May 2018 | Santiago Millán, CFA, Macroanalyst
AS GROUNDBREAKING AS ARTIFICIAL INTELLIGENCE (AI) IS, seen through an economist’s lens, it is merely another technology that lowers costs. Just as electricity lowered the cost of energy production and distribution and microchips lowered the cost of arithmetic, AI lowers the cost of prediction. As the cost of prediction falls, the number of predictions made will rise, enabling the people and devices that use predictive data as inputs to become more productive.1
By affecting the prices of a wide range of goods and services, the increased application of AI can create opportunities for investment. Like electricity and microchips before it, AI will likely displace some products and industries, but pave the way for many more.
When microchips made doing arithmetic exponentially faster and cheaper, arithmetic was built into the production of countless products, creating massive new markets and displacing others. Microchips obviated the need for typewriters, for example, but created the market for everything from personal computers to digital cameras. I would argue that microchips fundamentally changed the field of photography, with computations replacing filters, dark rooms, and other means of image transfer, and enhancing the value of lenses and sensors. I believe AI’s transformative effects will be analogous across many industries and pursuits.
Nowhere is this transformation more obvious today than in China, where AI is an exploding industry. Figure 1 shows the surge in patent applications in China that contain the words “deep learning” or “artificial intelligence” in their title. China is now home to several of the largest, most well-funded AI startups in the world. In 2017, Chinese companies garnered nearly 50% of all investment capital going to AI startups.2
With many emerging long-term trends, it has been fruitful to invest in the companies producing products complementary to that trend, or that are enabled and improved by it. (The old adage of entrepreneurs selling shovels to California gold-rush prospectors in the 1850s comes to mind.) AI will likely result in compelling investment opportunities in companies that are coding the native technology, but in my view, enterprises building second-derivative products that will use or benefit from those advances will far outnumber them. Examples are just about everywhere you look. The following are a few of the industries and themes that I see benefiting most from AI within China.
The development of autonomous vehicles is a great example of how AI is changing an entire industry. Before AI, autonomous driving was an unrealistic proposition — even with decades of ever-cheaper computing power. AI changes the nature of problem-solving, using far less brute computation and far more predictive analytics capacity. Without AI techniques, the amount of data needed to solve the many decisions, risks, and contingencies associated with autonomous driving would be orders of magnitude larger than existing data sets. New prediction techniques have made the challenge more tractable.
Companies producing components and sensors that coordinate tasks like steering, braking, and parking could benefit tremendously from the adoption of self-driving cars. This brings us to China. Chinese automakers already benefit from enormous amounts of data and from entrepreneurs working to build self-driving cars. China also has one of the largest automobile-component markets in the world. The government is seeking to become a global leader in the production and use of autonomous vehicles, and has promoted development of this industry by supplying funding and facilitating testing zones, products, and systems.
In my view, health care is probably the largest opportunity for growth in China and the industry most likely to benefit from AI. The concurrent expansion in big data and prediction capacity should be transformative for the fast-growing Chinese health care, pharmaceutical, and biotech industries, which are fervently aiming to match the quality of peer industries in the developed world.
To date, I think the biggest obstacle preventing Chinese health care spending from matching the standards of global peers has been a poor incentive structure for medical professionals and a woefully underdeveloped delivery system. If one considers a diagnosis to be a prediction, then it follows that cheaper prediction technologies can provide health care professionals with lots more diagnoses. AI could enable doctors to work faster and more efficiently as predictions (diagnoses) become more accurate over time, enabling them to treat more patients.
This should increase both demand for and supply of physicians, especially those trained in less-clinically intensive areas like psychology and elderly care. China ranks 27th globally in doctors per capita,3 and while the government is working to narrow that gap, it seems clear that the increased application of AI in health care settings can benefit providers and patients alike.
Predictive technology can provide more customized entertainment experiences and promote virtual consumption. Virtual consumption can open new avenues for economic growth. The marginal utility of consumption diminishes amid greater variety, and in the virtual world, variety is essentially limitless. Gamers increasingly pay real money for virtual products and services such as video streaming, lessons, or tools like special armor or clues that give you an advantage in a video game. Online gaming has been one of the fastest-growing forms of entertainment in China, with revenues expected to surpass 251 billion yuan — US$400 billion — in 2018.4
By lowering costs and expanding the reach of education, I believe predictive technology will lead to greater demand for and supply of educational tools and services in China and around the world. AI can be instrumental in training people in the skills needed to thrive in an increasingly technology-enabled and technology-dependent labor market. One Chinese company has produced a robot that passed China’s medical licensing exam. In time, what’s to say it can’t train humans to do the same?
I think predictive technology, automation, and the Internet of Things will be instrumental in the development of “smart cities.” By collecting and sharing data about activities like infrastructure use, energy consumption, and traffic patterns, municipalities around the world are aiming to make urban living safer, cleaner, and more efficient. According to China’s Economic Information Daily, of approximately 1,000 smart city initiatives worldwide, nearly half of those are in China.5
The electronic surveillance market is starting to use prediction by incorporating facial recognition and other predictive tools. Despite the obvious privacy hurdles that need to be overcome, several leading Chinese players in the surveillance market already sell more than a third of their output outside of China. Many developing countries are prioritizing the potential benefits of smart cities and other management and security systems over privacy concerns.
1 Agrawal, Ajay, et al. “The Simple Economics of Machine Intelligence,” Harvard Business Review, 17 November 2016. | 2 “Top AI Trends to Watch in 2018,” CBInsights, 2017. | 3 OECD.org, 2015 data. | 4 iResearch Global, Inc, March 2016. | 5 ChinaDaily.com, 21 April 2017.
This is provided for informational purposes only and should not be considered investment advice. All investing involves risk. Investors should consider the risk that may impact their capital before investing. The value of your investment may become worth more or less than at the time of original investment. Please refer to the investment risks page for more information.
Views expressed have a six- to 12-month horizon and are those of the author. Views are as of April, based on available information, and subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities.
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