Investment Matters

Leviathan Reorganised

Since at least AD 1651 there has been debate amongst citizens and rulers alike, regarding the exercise of power and the proper role of the state.

Today, in a COVID challenged world where change is measured day to day, it is fascinating to consider that the idea of a social contract was introduced more than 350 years ago with Hobbes’ Leviathan.

Despite the passage of time, the concept remains central to our modern experience.

Whilst Hobbes argued absolute power of the sovereign was justified by the consent of the governed in exchange for a guarantee of peace and security, its broader application justified any political principles or arrangements by appeal to the agreement that would be made among suitably situated rational, free, and equal persons.

Today, as the world peers post COVID, contemplating an increasingly aggressive China with a lifetime president in Xi Jinping, many nations, including the United States are reimagining the role of government in the nation's industrial and information economy.

This week we were drawn towards a recent publication by The White House titled “BUILDING RESILIENT SUPPLY CHAINS, REVITALIZING AMERICAN MANUFACTURING, AND FOSTERING BROAD-BASED GROWTH”.

As the name suggests, the American leadership has analysed the political and economic weakness of the current organisation of global supply chains in key areas of the global economy. It foresees an increased role of government intervention and additional investment, in building resilience against this.

In short, the scope of the social contract is changing, as weaknesses emerge in the current model of security, peace, and prosperity. These changes provide an opportunity for patient, active, long term investors.

The report

The White House report covers four industries (below). These are the first of ten highlighted sectors of the economy that the US Government is reviewing:

  • semiconductor manufacturing and advanced packaging;
  • large capacity batteries, (like those for electric vehicles);
  • critical minerals and materials; and
  • pharmaceuticals and advanced pharmaceutical ingredients

The tone of the report is well expressed in the covering letter;

…steps to strengthen U.S. manufacturing capacity for critical goods, to recruit and train workers to make critical products here at home, to invest in research and development that will reduce supply chain vulnerabilities, and to work with America’s allies and partners to strengthen collective supply chain resilience. Both the public and private sector play critical roles in strengthening supply chains...

The ironic similarity to Strategic Emerging Industries, a section of the Chinese Five-Year Plan, cannot be dismissed as coincidence. Following more than forty years of the free development of markets in the USA, the changes envisaged in the new supply policy are significant.

Implications: the US and clients’ international holdings

History shows that powerful investment thematics have emerged during similar transitions. These include the liberalisation of markets post WW1, the dividends of peace during the 1950s after the institution of the Marshall Plan, the huge investment during the US Corporate and Social contract of the 1960’s and the rapid acceleration in globalisation after the Berlin Wall fell.

Companies emerge, monetary policy changes, inflation risks appear and relative value changes. We believe such periods, including today, are well-suited to active, patient, long-term investors.

As Victor Schvets at Macquarie Bank highlights, the White House report declares the end of unconstrained globalization. This has come during a time where there is a shift to strong and pervasive industrial and state policies, coupled with “unmatched intellectual assets”. The combination of these factors is likely to drive fundamental change in the US economy.

Implications: Australia

We are not holding our breaths for similarly considered public policy in Australia. However, we note the fabulous pedigree Australia has in similar policy areas, the calibre of our intellectual assets, and our ability to punch “above our weight” on occasions when multi-lateral co-operation is desirable.

More optimistically the past twelve months have shown our governments, of all flavours, are increasingly confident that in the face of existential or critical challenges, we need to spend to support the economy.

With respect to supply chains, it has been disappointing that is has taken the dramatic events such as a shortage of PP&E or semi-conductors to remind nations of the risks of globalisation.

Detractors of more interventionist policies have missed the range of spill over benefits that come from strong industrial policy, public and private investment in research, and broader improvements in the resilience of supply chains.

Spill-over effects of changing industrial policy include higher productivity, capital deepening and rapid skills transfer, as firms across an economy benefit from a technically trained workforce and strong investment in R&D. Such benefits extend to a range of companies we invest in.

Implications: your portfolio

The Australian economy, the listed companies on the share market and crucially clients’ portfolios are well placed to leverage these trends.

Global supply chain reorganisation provides our nation an opportunity to diversify away from population led growth.

Whilst the White House report envisaged a degree of separation from China, clearly the Australian position is more delicate, and will require more nuance.

For instance, realising value from our endowment of iron ore for instance relies on a global supply chain with China. Even with a light touch, risks are elevated and remain a consideration we actively manage.

At the portfolio level, the fabulous performance of Lynas (a producer of rare earths) in FY-21 is supported by the report. In addition, clients own a variety of other materials important for batteries and broader industry.

We expect to make an investment in another company likely to benefit from these changes in the coming weeks.

Should Australia embrace a similar approach to leverage our human capital and natural endowments there many opportunities for our companies in the four sectors of the economy mentioned, along with others.

These include public health and biological preparedness, information technology industrial base, energy sector and supply chains for production of agricultural commodities and food products.

The Hobbes of history would caution short-sightedness and a political economy dominated by the pursuits of individual actors. The Leviathan may indeed augur a new social contract that your portfolio can leverage.