Thursday, 5 December 2013

The real wage gap once again

Miguel Lebre de Freitas, 4-12-2013


It is amazing how wrong ideas can last for so long, just because they fit well in the narrative: it became vox pop that wages in Portugal have increased ahead of productivity, eroding external competitiveness, and that this caused the huge current account deficits that emerged in the decade before 2008. Fortunately, along the last couple of years, the profession has increasingly recognized the role of capital flows as the main drivers of external imbalances across the euro area. Still, the claim that wage-setting institutions in Portugal are naïve and eventually not prepared to live in a low inflation environment remains very popular in the opinion-making arena and is feeding speeches of radical euro-sceptics.

As I already argued here  (and here), the evidence does not conform well to the idea that the private sector in Portugal engages in crazy wage setting. However, my purpose at that time was to explain why economy-wide indexes of relative unit labour costs are poor measures of external competitiveness. In this post, I use the available data more intensively, to refute the claim that wages have increased above productivity. Actually, as for the last couple of years, the data suggests exactly the opposite: real wages look like having fallen below the productivity trend. This suggests that, if private investment is not responding at this moment, the reason should not be labour costs, but something else.

The variables used

Before starting, allow me a little remark: the following discussion presumes that the elasticity of substitution between labour and other inputs in the production function is equal to one. This is not a general case, but it works well with the historical data and it looks like working pretty well in the Portuguese case too - as we will see in a minute. But if you don’t buy this, please stop reading here.

Now, let me introduce the four variables we are going to play with. These are:

W - Nominal compensation per employee (euros);
V – Gross Value added at constant prices;
L – Employment (1000 persons);
P – Price deflator of Gross Value Added.

The raw data are from the European Commission, AMECO, backed by INE. The figure for 2012 has to be taken with caution, as it is based on an EC forecast that comes ahead of the INE’ official release.

The following sections explore different combinations of these four variables. We focus on two broad sectors that account for 80% of employment in Portugal: “Services” and “Manufactures”. It is worth distinguishing these two sectors, because they are differently exposed to international competition: manufactures consist on tradable goods only, while services include both tradable and non-tradable. Moreover, in the case of services, 1/3 of employment is accounted for by civil servants.

Angle 1: Real wages and productivity

We start with Figure 1. This figure compares the evolution of real wages (W/P) and of the average product of labour (V/L) in manufactures and in services, taking 1995 as the base year.

Figure 1:  GVA per person employed and Real compensation per employee (1995=100)

The first message in the figure is that productivity growth  has been much faster in manufactures than in services. This fact fits well in the story that large capital inflows, by inducing a reallocation of labour towards non-tradable goods, reduces a country’ exposure to the benefits of learning-by-doing, delivering lower growth and long-lasting effects. In the case of Portugal, this adds to a productivity growth in manufactures that does not stand out in international terms.  

The second message is that the indexes of real wages and of productivity have evolved mostly in parallel. Interesting enough, during the collapse of international trade in 2009, the productivity index in manufactures fell more than that of real wages, but in the years that followed the increase in real wages was smoothed downwards: it looks like inter-temporal trade between workers and firms is taking place, as an informal insurance against dismissals. In the case of services, the data in Figure 1 also points to a deceleration of real wages relative to productivity during the bailout period. 

Angle 2: Prices and Unit Labour Costs

Now, we use the very same variables to analyse the change in Unit Labour Costs, ULC=WL/V. In a world without frictions, one should have P=ULC/b, where b denotes for the elasticity of labour in the production function. In the case of tradable goods the output price is determined abroad, so the gaps between unit labour costs and prices can be taken as an index of external competitiveness (the famous Z in Blanchard).

In Figure 2, we compare the indexes of Unit Labour Costs and of Prices in manufactures and in services, using 1995 as the base year. 

The first fact in Figure 2 is that unit labour costs in each sector remained close to price developments. Just like in Figure 1, in the case of manufactures we see a significant jump in  ULC  ahead of prices in the year of 2009, but this move was immediately recovered. The figure also points to increasing producer’ margins in both sectors along the bailout period.

Figure 2:  Price deflators and Unit Labour Costs (1995=100)

The second fact in the figure is that, until 2008, prices increased much faster in Services than in Manufactures. This is the textbook response to a large capital inflow, as manufactures are exposed to international competition while many sectors in services are basically not. The figure thus illustrates quite clearly why the increase in economy-wide unit labour costs in Portugal relative to other countries has little to do with dysfunctional wage setting: unit labour costs increased wherever prices increased. In this particular episode, the real exchange rate measured with unit labour costs captures basically the increase in the relative price of non tradable goods, not wage productivity gaps.

Angle 3: Nominal wages and nominal productivity

Figure 3 turns to nominal wages. To stick with wages in euros (instead of using an index), we use a little trick: we simulate the marginal product of labour, by multiplying the average product of labour in nominal terms each year by the average share of labour in Gross Value Added along 1995-2010, which we take as proxy for b (that is, we compare W with bPV/L, presuming an unchanged b). The advantage of this procedure is that it takes as reference the entire period, rather than a base year, so we move forward, risking some measuring.

Figure 3: Nominal wages and the (simulated) marginal product of labour (ECU/Euro)

As shown in the figure, nominal wages increased in both sectors during the capital inflow episode. The stylized interpretation is that the expansion in the demand for labour in non-tradable goods sectors caused wages to increase in manufactures too. The fact that wages evolved almost proportionally in manufactures and in services along most of the period is suggestive of  cross-sector labour mobility.

The figure also reveals that, during the bailout period, nominal wages evolved in different directions in manufactures and in services. To a large extent, this reflects the cuts in government sector wages.

Turning to the wage gaps, as shown in Figure 3, departures of nominal wages away from the calibrated “labour demand” remained small along most of the period until 2008. In the case of manufactures, a significant positive wage gap emerged in 2009 (+4.6%). This was subsequently replaced by a negative one, that reached -4.6% in 2012. In the case of Services, gaps have also remained modest along most of the period, but a significant -4.3% emerged in 2012. Note that the negative wage gap in services cannot be accounted for by the cuts in public sector wages, because government wages and productivity are the same.

Angle 4 - Labour shares

Because the data on services above accounts for many sectors, including the government, it is worth  looking inside. Unfortunately, detailed data by INE is available until 2011 only.

In order not to repeat the three steps above, we focus on a summary variable, the labour share on gross value added, or – which is the same – the ratio between real wages and productivity (s=WL/PV). Without frictions, the labour share should be constant and equal to the elasticity of labour in the production function, b. The difference between these two, s/b (or 1/Z), is often labelled the “real wage gap”.

Table 1 displays the shares of labour in gross value added at the sectoral level (agriculture is excluded because the adjustment employment/employees produces odd results). The first column displays the shares on employment, as of 2010. The last column shows the average labour shares along 1995-2010.

As shown in the table, at the country level, the share of labour on domestic income has remained pretty stable around 67.3, reaching a maximum of 68.6 in 2005. With no question, this is too little to support the claim that wages have in general evolved ahead of productivity. In the case of manufactures in particular, the maximum observed labour share was  64.9 in 2009, which compares to the 61.9 average (hence, the +4.6% gap). In 2010, the gap in manufactures was already negative. 

In general, labour shares at the sectoral level are more or less trendless. There are however, some exceptions: on the up-side, "information and communication" stands out ("Building and construction" too, but we have reasons to suspect that the data for this sector, as well as for agriculture, is plagued by changes in the proportion of temporary labour or by changes in the level of informality); on the downside, sectors where the wage shares have been declining include "Transportation and storage", "Arts and entertainment" and – guess what –  energy supply. The industry of financial services also exhibited a declining labour share until 2008, but the productivity fall in the years that followed partially reverted the situation.  

Table 1 – Labour shares 

Summing up

1 – The claim that real wages have departed significantly above productivity does not match the national accounts data. In the case of manufactures, the maximum observed real wage gap amounted to 4.6%, during the 2009' collapse of international trade, to recover one year after.  

2 – In general the data supports the narrative that aggregate demand effects, rather than nominal wage stickiness explain the pre-2008 external imbalance: during the capital inflow episode, prices of non-tradable goods increased, pressing nominal wages up. This forced average productivity in manufactures to increase, in some cases with technological change, but mostly through the shutting down of low productivity firms, while labour was reallocated to low-productivity-growth non-tradable good sectors. 

3 – The preliminary data for the bailout episode suggests that real wages have been evolving below productivity, not the other way around. By 2011, this trend was more evident in transportation and storage, financial services, and energy supply. 

4 – The preliminary data for 2012 also points to the case that real wages in manufactures fell short the productivity trend by some 4.6%. This suggests a scope for entrepreneurs to raise profits by hiring more workers. However, there are reasons to believe that in the current juncture, other factors apart from labour costs are constraining the entrepreneurs’ choices. This will be the subject of my next post.

Wednesday, 20 November 2013

Full circle

Economists of my generation, who had been more pessimistic about the end-of-war outlook, within six months after mid-1945 mostly realised that they had better cut their losses and work the other side of the street of high employment. 
Keynesianism as a tool of analysis superseded Keynesianism as a depression ideology. The old King is dead; long live the new King of the "neoclassical synthesis!" 
P.A. Samuelson 1988

I wish we will continue to circle and that Say's law will hold at least in the long run. (If you have not, read Krugman, Wolf on Summers intervention last week, might need subscriptions). There is something disturbing in the long term data. Here are the US (click to enlarge):

To understand how to connect the figures I will refer to the usual brilliant suspect. J.M. Keynes, who else? (here). We might need more clear thinking in connecting Long Run and Short Run saving glut varieties to identify the right set of policies.  

I plot the implicit rate of depreciation on fixed assets (an old acquaintance I might say), to distinguish net and replacement investment. You can also connect it to Keynes period of production. Yes, you can also interpret it as technological embodied progress. But most of it, is due to a composition effect.

By the way, my Phd thesis (2004) was (maybe) connected to the decrease in the depreciation rate you observe during the last recession. I had postulated that replacement investment had become an important margin of adjustment during cyclical fluctuations and studied some of the consequences on the aggregate economy (basically a more elastic aggregate supply).

Wednesday, 13 November 2013

Feeling the Blues

Moral hazard and debt dilution in Eurobonds before 1914

In a recent paper with Coskun Tuncer from UCL, I use five historical case studies of debt mutualisation to investigate some of the potential implications of the issue of Eurobonds. The abstract is:

Debt mutualisation through Eurobonds has been proposed as a solution to the Euro. Although this proposal has found some support, it also attracted strong criticisms as it risks raising the spreads for strong countries, diluting legacy debt and promoting moral hazard by weak countries. Because Eurobonds are a new addition to the policy toolkit, there are many untested hypotheses in the literature about the counterfactual behaviour of markets and sovereigns. This paper offers some tests of the issues by drawing from the closest historical parallel–five guaranteed bonds issued in Europe between 1833 and 1913. The empirical evidence suggests that contemporary concerns about fiscal transfers and debt dilution may be overblown, whilst creditors’ moral hazard may be as much of a problem as debtors’.

And a version of the full paper can be found here.

Tuesday, 12 November 2013

The Review: a dialogue between Germany and Europe

Germany’s current account surplus has been a subject of heated debate for some time… () …If Germany can take steps to lift domestic demand and investment, while France embraces reforms to its labour market, business environment and pension system to support competitiveness, they will together do a great service to the entire eurozone providing stronger growth, creating more jobs and reducing social tensions.
Olli Rehn, 11-11-2013

Eight European nations agreed today to realign their currencies after West Germany accepted French demands and agreed to a set of currency values that avoided the possible collapse of the European Monetary System…()...German officials said Mr. Delors had given assurances that France would reduce its budget deficit by cutting spending on social programs and welfare payments. Mr. Delors also reportedly said that France would try to reduce the deficits of its nationalized industries, another cause of inflation. The devaluation itself would cut the trade deficit by making imports more expensive and exports less costly to others.
New York Times, 21-3-1983

The EC will likely start an in-depth review of the German economy in the framework of the EU's Macroeconomic Imbalance Procedure. The persistent current account surplus of Germany stands above 6% of GDP since 2006 (according both to Eurostat and the IMF, see figure below) and is a serious imbalance that might have warranted a more timely identification than waiting for the US Treasury wake up call. (click to enlarge)

You could think better later than never, but the timing is not on Europe side. As the commissioner underlines in his piece, a government must still be formed in Germany. Let me add that the European elections are 6 months away (how optimistic I was ...). What I want to convey is that the publication of an official EC document that basically prescribes to Germany inflation must be well prepared and timed. Especially after the votes against the decrease in the ECB key interest rate last Thursday by the three central bankers of what was de facto the old mark block.
That takes me to the initial quotes.
There is narrative that says that going back to national currencies (and the ERM) could simplify realignments when they are needed. This narrative pleases the anti-euro fraction of society and UK civil servants. In the not too distant past, to have realignments, everybody had to agree. That was the case during the episode reported by the NYT in the introductory quote. Shortly after the realignment, Mitterrand initiated "Le Tournant de la Rigeur" (or was it the "Virage"?). At that time France started a process of internal devaluation that lasted a decade and was helped by a second realignment in 1986. It was tough on unemployment. In another occurrence, post Berlin Wall, agreement on realignment was not reached (click).
There is another narrative that says that the euro countries have reached a level of integration (for example the level of the external assets and liabilities, think of the underlying contracts, but also trade in services, supply chains, etc) that makes strengthening the architecture of the euro-zone a superior solution. Moreover, while the flaws in the euro architecture have helped the creation of imbalances, the global shocks and processes occurred during the last decade cannot be ignored. This narrative pleases the pro-european fraction of society.
I would suggest to both groups to abandon the narrative approach, useful, but prone to drama, and start a conversation with the objective to give a reasoned and detailed description of what are the outcomes and choices that the people will have to vote for or against in the next elections. The review could be an opportunity. In the trade-off between further integration and decentralisation I restricted my thoughts to the economic sphere as I believe that economic integration is compatible and subordinated both with cultural diversity and "decentrism" to use a word from my sharp follower uberwomen who deserves a better answer. But I need some time to articulate it.

Saturday, 9 November 2013

The rise and demise of the Troika virtues: Portugal, 2011-2013

The Memorandum of Understanding on Specific Economic Policy Conditionality, signed between the Portuguese Government and the European Union, the IMF and ECB, on 3 May 2011, was praised by a large number of Portuguese politicians, economists, and a considerable share of the public, from socialists to social-democrats and Christian democrats. The 34-pages long document was declared by many as an amazing, in-depth and detailed exercise, imposing measures that would overhaul the Portuguese economy, the State or the judiciary, in order to put the country in the right track and never default again in the future. The first press conference of the Troika representatives, on 5 May 2011, was attended massively by the media, and received widespread attention by a thrusting public, eager for a definite solution for the domestic economic problems. Since then, all has changed. The Troika representatives do not appear in press conferences or under the public eyes any longer and the number of politicians and economists that still praise its role has been reduced to a few diehards of austerity. This talk argues that the initial popularity of the Memorandum and the Troika is the outcome of a long-standing misperception of Portugal’s growth potential and position in Europe, which has long roots back in History. The analysis of the Troika experience, however, may be a valuable contribute to a better understanding of the problems facing the Portuguese economy within the European Union. Here.

Friday, 8 November 2013

Labour market in Portugal (take 2)

Yesterday, Francesco Franco posted a quick view of the recent numbers. I felt the need to have some extra information - more on the past (I propose for discussion to start on the first quarter of 2011), and add the movement in total population.
The picture below shows the relative evolution (all series normalized to 1 in the first moment; the unemployed index series is shown in the right-hand-side axis).

Adding to the good news noted by Francesco, we have the news that total population has a downward trend in 2012, becomes stronger in 2013, and the same occurs to the active population. Looking at the absolute change in numbers from previous trimester (second figure) is somewhat messy. And I suspect that full numbers of emigration may not be totally reflected yet.

Thursday, 7 November 2013

Labor market in Portugal

Good news from the labor market front in Portugal. The unemployment rate in 3Q-2013 is estimated to be 15.6%. Still high but lower than expected. As the number of unemployed has decreased this is unambiguously good news both for people and for public finances. Nevertheless we need to stay objective and fully accept what the unemployment rate measures. Portugal labor force and employment have been shrinking since last year (but not in the last quarter). As an illustration consider the following thought exercise: what would be the unemployment rate if the labor force did not decrease an stayed at her 3Q-2012 value of 5,527.2 million persons. (click to enlarge)

Monday, 14 October 2013

Debt sustainability

The figure (click to enlarge) shows four high public debt experiences in the EU. Assessing the sustainability of government debt requires checking that the inter-temporal budget constraint of the government, holds. The relevant horizon is long by modern standards.  The conditions for sustainability have an objective dimension. These conditions are objective but linked and linked in an uncertain way. They are linked because a change in the path of deficits or surpluses affects both the growth rate of income and the interest rate on sovereign. They are linked in an uncertain way because the size of the effects appears to depend on the state of the economy. To complicate things, the conditions for sustainability are also subjective. Conditional on the uncertainty, the path of deficits and surpluses must be credible. The capacity of a government to control tax revenues and expenditure is key.
For Portugal the difference between the blue an red line in the last 3 years is caused by the item labeled "residuals". Residuals is a voice that includes change in deposits, support to financial sector, recognition of implicit contingent liabilities, reclassifications, unidentified financial transactions, and cash-accrual adjustments. In Portugal, for 2011, it included accumulation of deposits (6 percent of GDP) and BSSF funds (0.6 percent of GDP). For 2012, it included accumulation of BSSF funds (4.2 percent of GDP) and non-BSSF bank recapitalization (1.6 percent of GDP). In fact while debt to GDP increased by 40.7%  from 2010 to 2012, only 21.2 percentages points are caused by the deficits and the economy dynamics; 19.5 percentage points are caused by the Residuals, a very significant number.
The good news is that  for 2013 Residuals includes use of deposits (-5.9 percent of GDP) and acquisition of financial assets (0.3 percent of GDP), namely we are expecting that the residuals will improve the debt to GDP ratio in 2013 by 4.9%.

Tuesday, 24 September 2013

Banking Union: a powerful reform

A single policy or reform can rarely achieve multiple objectives simultaneously. The Banking Union is potentially such a policy. First, the Banking Union can solve the credit supply malfunctioning within the euro area, namely it can permit the monetary policy impulse to be transmitted more uniformly across the Union. Second, the Banking Union can solve the credit demand malfunctioning within the euro due to the uncertainty on the future existence of the eurozone.

A short narrative

Consider Figure 1 that shows on the left panel the 1-month Libor on the euro (and the dollar). The crises in the euro periphery that resulted in the sequential bailouts program of Greece, Ireland and Portugal are closely related to the increasing tension in the european interbank market. The right panel of Figure 1 plots the spread between the Italian and the German bonds and shows that shortly after Portugal's bailout the tension precipitated in a fully fledged financial crisis. Figure 1 also shows the approximate dates of the ECB main interventions. These interventions have been highly successful in lowering tensions in the interbank market, first by intervening directly in the banking sector and second by announcing the OMT.  Figure 2 shows fixed investment spending for Germany, France and Italy together with the MFI interest rates on loans on new businesses. Fixed investment is basically the only component of spending that co-moves during that period in the three largest economies of the euro area (other spending components, or say unemployment exhibit a different, more idiosyncratic, behaviour). Fixed investment decreases after what could be labeled a large uncertainty shock (the increase in the btp/bund spread). The observation that fixed investment in UK increased (not shown) after the shock is an indication that the uncertainty concerns the euro. The Banking Union would signal a very strong commitment to the euro and potentially reverse the negative uncertainty shock. A positive certainty shock could even boost investment. The right panel of Figure 2 shows that the normalisation in the interbank market has not yet  been transmitted uniformly to the real economy across the three countries. The Banking Union should permit a more uniform transmission of the monetary policy allowing credit conditions to be more harmonised across the euro area.

Click to enlarge


Tuesday, 17 September 2013

Fiscal multipliers and Income share distribution

There is a literature that studies the consequences of fiscal consolidation on inequality. First a fiscal consolidation usually increases unemployment which is usually associated with a decrease in the wage share. The lower wage share increases inequality given the higher wage share in the total income of lower income groups. Second fiscal adjustments biased towards more regressive taxes (such as consumption taxes) or on cut-backs in progressive spending tend to increase inequality. Finally there is new evidence that fiscal consolidations success stories are related to taming inequality. Now there is a second issue which has not gained much attention in the empirical literature: is inequality related to the size of the multiplier?. This second question is natural if there is a mapping between credit constraint households and relatively low income households. If the link between inequality and the multiplier exists, fiscal consolidation policies that increase inequality are likely to have lower probability of success in their consolidation effort.
A recent influential paper by Blanchard and Leigh 2013 investigates the relation between growth forecast errors and planned fiscal consolidation during the recent financial crisis. They find that fiscal multipliers were substantially higher than those implicit in the models used by forecasters. Blanchard and Leigh also check if their results are robust to controlling of additional variables that could have possibly triggered both planned fiscal consolidation and lower-than-expected growth. The list of control variables is comprehensive and includes the initial debt ratio, the initial fiscal balance, the initial structural fiscal balance, the initial sovereign CDS, the initial bank CDS, a banking crisis dummy, the initial growth forecast, the initial potential growth forecast, the trading partner fiscal consolidation, the pre crisis current account balance, the pre crisis net foreign liabilities and the pre crisis household debt. Table 1 reproduces their baseline results for a sample of 26 european countries in 2011. The baseline coefficient is closed to -1 and is barely influenced by the inclusion of any of the controls. Remarkably none of the controls appears to be statistically significant. (click to enlarge)
Table 2 presents the same baseline regression augmented with a new set of controls that measure inequality. More precisely the controls are the income quartile, quintile, decile, fifth and first percentile share ratios. (click to enlarge)

They are calculated as the ratio of total income received by respectively the 25%,20%,10%,5%,1% of the population with the highest income to that received by the 25%,20%,10%,5%,2% of the population with the lowest income. All income measures are initial (end-2009) equivalized disposable income .(The equivalised disposable income is the total income of a household, after tax and other deductions, that is available for spending or saving, divided by the number of household members converted into equalised adults; household members are equalised or made equivalent by weighting each according to their age, using the so-called modified OECD equivalence scale.) and are shown in Figure 1. (click to enlarge)

 The coefficient on the consolidation forecast does not change, so that the results of Blanchard and Leigh still hold. However the coefficients on the controls are statistically significant and fairly large. Take for example the income quartile share ratio. The average income quartile ratio across the 26 countries in the sample is approximately equal to 4 implying that the 25% percent with higher income has on average 4 times the income of the 25% with lower income. The estimated coefficient on the income quartile share ratio implies that an increase from 4, Switzerland, to 5, Portugal, would lead to a domestic output loss of -0.93% larger relative to forecast in Portugal relative to Switzerland. This is of the same order of magnitude of the underestimation of the multiplier. Figure 2 collects the coefficients together with the 95% confidence intervals. (click to enlarge)

Recall that the controls are initial period value (end-2009) so that the causality is likely to go from distribution to growth forecast errors. Given that most of the countries in the sample have experienced a recession, the negative and significant coefficient on the income distribution measures is suggestive of standard Keynesian channels if the income distribution proxies for share of households that are credit constraints and/or have higher marginal propensity to consume. In any case further analysis must be performed to better interpret the results.

Thursday, 12 September 2013

Expanding times

The German economy is enlarging (the antonym of shrinking). Blue lines are flows, green lines are prices, red lines are stocks. Click figures to enlarge. I could not find the deficit/surplus data for the first and second quarter of 2013. I thought it could be interesting to know the public finance stance of the largest eurozone economy. However, der Teufel steckt in der Fussnote...
Certain transactions, including net lending (+)/ net borrowing (-) are under embargo until all quarters of the current year are available.

Mais aucun problème.
Certain transactions, including net lending (+)/ net borrowing (-) are under embargo until all quarters of the current year are available.

Thursday, 29 August 2013

A note on the IRC reform proposal

This note is based on the preliminary proposal for a reform of the corporate income taxation in Portugal.

The subtitle of the proposal states the scope of the reform: to improve competitiveness, increase growth and create employment. To achieve the latter goals the proposal stands on three elements. First a simplification of the IRC code, the fiscal-legal element. Second a gradual and certain decrease in the tax rate, the budget-macro element. Third a corporate tax coherent with the new international environment, the international cooperation element.

The legal-fiscal dimension is the central focus of the proposal. The authors have produced an impressive and detailed code that contains new articles and alterations to the older ones. Being a macroeconomist with a weak understanding of the legal technical language, I am not in measure of evaluating the contents of these articles. Surely the objectives of simplification and increased efficiency are of primary importance. Overall given the background of the commission this appears to be the strong element of the reform. 

The budget-macro dimension is weaker.  The key point of the document is the large decrease in the average corporate tax rates across the OECD and G20 countries that went from 40.9 percent in 1990 and decreased to 26.3 percent in 2013. The authors maintain that this decrease has caused growth, investment, employment and a reduction of tax fraud. To strengthen the causal link they present several graphs showing a negative correlation between the tax rates and tax revenues. The idea is that the reduction in the tax rates has increased the revenues partially through a broadening of the tax basis and especially in response to a “virtuous” supply side mechanism (that also caused growth, investment and employment). The analysis should be more nuanced. The international reduction in corporate tax rates started 30 years ago is most likely a response to the greater mobility of capital.  Increased profitability in the corporate sector explains, at least partially, why revenues as a percentage of GDP did not decrease despite the reduction in rates. The large increase of the financial sector during this period is also part of the explanation. The authors recognise that beyond the stylised evidence presented, no evaluative research to legitimate the practical implications on competitiveness, growth and employment of the proposal has yet been done.

The budget implications have been quantified for three different scenarios and are approximately 220 million euro per year, with a 5 years cumulative effect on fiscal revenues in the range of 1200-1400 million euro.  The quinquennial horizon of the reform responds to the necessity of spreading the loss in tax revenues during this period of budget consolidation.  A legitimate question is to ask if the decrease of the corporate tax rate from 31.5% to 19% that costs 220 million euro per year is welfare superior to different proposals such as decreasing the tax on labor. It might well be that this is actually the case but evidence would be welcomed.

The international cooperation dimension suggested is the one I more tenaciously debate. The stance of the reform is the one of a realist state-centric small economy. Somewhat a paradoxical posture for a European country, especially when the G20 is pushing for new international standards to be designed to ensure stronger coherence of corporate taxation across countries. The OECD, called to develop an action plan, has heralded the proposal of cooperation a “once in a century” opportunity to fix a creaking taxes system. Critics will call it a rhetorical statement and that taxation is the last line of defence of countries sovereignty. Perhaps, but I believe that only through cooperation, nation states, especially the small and medium sized, will be able to maintain their sovereignty.

Ultimately the Portuguese authorities want to implement a corporate tax reform to increase the welfare of all Portuguese citizens. Trade-offs are present: fiscal stability versus stimuli effects, allocational efficiency between capital and labor, short term versus long-term effects. Overall the case on the desirability of the reform can be made. I would suggest changing the methodology and riding the opportunity given by the G20-OECD action plan on corporate income tax reform. Become the first mover to launch and implement the coordinated plan. This could be the stance of a cosmopolitan nation state.