Will Technological Innovation Lead To The End of Interest Rates ?

Wondering what will happen in the future with the financial markets is a matter that is on many people’s minds, especially following the financial crisis which did so much damage for so many people. Some economists have set about trying to understand what is likely to happen. There is a body of thought that believes that interest rates will eventually end, and reach zero. One such proponent of this idea is Paul Gebhardt. In explaining himself, Gebhardt says:

“There is substantial evidence that the return on capital (or cost of capital, depending on your position) will converge to zero as the slope of technological progress approaches one.”

At first this may appear to not be very logical, but Gebhardt has good reasons for making this assertion. The first is regarding technology and its benefits. It is explained that technology has the impact of making innovation much cheaper. The net effect of this is that capital is plentiful. In the past it was really expensive to get started with new businesses – many new businesses were manufacturing based and required lots of equipment to get underway. However, we have arrived at a point where it is extraordinarily cheap to get up and running with a new business. This means that there is a lower need for capital. Following on from this there is higher supply and this is expected to lead to lower returns.

Another factor said to be influencing all of this is the fact that technology in itself makes it easier and more efficient to allocate the plentiful capital. Capital markets become significantly more efficient. The use of algorithms for trading is one important example of how markets are made more efficient. Additionally crowdfunding companies also have an impact, increasing efficiency in private investments. This means in turn that there are lower opportunities for arbitrage. It means that there is more capital looking to invest in less opportunities than in the past. This too clearly will lead to lower returns. Companies that have the most assets will struggle more in this type of environment. This will also impact on the way in which companies are valued since assets will no longer be as important, and intellectual property, software and brand value will come into their own. There may be a need to rethink how ratios are used for valuing.

One of the big changes that we have seen over the last few years is just how easy it is to get started with a new business these days. There are ever reducing barriers to entry into markets as all that may be needed is a website, and these can initially be produced for free. Pointing to evidence of this, it is explained that the life expectancy of companies has reduced. Looking at the Fortune 500 it can be seen that 50 years ago the life expectancy of a company was 75 years, but today it is just 15 years. Investors are seeking out opportunities for high return but those are fewer and farther between.

All of this has consequences for entrepreneurs that are getting up and running today. One of the most positive is that because capital is more plentiful it will be easier for entrepreneurs to find capital to get their business underway. Evidencing this, there have been increasing sums entering private equity and venture capital, with venture capital funds growing manifold over the past 30 years. At the same time, both private equity and venture capital funds will have lower returns than may have been expected historically. Given that there is such a large increase in capital, and ever evolving economic conditions it is predicted that it will be much more difficult to understand when we are facing a market bubble.

The pace of change and innovation will continue and will further accelerate. This situation is two fold. If on one hand it means that it is likely that it will become even easier than ever to have a disruptive effect on an entire industry, it will be increasingly challenging to hold a position in the market for any period of time. This means that the Apples and Facebooks of today will be more likely to get underway and decline much more quickly.

Which is good news to all.