Waiting for a new innovation wave

Key takeaways

• Innovation is an essential driver of economic progress. According to our analysis, innovation goes through three stages (as per the S-curve, these are: slow beginning, progressive strengthening and maturing).
• The current innovation wave has plateaued. A new wave will be increasingly felt in the next few years. Technological innovations are mainly being driven by two large countries: China and the US.
• Innovation will remain a key driver for economies and for equity market performance in the coming decades.
  

Waiting for a new innovation wave

Generally, innovation comes in waves and forms what is known as an ‘S-curve’. In other words, from slow early beginnings as technology or processes are developed, innovation waves strengthen progressively (forming a steeper line in the S curve) until they mature and flatten over time. The wave of technological innovation that started in the late 1980s has followed a similar pattern and now looks like having reached a plateau. Whether we quickly see another innovation wave depends on technological breakthroughs.

Chart 1 shows the different phases of new technology adoption in an economy. In the first part of an innovation wave, only true innovators or geeks adopt the new technologies initially (based on historical data, these categories represent about 2.5% of the population). Technological innovation is adopted progressively by other categories of the population according to the sequence shown in chart 1.

According to our analysis, innovation goes through three stages (as per the S-curve, these are: slow beginning, progressive strengthening and maturing). The current innovation wave has reached the stage of maturity. A new wave will be increasingly felt in the next few years, and will be covered in future editions of Horizon. The technologies of the current wave of innovation have been adopted on a large scale by the populations of developed economies, as can be seen in the rise of social networks, ecommerce etc. .... But this wave has matured.

Chart 2 attempts to show the economic impact of the different stages of innovation since 1990. We believe the innovation wave that started around then should continue to ripple through economies until about 2050. This belief stems from our analysis of how innovation is being adopted at different stages and the actual transformative power of new technologies. Applying our work to Kondratieff Cycle theory (which extrapolates long-term economic cycles out of technological innovation) bears out our findings.

Different dynamics at work in innovation waves through time

1. Self-sustaining dynamics.

As American economist William Baumol has analyzed in his research on this topic, innovation is underpinned by a self-perpetuating dynamic. In other words, one piece of innovation leads to another. Hence the succession of innovation waves over long periods, sometimes triggering a Kondratieff cycle. Technological innovation follows this dynamic.

2. Pause.

There is a debate about the process of innovation. Is it a continuous process or is it periodical? In reality, innovators work on new technologies every day. From this point of view, innovation is continuous. But the impact of these new technologies on the broad economy can be slow to appear. There can be a time lag between the appearance of a new technology and its take-up; in other words, innovation can have slow beginnings before it spreads widely and rapidly.

3. Integration.

Given that innovation is self-sustaining, the adoption of revolutionary technologies or techniques in one area should help drive innovation in others. In the current innovation wave, this is particularly noticeable in sectors such as health technology, where innovation is building on progress in nanotechnology, digitalisation, robotisation, cognitive sciences, etc.

4. Economic and market reversals.

Downturns in economics or financial markets can put innovation on pause. For example, between its first and second stages. This happened when the US went into recession in 2008, at a stage when the current innovation wave was still in its prime. Now, in light of the conflict in Ukraine, recession threatens again—but the innovation wave has already started to ebb.

In conclusion, innovation will remain a key driver for economies in the coming decades. Technological innovations are mainly being driven by two large countries: China and the US. Other countries and economic blocs, such as the EU, are less important as innovation powerhouses. Innovation is a key driver for equity market performance. However, the impact of innovation is set to diminish in the short term (and may even have a short-term negative effect on growth). We take all these factors into account in our long-term economic forecasts and in our calculations of expected returns.