How Can We Introduce Technology in an Economic Model?

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Space Station (Photo credit: Wikipedia)

Many people think that everything can be introduced in an economic model, however, innovation and technology are not easily measurable. A model based on magnitudes that cannot be measured is not useful to make predictions about the future.

At macroeconomic level, some models include the technology level inside the production function. We cannot measure directly the technology level, but we can estimate a value looking at the historical sequence solving a certain equation system assuming that the technology level  do not change greatly in a period of a few years. Innovation (a remarkable increase of the value of the technology level) would not be easily identified with a short historical sequence and it will be only a source of uncertainty in this kind of model.

On the other hand, perhaps, we should start following the opposite route introducing economic magnitudes in technology models because this approach has been developed yet. Engineers do not think in technological terms only, an engineering project is done always following both technical and economic aspects. Then, there is, clearly, a way to model future considering technology and economy simultaneously in certain fields.

But, why cannot we get a similar macroeconomic model to forecast? There is a clear reason: planning.  We can try to predict the future of a technology investment because the technical part is planned, however, the technology level produced by innovation, and then, the increase of productivity at the production function when we are looking at macroeconomic level cannot be planned. At this level, we can prepare budgets related to innovation expenses but we cannot determine the incomes that a future (and unknown) innovation will produce in the future.

Innovation includes two sources of uncertainty, there is market uncertainty (uncertainty linked to the acceptation of the innovation by the customers) and there is technology uncertainty (uncertainty linked to the capability of the society to provide that increase of technology level).

If we are thinking in macroeconomic terms, we can introduce an additional source of uncertainty: political uncertainty. At microeconomic level an investment in innovation is analyzed in terms of cost-benefit, however, when we are looking at the big picture things can be very different. Governments promote different technology areas using several mechanisms due to political reasons exclusively. The technology development, and then, the technological level and the productivity of the economy, can be very influenced by political decisions. For instance, in the energy sector, different governments have different visions about the goodness of some technologies. Some political parties provide support for nuclear or renewable energy and other ones can try to stop their development. As different technologies have different degree of development and different effect on the production function of the macroeconomic model, this uncertainty would have a great influence on the goodness of the economic model. Governments change every four years in most countries while the development of technologies that can have significant influence on the economic model usually requires a lot of years more.

In other words, we can say that, sometimes, economists forget that the higher the technological level the higher the complexity of the economy. A complex economy would imply in mathematical terms a model with a lot of equations and parameters and a lot of uncertainty linked to the parameters. Our capability to forecast would be reduced drastically. But, if we prefer to visualize this fact in more practical terms, we can use the following example: While the technological level increases, the requirements of specialization of the workforce do too, and then, for instance, the relationship between employment and labor costs changes. We cannot suppose that reducing the labor costs the employment will increase in a linear way, because the labor market is going farther a market of perfect competition when the technological level increases due to the effect of the requirements of different technical knowledge of the working staff. Any action that tried to change directly the labor costs would be worse than an action that tried to make the market more flexible in order to simplify the economy. Good actions for economies with lower technology level could be harmful for an economy with a higher technology level due to the difference of complexity.


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