September 2012: On the Road to an Analysis of the Real Economy

2011 Ferrari 458 Challenge Race Car Engine

2011 Ferrari 458 Challenge Race Car Engine (Photo credit: Netcars.com)

Economics is the science that studies how a society organizes its money, trade and industry, but sometimes we forget the differences between economy and finances. Economy has a physical sense and many economists usually refer to it as real economy. The basement of economy is the physical transformation of raw materials into consumer goods through industry and their physical distribution through trading.

If finances are not real economy, we can think that finances are some kind of virtual economy. This cannot seem odd but, in fact, today many physical devices have incorporated virtual mechanisms inside. Today the engine of a car can be controlled by an electronic chip programmed with certain rules. This chip is a physical device, but the software is different, you can remember an old description of the difference between hardware and software: “If you can kick it, it’s hardware”.

The introduction of more bank notes by the central bank in the flow of money is not the result of a physical behavior; it is a technical artifice to improve the performance of the economy. It is true that we can kick a ball of bank notes but we cannot kick its value that can be changing in the financial markets while we are moving our leg.

But we must analyze this in deeper. In a virtual world, we can define our own rules, and any system will evolve following them. In a virtual device connected to the real world this is not true. Any general knows that to win a war is not as easy in the battlefield as in a virtual simulator.

When we connect a virtual device to a physical system the dynamics of the full system changes too. The reason because we introduce a control device in a physical system is to make it more stable and controllable. The advantage of the virtual technology is that we can design easily our own rules searching for a certain dynamic behavior of the whole system. But, here it is the key of the problem. Any introduction of financial artifices in the financial system is providing a new dynamic behavior of the whole system that can make it more or less stable.

When an engineer designs a controller for a mechanical system he previously measures a set of parameters of the system dynamics, he extracts a model of the dynamic behavior with enough precision, and finally he calculates mathematically a proper controller for a certain searched dynamics. This is very different to the blind introduction of complex financial products with an unknown dynamics in a highly complex system with a dynamics that cannot be modeled with enough precision in a very uncertain environment. The results are clearly very different too, how recent history has shown.

We need to remember three important things from the previous exposition:

          Real economy has physical laws that always must be considered.

          Financial economy should be analyzed in terms of improvement of the whole system in stability and manageability.

          An Economic system cannot be usually modeled with the same precision as a mechanical one. Financial models can be useless to calculate financial controlling artifices.

To illustrate this previous essay I am going to show a little example.

Real production needs consumption of real energy:

Graph 1 Total Energy Consumption of Spanish Regions. Data Source INE (Spanish Government)

As we can see, Catalonia has the higher consumption of energy in Spain. The reasons are associated to its productive model with high component of industry.

But this piece of data cannot be considered as a true indicator of the performance of the real economy for many reasons. These are a few ones:

          Workforce is another kind of energy consumption. Romans could build roads all over Europe with a lot of men and animals fed with food only. Although today, we prefer a few bulldozers fed with petrol due to obvious reasons.

          Consumed energy in a certain activity depends on the applied technology.

          Different resources provide different economic activities.

          Professional services activities as machinery development are not requiring a great amount of energy but they have a high added value for the industrial activity and a direct reflex on the GDP.

As this indicator does not seem very good, it should be better to analyze this piece of data over the GDP. The results are shown now:

Graph 2 Consumed Energy over GDP. Data Source INE (Spanish Government)

This graph can show the performance in the use of energy for economic production. The lower the figure the better the economy is in terms of energy consumption.

The GDP of the region of Madrid is very similar to the GDP of Catalonia and the population is similar. However, its economy is much more efficient in terms of real energy consumed (3.75 times). This indicator would be showing a region as an engine that uses energy and turns it into money instead of kinetic energy.

The differences between these regions depend on different factors but they are not related to the financial system. They have the same currency and all Spanish banks, or at least all Spanish large banks, are operating in both regions with the same financial products. The differences will depend on:

          The productive activities selected.

          The own material and human resources that can be used.

          The way that they are applying the financial resources.

On the other side, we can see that La Rioja is a region with low energy consumption but a consumed energy over GDP indicator similar to the Catalonian one. This can be showing a problem of inefficiency of its real productive model.

 

 

 

 

 

Mr. Luis Díaz Saco

Executive President

saconsulting

advanced consultancy services

 

   Nowadays, he is Executive President of Saconsulting Advanced Consultancy Services. He has been Head of Corporate Technology Innovation at Soluziona Quality and Environment and R & D & I Project Auditor of AENOR. He has acted as Innovation Advisor of Endesa Red representing that company in Workgroups of the Smartgrids Technology Platform at Brussels
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2 thoughts on “September 2012: On the Road to an Analysis of the Real Economy

  1. Alexander KOPRIWA says:

    This indeed is a sound a clear clarification of the essentials:
    1) Energy
    2) Economy
    3) Environment
    Why can we not find leaders capable of steering the Titanic correctly?
    Alex

  2. Tim says:

    But GDP itself, as reported, is a lie. Headline GDP should be adjusted by the fiscal deficit to identify real GDP. In the long run that is what really matters. Countries complain about “Austerity” but the truth is that massive fiscal stimulus continues……..

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