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- [00:01]
A
Welcome to Thoughts on the Market. I'm Robert Feltman, senior advisor at Morgan Stanley MUFG securities in Tokyo.
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And I'm Michael Gapen, Morgan Stanley's chief U.S. economist.
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Today we'll discuss why the U.S. and Japanese economies may react differently to the AI productivity test. It's Thursday, July 9th, at 8pm in
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Tokyo, at 9am in New York.
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AI is the biggest theme around the world right now. But AI will play out differently in different economies. Take the cases of the US and Japan. In the us, it's already a catalyst in investment, imports, productivity, and the labor market outlook. But here in Japan, it's seen as a savior for an economy with an intense labor shortage, low unemployment, and very little room to raise labor force participation. Mike, in the US, AI's contribution to real GDP growth will rise from about 0.05 percentage points in 2024 to an estimated 0.43 percentage points in 2027. What does that mean for markets?
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Well, Robbie, I think it means a number of things, but you know, I'm an economist, so the answer is always it depends. I think the, the real crux of the issue over time in the US and therefore what it means for financial markets is ultimately whether AI is labor replacing and pushes the unemployment rate higher, or it acts like a more traditional general purpose technology that's labor augmenting. So if that's the case, meaning it looks similar to the Internet and digital era, then it would mean faster output growth, stronger productivity growth, but still an economy that's running at or near full employment. That would be very beneficial in our estimation for risk assets, equity markets, credit markets. And it would probably mean that we stay in an interest rate environment that's certainly higher than it was during the post GFC period. But if AI is a very different technology than we've seen in the past, and it displaces labor and we get increases in the unemployment rate as AI diffuses through the economy, then it could be very different for markets. Maybe returns to capital and equity markets are supported, but that might be more narrowly for technology stocks and not broader, say, consumer discretionary stocks. So the answer, of course, is it depends. We don't know. And I think ultimately we come down on the side of thinking that AI will not create dystopian outcomes in the labor markets that employment will hold up. So we have a fairly constructive view, perhaps an optimistic view, and we think ultimately it'll benefit markets greatly, similar to what we saw from the mid-90s to the early 2000s.
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Well, in your model, you have a particular variable that captures the speed of diffusion. But your baseline has AI spreading twice as fast as the Internet did. But without that rise of employment. Is that really manageable? And if it's not, what economic indicators would warn us if we're crossing into the danger zone?
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So this is really the tricky part. As you know, we have a new technology, we have to model how it diffuses through the economy. And I would say, I think there's, you know, there's an argument here that penetration rates and usage rates are very different than what economists think about diffusion, which is how the production process is reshaped because of this new technology. And so most economists look at the Internet and digital era and think it took 20 to 25 years to fully diffuse mass penetration in maybe 10 years, but full diffusion in more like 20 to 25 years. And so each innovation cycle tends to happen more rapidly. So I do think AI will spread more rapidly. And even by saying it spreads twice as fast as the Internet did, still means that it'll take roughly a decade, maybe 10 to 12 years for this to fully diffuse. So our argument here would be that that is enough time for a flexible economy and a flexible labor market like we have in the US to rebalance labor. But if we're wrong, then Robbie, what I think you will see is that as AI rolls through, it diffuses faster. And what we would see then is increases in rates of job separation and layoffs that would overwhelm the labor market's ability to reallocate workers. So I think we would see two things or three things. Larger scale layoffs, a rise in the unemployment rate, and probably a significant amount of underemploy who get rebalanced may be rebalanced into work that's not say, consistent with the skill of that worker. So I think we would see a very disrupted labor market in the process. But if it takes a decade, maybe 10 to 12 years, we think ultimately the US economy is flexible enough to rebalance labor without large scale layoffs.
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People are afraid of a lot of things, but one other thing is that AI might create new kinds of jobs. New kinds of tasks have different impacts on people's wealth and different responses from policymakers as well. How do these knock on effects change the AI labor story?
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B
Yeah, that, that's right. And you make, I, I think you make a very good point there that I think it's easy to fall into what an economist would call a, a partial equilibrium trap. So for example, we, we look at occupations exposed to AI task replacement and we Say, wow, if all these tasks are replaced, we might lose 10 million workers or 20 million workers. But that's too simplistic in our view, because as you note, AI may destroy some tasks or replace some tasks, but it's also going to create new ones. So it may eliminate some types of occupations, but create others. And in addition, if people are, say, laid off because of AI, you get a loss in labor market income for the economy. But AI will likely create returns to capital, say, stronger equity performance. And that's an indirect wealth effect. So our model kind of looks at, say, three wedges or three horse races in the economy. Then it's about the speed of diffusion of AI against the ability of the labor market to rebalance its task of destruction or task replacement versus new task creation. And then third, it's, we might have weakness in labor market income in the short run, but there are indirect wealth effects. So thinking about it this way, in a richer general equilibrium context, these feedback effects matter a lot. So the combination of if the labor market's disrupted, we get easing in monetary policy, maybe a fiscal response. There are new tasks, new jobs that are created for workers to rebalance to over time, and overall demand in the economy gets held up because wealth effects can offset some lost income. All of that is extremely important in our view, that ultimately the US Economy can rebalance and handle the AI diffusion in a manageable way. We could be wrong, of course, but our main point here is you have to think about this in a richer context. You can't just simply say, stack up workers and occupations and say, oh, we're going to lose a lot of employment. That's not the way innovation waves have worked in the past. We don't think they're going to work that way in future.
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A
That's fascinating because the situation in the United States is so different from that in Japan, largely because of the demographic situation. Here in Japan, the key element is how much AI can ease the labor shortage. In fact, in some labor intensive jobs now we're seeing 6% wage increases. And that's great. As long as productivity rises fast enough, the price hikes aren't necessary.
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Robbie, in your scenarios for Japan, the same 10% productivity gain can lead to very different outcomes. Deflation and weaker employment, and in one case, more inflation, higher wages and more employment in another. What do you think drives the difference?
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Well, the crucial element really is the flexibility of goods and labor markets. With high flexibility, you get higher gdp, higher employment and moderate inflation. With low flexibility, you may get a bit higher gdp, but employment plunges and there's deflation of both prices and wages. More in wages now in Japan over the last two decades, we've seen monopoly power in key markets go down, for example agriculture and energy. Labor markets are more flexible too. But lifetime employment system still applies to about 2/3 of the economy, and that deters people from trying to find better jobs and even from acquiring the skills needed for a new job.
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What conditions are needed for AI to be additive to Japan's economy?
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We need more reskilling. Japan is lucky because people are healthy and they want to work into their 70s and beyond. But acquiring the skills to remain productive is a challenge, even though Japan's workforce is well educated and still has a strong work ethic. So to sum up, in the US the race is between diffusion and absorption, but in Japan it's between labor scarcity and productivity. Is that fair?
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It is fair, and we come down on the side of optimism. We think diffusion will happen fast, but it'll happen at a pace that the US economy can handle. So we come down having a positive view. Overall, we do not lean in the direction of dystopian labor market outcomes.
- [10:32]
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I agree with that as well for Japan. So Mike, thanks for taking the time to talk.
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Great speaking with you, Robby Sohn and
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thanks for listening everyone. If you enjoy thoughts on the market, please leave us A Review Wherever you listen and share the podcast with a friend or colleague today.
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