Archive for January, 2015

Sisyphus determined

January 26, 2015

Let us assume that come daylight, all creditors of Greece’s public sector officially declare either that they completely write-off the country’s public debt, or at least that for the next ten years they freeze all principal payments and also, they freeze any interest accrual. Why am I making this impossible assumption? In order to focus on what is the real socioeconomic issue here, which is making the level of the economy’s operations analogous to the population: this is my fancy way to talk about unemployment.  And in Greece we have 1 mil unemployed more than we used to, before the crisis. Let’s approach this challenge a la Enrico Fermi.

Let’s say we have no public debt to worry about and all we want is to create 1 mil jobs (this is almost 9% of the Greek total (not working) population, to get an idea of what we are talking about), without splitting the current pie to more workers. And let’s say we ‘re reasonable and mid- to long-term : we plan to spread evenly these 1 mil new jobs over the 10-year period during which the counter on the public debt will be frozen, relying on (off-line) social networks and home production to take care of those people that will remain unemployed for all these years. In what follows all prices are 2013.

So we want to create 100,000 jobs per year for the next 10 years. Let’s put the figure of the yearly raw labor cost (full-time yearly equivalent) at 14,000 euros (including social security, income tax and disposable income). Since in the private sector we still pay out 14 salaries per year, this is 1,000 euros cost per salary (which if we subtract employer’s contribution to social security, corresponds roughly to where the new government has said it will set the minimum wage).

14.000 euros X 100.000 jobs = 1,400,000,000 euros (EUR 1.4 bil) yearly. Now let’s remember undergraduate production theory that states the self evident, that output is given to the factors of production as payments. Remembering also the lessons from Growth Theory, the “traditional” split 2/3 (Labor) – 1/3 (Capital) should be adjusted to ~50-50, especially if we include Human capital in Capital. Since we have calculated payments to Labor at the minimum wage level, it is reasonable to do so.

The important thing to realize is that this “split” is not just a distributional issue -it also reflects how much capital services flow is needed in order to make production happen. So we want another EUR 1.4 bil in value of capital service flows yearly to make production corresponding to 100.000 jobs happen (and let’s assume that local/international demand for this production is guaranteed).

1st conclusion: to create 100,000 jobs yearly we need EUR 2.8 bil. additional Gross Domestic Product yearly (2013 prices).

Let’s assume that Capital lasts on average 10 years (which is reasonable since we are not talking about buildings as we will see below). Adopt the straight line method to calculate capital flows, and we arrive at

2nd conclusion: to create 100,000 jobs per year for the next 10 years, we need 14 billions of new capital investment every year for the next ten years, while keeping also wages fixed for the duration.

Currently (2013), gross capital formation stands at EUR 21 bil. But this is EUR 13 bil. less than consumption of fixed capital. We need this to remain constant so as not to lose additional jobs. So

3d conclusion: to create 100,000 net new jobs per year for the next 10 years, we need Investment to jump from EUR 21 bil.  to  EUR 48 bil yearly (EUR 13 bil. additional replacement-Investment  + EUR 14 bil for the new jobs).  This is a mere (48/21)-1 = 128% investment increase from current level.

2013 Gross Domestic Product was EUR 182 bil. So current gross capital formation stands at 20/182 = 11% of GDP, and we want it to go to

4th conclusion: to create 100,000 net new jobs per year for the next 10 years, investment must rise to 26% of DGP (permitted to gradually fall as GDP increases over the years).

Greece has seen 25% of DGP of gross capital formation for some years during the 2000’s – but 15 percentage points out of the 25 were due to residential housing -and no one should expect anything remotely close to this figure from that sector in the years to come.

5th conclusion: to create 100,000 net new jobs per year for the next 10 years, we need 25% of GDP in traditional, directly productive new investment -machinery, equipment, technology, training -every year.

Granted, currently there is idle capital due to the crisis. But a large part of it is residential houses, office and retail space and equipment, and low-level machinery. Granted also, there are natural resources, starting from the natural environment itself and its touristic potential. I am not in a position to estimate how much these can contribute to the + EUR 27 bil. needed in investment, but my feeling is not critically much.

How boring: where are international economics, European Union, financial markets, quantitative easing, exports, and all the rest of the sparkling heights of the modern global economic system?

Well, all these are just ways to get what is needed and manage the process. We can fight it out regarding how to do it, but we must know what, and more importantly, how much is needed. We may baptize it as we want, we may envision whatever scheme, system, process, mechanism we want -in the end it is +EUR 27 bil, and EUR 48 bil. total, of productive resources that somehow must be invested in this land, yearly, for 10 years in a row.

But hey, in this modern international economy that we live in, productive resources can come from somebody else’s present in exchange for our future: this is my fancy way of talking about debt. And since in this scenario the public sector has no debt, we can borrow the funds, right? Isn’t this what “modern states do”? I will comment on this prospect, that I am pretty certain it is under consideration in some corners with the current debt being alive and well and not frozen, with another picture:

Sisyphus brain

That was a nice way to start the year. My paper  Vintage megaphone“Introducing the Influential Expectations Hypothesis for Aggregate Expectations, with an application to the Optimal Growth model”, which is essentially the first part of my PhD (still in progress of course), was one of the three papers that received an award from KEPE in a competition among papers that contained unpublished research from ongoing or finished PhDs. And today was the ceremony of the thing (I guess KEPE will issue a press release for the matter in the following days). The three awards were of equal standing.

What is “Influential Expectations Hypothesis(IEH)? In short, a new Hypothesis on how aggregate expectations on economic variables are formed.

Why should we care? For three reasons: [1] The global economic system as well as national economies are clearly not in a state of “long-run equilibrium” in the last 25 years. This means that we need models that deal adequately with short-run dynamics and economies in transition. [2] The recent global “Debt crisis” highlighted once more the importance of Expectations in bringing about wild fluctuations and crises. [3] The current Hypotheses we use (predominantly Rational Expectations but not only), are either not too friendly towards short-run dynamics, or too quickly come to rely exclusively on simulations in order to solve the models (respectable, but I always had a thing for analytic solutions).

[1],[2],[3]=> Try new expectations formation hypotheses (among other directions of research).

And this is what I did with IEH. Being a foundational subject, it has applicability to any stochastic macroeconomic model whatsoever -this means that [a] it can be exhaustively tested at the theoretical level and see whether it produces new/different results and [b] it can then be exhaustively tested against the data. Will it stand these tests? This is what I am going to find out. Its application on the most basic Optimal Growth model produced indeed new results, and my problem now is to choose the next step from all these  possibilities for theoretical and empirical application. But that’s a good problem to have.

Tom Waits megaphone Since I will submit the paper for publication in peer-reviewed journals, I stop short of describing what the Influential Expectations Hypothesis actually assumes, but of course, the two great pictures here (the vintage and the Tom Waits one), have something to do with it.