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The economy is growing

There are many indications that digitisation and transition from a linear production model to a circular model will be the key drivers of companies’ development in the coming decades. The related challenges and possible scenarios have been discussed extensively in the two most recent reports in our FFbK series. The conclusions of both reports are similar: those processes cannot be avoided, and they are profoundly changing rules of the game in business by integrating companies with the natural and social environment.

The economy is growing

Digitisation and circular economy already have a significant impact on economic activity, both at the level of individual businesses and national economy as a whole. The problem is that the measures currently in use, such as companies’ earnings or Gross Domestic Product, fail to capture many effects and consequently do not measure the full dimension of development. Worse still, if we choose to be guided by those measures, we are in no way encouraged to engage in sustainability activities.

The Gross Domestic Product concept was developed at the end of the 1920s, when the world’s population was two billion, and manufacturing (value-creating) activities were yet to face the barrier of natural resource shortages and did not yet result in any visible damage to the environment. GDP, just as company earnings, is based on the concept of market value, with the key factor being prices of market products and services produced in a given year. Prices serve as weights in the process of adding up the value of products and services. Products and services with a price of zero do not generate earnings for companies and are not reflected in the GDP account.

Over the past three decades, computing power has grown more than a million times, and digital memory and telecommunication network capacities expanded at an only slightly lower rate. However, when we look at the share of telecommunications services in GDP, it has changed little over the same period. In the US, it stood at 4.6% in 1983, and now is still at 4.6%. Why? Most digital communication services are now provided free of charge! And GDP does not reflect the benefits they bring to users. Facebook creates value for billions of users around the world, but this value is not visible in GDP because the service has no market price. MIT researchers have made an attempt to estimate the value of the Facebook service to a user. They asked the users: how much would I have to pay you not to use Facebook for a month? It turned out that the average value of the Facebook service to an individual user is USD 48 per month.

Source: World Economic Forum

How is digitisation affecting company earnings and GDP? A good example is UBER. The digital application (a robot) connected private car owners who had some time to spare with customers interested in inexpensive private transport. As the digital robot replaced a taxi company, it reduced the cost and generated additional demand for the service. By increasing competition, it put pressure on taxi fares, which also led to an increase in the number of taxi journeys. This new market value (for drivers, passengers) was created without any investment, by employing existing non-production assets and available labour resources. Also, the use of a digital robot for this purpose (an intangible production asset generating market value for UBER) was for free, and thus was not reflected in GDP. The direct effects of UBER’s activities that are visible in the taxi companies’ earnings and in GDP are a reduction in taxi drivers’ pays and the companies’ lower profits. What is not visible in GDP is an increase in the incomes of people working as UBER drivers in their free time. Research shows that the application has increased the total number of working drivers (both UBER and taxi drivers). What is captured in GDP is the effect of higher incomes in the form of increased consumer spending (and savings) of households.

Any digital innovation can immediately spread around the world. With cloud services, rapidly growing companies gain access to customers, financing, networking opportunities, work efficiency, computing power and software. In this increasingly digital economy, ‘normal’ workers do not see any growth in their wages because they compete with cheaper, more efficient digital robots. The return on invested ‘normal’ capital, measured by real interest rates, has also declined strongly (digital production assets are available at zero cost). These phenomena cannot be explained in terms of classical economic theory. Technological progress, which increases the possibility of replacing labour with capital, should translate into higher interest rates, at least in the short term. Why? Suppose that companies unexpectedly gain the possibility of replacing certain employees with highly efficient robots. In the analogue world, to be able to leverage the competitive advantage created by this attractive investment opportunity option companies would increase demand for credit financing, driving up interest rates. But in the digital world, they do not need to do that because highly efficient robots are available at a cost close to zero (UBER). For those interested in the subject, I recommend the following link: MIT Initiative on the Digital Economy

Let us now move on to the circular economy. The ‘use instead of own’ social megatrend, already present in mobility (as car sharing or ride hailing), can be extended to many other durable goods purchased by households. For example, a washing machine is designed by the manufacturer so that it is durable and 95% of the materials used in its production are reusable. It is not sold to the consumer but leased out and serviced by the manufacturer, and when a new model is placed on the market, the manufacturer replaces the old one for the customer at a price reduced by the value of reusable materials. Such ‘closing the loop’ models for the use of raw materials and consumables fit well into the business concept of a product as a service. The paradox of modern development is that manufacturers, with tacit agreement from consumers, have for several decades been moving in the opposite direction: from durable, reusable goods (such as washing machines or telephones that could be repaired and last for many years) to unrepairable, disposable products, which are most easily thrown away as rubbish.

What will be the effects of closing the loop on companies’ annual earnings and GDP? Production will be cut down as longer-life products will be needed in smaller numbers. Revenue will be spread over time: the customer will make annual lease payments rather than buy the product. Sales of raw materials and consumables will be reduced as the lion’s share of what is needed for production will be sourced in the form of recovered materials. There are many similar examples. For those interested in the subject, I recommend the following link: World Economic Forum 

How to measure sustainable development? Among the many proposals that I had the opportunity to get to know (also during this year’s conference in Davos), the one I find most interesting is what Canadians have already done. The summary of the report ‘Comprehensive Wealth in Canada 2018 - Measuring What Matters in the Long Term’, published in October 2018 by Ivey Foundation and the International Institute for Sustainable Development, contains the following conclusion:

Comprehensive Wealth in Canada 2018 – Measuring What Matters in the Long Term (.pdf)

GDP measures income today. But what matters in the long run is wealth, the foundation of income in the future. More specifically, a country’s produced, natural, human, financial and social capital determine its prospects for the future.

  • Produced capital is made up of the buildings, machinery and infrastructure owned by households, businesses and governments.
  • Natural capital includes the forests, lakes, minerals, fossil fuels, land and other elements that make up the natural environment.
  • Human capital is the value of the skills and knowledge bound up in the people that make up the workforce as represented by lifetime earning potential.
  • Financial capital includes stocks, bonds, bank deposits and other financial assets owned by households, businesses and governments.
  • Social capital measures the degree of civic engagement and trust/cooperation among the members of society.

Together, these five types of capital make up what is known as the comprehensive wealth portfolio. Comprehensive wealth is the foundation for producing all the goods and services—both market and non-market—needed to support well-being. For well-being to be sustainable, comprehensive wealth must be stable or growing over time on a per capita basis. If it is not, the country is eroding its productive base, living off its inheritance rather than building for the future. Based on Canadians’ calculations, in terms of comprehensive wealth their economic growth between 1990 and 2014 was the slowest among the G7 countries, with an average annual rate of 0.23%. Over the same period, Canada’s GDP grew at an annual rate of 1.31%.

Adam Czyżewski

Adam B. Czyżewski, Ph.D., has been the Chief Economist at PKN ORLEN since 2007. He specialises in the changes of the global energy sector that are driven by economic policies and revolutionary innovations.