium­skill jobs. As we out- line in the next section, the relative impact of this extreme automation on income inequality between low­skill and high­skill labor looks set to intensify.

The authors expect artificial intelligence (AI) to be a pervasive feature of the Fourth Industrial Revolution. Extreme automation via AI will increasingly automate some of the skills that formerly only humans possessed. Where AI could be poised to make the biggest gains is in big data processing, potentially including the processing of language and images, which have thus far been off-limits for computers to understand. Extreme automation could allow more robots and AI to produce output, analyse results, make complex decisions, and adapt conclusions to environmental factors.

Extreme connectivity enables more universal, global and close to instant communication. It is giving rise to new business models and is opening up economic supply in ways previously not possible. Indeed, the creation of Uber, the taxi-hailing smartphone app, was only made possible by the explosive increase in portable Internet-enabled devises. Supply effectively created its own demand. Services like Facebook, WhatsApp, Pinterest, Snapchat, Twitter, and Instagram have come to play a pivotal role in the social interaction of citizens around the world.

Extreme automation can also be coupled with extreme connectivity, allowing computing systems to control and manage physical processes and respond in ever more “human” ways. This represents a democratisation of the ability to communicate between and among governments, corporates, humans, and machines. The advent of “cyber-physical systems” may allow robots and AI, via extreme automation and connectivity, to “cross the chasm” between the technosphere, the natural world, and the human world.

A number of radical implications may arise from the Fourth Industrial Revolution. We shall now look at how extreme automation and extreme connectivity may impact the global macro-economy, regional economies, and investment opportunities.

 

The potential global consequences

Polarisation of the labour force as low­skill jobs continue to be automated, and this trend increasingly spreads to middle­skill jobs. This implies higher potential levels of inequality in the short run, and a need for labour market flexibility to harness Fourth Industrial Revolution benefits in the long run.

Greater returns accruing to those with already high savings rates. In the short-run, this could exacerbate inequality via relatively lower borrowing costs and higher asset valuations.

A polarised labour force: While technological revolutions often stoke fears of declining employment as “robots do all the work,” the authors believe a decline in aggregate employment is unlikely. As we discuss in the assessment of regional winners and losers, the attributes of the Fourth Industrial Revolution – extreme automation and particularly extreme connectivity – could improve the productivity of existing jobs or create demand for entirely new jobs. It is usually difficult to envision today what the jobs of the future might be. However, the UBS authors believe that extreme automation and extreme connectivity could actually increase demand for customised “human” work.

That is not to say we will not see an impact on relative differences in regional labour forces in the short run. Low­skill employment will likely continue to contract, and an increasing range of middle­skill jobs will become vulnerable as extreme automation is rolled out. While aggregate employment is unlikely to fall in the long run, we could start to see polarisation in the labour force and frictional unemployment until workers reskill, relocate or alternatively adapt. Additionally, labour-intensive goods could see their prices fall relative to more capital-intensive goods.

Some of the low­skilled parts of the labour force (for instance, assembly line work) that have already been heavily affected by basic automation could be further impacted. The advent of “cobots,” or collaborative robots, which are able to “move around” and interact without the need for fixed positions, have the potential to work at a higher rate of production relative to that of lower­skilled human workers. The greatest disruption, however, could be experienced by workers, who have so far felt immune to robotic competition, namely those in middle­skill professions.

As the issuer of the world’s reserve currency, the US’ competitive advantages, sitting at the heart of the Fourth Industrial Revolution, could tighten effective monetary conditions among US dollar linked economies.

The authors further expect developments in extreme automation and extreme connectivity, blended in AI solutions, to have a significant impact on the nature of knowledge work.

Automation will initially affect clerical work, sales, customer service, and support functions. Robotic process automation, automatic reporting, and virtual assistants will become common. Minor claims in insurance could be processed without human intervention, most incoming customer queries answered automatically, and many customer calls deflected. In finance, “robo­advisors” are already available in the market. In the legal world, computers can quickly go through millions of emails and dramatically cut the cost of investigations. If fewer people are employed in a sector, fewer managers will likely be needed in that sector.

This combination could force a broad swath of workers to adapt. Lower­skilled and middle­skilled workers may face greater unemployment in the near term unless a number of criteria are met, allowing them to reskill into tasks that extreme automation cannot perform, or move into industries where extreme connectivity permits them to work outside of traditional global or regional boundaries. Equally, higher- skilled workers, particularly those who do routine tasks, may face future threats from the developments in advanced artificial intelligence such as natural language processing. Once again, we do not expect the Fourth Industrial Revolution to result in an aggregate increase in global unemployment; however, the author examined, in their regional section below, which countries may be best placed short-term to harness fully an extreme automation and connectivity benefits.

The authors expect developments in extreme automation and extreme connectivity, blended in AI solutions, to have a significant impact on the nature of knowledge work. Automation will initially affect clerical work, sales, customer service, and support functions. Robotic process automation, automatic reporting, and virtual assistants will become common. Minor claims in insurance could be processed without human intervention, most incoming customer queries answered automatically, and many customer calls deflected. In finance, “robo­advisors” are already available in the market. In the legal world, computers can quickly go through millions of emails and dramatically cut the cost of investigations. If fewer people are employed in a sector, fewer managers will likely be needed in that sector.

This combination could force a broad swath of workers to adapt. Lower­skilled and middle­skilled workers may face greater unemployment in the near term unless a number of criteria are met, allowing them to reskill into tasks that extreme automation cannot perform, or move into industries where extreme connectivity permits them to work outside of traditional global or regional boundaries. Equally, higher- skilled workers, particularly those who do routine tasks, may face future threats from the developments in advanced artificial intelligence such as natural language processing. Once again, the authors do not expect the Fourth Industrial Revolution to result in an aggregate increase in global unemployment; however, the authors do examine, in their regional section below, which countries may be best placed short-term to harness fully extreme automation and connectivity benefits.

Higher savings at the top

Near­term polarisation in the labour force and greater income inequality imply larger gains for those at the top of the income, skills and wealth spectrums. These individuals are likely to be best placed – from a skills perspective – to harness extreme automation and connectivity; they typically already have high savings rates and will benefit from holding more of the assets whose value will be boosted by the Fourth Industrial Revolution.

The pattern may not be limited to individuals. The Fourth Industrial Revolution can be characterised by relatively low capital intensity via deployment of extreme automation and connectivity. Put another way, the prototype company in the Fourth Industrial Revolution may enjoy a small human capital pool, but a large economic value, either private or in equity market capitalisation. An example from our 2015 whitepaper on “The New Global Context”: WhatsApp generated impressive returns for a small group of founders and investors when Facebook agreed to pay what ended up being USD 22 billion for the company in February 2014, despite the fact that the firm had only 55 employees. By contrast, US airline United Continental has a similar market capitalisation as of mid- December 2015 of around USD 22 billion, but around 82300 employees. The USD 400 million of enterprise value per person garnered by WhatsApp is an extreme example, but it highlights the possible outsized gains and inequality that may arise from low capital intensity business models of the future.

Even in low capital-intensity businesses, the capital goods that are employed – that perhaps used to suffer from “asset specificity” – are now divisible into smaller and more accessible units of usage, as exemplified by AirBnB and Uber. The growing use of the Internet of Things and extreme connectivity allows these more accessible units to be monitored, and their efficiency evaluated in real time. (The October release from AirDNA, a data analytics company that aggregates AirBnB listing data, may be one example.)

As such, investments by firms benefiting from the Fourth Industrial Revolution may become more efficient and, over time, less burdensome in terms of capital deployed. Consequently, even companies who invest heavily may often be able to fund these investments out of earnings, without the need to borrow. In this regard, it perhaps should not be regarded as a coincidence that many tech giants run such large cash surpluses, in sharp contrast to the capital intensive investment cycle of many basic resources funds.

Eventually, as the authors highlight later on, flexibility of capital and infrastructure may balance out some of this capital inequality. Yet early adopters of extreme automation and connectivity may enjoy lower borrowing costs in the short run, and put downward pressure on interest rates in parts of the economy where they operate. This is likely to drive up asset valuations of Fourth Industrial Revolution beneficiaries and further widen inequality levels.

The Dollar Dilemma

As we highlight in the regional analysis of this paper, the United States possesses many of the key attributes necessary for success in the Fourth Industrial Revolution. While technology is ultimately universal, economic structures tend to exacerbate differences between regions in the short run.

While the United States faces a variety of structural issues, including falling high school education rankings, increasing income and wealth inequality, and a problematic healthcare system, it remains an attractive destination for investment, company establishment and headquartering. This creates a plausible scenario where the USD maintains its structural strength. This trend has been in evidence during 2015, as the US business and credit cycle looks to be more advanced than those of other regions.

Further dollar strength would add to the difficulties of emerging market economies whose struggles are currently garnering headlines. Countries maintaining dollar pegs would face extra competitive pressures. And the cost of debt servicing would also rise for emerging countries and companies that have used the period of low US interest rates and broad USD weakness since the financial crisis to increase significantly their USD­denominated borrowing.

Furthermore, the authors noted in a previous UBS whitepaper, “Macro problems, micro solutions,” that shifts in technology may prove disruptive for other economies and sectors.

Labour markets in manufacturing could be materially affected as capital such as robotics and 3D printing, for example, displace low and middle­skill jobs. For some economies on the cusp of joining the global manufacturing and trading system (for example in South Asia, the Middle East, Africa, and parts of Latin America), extreme automation of capital in the US could have short-run negative demographic and employment effects. In addition, the “on-shoring” of work back to the US (and shortening of global supply chains) from areas with a former comparative advantage of labour could be seen as a risk to developing nations.

As highlighted in more detail in a later section of this paper, however, extreme connectivity may allow a shortening in the length of global supply chains. One particular implication of extreme automation and connectivity in the Fourth Industrial Revolution will be the role of “virtual” trade in ideas and intellectual property versus “traditional” trade in physical goods. Relative advantages in developed market legal protections of intangible ideas may lead to “onshoring” from emerging markets to the developed world initially, but this trend may reverse over the longer term as emerging nations grow and develop their infrastructure to embrace extreme automation and connectivity.2

Rising risks, relating to cyber warfare and geopolitics

Extreme connectivity also increases the risks posed by cyber security breaches, as UBS authors have highlighted in previous White Papers, including “The New Global Context: Could economic transformations threaten stability. In particular, the rise of extreme automation and connec- tivity via “smart grid” systems, while improving energy efficiency and helping match supply with demand more effectively, may be vulnerable to hacks which shut down electricity transmission or generation systems entirely.

According to Symantec, the energy sector is now one of the five most targeted sectors for hackers globally, and in 2012 Saudi Aramco spent weeks repairing its computer systems after a virus attack. In 2013, parts of the Austrian and German power grids were  threatened after an IT acci- dent led to the network being flooded with data.

Similarly, cloud computing allows companies to outsource a host of IT tasks via extreme connectivity, including soft- ware installation and server maintenance. This gives them more flexibility and allows them to better deploy capital to their core business. But if the IT infrastructure of a large number of companies is being managed and distributed by a single cloud­computing provider, the damage inflicted by hackers could be significantly greater than an attack on a single company.

Cyber security dangers vary significantly between nations, with many emerging markets more exposed. Eurasia Group’s cyber risk index, which rates the threat to businesses from 1 to 100, indicates a relatively elevated risk reading of 88 for Chinese firms, versus a safe score of just 14 for Swiss firms. The United States, despite its relatively robust cyber environment, is considered a prestige target by foreign states and dissidents and as a result Eurasia Group gives it a rating of 77, putting it at far greater risk than most rich nations.

The potential magnitude of such impacts could increase as connected networks grow larger due to the Fourth Industrial Revolution. Without strong international and institutional frameworks governing the protection of data, cyber security, and Internet privacy, access to the full benefits of extreme connectivity may be stymied. In January of last year, UBS’ whitepaper “The New Global Context” called for greater global coordination on cyber-security. The authors expect these calls to continue and intensify.

Extreme connectivity is also fostering geopolitical tensions in several ways. It increases the ability of diverse groups to organize protests and offers the potential for greater publicity to violent extremists. Recent examples have highlighted the convening power of social media across the world. Widely distributed images of Mohamed Bouazizi, and his self-immolation in protest over police corruption, helped give rise to a mass movement that displaced the Tunisian government and triggered the broader Arab Spring in the Middle East. Extreme connectivity has also proved a threat to mainstream political parties across the globe. The 2015 mass protests in Brazil drew millions to the street, with social media again proving a driving force. In Western Europe too, mainstream political parties have been threatened by the rapid rise of protest movements that have exploited social media to galvanise their followers.

Extreme connectivity has the potential to aid violent extremists – both in recruitment and in generating publicity. A large quantity of online propaganda material is now being posted on social media platforms. The Islamic State has been deploying the Internet to win supporters throughout the world, managing to recruit citizens from the US and Europe to their cause. Furthermore, social media has tended to magnify the impact of violent events – such as the tragic terrorist attacks in Paris. The photographs and videos taken by witnesses can now be