The title of this publication gives a strong clue:

While I have long been interested by the observation that the world around us is an improving one, what use would this observation be without figures, dates or facts? Matt Ridley put it in a nutshell for me in his book, “The Rational Optimist: How Prosperity Evolves.” I am also indebted for inspiration to Angus Deaton and his book “The Great Escape: Health, Wealth, and the Origins of Inequality.” This study would not have been possible without Hans Rosling, whose website “Gapminder” allows statistics to speak for themselves and upends our habitual ways of thinking about the world, and Max Roser’s website “Ourworldindata.org.”

As a behavioral economist, I know that we humans tend to respond to negative news far more strongly than we do to positive news: a survival strategy handed down by our Stone Age hunter-gatherer ancestors. To understand the modern age, we need to identify the developments that are helping to improve the world around us, particularly in times of technological transformation. This is not just a question of investing wisely; it is the only way to defend “the open society” from its enemies (Karl Popper). It is only with rational optimism that the search for meaning makes sense (in memory of the great Viktor E Frankl and his work “Man‘s Search for Meaning: The classic tribute to hope from the Holocaust”).

The creative power of disruption

“Disruption”: no word better describes the age we live in. Disruption – the destruction of the old by the new (and better), driven by technologies based on digitalization and artificial intelligence. Yet periods of dramatic change are nothing new in the history of industrialization. On the contrary, they are an inherent part of that history. As long ago as 1926, the Russian economist Nikolai Kondratiev, who would one day be murdered by Stalin, examined the long waves of technological development in his work, “The Long Waves in Economic Life.” Later economists continued the “Kondratiev waves” up to our present day.

Kondratiev’s idea inspired Joseph Schumpeter to coin the still commonplace expression, “creative destruction.” Were he alive today, Schumpeter would likely also write about “creative disruption.”

From the steam engine, the railway and the automobile to information technology, robots and artificial intelligence – groundbreaking innovations have always been the driving force behind changes in working processes and social structures (see chart 1), thereby helping to create the growth of affluence.

We can visualize this by looking at the growth in global gross domestic product (GDP) (see chart 2). For centuries, GDP barely changed at all in a measurable way. Then, with the dawn of industrialization, it began to rise sharply, even exponentially. Population growth followed suit. At the beginning of the 19th century, the global population exceeded one billion for the first time. Yet the famines feared by Robert Malthus did not come to pass. Innovations in agricultural technology not only ensured that more and more people could be fed, but also increased prosperity (income per head). Prior to industrialization, bitter poverty had been the norm for all but a powerful elite. By the early 1980s, the proportion of the world population living in absolute poverty (living on less than US$ 1.90 a day) stood at 45 %. Today, it is just 10 %, despite the fact that the global population has grown to approximately 7.5 billion. Without innovation, without technology, many would simply have starved.

”There are plenty of reasons for “rational optimism.” Things are often better than we think.” Hans-Jörg Naumer

The decline in absolute poverty has been paralleled by the emergence of a “global middle class.” The World Bank defines the “middle class” internationally as comprising those earning between US$ 11 and US$ 110 a day, based on 2011 purchasing power parity. As the Brookings Institution think tank has concluded, the world recently reached a “tipping point” in September 2018: for the first time, half of the global population are now “rich” or “middle class,” and the other half “vulnerable” or “poor.” Brookings predicts that this trend of declining poverty and a growing middle class will continue. While the number of people considered poor will fall further, the ranks of the middle class are set to swell to 5.3 billion people by 2030.

It is not only the population size that is growing, but also life expectancy. At the end of the 18th century, average life expectancy around the globe was less than 30. Today, it is more than 70. The average American lives to almost 80, and the average European even longer. In Africa, average life expectancy is around 60, while in Asia it is over 70.

Child mortality – a measure of how the weakest members of society are faring – has also fallen, even in absolute terms. While the world population – and thus the number of children – has continued to grow, the proportion of children dying before their fifth birthday halved between 1990 and 2017. The employment rate among 10 to 14-year-olds – i.e. the level of child labor – also reduced by more than half in the period from 1990 to 2012. In 1990, 16 % of 10 to 14-year-olds were in employment. By 2012, this had fallen to just slightly more than 8 %.

Growing prosperity is the driver behind these developments and is leading not only to higher living standards thanks to medical care, access to clean water and electricity, but also to the spread of technology. Over 85 % of people have access to electricity.

At the same time, the spread of information is accelerating, and an ever-larger share of the world population has access to knowledge and markets (e.g. via smartphones and the Internet).

Example: India and Nigeria. In these countries, approximately 70 % of people have a cellphone. In China, coverage is almost 100 %. The spread of information makes markets and prices more transparent, promotes knowledge and innovation and drives competition.

Also see our studies on investment income in the second machine age and on artificial intelligence as a part of our everyday life and the driver of our future.

What now?

Of course, there is a flip side to everything. This is clearest when it comes to the environment, and especially the level of CO2 in the atmosphere, which has increased exponentially since the Industrial Revolution. The concentration of CO2, which stood at approximately 280 ppm in the centuries prior to industrialization, is now 400 ppm and rising.

But there is another interesting trend: CO2 emissions per dollar of GDP have declined in recent decades, as has energy intensity (units of energy per unit of GDP). Though it remains low, the share of renewables in the global energy mix is climbing.

Active is: Investing as a rational optimist

The world is changing – but is our investment approach changing with it? Rational optimists should consider the following:

1. Investing in shares – investing in tangible assets
The most important question investors should ask themselves is: “If I follow the paradigm of rational optimism, am I also investing in this “optimism,” this “transformation?” “Do I participate in innovation and value creation?” This means investing in companies (e.g. through equity strategies) and therefore in real assets. Savings books and government bonds will not cut it.

2. Investing in the drivers of change.
Technological change pervades every industry and every region. Why not also invest in those companies that are bringing about this change and leading the way in implementing new technologies?

3. Investing in “themes” rather than countries and industries.
The development of prosperity and growth are a manifestation of creative disruption. Existing systems are being disrupted, and new and better alternatives created. This disruption is being felt across countries, continents and industries. Is it not rather old fashioned to allocate by country and industry?

After all, there is no such thing as the “digitalization industry.” Digitalization pervades every sector, separating the wheat from the chaff. Demographic change is a global phenomenon leading, with regionally differing chronologies, to falling birth rates and aging populations. Growing prosperity is not confined to a fortunate few, but is happening everywhere free markets, a well-functioning legal system and competition are to be found.

The investment approach of the future could be “thematic” rather than country- or industry-based investing. This concentrates not on which industries or regions firms belong to, but on whether they are among the primary beneficiaries of change.

4. Investing in a better world
The world may be improving, but there is still a long way to go. Child labor still exists, working conditions remain poor in parts of the world, and some businesses and countries are badly governed. There is still inequality, environmental pollution and an excessive human carbon footprint .... The list could go on.

For investors, it is therefore important to invest in a better world. This need not mean missing out on profits. It is striking how “ESG” (Environmental – Social – Governance) criteria have become more important to investment decisions in recent years. The ESG criteria are a growing and evolving catalog of investment criteria that help to direct funds into investments that value environmental protection, good working conditions and good corporate governance.

This approach, long used by institutional investors, is steadily gaining importance among individual investors, too – especially with the trend toward integrated ESG among investment professionals/strategists. The ESG criteria are no longer regarded as a category used to exclude investments, but as an integral part of analysis and security selection. Academic studies have shown that this need not be to the detriment of investors (see below).

There are plenty of reasons for “rational optimism.” Things are often better than we think.

Active is: Investing as a rational optimist.
Hans-Jörg Naumer

The growing importance of ESG criteria and their impact on investment is revealed by parts 1 and 2 of our study on what ESG means for investment, Hans-Jörg Naumer in "AbsolutImpact", 01 / 2017.