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What I Care About This Week | 2022 July 18

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Photo by Johannes Plenio on

by Franklin J. Parker, CFA

The Summary

The Details

There is a somewhat arcane metric in economics called “total factor productivity” (often called TFP for short). In essence, if you add up all of the labor in the economy and all of the capital in the economy, you have some growth left over, and that growth is attributed to TFP.

Economists think of this as the role of technology in an economy. As technology advances, both labor and capital tend to get more productive. So, technological advances add a multiplier to economic growth that would otherwise be constrained (because there are only so many people in the world and there is only so much capital in the world). For example, TFP accounts for the difference between one worker making a pair of shoes by hand in a day, and one worker running a machine that makes 1000s of shoes in a day. 1000s of shoes took the same input of labor (1 day of work), but they took more capital (the machine), and more technology. TFP measures this technology component.

Historically, TFP tends to grow at about 0.68% per year, but there are periods of stagnation. The period from the early 1970s to the early 1980s, for example, was a period when technological adoption through the economy appeared to stagnate (at least, as measured by TFP).

The bottom line is that, as investors, we cannot underestimate the role of innovation in the economy. Without it, the economy can stagnate and run sideways, even amidst population and capital growth. With it, growth can easily outstrip what should be possible with labor and capital investments alone.

Innovation has been—and is very likely to continue to be—the key to increasing our standards of living via economic growth. Especially as the economic waters grow murkier, investors would do well to focus on the basics: companies adding real value to real people in the real world.

Chart of the Week

This week’s chart shows the divergence between expected earnings growth for US vs European companies. In both cases earnings are expected to grow, but analysts have gotten more pessimistic about the growth story in Europe and more optimistic about the growth story in the United States.

Of course, earnings growth is only part of the story. For investors to harvest differences in return also requires exposure to currency risks. With the Euro falling strongly against the dollar, dollar-based investors may be better poised to harvest these differences in return than Euro-based investors.

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