For as long as one can remember the path to a better future began with a college degree. Especially in emerging markets where college graduates used to be a scarce commodity this was particularly true. In small, rapidly growing markets the scarcity premium was high. Even public sector jobs paid a substantial premium for college graduates while providing them with job security.

There was also a certain respect for college graduates over and above their economic value which today seems quaint. The disciplines of choice were medicine, law, the sciences, followed by the arts. Economics, business and commerce were subsumed under the arts and have not commanded a premium in either prestige or remuneration.

As with all human endeavors extrapolation, mistaken strategy, slow reaction times have led to a certain cyclicality in the supply of certain trades. The 3 to 4 year gestation of a college degree, (sometimes longer as in medicine for example) also exacerbate cycles as supply lags demand.

A college education has a strong element of signaling embedded in it. Often the precise content of the degree courses bear little relevance to the jobs the graduate actually obtains. Generalist degrees prepare the individual for a wide range of jobs by equipping them with a spectrum of abilities and skills. The MBA is a prime example. The MBA may be specialized with particular accents but is usually sufficiently diverse in scope to equip its bearer with generalist skills to tackle most problems. It’s value lies in its versatility; it can be thought of as an option whose value depends on the diversity of jobs it opens up to its bearer. Be that as it may, the unemployment problem is best addressed by more specifically meeting the labour demands of the economy. Wage transparency should be encouraged to signal the evolution of demand for different types of labour to encourage supply. Current wage data is noisy and suffers from agency issues. Individual’s pay is often secret. First and second moment aggregates and time series should be published to improve he dissemination of labour market information in the economy.

Broadly, finance, managerial, social sciences are oversupplied while the sciences, engineering and the professions are under supplied. Some disciplines are easier than others in terms of obtaining a degree. The hard sciences and engineering are more difficult or considered dry subjects whereas social sciences are more popular, the professions have purposefully established high barriers to entry to encourage under supply but each discipline has its own supply dynamics.

Wages are not just determined by demand and supply, individuals are rewarded based on the return they generate for their employers. Employees are paid depending on their marginal product as well. Certain industries command more assets per person and thus are able and willing to pay higher wages. The highly leveraged financial industry is one such industry that tests the limits. Service industries, and intellectual property based industries also exhibit this capital efficient feature that leverages assets per employee. Consultants offer another good example.

The mismatch between supply and demand of jobs leads to increasing inequality of compensation. Under-supplied labour markets face rising wages and remuneration while oversupplied sectors see unemployment and wage stagnation. Income inequality is not sustainable over the long run. Apart from building social pressures, a rich poor divide encourages Socialist progressive and redistributive tax policies. Governments are vulnerable to such populist policies at a time when they struggle for legitimacy and a balanced budget. This will delay enlightenment in tax policy and keep marginal tax rates high while tax revenues languish and economic growth stagnates.

A more promising goal must be to provide as much information as possible about the demand for jobs in order to facilitate their matching and to encourage effort and enterprise through friendlier tax regimes. In addition to helping allocate resources to training, try content of each course should be made more practical. Purists may argue against this but ultimately the labour market will decide. A theoretical foundation without practical delivery is a waste. Application without fundamental basis is incomplete and risky. While the purists have defended learning for learning’s sake it is expected that pragmatism will prevail. Underfunded universities dependent on government subsidies will eventually be swayed towards a more utilitarian curriculum. Time will tell if this is efficient.

Dynamic systems involving human behavior are invariably cyclical as a result of delays in signal interpretation, reaction times, gestation periods and extrapolation. The soft disciplines such as he arts and social sciences will likely see a contraction in supply while engineering, the hard sciences, and professions will likely see an adjustment upwards in supply. Between science and engineering, immediate demand favours engineering while longer term demand requires scientists. Short term-ism may prevail as corporate management and government tenures favour shorter horizon investments.

A further factor in employment is risk. 30 years of stability, Great Moderation, low volatility and risk mitigation has led to individuals being more willing to accept greater career risk in return for higher reward. The financial crisis of 2008 was a turning point. In the immediate aftermath of the crisis and recession individuals clearly struggled to reconcile risk and reward, many seeking the rewards available in the past but refusing to accept the risks associated with the new landscape. Individuals are already adjusting their preferences and many now seek stability over reward.

Western governments with unsustainable fiscal cash flow characteristics are trying to limit the growth of public sector jobs. In the Emerging Markets which were able to navigate the crisis, healthier balance sheets and cash flow may afford latitude in increasing public sector employment. In any case the demand for public sector employment will likely outstrip supply at least on a relative basis across the globe.

How is the global economy evolving in terms of demand for talent? What are the relevant skills for the next few decades?

How should and how will education respond and evolve to address the needs of the economy going forward?

What are the implications of the evolving nature of labour demand, supply and production on innovation, risk and growth?

These questions will not be answered quickly. The answers will be revealed over multiple years.

Tangent:

There are other factors as well such as automation and robotics where machines may replace or compete with humans in filling certain functions. Repetitive, hazardous, unrewarding tasks will likely find some sort of automated solution. Yet it is not clear how efficient robots will be at replacing humans in a given job. Humans will have a monopoly over certain types of jobs which require that hard to define ‘human touch.’ Even this criterion is a moving target as the abilities of robots adapt and evolve. What is also interesting is to understand the economics of a world where robots are a viable competitor for most if not every job. As robots perform more and more functions, will this create more unemployment? Who owns the robots? Is a more utilitarian economy one that lends itself better to automation and is thus more vulnerable to having machines replace humans? It is well to argue that automation may create more new jobs but it is more reassuring to those about to be replaced if they knew what those jobs might be so they could prepare to fill them. In the limit, if every job was done by a machine, then who owns the machines becomes a very important question. Also, how do people who have no work and do not own machines generate income?

Instability: Macro, Banking and Agency:

Thirty years of prosperity, falling interest rates, rising stocks and bonds, moderate inflation and widening inequality of wealth within nations had led to an unstable position. While inequality has receded between countries, it had increased within countries regardless of their economic model or system of politics.

The financial industry was not alone in seeing greater inequality of remuneration and reward but it was the extreme example that stood out when matters came to a head in 2008. The financial crisis was not the simple product of these imbalances which included imbalances within economies and between them. The current account imbalance between East and West, the export dependency of China and other Asian economies, the consumption dependency of he Western economies were contributors to the instability in the system, but no single factor precipitated the crisis. Neither was 2008 such a milestone in the dynamics of this theme in history. It was certainly no terminal point, more of an important node. What it did do was to expose the failure of principal agent relationships by focusing public attention on their particular manifestation in the financial industry.

Leverage in the banking system had increased steadily over multiple decades. There are a number of reasons for this including greater diversification of business within banks, a great moderation of volatility resulting in higher model prescribed optimal leverage, a non-trivial dose of complacency, and diminishing marginal returns to scale. The Basel framework for prescribing appropriate levels of capital to be held in order to absorb the riskiness of assets was a reaction to reign in excessive leverage. Central banks recognized that in the event of a sufficiently large bank failure they would have little choice but to bail out the errant bank in order to secure the system as a whole. This was a reality not lost on the banks.

The intellectual capacity dedicated to the financial industry is considerable. Banks, insurance companies and hedge funds hire mathematicians, physicists and engineers among a wide array of scientists to help them make money. They also hire legal and regulatory minds of the highest calibre to help them to engage with regulators. No wonder then that regulators efforts to control the behavior of financial institutions have been confounded at every turn.

An example of this was the growth of the so-called Shadow Banking industry, a system of financial institutions which operate largely beyond he control of regulators by eschewing deposit taking and other retail investor interface. In the years leading to the 2008 crisis banks created massive off balance sheet entities such as SIVs, which were little more than off balance sheet banks with complex capital structures designed to run unregulated, and CDOs which had a similar structure with a few additional stabilizing constraints. These structures allowed the application of almost boundless leverage which escaped he regulators’ control if not scrutiny. As a system therefore, leverage surged beyond he estimation of the regulators and conventional metrics.

The attraction of the financial industry was precisely this leverage seen from a different angle. For a given capital base the financial industry offered the highest per employee assets of any industry. Since labour is compensated with a proportion of its marginal product, labour naturally seeks such industries out which deploy more assets per person. Pay levels and bonuses in the financial industry surged attracting he brains which would perpetuate the increase in assets per employee.

Diminishing marginal returns afflict even the financial industry. It is necessary to increase assets per employee but it is not sufficient. In order to generate high levels of pay and bonuses returns on equity capital need to be maintained, grown and maximized. This is the principal agent contract. Shareholders will only tolerate high payouts if the custodians of their business are generating sufficient returns on their equity capital. As the size of the system’s combined balance sheet grew, too much money was chasing too few opportunities. Returns on assets understandably fell or moderated leading managers to increase leverage in order to maintain returns on equity. The principal agent compact is incomplete in that it fails to address the prospect of losses. An agent is paid a basic salary to cover living expenses, or so the theory goes, and paid a share of profits. In order to retain talent and to align interests a portion of the years bonus is retained for a number of years usually 2 to 3 years. Unfortunately there is usually no clawback so contracts do not prescribe for losses. Traders who lose a sufficient amount of money are either fired or incentivized to leave the firm rather than work for free. Since contracts provide agents with upside but no downside they resemble call options and option pricing theory advises that the value of an option is highly dependent on the volatility of the underlying instrument or asset. Agents are therefore incentivized to increase the riskiness of their portfolios in order to maximize the value of the option which they hold.

In the wake of each crisis come regulations to prevent recurrence. Glass Steagall which was enacted during the Great Depression was repealed during the Clinton administration as the world came to accept the Great Moderation. The 2008 financial crisis has led to reconsideration and the introduction of Dodd-Frank with similar content and intent. Basel 3 is another piece of regulation intended to stabilize the banking system, among a slew of other regulations. Each new regulation comes with its own complications and unintended consequences. Basel for example, starves the economy of credit while governments are trying to reflate their flagging economies. Gradually, the shadow banking industry is expected to rise again as mainstream banks are hobbled by regulation. Talent can be expected to bifurcate to the safest banks and to the unregulated shadow banking institutions, at least until a clearer future emerges.

In early 2012 it gradually became apparent that the world was slipping into a synchronized slowdown. At least it became gradually apparent to slower minds like this one. By mid 2012 it became quite clear that the US recovery which started in August or September 2011 was petering out, Europe had never really picked up since the Summer of 2011 when Greece first exposed the vulnerability of the Union, and China’s slide was gaining momentum. In the last month we have seen better numbers from China, continuing weakness in Europe and in the US, a rebound in the real estate market if nowhere else in that economy.

What are governments hoping for and working to? The scale of the debt problems whether in the West or in Asia are too much not to enlist the aid of time. Some call this kicking the can down the road. Its not a good strategy, on its own, but its not a bad strategy if it buys sufficient breathing space to address more fundamental problems. The problem in Western democracies is that the gestation of such policies extends beyond the election cycle.

Lets make a to do list for a garden variety sovereign in a bit of a tight spot.

1. Increase real GDP growth. This is hard to do. Increase nominal GDP growth. This is also not easy without fiscal intervention which is constrained by budgetary issues. Keeping a low but positive real or nominal GDP growth seems to be the easiest best that one can do.
2. Reduce unemployment. This depends on the success of 1 above.
3. Keep inflation high as long as it does not surface in official statistics or lead to social unrest. This should debase debt without damaging officially measured real GDP growth.
4. Keep the banking system functioning. Only Europe has a real problem on this point. The US has recapitalized its banks and Asia looks healthy for now. The opacity and complexity of banks’ financials mean that this problem never ever truly goes away. Vigilance is required at all times.
5. Keep interest rates low. Facilitate the refinancing of the government and other credit strapped institutions. QE suffices for now in achieving this aim. Ideally there will be sufficient demand for government debt that debt monetization can stop. Low interest rates are necessary for an over-indebted world. If interest rates rise the implications for large swathes of the economy are highly negative.
6. Keep a competitively low exchange rate. The world’s economies cannot all simultaneously operate this strategy successfully. Yet attractive terms of trade are necessary to keep the export sector supported. In a sufficiently globalized world excessive success of one country can likely lead to instability for its trading partners making any such success short lived. Low FX volatility is good for all.
7. Balance the budget. This is almost intractable but it needs to be addressed at some point. By addressing refinancing risk in 5 above, central banks have bought time for governments to at least turn the budgets in the right direction. The longer term goal of balancing the budget is of course to reduce the outstanding amount of government debt and improve.

The above is a realistic, practical and feasible strategy to pursue, subject to a few limitations.

1. The time bought by debt monetization might not be well spent. There are many issues to address and the extra time obtained by debt monetization is finite. Many things can go wrong.
2. The scale of the problem might be bigger than everybody thought. This is a serious risk and one that can come from the banking system or sovereigns hiding the scale of their solvency issues.
3. Central banks are unable to reduce the banking system’s balance sheets sufficiently quickly in the face of accelerating inflation or recovery. Point 3 above is a risky strategy as it assumes that a desired level of inflation can be sustained without accelerating beyond targets.
4. Investors’ patience runs out before the root causes of the sovereign crisis are adequately addressed. This can lead to higher interest rates even in the absence of inflation or recovery and can threaten the cash flow solvency of sovereigns. Companies’ cost of debt would likewise rise. Given the current low levels of interest rates, the immediate impact on debt service could be severe. The stock market may also give up which would damage sentiment and cause a recession or depression.
5. Debt monetization and fiscal reflation are redistributive policies. The proposed redistributions may prove unpopular and precipitate a reaction.

The strategy is not entirely without merit and not completely hopeless, but there are serious risks, some of which have been understated above.

The yield on high yield bonds is not very high.

The ability of an insolvent concern to raise debt can stave off insolvency.

• I’m sorry, I can’t pay you in silver or gold, will you take an IOU?
• But that’s what you said last time. Can you pay off the last IOU?
• Will you take paper money? 

• Who is going to lend us money?
• Well, we are.
• What? We are going to lend us money? Why? How?
• Its simple really. You ask for a loan and we will give you one.
• With what money?
• With the money you borrowed from us.
• I see. Quite elegant if I may say so. How will we repay it?
• You’re going to have to balance the budget.
• That’s problematic. We can’t raise taxes.
• We don’t want you to. Can you spend less?
• We could but if we did I’m afraid that apart from healthcare being completely underfunded, unemployment benefits and other social welfare costs are not likely to abate.
• In that case you’ll need to raise taxes.
• We can’t. If we did the drag on the economy would put us back in recession. And tax receipts might fall. As it is we have cash flow problems. That’s why we need to borrow some money. The problem is no one will lend us any.
• Don’t worry, we will. But you will have to balance the budget.
• That’s problematic…

The better game show host won.

Since the great transfers following the great crisis of 2008 and the realization that debt levels had surged out of control, inflation has seemed like a tantalizingly viable and easy solution to the debasement of debt.

It is clear that central banks and governments would be encouraged to create as much inflation as possible as long as this inflation is not picked up in official data. So far their efforts have led to an asset bubble in bonds and emerging market assets and currencies. It seems as though the results of quantitative easing are invariant to the perpertrators of QE, that is, you can print but you cannot direct. The liquidity will flow to where the liquidity will flow. For emerging markets this has been a painful side effect of Western government’s efforts to save their own skin. For Western governments this has been frustratingly like blowing up a punctured balloon.

Those who support these inflation policies should understand that economics is not physics or chemistry and that inflation targeting and debt erosion tactics are a bit like running a nuclear reactor. A controlled chain reaction in a nuclear reactor provides heat energy which is harvested. The key word here is “controlled”.

Given their explanatory and forecasting track record of economists and central bankers, would anyone like to entrust an economic nuclear reactor to them?