WITHIN A FEW years, artificial intelligence will displace a significant portion of the world’s highly paid knowledge workers. Aggregate demand will suffer, but flows into retirement investment accounts will turn net-negative: workers won’t just stop paying in, they will need to withdraw funds.
The job displacement will fall disproportionately on highly educated, well-paid workers whose retirement savings drive America’s stock markets. (REUTERS)
These outflows will come largely from passive investment funds, particularly S&P 500 index trackers. Although such redemptions sell every constituent in proportion to its index weight, the price impact will not be evenly distributed. The AI “mega-caps” that have powered the index higher, such as Nvidia, Microsoft and Amazon, are also the names whose valuations have been most dependent on mechanical passive inflows as the marginal buyer. The result, ironically, is that the companies powering the AI revolution are likely to suffer the largest price drops.
AI is at the inflection point at which large language models are improving at a rate that is non-linear and will soon become exponential because they are themselves coding their successors. The most sophisticated users of AI are in tech companies. Using the current generation of models, they have in many cases reduced teams that previously had half a dozen workers or more to just one. It is reasonable to believe that within three to four years AI will have replaced 15% of jobs in America’s broader knowledge economy.
The two counter-arguments are the “Jevons paradox”—the historical experience that new technology that increases efficiency also increases demand, thereby creating new jobs that offset losses—and scepticism about the slope of the adoption curve. Both will be proved wrong.
Humanity’s ability to innovate and invent clearly outpaces its ability to adapt to its innovations and inventions. AI models are doubling in power roughly every six months. This means that workers made obsolete will not be able to develop the skills to use AI as a tool, rather than to compete with it.
Even if demand for services and products increases because of falling costs and prices, many displaced workers will still be obsolete, with more workers made so by successor model generations. AI will have such a profound impact on businesses’ cost and pricing structures that failure to adopt rapidly will prove existential for a large swathe of the economy.
The job displacement will fall disproportionately on highly educated, well-paid workers whose retirement savings drive America’s stock markets. Michael Green of Simplify Asset Management has shown how passive investing has resulted in “broken” equity markets that are largely driven at an index level by flows into retirement accounts. His and others’ research shows how passive investing has led to multipliers on the aggregate market and individual stocks that cause the net inflow or outflow of one dollar to have a much larger impact on the equities in which it is invested, possibly as high as a multiple of 75-100 for the largest companies.
The S&P 500 has become an index that creates its own momentum for its largest constituents. Because the top ten companies now represent an unprecedented share of the market’s value, the index is no longer a diversified basket but a concentrated volatility trap. When the professional class begins to draw down its accounts to service mortgages, the resulting market impact will be sudden and violent, as passive funds are forced to sell the index to meet the redemption demands of the displaced losers.
Ironically, the companies with the highest multiples, which present the greatest risk from net outflows, are largely those that make up the AI stack. When the labour-displacement thesis plays out, it will be the stock prices of these new-world stars that get clobbered the hardest.
The resulting crash in equity prices, particularly combined with decreasing aggregate demand, will itself be enough to cause a financial crisis on the scale of the global one of 2007-09, if not larger. Problems in private credit and insurance companies’ balance-sheets may well make things worse. A reduction in liquidity globally will impact all asset values. Deflationary pressures will mount.
The good news is that the crisis of almost 20 years ago has given policymakers a well-tested playbook to restore liquidity and reflate assets. The bad news is that stabilising the financial markets will be the easy bit for governments. They will struggle far more to manage the reordering of society that will result from the mass displacement of highly productive labour.
Ultimately, in another irony, the AI revolution will lead to a world in which many consumers no longer have the income to participate in the revolution. Remaking a society in which growth has been decoupled from employment is a task for which today’s political structures are unprepared, to put it mildly. We will witness not just an almighty market correction, but the end of the existing social contract. In terms of politics and policy, as the old saying goes, “You ain’t seen nothing yet.”
Carson Block is the founder and chief executive of Muddy Waters Research.
