Here’s the part nobody wants to say out loud: we’ve seen this movie before. Four times, actually. Each time, a transformative technology arrived, productivity surged, markets celebrated, and then—slowly, painfully—the economy entered a long stall that nobody saw coming.
The pattern is simple. Technology makes production cheaper and faster. Companies capture the gains. Workers lose bargaining power. Wages stagnate. Demand weakens. Growth stalls. Markets eventually notice, but only after years of pretending otherwise.
We’re watching it happen again with AI. But this time, the shock is hitting cognitive labor, the part of the economy with the highest propensity to consume. That makes the endgame more fragile, not less.
Act I: Manchester, 1811—When the Looms Came ...
Act II: Detroit, 1973 - The Robots Arrive ...
Act III: Shenzhen, 1995—The Great Outsourcing...
Act IV: Tokyo, 1990—The Stagnation Nobody Expected ..
Japan is the cautionary tale everyone ignores until it’s too late.
In 1989, Japan was the envy of the world. Tokyo’s real estate was worth more than all of California. The Nikkei hit 39,000. Japanese companies dominated global manufacturing. The future belonged to Japan.
Then the bubble burst.
But here’s what’s misunderstood: Japan’s problem wasn’t the crash itself. It was what came after.
Japan remained highly productive. Innovation continued. Quality stayed world-class. Companies were profitable. And yet, the economy barely grew for thirty years.
Why? Demographics played a role, but the core issue was demand. Japanese households and corporations became pathologically risk averse. They saved rather than spent. Wages barely budged. Deflation became entrenched.
The productivity was there. The technology was there. What wasn’t there was circulation of income.
The Bank of Japan tried everything: zero rates, QE, yield curve control. Nothing worked, because monetary policy can’t force people to spend if their incomes aren’t rising and their job security is weak.
What Markets Did:
The Nikkei peaked at 38,916 in December 1989.
It didn’t reclaim that level until 2024, 35 years later. Think about that. An investor who bought Japanese stocks at the peak would have waited an entire career to break even. No dividends could compensate for that opportunity cost.
This is what a productivity trap looks like in financial terms: not a violent crash, but a slow erosion of capital. Markets don’t die, they just stop working.
Real estate fared even worse. Tokyo property prices fell 70% and have still not fully recovered.
The lesson is stark: you can have advanced technology, high productivity, low unemployment, and political stability, and still experience decades of stagnation if demand doesn’t circulate.
The Pattern: What the Four Acts Teach Us
These aren’t isolated incidents. They’re variations on a theme.
Every time a major technology or structural shift arrives, whether it’s power looms, robots, global supply chains, or asset bubbles, the same sequence unfolds:
- Productivity surges. Technology makes production faster, cheaper, or more scalable.
- Labor loses scarcity. Workers become more replaceable, either by machines, foreign labor, or platform scalability.
- Wages stagnate or fall. Bargaining power shifts to capital. Compensation growth decouples from productivity.
- Demand weakens. Without wage growth, consumption slows. Debt can mask this temporarily, but not indefinitely.
- Markets initially celebrate. Investors focus on cost-cutting, margins, and productivity gains. Equity valuations rise.
- Reality sets in slowly. The demand problem becomes undeniable. Growth disappoints. Markets enter long, grinding stagnation.
- Policy adapts, eventually. Redistribution, regulation, fiscal intervention. But it takes years or decades.
The timeline varies, sometimes it’s 15 years, sometimes 35, but the mechanics are consistent.
Why AI Makes This Worse
Here’s what makes the current moment different, and probably more dangerous.
Previous shocks hit blue-collar labor: factory workers, dock workers, manual laborers. AI is hitting cognitive workers: programmers, analysts, writers, middle managers, designers.
This group has the highest marginal propensity to consume. They buy houses, cars, vacations, education, healthcare. When their incomes compress, aggregate demand takes a direct hit.
AI also scales differently. A factory robot replaces 5 workers. An AI model can replicate the output of hundreds knowledge workers, instantly, globally, at near-zero marginal cost.
And unlike previous technological shifts, AI isn’t creating obvious new categories of labor-intensive work. When manufacturing automated, service jobs absorbed displaced workers. What absorbs displaced programmers? Delivery drivers?
The mismatch is severe. The jobs being destroyed pay $80k-$150k. The jobs being created pay $30k-$50k. You can’t maintain aggregate demand through that transition without massive redistribution.
Markets are pricing first-order effects: cost savings, margin expansion, productivity gains. They’re ignoring second-order effects: weak demand, political backlash, output quality degradation in high-stakes domains.
Macro Implications: The Coming Regime
So what does this mean for the next 5-10 years?
- Persistent Weak Demand
Wage compression among high-earners means slower consumption growth, particularly in discretionary categories like travel, dining, entertainment, and durables.
This isn’t a recession. It’s a structural deceleration. GDP might grow at 1-2% instead of 3-4%. That’s the difference between expansion and stagnation.
- Central Banks Lose Potency
Monetary policy works by stimulating demand through cheaper credit. But if incomes aren’t rising, households and businesses won’t borrow, even at zero rates.
Japan proved this. Europe confirmed it in the 2010s. The Fed learned it after 2008.
Result: rates stay lower for longer, but growth remains anemic. The yield curve flattens permanently. Recession risk becomes asymmetric, easy to fall into, hard to escape.
- Fiscal Policy Becomes Essential, but arrives late
The only way out is redistribution: public investment, job guarantees, universal services, wage subsidies.
But fiscal policy is slow. It requires political consensus, legislative action, and implementation capacity. By the time it arrives, years of growth have already been lost.
And today, the starting conditions are worse: debt levels are already high, political polarization is extreme, and institutional trust is weak.
- Geopolitical Fragility Increases
Stagnant incomes breed populism. Weak growth reduces fiscal capacity. Tight labor markets disappear. Governments become less stable.
This makes the system vulnerable to shocks—tariffs, energy crises, conflicts, pandemics. In a robust economy, these are manageable. In a fragile one, they cascade.
- Duration Matters More Than Severity
The risk isn’t a 2008-style collapse. It’s a 1990s Japan scenario, no crisis, just endless mediocrity. Growth remains positive but disappointing. Markets churn sideways. Wealth slowly erodes in real terms.
Market Implications: What This Means for Investors
If the macro regime is long, grinding stagnation, what does that mean for portfolios?
- Index Buy-and-Hold Stops Working
Passive equity strategies thrive in secular bull markets. They suffer in sideways regimes.
From 1968-1982, the S&P 500 went nowhere. From 1990-2024, the Nikkei went nowhere. In both cases, buy-and-hold delivered zero real returns for decades.
If we’re entering a similar regime, passive indexing becomes a wealth destruction strategy. You need active rotation, factor tilts, or alternatives.
- Dispersion Becomes Extreme
Even in stagnant markets, some stocks soar. The issue is that the winners are fewer and harder to predict.
In the 2010s, tech mega-caps carried the entire index. Everyone else underperformed. That concentration intensifies in weak-demand regimes because only a handful of companies can keep growing.
Implication: you need to be in the right names, not just the right sectors. Broad exposure doesn’t help if 90% of stocks are dead money. It could be time to rediscover stock picking again. (I’m working on it, feel free to reach out if you’re interested)
- Volatility Becomes Structural, Not Cyclical
Stagnation doesn’t mean calm. It means instability, sharp rallies followed by sharp selloffs, policy uncertainty, regime shifts every 6-12 months.
Japan’s market didn’t decline smoothly. It whipsawed violently for 30 years. Same with the U.S. in the 1970s.
This makes volatility an asset, not a risk. Strategies that profit from dispersion, options, tactical rebalancing, momentum, outperform in these environments.
- Cash and Optionality Become Valuable
In secular bulls, cash is a drag. In sideways markets, it’s a weapon.
Why? Because dislocations become frequent. Panics happen every 18-24 months instead of every 10 years. If you’re fully invested, you can’t capitalize. If you hold dry powder, you can buy crashes and sell rips.
- Gold and Real Assets Strengthen Structurally
When growth is weak and policy is erratic, hard assets outperform financial assets.
Gold thrived during the 1970s stagflation and Japan’s lost decades. It’s not an inflation hedge, it’s a policy uncertainty hedge.
Same logic applies to commodities, infrastructure, and scarce real estate. These assets preserve purchasing power when financial engineering fails.
- Fixed Income Is a Trap, unless you trade it
Bonds offer no yield and no duration protection in a stagnation regime. Rates are already low, so there’s limited room for capital gains from further cuts.
But: if you’re tactical, bonds become a volatility play. Buy when equity crashes, sell when rallies resume. Don’t hold them passively.
- The Tech Narrative Will Break..slowly
Right now, markets are betting that AI companies will sustain 30%+ earnings growth indefinitely. History says this is delusional.
Why? Because AI’s biggest customers are the same companies cutting costs via AI. If corporations are firing knowledge workers, who’s buying enterprise software? Who’s upgrading cloud infrastructure?
Second-order demand effects catch up slowly, which is why tech can stay overvalued for years. But eventually, revenue growth disappoints, margins compress, and valuations mean-revert.
Being right too early is indistinguishable from being wrong. The key is recognizing when the narrative is cracking, not if.
Conclusion: the “Productivity Trap” doesn’t end, it adapts
The productivity trap isn’t a bug. It’s a feature of capitalism when technology advances faster than institutions.
It happened in the 1820s. It happened in the 1970s. It happened in the 2000s. It happened in Japan. And it’s happening now with AI.
The pattern is brutally consistent: productivity rises, labor loses bargaining power, wages stagnate, demand weakens, markets rally on cost-cutting narratives, then eventually grind sideways for years as the structural reality sets in.
What breaks the cycle? Policy. Redistribution. Education. Infrastructure. Social contracts get rewritten, but only after years of pain.
This time, the shock is hitting the cognitive class, the people with the highest spending power. That makes the demand problem more acute. And the policy response more urgent.
But urgent doesn’t mean fast.
We’re likely looking at 5-10 years of grinding, volatile, sideways markets. Not a crash. Not a boom. A slow erosion of returns punctuated by violent swings.
For investors, this means abandoning heroic narratives. No FOMO. No diamond hands. No this time is different.
It means discipline. Risk management. Rotation. Cash as optionality. Tactical exposure. Asymmetric bets.
The winners won’t be the ones who believe hardest in the AI revolution. They’ll be the ones who understand why productivity alone isn’t enough, and who position accordingly.
Because when incomes don’t circulate, nothing else matters.
