Capex and the challenge of rising labour costs

For many decades, the response to rising costs has been to move production to regions with a lower cost base, largely to developing countries with vast labour pools. However, labour shortages and wage inflation are today hitting various sectors and geographies globally. Besides, geopolitical concerns make it unlikely that the corporate sector will want to concentrate production further in certain geographies.

Automation investments vs people

Capital spending does indeed offer one possible solution to this issue. While the potential for automation to enhance productivity has long been acknowledged, shortages of labour and consequent wage inflation have created additional incentives.

A number of complementary factors support the idea that increasing capital spending will be the corporate sector’s response to wage inflation.

The installed fleet of fixed capital equipment has aged in the past decade, especially post the global financial crisis. Capex-to-depreciation trends show signs of a recent rise; these have been backed up by surging orders reported by providers of capital equipment.

The industrial world is also currently in the midst of several structural growth trends that complement the need to replace ageing equipment:

The new industrial revolution

Telecom operators around the world have recently started rolling out 5G networks; this has the potential to spur an innovation and investment cycle in the Industrial Internet of Things.

Artificial intelligence is already finding uses in manufacturing, and this comes alongside significant progress in industrial machine vision, robot guiding and equipment with embedded industrial software. All these systems could help tackle the problem of rising labour costs. 5G network rollouts could prove the tipping point in adoption of these industrial technologies, potentially paving the way for innovative industrial businesses over the next couple of decades.

After a long period of economic growth being dominated by consumption trends, we appear to be on the cusp of industrial investment taking on the growth mantle. While there are clear economic cycles at play that could make the road bumpy, the need to offset labour-cost inflation, coupled with structural megatrends, suggests we are in the early stages of a sustained capital spending cycle.