The NEMESIS Reference Manual Coordination Erasme Team,France Prof. P. Zagamé B. Boitier,A. Fougeyrollas,P. Le Mouël Core Teams National Technical University of Athens, Greece Prof. P. Capros,N. Kouvaritakis Federal Planning Bureau, Belgium F. Bossier,F. Thierry, A. Melon The NEMESIS model had been partially funded by the research programs of the European Commission 2 Contents Introduction to NEMESIS 8 I. The core economic Model 15 I.1. Current version of the endogenous technical change module . 15 I.1.1. The stock of knowledge . 16 I.1.2. From stock of knowledge to innovation . 17 I.1.3. innovation to economic performance . 18 I.1.4. Calibration in the model . 21 I.2. New production functions with embodied endogenous technical change and skills . 21 I.2.1. Multi-level, putty-semi-putty CES production functions . 22 I.2.2. The Endogeneization of Technical Change . 26 I.2.3. Estimation results . 33 I.3. Households’ final consumption . 47 I.3.1. Aggregate consumption . 47 I.3.2. Allocation of aggregate Consumption . 49 I.4. External trade . 54 I.4.1. Intra-European trade . 54 I.4.2. Extra European Trade . 57 I.4.3. Imports and Exports prices . 59 I.5. Wage setting . 61 I.5.1. Theory . 62 3 Contents I.5.2. Model . 63 I.5.3. Data . 64 I.5.4. Results . 68 I.6. Labour supply . 75 I.6.1. The data on participation rates of working-age population . 76 I.6.2. Determinants of participation rates . 78 I.6.3. Calibration of labour supply . 83 I.7. Taxation and subsidies . 87 I.7.1. Institutional sectors accounts . 87 I.7.2. Public finances . 87 I.7.3. Focus on most important taxations system . 89 I.8. Sectoral Interdependencies . 92 I.8.1. Demand flows to products . 92 I.8.2. technological progress interactions. 95 I.9. housing investments . 98 I.9.1. Methodology . 99 I.9.2. The data . 102 I.9.3. Model estimate and results . 103 I.9.4. Sensibility analysis . 106 I.9.5. Concluding Remarks . 109 4 List of Figures .1. Basic functioning of the model . 10 .2. NEMESIS modularity . 11 I.1. From R&D expenditure to the R&D stock . 17 I.2. The stock of knowledge . 17 I.3. Two types of innovation . 18 I.4. Process innovation and economic performance . 18 I.5. Product innovation and economic performance . 19 I.6. CES nesting structure . 23 I.7. Ex-ante and ex-post isoquants . 25 I.8. EU National share of high skill on total employment, in 2005 (source: Eurostat) . 36 I.9. European high skill share in total employment for NEMESIS sectors, (source EU-KLEMS) . 38 I.10. European high skill share in total employment for NEMESIS sectors . 39 I.11. Sectoral illustration of the final results . 40 I.12. Ratio of European employee unit cost between high and low skills at sectoral level . 41 I.13. Corrected European share of compensation of employees for high skill at sectoral level in 2005 . 43 I.14. Allocation of Durable Goods . 50 I.15. Allocation of Non Durable Goods . 50 5 List of Figures I.16. 70 I.17. results whole model . 71 I.18. Sectoral results P1 . 73 I.19. sectoral results P2 . 74 I.20. Participation rates to labour market of men and women aged 25 to 64, EU27 + Norway, 2005 . 76 I.21. Participation rates to labour market of women aged 50 and 64 by skill, EU27 + Norway, 2005 . 77 I.22. Social Contribution paid . 91 I.23. Social contribution received . 92 I.24. Sectoral interdependencies in NEMESIS . 94 I.25. Knowledge spillovers . 97 I.26. Rent Spillovers . 98 I.27. Sensibility analysis with common adjustment coefficient . 107 I.28. Model response to 1% shock on households real disposable income: Com- parison according to adjustment coefficients . 108 6 List of Tables I.1. Labour compensation growth, period 1998-2005 . 65 I.2. Unemployment rate , period 1998-2005 . 66 I.3. Price growth and high skill share , period 1998-2005 . 67 I.4. Labour productivty growth, period 1998-2005 . 68 I.5. Coefficients summary . 69 I.6. Estimation results of participation rates . 82 I.7. Elasticities of activity rates in NEMESIS in 2008 . 85 I.8. Estimates results of households gross fixed capital formation error correc- tion model . 105 I.9. Estimates results for short term model with individualised adjustment coefficients . 106 7 Introduction to NEMESIS The NEMESIS model (New Econometric Model of Evaluation by Sectoral Interdepen- dency and Supply), has been partialy funded under the fifth and sixth RTD Framework Programs of European Commission General Directorate of Research1. It is a system of economic models for every European country (EU27 less Bulgaria and Cyprus, plus Norway), USA and Japan, devoted to study issues that link economic development, competitiveness, employment and public accounts to economic policies, and notably all structural policies that involve long term effects: RTD, environment and energy reg- ulation, general fiscal reform, etc. The essential purpose of the model is to provide a framework for making forecasts, or ‘Business As Usual’ (BAU) scenarios, up to 25 to 30 years, and to assess for the implementation of all extra policies not already involved in the BAU. NEMESIS uses as main data source EUROSTAT, and specific databases for external trade (OECD, New CRONOS), technology (OECD and EPO) and land use (CORINE 2000). NEMESIS is recursive dynamic, with annual steps, and includes more than 160.000 equations. The main mechanisms of the model are based on the behaviour of representative agents: Enterprises, Households, Government and rest of the world. These mechanisms are based on econometrics works. 1The core teams of the NEMESIS model are : • ERASME (France) as coordinator • CCIP (France) • Federal Planning Bureau (Belgium) • National Technical University of Athens (Greece) 8 Introduction to NEMESIS The main originality of the model, when compared to others used for similar policies, lies in the belief that the medium and long term of macroeconomics path is the result of strong interdependencies between sectoral activities that are very heterogeneous from a dynamic point of view, with leading activities grounded on Research and Development, and from environment and sustainable development with a huge concentration of pol- lutants on few activities. These interdependencies are exchanges of goods and services on markets but also of external effects, as positive technological spillovers and negative environmental externalities. Another originality of NEMESIS is that it is a “Framework model” with different possibilities on the several mechanisms involved in the functioning (see figure .2 for the different available modules). Although econometrics, the model cannot be classified as a neo-keynesian model, in the new version that built-in the new theories of growth; it escapes also to the classification of general equilibrium model, as it incorporates original mechanisms that do not refer to the strict orthodoxy of the mainstream neo-classical approach, on which was based the general equilibrium approach. We now present the main mechanisms, outputs and uses of NEMESIS. Main NEMESIS’ mechanisms On the supply side, NEMESIS distinguishes 32 production sectors, including Agri- culture, Forestry, Fisheries, Transportations (4), Energy (6), Intermediate Goods (5) Capital goods (5), Final Consumption Goods (3), Private (5) and Public Services. Each sector is modeled with a representative firm that takes its production decisions given its expectations on production capacity expansion and input prices. Firms behaviour includes very innovative features grounded on new growth theories, principally endoge- neous R&D decisions that allow firms improving their process productivity and product quality. Production in sectors is in this way represented with CES production functions (with the exception of Agriculture which uses Translog functions, and Forestry and Fish- eries where technology is represented with Leontief functions) with 5 production factors : capital, unskilled labour, skilled labour, energy and intermediate consumption, where also endogenous innovations of firms come modify the efficiency of the different inputs (biased technical change) and the quality of output (Hicks neutral technical change). The production function was estimated by the dual approach and estimation and calibration of links between R&D expenditures, innovations and economic performance were picked up from the abundant literature on the subject. The pricing of enterprises results from 9 Figure .1.: Basic functioning of the model 10 Introduction to NEMESIS Figure .2.: NEMESIS modularity an arbitrage between firms engaged in competitive behaviour and those with a pricing by mark-up (due to innovation that creates monopoly situations). Interdependencies between sectors and countries are finally caught up by a collection of convert matrices describing the exchanges of intermediary goods, of capital goods and of knowledge in terms of technological spillovers, and the description of substitutions between consump- tion goods by a very detailed consumption module enhance these interdependencies. On the demand side, representative households’ aggregate consumption is dependent on current income. Total earnings are a function of regional disposable income, a mea- sure of wealth for the households, interest rates and inflation. Variables covering child and old-age dependency rates are also included in an attempt to capture any change in consumption patterns caused by an ageing population. The unemployment rate is used, in the short-term equation (only), as a proxy for the degree of uncertainty in the economy. Consistent with the other behavioural equations, the disaggregated consump- tion module is based on the assumption that there exists a long-run equilibrium but rigidities are present which prevent immediate adjustment to that long-term solution. Altogether, the total households aggregated consumption is indirectly affected by 27 different consumption sub-functions through their impact on relative prices and total income, to which demographic changes are added. Government public final consump- 11 tion and its repartition between Education, Health, Defence and Other Expenditures, are also influenced by demographic changes.