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Insights 6 May 2014

The Unusual Suspects: Leo Johnson

By Rob Cameron

Leo Johnson talking to Rob Cameron at our London office.

This article originally appeared in Radar Issue 03: What Chance Change? Exploring Sustainable Finance.

Leo Johnson, a partner in PwC’s Sustainability and Climate Change team, has recently co-authored Turnaround Challenge: Business and the City of the Future, which explores how capitalism can reinvent itself to offer sustainable growth.

Rob Cameron spent a morning with Leo exploring his views on the wisdom of Hollywood icons, tequila capitalism, jujitsu moves and the parallels between banks and rock ‘n’ roll.

Rob Cameron: Let’s start with that most British of questions – what do you think of the recent weather here in the UK? I ask because I wonder if it takes this kind of flooding disaster to get politicians to pay attention to the risks of climate change?

Leo Johnson: We should be so lucky. My take is that major progress won’t result from flooding. If anything my fear with big-time impacts from climate change is that they could bring what they call ‘threat rigidity’, the draw-bridge going up. My optimism comes from a different place than disaster. To me, it’s most simply put by Marilyn Monroe. She said: “Sometimes good things fall apart so that better things can fall into place.”

This is exactly what Schumpeter was trying to say too. His idea was that there are these waves of ‘creative destruction’ where the technological model that was triumphant starts, as it gets fully deployed across the economy, to burn out and then becomes dysfunctional, creating the space for disruptive technologies to erupt.

Are we there in the West now? There is a killer statistic from Deloitte’s Shift Index that shows that there has been a 40-year nose-dive in Return on Capital Invested from 6% or so in 1965 to about 1.3% in 2012. What does this reveal? It’s pure Schumpeter. It’s consistent with the dominant general purpose technology (GPT) of mass production getting fully deployed across the economy. At the early stages, it brings transformational gains in productivity and therefore high returns to invested capital. Decades later, as the marginal productivity gains peter out in an already automated economy, returns fall off.

This is the core financial symptom of the decline of mass, but what you also see are some other side-pathologies building up too. On the environmental side – carbon; on the social side – offshoring, job loss and wage stagnation; and on the economic side – credit-fuelled consumption and skyrocketing household and national debt. And capital, meanwhile, starts getting frustrated with the low returns in the real sector and looking for whatever asset bubbles might give the apparent chance of doing better.

Which it continues to do, through ‘financialisation’ of the economy and finding apparent efficiencies but not creating jobs?

Absolutely. Capital, like mercury, will seek out whatever avenue it can to make superior returns, the sub-prime mortgage market as the most recent example. But this, as we have seen, is a short-term win. If the underlying technology isn’t raising productivity in the real sector — if it’s value transfer and not creation — the value can’t be sustained and the bubble pops. Interventions like quantitative easing can prolong the bubble, but they aren’t ushering in a new phase of sustainable growth unless they are directed at the next wave of growth.

So where are the grounds for optimism?

You can look at where we are and think, “This is Armageddon. We’re locked into the pathologies of mass production.” Or you can think the opposite. Why do I say this? It’s like squeezing limes for tequila. When do you reach for a new lime? Once the old one is finished? It’s the same for capitalism and its dominant technologies. Look around us. Detroit, the old manufacturing hub, mass production there is out of juice. The pips are squeaking and to my mind this diagnosis is actually the single biggest reason for optimism. The stage is set for another GPT to create a next wave of growth. I guess this is the tequila theory of capitalism.

That’s all great, in theory, but what if anything is this new GPT waiting in the wings?

Looking back over the past 200 years, there’s something of a pattern that could give us some hope. From water power and the spinning looms, to coal and the steam engine, to electricity and the transmission line, to oil and the combustion engine, in all of these great surges of technology driven growth you have two core factors. First, there is a new power source and second a new manufacturing process that harnesses the new power source and rolls it out into the economy.

The combination raises productivity, giving new people the power to do new things. What is exciting is that might be where we are headed once again. The ICT revolution has the potential, if we deploy it right, to transform the energy system, putting abundant low cost renewable energy into the hands of the 1.4 billion people without power. With precision engineering, it also has the potential to displace the model of expensive centralised machines and recreate a model of local making to harness and distribute the benefits of that new power source. These are big potential shifts under way.

The economy will change dramatically in the next 50-100 years; however, the scale of the challenge, the scale of globalization, and the scale of the fossil fuel economy are much bigger than anything we have faced in the past. It’s not that things aren’t going to change; the question is how do we make the transition fast enough?

I agree that it’s about accelerated transition in time to address the challenges we face. What the past suggests is that the transition only happens, and at pace, if there is a new GPT that delivers radically more productive capacity to people. That’s what drives it through the economy. Is this happening? Let’s take the example of the M-KOPA business model in Southern Africa. M-KOPA are putting SIM cards into solar lights allowing people to lease the lights for a 50 cents a day, instead of buying them. This decreases kerosene costs and health impacts, raises exam pass rates and gives access to finance and insurance. It also allows users to make micro-payments for things like the Kickstart agricultural hand-pump which brings access to the underground water table and lets them plant triple the number of crops. This type of impact on productivity took incomes up in one study from USD160 to USD1600 per head a year. Bottom of the pyramid spending for kerosene is USD38 billion a year. It’s a small example but what it shows are the early signs of a new GPT being deployed in ways that are raising productivity again, in some cases transformationally.

What does it mean for the future?

If you look at examples like M-KOPA, there are parallel shifts starting to disrupt the norms that business has thrived on. These fundamental shifts, all long scale transitions, are from:

  • fossil fuel to fossil fuel plus renewable,
  • top down to top down plus distributed,
  • mass to mass plus micro-production, and
  • exclusive markets addressing the urban and suburban billion to more inclusive markets.

These four transitions, underpinning the new GPT, will be critical to the success of business.

Let’s talk about growth. Your book mentions ‘prosperity without growth’ but instead proposes a growth path. Surely any paradigm that is locked into growth is bound to fail in the longer term?

This is the big question. Look, I agree with the vision. The issue is just the maths. Debt compounds and if you’re starting from the position of a whacking big national debt, it will just balloon if you don’t grow enough to
pay it off. At the most brutal level, it’s grow or cut schools and hospitals. As authors, we were looking for a pathway that was both adequate to the global challenges and practically achievable – and we found that the ‘prosperity without growth’ scenario, however appealing, failed on the second test. But we are still cautiously optimistic. We believe there is a new GPT in the form of the ICT revolution. It has huge potential, but it’s not in the bag.

We see three ‘cities’ or models of business and capitalism for the future, each with different models of growth. The first city, Petropolis, remains rooted in growth from fossil fuel-driven mass production. This ends as the swamped mega-city, overwhelmed by the 200,000 a day fleeing the broken countryside in distressed migration. The second city of the future is Cyburbia, a business model that bolts on ICT onto the current paradigm of fossil fuel driven mass production. This is the gated community ‘smart city’, with technology gilding the speed-boat the few use to escape the sinking Titanic of the megacity. The third is the bottom up or distributed city. This is a thriving city, but its growth is based on new drivers. Kentaro Toyama says that “technology is not the answer, it’s the amplifier of intent”. In this bottom-up city, technology is deployed not vertically to benefit the few, but horizontally, as with M-KOPA, to address the environmental, social and economic challenges that confront the many, with growth not as goal but as outcome.

Aren’t we locked in at the moment by the rules of the game? We are dependent on the success of a relatively small number of large companies. The economy needs the fossil fuel sector to succeed and the rules are set for these companies. How do we change the rules of the game?

Of course there is lock-in, massive lock-in and inertia. This is all about the timing of the jujitsu move, and I think there is some warm up action on the judo mat. Take energy. Pensioners need cheap energy. It’s only at the moment of cost parity that government can start to shift the incentive regime
from fossil fuels to renewables. The data suggests that by 2030 80% of the world’s population will be living in places where renewables are below cost parity with fossil fuels. The cost curves are starting to collide. As they cross, instead of subsidising fossil fuels directly and indirectly. Government can start to underwrite the innovator technology. That’s the moment of accelerated transition that we are potentially approaching.

You’ve worked a lot with banks – what role for them in driving this change?

There are some brilliant sustainability practitioners at banks but there’s a timing issue. There’s an old distinction in Marx between risk taking ‘financial’ capital, and lower risk ‘production’ capital. It’s the same in rock. You’ve got either Keith Richards institutions doing “Start me up” at the irruption phase, or Cliff Richard institutions doing “Celebration” at the late stage in the cycle once everything’s settled. Banks are late stage. They’re Cliff. They are not the ones to drive the high-risk change in the short term. Later they are key. Banks are vital to scale up the post- parity technology. But at the early stages its private equity we need to provide the risk capital.

So is Marilyn Monroe right? Is something better going to fall into place?

For me, there’s only one footnote. This stuff doesn’t fall into place. It has to be worked, teased and pushed. We need innovators, an enabling state, enlightened investors, superb practitioners and above all smart citizens, empowered to produce the future.



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