Master Thesis

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Master Thesis

“An analysis of the influence of Unit Labour Costs on changes in trade

and investment flows between The Netherlands, Portugal and Spain,

and subsequent implications for Dutch companies operating there,

1996-‐2012”

Louk Goorhuis Supervisor: Mr. H. Vrolijk Co-‐assessor: Mr. W. Westerman June 20, 2014

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Abstract

This research focuses on the influence of Unit Labour Costs (ULC) on trade and investment flows between the Netherlands on the one hand and Portugal and Spain on the other hand. Considering the importance of Portugal and Spain as trade and investment partners of the Netherlands, and the debate on the nature of recovery of both countries after two crises, the need for an assessment of the true impact of ULC on this relationship is prevalent. A clear overview of the pitfalls and opportunities of Portugal and Spain’s macro and meso environment could benefit investors and managers in their decisions to locate production facilities or engage trade with these countries. Using publicly accessible databases as main source of data, trade and investment flows are mapped out in order to see in what way ULC influences the trade and investment trends on a national and sectoral level. Moreover, a regression analysis is performed to measure the influence of ULC on the trade balance. The gain in cost competitiveness of Portugal and Spain has so far contributed to an improvement in exports, it seems. However, FDI has not responded in a similar fashion, and the regression analysis cannot provide a decisive answer about the influence of ULC on the trade and investment balance. It seems that ULC is not adequate as a prime indicator that influences the company’s decision to invest in a country. Other factors have an important impact as well.

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1. Introduction

During the past decades, an increasing number of companies have started to operate outside their home country borders. When enlarging their scope of business, firms can decide to export more or choose for a more complex form of internationalization: Foreign Direct Investment (FDI). Both are influenced by a variety of factors, including macro economic factors as well as business management decisions.

The choice between these two modes of trade is subject to certain macro economical events. The entrance of a country to the European Monetary Union (EMU) is such a macro economical event. For each of the participating countries, there are major advantages to the EMU, such as a reduced and stable inflation rate, currency stability, a lower interest rate and the elimination of adverse spillovers from competitive devaluations (Beetsma & Giuliodori, 2010). These advantages influence both exports and FDI. Fifteen years after the EMU went into full effect, large imbalances in trade and investment have surfaced between member countries. Two crises exposed these imbalances, the first one being the global financial crisis of 2008 and the second one the euro crisis of late 2009. The first crisis started with the collapse of the housing bubble in the US1_and

afterwards contaminated Europe and the rest of the world. Both the US and a large part of the European economies were thrown in a deep recession. The euro crisis originated from rising governmental debt levels, partly as a result of the global financial crisis. Rising doubts about whether governments would be able to meet their debt obligations nearly resulted in the bankruptcy of some of these countries2_{.
However,
at
the
heart
of
the
second
crisis
seems
to
be
another
cause:}

a lingering imbalance in competitiveness among EMU countries.

The euro crisis brought to light that the economic progress of the years before was not balanced between member countries. The so-‐called ‘northern’ countries achieved real growth, whereas the ‘GIPSI’3_{countries
lagged
behind
(IMF
2013).}

Darush et al. (2010) set out the sequence of events that resulted in the loss of competitiveness of the GIPSI countries. First, the introduction of the euro decreased interest rates and spurred confidence that institutions and economies were expected to converge to the northern core economies of the EU. Secondly, domestic demand surged, leading to a increase in wages relative to productivity. Thirdly, as a result of this, growth accelerated, further encouraged by a growing construction sector (especially the case in Spain) and government spending. Moreover, exports stagnated as share of GDP and imports increased. There was abundant foreign capital to finance this, according to Darush et al. (2010) leading to a rising public and private indebtedness.

Regaining competitiveness then is one of the most important ways of restoring the balance in the EMU. Since the exchange rate mechanism is not available

1_{For
an
overview
of
the
causes
of
the
global
financial
crisis,
see}

http://www.economist.com/news/schoolsbrief/21584534-‐effects-‐financial-‐crisis-‐are-‐still-‐ being-‐felt-‐five-‐years-‐article

2_{For
an
overview
of
the
causes
of
the
euro
crisis,
see} http://www.economist.com/node/21536871

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anymore to the countries involved, nor is independent monetary policy, few options remain. One option is political and economical reform, which runs through institutions. The other is bringing the labour costs down, which might lead to fundamental changes in trade patterns (Wihlborg et al. 2010). The latter option will be the focus of this research, which will analyse the trade and investment relationships between two GIPSI countries, Portugal and Spain, and one of the European core countries: the Netherlands. It will assess the developments in Unit Labour Costs (ULC) in all three countries, and its subsequent impact on both conventional trade and FDI. What are recent developments in ULC in these countries and has there been a visible effect in the trade and investment statistics?

The Netherlands is an important trading partner for both Portugal and Spain. It is the premier investor in Portugal, and the main destination for Portuguese investments too. Moreover, the Netherlands is the fifth largest exporter to the country (IMF CDIS). The Netherlands is Spain’s main investor as well, and the third most important destination for Spanish investments. Furthermore, it is the seventh trade partner of the Netherlands. Considering the importance of these countries as trade and investment partners for the Netherlands, the goal of this research is to outline both the long term and recent developments in the macro-‐ and meso environment in which Dutch companies operate when starting or expanding activities in Portugal and Spain, at the hand of the ULC indicator. The role of ULC will be explored by a trend analysis and a regression analysis.

The main research question will be as follows:

How have the trade and investment flows changed in the period 1996-‐2012 between The Netherlands on the one hand and Spain and Portugal on the other hand?

1.1 Overview Countries

In order to present a clear picture about the countries subject to this research, I will shortly review the economic and political situation in Portugal and Spain since the 1970s. Figure 1.1 and 1.2 show the trends in economic growth of the three countries and the world. All countries start with increasing economic growth. Then, varying from 1998 to 2000, each economy falls into a recession, in which Portugal and the Netherlands are hit the hardest. Spain and the world in general quickly regain momentum, which last until 2006, when growth starts declining again and eventually falls drastically as a result of the global financial crisis. Portugal and the Netherlands struggle up but then plunge into negative growth rates as well. After a short revival, the European countries enter into the negative growth rate number again whereas the world economy performs remarkably better.

1.1.1 Portugal

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1985 until economic growth truly returned, and in 1985 Portugal joined the EEC. In 1999 Portugal joined the European Monetary Union (EMU), which provided exchange rate stability, falling interest rates, and falling inflation. Falling interest rates, in turn, lowered the cost of public debt and helped the country achieve its fiscal targets. From 2002 onwards, the Portuguese economy stagnated once more, with GDP per capita falling from 80% of the EU 25 average in 1999 to 70% in 2007. Also, unemployment increased by 40% in this period. It was not until the late 2000s that Portugal encountered another severe financial crisis, which threw the country into recession and forced the country to negotiate with the IMF and the EU to stabilize the country’s finances again.

1.1.2 Spain

Spain has also known a period with much political turmoil in its recent past. After a devastating civil war started in 1936, the emergent political system was a dictatorship under general Franco. For this reason the country was internationally isolated until the 9160. During the 1960s, Spain experienced a significant economic growth. After the death of Franco in 1975, democracy was restored, resulting in Spain joining the NATO in 1982 and the EEC in 1986. After suffering from the global recession in the early 1990s, Spain regained economic growth for a long period until 2007, fuelled by accession to the EMU which, just like in Portugal’s case, resulted in low interest rates. This in turn spawned a property bubble, which busted as a result of the financial crisis in 2008 and caused a deep and long term recession, throwing unemployment levels back to about 25%.

Figure 1.1 Annual Economic Growth the Netherlands, Portugal and Spain

Source: EuroStat, UNCTAD

-‐5% -‐4% -‐3% -‐2% -‐1% 0% 1% 2% 3% 4% 5% 6%

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1.2 Outline

First of all, a theoretical background will be presented in which I discuss relevant macro economical and business management theory. After gaining an understanding of the factors that influence trade on both levels, the research methodology will be discussed. The main definitions of statistical parameters will be defined, as well as the differences between the statistics of the variety of databases that are used. Furthermore, the details of the regression analysis will be discussed. Also, several potential caveats in the data will be analysed. Thirdly, I will analyse the trade patterns from The Netherlands towards Spain and Portugal during the period 1996 -‐ 2012. Exports will de analysed first, both on a national and a sectoral level, followed by FDI. In this section, I will observe whether the trends in trade and investments resemble the expectations that derived from the theory. The influence of Special Purpose Entities (SPEs) on the data will be discussed as well. Afterwards, the regression results will be presented. Fourthly, I will discuss the results and their implications for Dutch businesses. Finally, the conclusion will summarize the findings.

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2. Literature Review

The next paragraphs will discuss the literature that will be used to analyse changes in trade-‐ and investment flows. First, macro economic literature will be discussed followed by a clarification on the difference between exports and FDI. Finally, relevant business management literature will be discussed. This literature might be able to provide an alternative explanation of trends in trade and investments that cannot be explained by macro economic theories. The theoretical section is concluded by an expectation on how each theory influences the trade and investment flows between The Netherlands and Portugal and Spain.

2.1 Economic Literature

2.1.1 Specialization and Factor Endowments

From the premise that comparative advantage determines fundamental trade structures, I will use a Ricardian perspective on relative ULC to analyse international competitiveness. International trade structures have been subject to research ever since Ricardo argued the benefits of trade through comparative advantages. According to him, even if one country does not possess any absolute production advantage over another country, it should focus on whatever product it has a relative production advantage in. This way, international trade would flourish to the advantage of both countries. Two other economists, Heckscher and Ohlin, elaborated on this model and pointed out that a country will export products that rely on abundantly present resources in the country, and will import products that do use the countries’ scarce production factors. Following this theory, a country with abundant capital will export capital intensive goods and import labour intensive goods, and vice versa for a labour intensive country. Eventually, the differences between the two countries will converge since there will be a rise in demand for labour in the labour abundant country, and a rise in demand for capital in the capital abundant country, resulting in an increase in wage and prices.

2.1.2 Ricardian Theory and Unit Labour Costs

Labour costs are the key relative price in the Ricardian model of trade. In terms of tradable goods, exports and imports depend on the real wage4_{.
Therefore,}

relatively low ULC will enable a country to produce at more competitive prices, stimulating exports. Furthermore, firms will be inclined to locate their production in countries where the costs of labour are relatively low. Unit Labour Costs (ULC) measure the average cost of labour per unit of output and are calculated as the ratio of total labour costs to real output. It is an indicator of how productivity relates to the costs of generating that productivity. The numerator reflects the major costs category in the production process, labour compensation, and the denominator the output from the production process (GDP). A low level of ULC relative to other countries can be seen as a source of competitive advantages of a country. On the short term, improving cost competitiveness can lead to loss of employment in some industries. On the longer run though,

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countries are able to gain larger shares of the world market and consequently create more jobs. In conclusion, decreasing ULC to regain competitiveness can happen through two distinct ways: either increase labour productivity, or restrain wages. An important notion here is that a balanced input of both ways is key to a sustainable edge in competitiveness, which results both more productive and better paid jobs. A decline in ULC by means of cutting wages leads to different consequences in the quality and wages of jobs than gains in productivity. For example, a strong emphasis on wage reduction threatens productivity growth since it can lead to deteriorating innovation and a fall in investment in human capital.

The use of ULC as a comprehensive indicator for competitiveness is not undisputed. Van Ark et al. (2005) summarize the main three drawbacks. First of all, since ULC measures only take into account the costs of labour, other costs of inputs are ignored, such as costs of capital and costs of intermediate inputs. These costs can influence the cost competitiveness of countries as well. Second, competitiveness stems not only from costs but also other factors like technological and social capabilities, which can improve product quality and yet is not taken into account in ULC measures. Moreover, factor inputs alone are not the only determinants of competitiveness, as the work on competitiveness by Michael Porter has shown. Porter’s Diamond (Porter, 1990) explains competitiveness from four dimensions. Next to factor inputs, demand conditions, the presence of local suppliers and clusters, and firm strategy, structure and rivalry play an important role in competitiveness. These latter three factors are not taken into account by ULC indicators. Thirdly and finally, ULC measures may be influenced by bilateral market access agreements, direct and indirect export subsidies or tariff protection. Despite these three main points of criticism on the use of ULC as indicator for competitiveness, research5_{has
shown
that
use
of
the}

Ricardian model has been relatively successful. Further empirical research supporting ULC as an indicator for competitiveness has been carried out by Rodríguez and Pallas (2007). They focused on the determinants of FDI in Spain during the period 1995-‐2008, and concluded that the key variable in explaining the behaviour of FDI is the difference between the productivity of labour and its cost. This, and the fact that ULC is a convenient and concrete tool to work with, makes the ULC indictor the preferred theoretical framework to investigate competitiveness and trade relations between the Netherlands, Portugal and Spain.

With this discussion in mind, certain expectations arise about on the one hand developments of ULC and on the other hand trends in trade-‐ and investment flows. First of all, a country’s external position will worsen when that country is relatively expensive compared to other countries. Its exports will decline since obviously, countries with rapid productivity growth rates and lower labour costs are better positioned to sell their products and services at lower prices. Moreover, increased UCL will probably exert further upward pressure on imports. Secondly, a country with relatively higher ULC will attract less direct investment, since it is relatively expensive to produce in that country. Vice-‐versa, decreasing or lower ULC will attract foreign capital. Foreign firms will invest in

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the country to benefit from lower production costs, enabling them to lower their prices and increase competitiveness.

2.1.3 Unit Labour Costs and the Current Account

The current account of a country represents the increase in claims of residents on foreign incomes or outputs, minus the increase in similar foreign-‐owned claims on home income or output (Obstfeld and Rogoff, 1996). This means that the current account does not only include the trade balance, but also net capital gains on existing foreign assets. Blanchard and Giavazzi (2002) concluded, only a short time after the establishment of the euro area, that the euro area’s current account imbalances could be explained by the increasing integration of financial markets and goods markets. The consequence of this process of integration was that countries with higher growth prospects experienced deficits and the more mature economies experienced surpluses. I will estimate the influence of ULC on the current account in order to capture the effect that ULC has on the trade balance.

2.2 Exports & FDI

Exports and FDI are the two main trade flows that will be analysed. Export is a part of international trade where goods are produced in one country, and then shipped to another country for sale or further trade. This way of international trade is seen as advantageous when a company is adverse to both higher investments and greater involvement in other countries in order to sell their products. Export is relatively cheap and does not require large upfront investments. FDI on the other hand does require higher upfront investments. The first decision to be made when considering FDI is to set up a new business abroad (greenfield investment) or to acquire an existing local firm (make an acquisition). FDI will allow the company to sell its product directly to the foreign market, cutting out transportation costs of its goods, but also allowing the firm to avoid trade barriers like tariffs and import quota. Moreover, FDI brings the firm in closer proximity to the end customer in a country, allowing it to improve its competitive position. In short, exporting is characterized by relatively low sunk costs, yet higher cost per unit as to FDI.

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transfer of technology. The threat of competition may stimulate domestic firms to innovate. Imitation effects and the movement of personnel trained by multinational subsidiaries also enhance the transfer of technology to local firms A final note on export and FDI concerns the fact that most theory describes exports and FDI as substitutes. When a company starts increasing their FDI, export will automatically decrease. However, is this truly the case? Conconi et al. (2013) focus on this question and come to a different conclusion. They focus on a different spectrum of the process of exporting and FDI, and consider exports as a method of reconnaissance. Their results suggest that firms, when exporting, gain valuable knowledge about foreign markets. This knowledge can trigger companies to start investing abroad via FDI, thus increasing both exports and FDI.

2.3 Management Literature

2.3.1 Dunning’s OLI Framework

In managerial literature, multiple models have been developed that explain the decision to export to or to produce abroad. Dunning (1977, 1981) developed the so-‐called OLI approach, consisting of ownership, location and internalization advantages. This framework entails that firms have to posses a certain set of advantages to transform into MNEs.

First of all, companies with the potential to become an MNE must have the ownership of certain firm-‐specific advantages, such as intangible assets like trademarks, managerial know-‐how and technologies or organizing capabilities. Markusen (1984) stresses that these advantages need to be internationally mobile, or usable between factories worldwide, in order to provide multi-‐plant economies of scale. Secondly, internalisation advantages stem from the intangible asset’s public good characteristic. The choice for internalization originates from several dangers. For example, due to opportunistic behaviour, intangible assets could quickly dissipate, due to the following reasons: it is impossible to write complete contracts, licensees can exploit their knowledge about the intangible assets after a licensing period, and licensees can free ride on the reputation of the firm (Williamson, 1981). Thirdly, firms have to have localisation advantages that make them prefer to produce abroad, rather than to just export abroad. In short, there must be some kind of cost advantage in producing abroad instead of exporting, Figure 2.1 summarizes Dunning’s framework. By determining which components of Dunning’s OLI framework a firm possesses, we can determine which mode of internationalization the firm will carry out.

Table 2.1 Dunning’s OLI Framework (Dunning, 1981)

Ownership

Advantages Internalization Advantages Location Advantages

Licensing Yes No No

Exports Yes Yes No

FDI Yes Yes Yes

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2.3.2 Process Theory of internationalization

Besides this seemingly rational choice between the two modes of entry, the factor time also plays an important role in the internationalization process, described in the so-‐called ‘stage theory’ of MNE evolution. Stage theory starts with the assumption that when the home market is saturated, an MNE has to evolve in order to maintain growth. Johansen & Vahlne (1990) pioneered this theory, describing the internationalization process as consisting of incremental steps, rather than large leaps taken by the company. They distinguish four modes of entry of a foreign business environment, each higher mode representing a higher degree of internationalization:

• Stage 1: No regular export activities • Stage 2: Export via independent agents

• Stage 3: Establishment of an overseas sales subsidiary • Stage 4: Overseas manufacturing unit

The reason for this processed way of internationalization, Johansen & Vahlne argue, in that rather than optimum resources allocation, internationalization is the consequence of incremental adjustments to changing conditions in the environment of the firm. The lack of routines in a new environment and lack of knowledge result in incremental rather than larger steps. This model is often called the Uppsala Internationalization Model, named after the university of the researchers, whose sample consisted of four Swedish MNEs. Tied with the concept of the different internationalization stages is the concept of ‘psychic distance’. Psychic distance is an umbrella term for all factors that influence the information flow between the firm and its markets, including factors like culture, language and political systems (Johanson and Vaulne 1977, p 24.) The process theory of internationalization indicates that over the years leading to current globalized marketplace, the share of FDI has decreased compared to the share of exports in trade flows. After all, the psychic distance has decreased after the accession of all three countries to the EMU, and the increasingly harmonizing effects of membership of the EU. Overcoming trade and investment barriers by FDI has become less necessary. However, this does not necessarily have to be the case. On macro levels, trade and FDI are complementary, since firms in one industry or nation are still in stage 1, whereas firms in other nations or industries are in stage 4.

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stage a company is in, meaning that after saturation, a company can evolve into a next stage, which is FDI.

What we can expect then is that if the ULC falls due to sustainable gains in productivity or long-‐term cost shedding, companies will start investing more and FDI will rise. At the same time, exports will rise and imports will fall. Deviations from these expectations can be attributed to other factors in the Porters diamond, or in the consecutive stage a company is in.

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3. Methodology

This chapter will outline the data collection process, the data sources and how they are used, and attain to some caveats in the data collection process.

3.1 Research Methodology

This research consists of an exploratory part, which investigates changes in trade and investment patterns between the Netherlands on the one hand, and Portugal and Spain on the other, and an econometrical part, which analyses the determinants of changes in the trade balance for Portugal and Spain. First, developments in ULC for all three countries will be discussed, followed by an overview of the trade patterns between the countries on a global a national and a sectoral level. The complete FDI analysis is analysed in the appendix because of its lower relevance in relation to ULC. A summary of the findings is however given in the text to provide the reader with the essential information. The developments in ULC and trade and investments will be compared to see whether they are in line with the theoretical predictions. If not, alternative explanations are discussed. Second, a regression analysis will be performed to determine the influence of several factors that affect the trade balance. This way, we can estimate the influence of ULC on the trade balance.

3.2 Data Collection

First of all, for the trend analysis of trade and investment relations between the countries involved, data has been collected from several international databases on trade and FDI, listed in the next subpart. Secondly, data for the regression analysis has been collected from the EU database AMECO. Thirdly, in order to complement the quantitative data on trade and investment relations, a small interview with an open character has been be conducted with Mr. van de Ven, employee of start-‐up located in Barcelona, to help highlight the considerations of a company in how to engage operations in Spain. The summary of this interview can be found in appendix 7.1. A final note on the data collection is that this paper will make use of FDI stock data, as opposed to FDI flows data. FDI flows are subject to larger fluctuations, thus making it harder to recognize any patters. FDI positions relate to the stock of investments at a given point in time (e.g. end of year, end of quarter). FDI flows and positions include equity (10% or more voting shares), reinvestment of earnings and inter-‐company debt. FDI income is the return on direct investment positions of equity (dividends and reinvested earnings) and debt (interest)6_.

3.3 Trend Analysis

The databases used for the trend analysis include UNCTAD Stat (United Nations Conference on Trade And Development), CBS Statline (Dutch Central Bureau of Statistics), OECD StatExtracts (Organization for Economic Cooperation and Development), IMF CDIS (International Monetary Fund) and the DNB (Dutch Central Bank). The table below summarizes the different databases used and what data they have provided:

6_{This
is
in
line
with
the
OECD
Benchmark
Definition
of
Foreign
Direct
Investment,
4th
edition} (2008)

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Table 3.1 Overview used databases

CBS OECD IMF UNCTAD DNB

SPEs included No No Yes Yes No

Re-‐exports included Yes Yes Yes Yes -‐

Currency € € $ $ €

CBS OECD IMF UNCTAD DNB

Country Level trade x x x x

Sectoral Level trade x x

Country Level

Investments x x

Sectoral Level

Investments x

Data on SPEs x x x

3.3.1 CBS

The data of CBS Statline is used for measuring imports and exports on a sectorial level in the bilateral trade between the Netherlands, Portugal and Spain. CBS uses a classification for the export of goods that is based on the “Nomenclature uniforme des marchandises pour les Statistiques de Transport, Revisée (NSTR).” This codification has been used in member states of the European Union since January 1st_{,
1967}7_{.
Yet,
for
statistics
involving
foreign
countries,
they
also
use
the}

Standard International Trade Classification (SITC)8_{,
which
makes
the
data}

compatible with data from sources like the OECD. 3.3.2 UNCTAD

The data of UNCTAD Stat is used for obtaining data on sector trade between Portugal, Spain and the world. Furthermore, global trade data has also been extracted from this database. UNCTAD data is listed in millions of dollars at the current exchange rate of the US$, so in order to compare them to the CBS and OECD data, they have been converted at the exchange rate of the date of consultation.

3.3.3 OECD

The data from the OECD is used to describe the general trade and FDI patterns in The Netherlands, Portugal and Spain. The OECD define FDI as “a category of investment that reflects the objective of establishing a lasting interest by a resident enterprise in one economy (direct investor) in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. The lasting interest implies the existence of a long-‐term relationship between the direct investor and the direct investment enterprise and a significant degree of influence (not necessarily control) on the management of the enterprise. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in one economy by an investor resident in another economy is the statistical evidence of such a relationship.”9

7_{"Goederenclassificatie
NST/R."
CBS.
The
overview
of
the
classification
is
available
at
-‐} http://www.cbs.nl/nl-‐NL/menu/methoden/classificaties/overzicht/nst/default.htm

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3.3.4 IMF

The IMF CDIS database was founded in 2009 to provide and improve the data availability and quality of direct investment worldwide. According to the IMF, the classification of data, concepts, valuation and coverage collected in the CDIS are consistent with the sixth edition of the Balance of Payments and International Investment Position Manual and the fourth edition of the OECD Benchmark Definition of Foreign Direct Investment. They define direct investment to take place when “an investor resident in one economy makes an investment that gives control or a significant degree of influence over the management of an enterprise that is resident in another economy”10_{.
Whereas
this
definition
seems}

to be similar to the OECD definition, the IMF CDIS data does include FDI flows that run trough SPEs. Utilizing this difference between these two data sources allows us to make inferences about SPEs.

3.3.5 DNB

The Dutch Central Bank (DNB) maintains statistics on foreign direct investment of Dutch companies. They include both industry-‐wide as well as national investment statistics. Industry wide data is limited to a certain group of countries though, in which Portugal is not concluded. Industry wide data from the DNB is thus only used for the case of Spain.

3.3.6 Zephyr (Bureau Van Dijk)

Zephyr is a database containing information about Mergers & Acquisitions. It provides information on worldwide M&A transactions, which can be broken down in many different categories. For this paper, ‘acquisition’ was defined as the acquirer company acquiring at least 50% of the target company, thereby gaining a majority share. This will gain the acquirer a profound impact on the target company, since it will hold a majority share and is thus able to influence the decision making process. The sample selected for Portugal includes 28 acquisitions during the period 1999-‐2011, and the sample selected for Spain contains 130 acquisitions, during the period 1997-‐2012. A detailed explanation of the dataset can be found in appendix 3.1.

3.4 Regression Analysis

The data for the regression analysis is collected from the AMECO database, the Annual Macro Economic Database of the Directorate-‐General for Economic and Financial Affairs of the European Commission. Although EuroStat is the EU’s statistical office, AMECO publishes most monetary and financial statistics in collaboration with the European Central Bank (ECB). The data encompasses the time period 2002-‐2012.

I will follow the literature on the intertemporal approach to the current account, which analyses the long-‐term relationship between the current account and several macro economic determinants. More specifically, I use the methodology applied by Collignon and Esposito (2011) to analyse the influence of ULC on the current account. Central in the intertemporal approach to the current account is the identity that the current account balance is equal to the difference between domestic investment and savings, aggregated across private and public sectors,

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and the trade balance. Thus, the determinants of the current account balance and the trade balance stem from factors that have an impact on investment and savings decisions. Collignon and Esposito (2011) take the following factors into account: private savings depend on macro economical factors such as the government budget balance, relative interest rate and GDP relative to a reference country. Relative GDP per capita reflects higher external borrowing requirements that catching up countries require (lower levels of GDP per capita result in the expectation that the country will converge and catch up with the higher-‐level GDP countries, thereby reducing the current account balance because of the need for more borrowing). The government budget balance reflects the twin deficit assumption11_{,
and
the
dependency
ratio
reflects
the}

higher consumption share of the non-‐working population (the ratio represents the population below 15 or above 65 years on the population between 15 and 65). The relative long-‐term interest rate reflects the fact that the long-‐term interest rate can increase savings since it makes current consumption more expensive compared with future consumption. It also increases opportunity cost of investments. Finally, the ULC reflects the competitiveness measure.

Concerning the econometrical methodology, the following considerations were made. To begin with, I estimated the equation in first difference estimators, because of the following reasons: first, estimating in first differences (calculated as the difference between the values of y in this period and in the previous period, denoted by the 'delta' sign) remedies for the autocorrelation. Secondly, this eliminates the potential fixed effects, yet also eliminates the constant in the equation. The use of first differences is also motivated by the fact that most of the variables are non-‐stationary, meaning that the joint probability distribution of this process changes over time, and parameters like the mean and variance, if present, change as well and do follow a trend. Economic data, like the data used in this paper, is frequently seasonal and connected with the non-‐stationary price level. To test whether the variables are stationary or not, a unit root test was conducted, which examines the null-‐hypothesis that the series contains a unit root (and consequently, is non-‐stationary) versus the alternative hypothesis that the series is stationary. The results of the unit root test are listed in appendix 3.4. Moreover, differencing the equation is used since there is not enough data available to use other, more approved econometrical methods, such as including lagged variables (ARMA regression or Autoregressive Distributed Lags model). In effect, the equation estimates the effect of the difference in the independent variables on the difference in our dependent variable (difference between two subsequent years). Country specific effects are left out, since we are merely interested in the ‘direction’ of the effect instead of a perfect explanatory model, keeping in mind the limited number observations. Based on the AIC (Akaike Information Criterium), which measures the relative quality of a statistical model for a given set of data, a trend variable was left out for Portugal but included for Spain. The AIC considers the goodness of fit of the model in relation to the complexity of the model. In the case of Portugal, the AIC for the model without the trend variable rendered a better model than the one with the trend variable included. For Spain, this was not the case. This confirms the choice of modelling

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the two countries separately. Even by comparing all the different models including and excluding variables like the constant and trend, the estimated influence of the independent variables on the dependent variable is still fairly similar. Again, the exact explanatory power might not been found, but an indication of the cohesion can be made.

The specification of the model is as follows:

∆𝑇𝐵_!,! = 𝛽_!∆𝐺𝐷𝑃𝑟𝑒𝑙_!,!+ 𝛽_!∆𝐺𝐵_!,!+ 𝛽_!𝐼𝑁𝑉𝑃_!,!+ 𝛽_!∆𝐷𝐸𝑃_!,!+ 𝛽_!∆𝐿𝑇𝐼𝑟𝑒𝑙_!,!+ 𝛽_!∆𝑈𝐿𝐶_!,!+ 𝜂_!+ 𝜀_!,!

In this equation, TB represents the trade balance, expressed as share of GDP. GDPrel is the difference between a country’s GDP and the US one, GB is the government balance in terms of GDP, INVP is the share of private investment of total GDP, DEP is the dependency ratio and LTIrel is the ration between a country’s long term interest rate and the US one. ULC represents a competitiveness measure, which in this case is the annual change in ULC. Subscript i indicates the country while t represent the time period. ηt are time specific dummies controlling for common shock and ε is the error term.

The regression results are discussed in chapter 7.

3.5 Caveats

There are a number of caveats in the data that need to be addressed. The first two caveats relate to trade data; the third one is about FDI.

3.5.1 Global Value Chain (GVC) Analysis

GVC analysis holds that value is added throughout each stage of the production of a product. Since stages of production can be performed in different countries, this means that multiple countries profit from producing one product. However, the exports are accounted to the home country of the company that sells the product. This means that the measure of national exports can distort the actual value of those exports (Sturgeon et al, 2013). Recently, these developments have been noticed by central statistical agencies, such as the Dutch Central Statistics Agency. In their most recent report on international trade12_{,
they
conclude
that}

the direction and size of the trade balance with a country does not give an unambiguous insight in what weight this trade partner has for the Dutch economy. For instance, according to the report, the 2,5 billion euro trade surplus the Netherlands experienced in trade with Brazil was reduced to a balanced trade balance after taking GVCs into account. However, trade databases do not take into account the effects of GVC analyses yet. Therefore, they have not been taken into account in this research.

3.5.2 Re-‐exports

A second issue to take into account relates to the fact that the Netherlands is a transit economy, meaning that it re-‐exports a lot of its imports. Re-‐exports include goods that have been produced in another country and are exported again, sometimes after a small modification. For transit economies, re-‐exports

12_{See

Internationaliseringsmonitor
2014
Tweede
Kwartaal.
CBS.
2014}.

Master Thesis

Master Thesis

“An analysis of the influence of Unit Labour Costs on changes in trade

and investment flows between The Netherlands, Portugal and Spain,

and subsequent implications for Dutch companies operating there,

1996-­‐2012”

Abstract

Table of Contents

1. Introduction

2. Literature Review

3. Methodology

1996-‐2012”