In this paper, we explore the connection between international interconnectedness, defined as trade and financial openness, and productivity in Switzerland. While empirical studies mainly use cross-country-, industry-, or firm-level data Hufbauer and Lu , studies at the country level only exist for catching up economies e. Switzerland is interesting to study as it is a highly innovative industrialized economy.
Studying the link between trade openness and productivity in an advanced economy might therefore yield important insights. On the one hand, Switzerland has a highly developed financial sector and has not been directly affected by the European debt crisis. On the other hand, Switzerland persistently runs current account surpluses such that a global economic slowdown should result in a capital retrenchment.
However, the cause of net capital inflows has substantially different implications for the costs of and therefore the desirability of financial openness. This makes Switzerland an especially interesting country to study. This is mainly due to the fact that there are different definitions of openness. First, there is a distinction between de jure and de facto openness. Second, there are different types of flows, i. In the following, we compare different measures of openness to provide a broad picture of the openness of the Swiss economy.
Freedom to trade internationally. Sample: —, Source: Fraser Institute. In addition, the Swiss regulatory environment is not conducive to business operation. Despite these shortcomings, Switzerland is characterized by sound institutional quality and a favorable investment climate. Nominal Openness. In percent. It should be noted that there are also some drawbacks to using nominal openness to assess the openness of an economy. Alcala and Ciccone argue that an increase in external trade may lead trading partners to increase specialization according to their comparative advantage.
Because of specialization, formerly domestically produced goods are substituted by imports, which increases productivity in the tradable goods sector but not in the non-tradable goods sector. Due to this asymmetry, the relative cost of production in the non-tradable goods sector increases, which results in a rise of relative prices and hence a rise of nominal GDP.
This will increase the size of both denominator and numerator of the nominal openness measure. Thus, an expansion of international trade might decrease nominal openness according to this measure. Real Openness. Complexity of exported goods. Sample: —, Source: Economic Complexity Index.
Financial openness can again be measured in terms of de jure and de facto openness. There are neither noteworthy barriers to entry nor restrictions regarding the pricing and volume of credit Abiad et al. Gross foreign assets as a share of GDP. Gross foreign liabilities as a share of GDP. In the following, we want to explore whether the high degree of financial openness in Switzerland might affect productivity growth. The literature assumes that different forms of capital investment have different effects on economic growth. FDI can entail a transfer of technological and management know-how.
Moreover, foreign direct investment decisions are much more long-term oriented than credit flows and thus facilitate knowledge spillovers to other enterprises and sectors. In sum, Switzerland is already a relatively open economy. This assessment holds true for de facto openness measures, particularly with regard to financial flows, which are based on actual data. Following the KOF Index of Globalization, Switzerland is one of the most economically globalized countries in Europe, with regard to actual flows.
At the same time, however, it is not as globalized as other European countries. Hence, as a means to also improve de jure openness, Switzerland may consider deregulation and a reduction of trade restrictions on goods and services. This assessment, however, is not to be understood in absolute terms. Measured by international trade volumes, the Swiss economy is by no means a closed economy.
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Trade openness—measured by foreign trade in relation to economic activity—is explained by two variables: foreign demand for domestic products and the size of the domestic economy. The underlying presumption is that production has to exceed a certain threshold in order for an economy to produce competitively on international markets. Therefore, the number of potentially competitive industries in an economy, which lowers the need to import these products, should increase with population size.
Foreign demand, on the other hand, should have a positive effect on trade openness. The market for domestic products should increase with rising foreign demand. To approximate foreign demand, the OECD constructs a variable that weights the size of a target market—measured by GDP—by the inverse of the distance to the respective target market.
The OECD uses several different weighting schemes for constructing this demand variable. The third measure uses economic activity in a cell and weights this activity by the inverse of the distance to the economically weighted Swiss grid cells. The fourth measure uses the inverse of the squared distance as a weighting scheme.
Comparison of estimated and actual trade openness using the inverse of the squared distance between grid cells as weighting scheme for economic activity. The discrepancy between actual trade openness and the model-based measure of openness for Switzerland is the most pronounced one among all OECD countries. It merely shows that given the geographic circumstances of economically prospering regions nearby—which results in a potentially high foreign demand for Swiss products—and the relatively small size of Switzerland—which prevents Switzerland from specializing in all products that are domestically consumed and therefore makes foreign trade highly desirable—foreign trade in relation to economic activity is relatively low.
This discrepancy between actual and projected trade openness is robust to all other demand measures under consideration OECD b , even though it is most pronounced for the demand measures based on grid data model 3 and ,model 4. One reason for this might be the proximity of economically prospering regions in Germany Munich, Stuttgart as well as in Italy Milan.
Using grid-based weights should therefore increase foreign demand and thereby expected foreign trade in comparison to the calculations based on the inverse of the distance to the capital as a weighting factor. Adjusted R 2. Demand weighted by the inverse of squared distance between capitals in model 1 model 2 , weighted by the inverse of squared distance between cells model 3 model 4.
Comparison of estimated and actual trade openness Model 4. Revisions of GDP. Revisions of foreign trade. Foreign trade to GDP. In sum, when taking into account the new classification of the national accounts ESA , the finding that Switzerland—given its small size and the geographic proximity to economically prospering regions—should be classified as relatively closed in comparison to other OECD countries can hardly be maintained. However, which accounting standard captures foreign trade more accurately is up for debate. The increasing openness of Switzerland during the last decades raises the question whether and in which sectors the Swiss economy has benefited from this development.
The economic literature highlights three channels through which openness can have an impact on the domestic economy: 1 international trade, 2 international capital flows, and 3 international productivity and technological spillovers. First, the exchange in goods is the key mechanism in the theory on international trade. This theory states that international trade raises productivity because economies are able to specialize on the production of specific products for which they have a comparative advantage.
Comparative advantages may result from economies of scale, differences in technology, or resource endowments. Moreover, international trade should result in increased competition in the tradable goods sector. This should raise productivity in the tradable goods sector as some domestic goods can be substituted by imports. Melitz argues that an increase in exports may also raise domestic productivity.
He shows that international trade fosters reallocation of resources towards more productive firms. This is the essence of the financial flow channel. Improved access to international capital markets facilitates overcoming domestic capital shortages by capital imports. Hence, a higher capital stock leads to higher labor productivity and stronger economic growth compared to economies in which capital is scarce. International financial integration also increases domestic incomes if the economy has excess capital. If desired domestic savings are higher than desired domestic investments, this would result in overinvestment in a closed economy, depressing the real interest rate.
Financial integration allows for transfers of excess savings to countries where capital is scarce. This raises capital income and thereby gross national income GNI compared to the case of a closed economy. Increasing financial market integration also enhances investment opportunities. Therefore, investors are able to reduce the overall risk of their portfolios. The diversification of idiosyncratic national risks allows for a more efficient allocation of resources and boosts the productivity of inputs Obstfeld In addition, a broader diversification of risks reduces risk premiums and hence costs, which positively affects investment demand and productivity Errunza and Losq The third channel through which openness may raise productivity and economic growth is the diffusion of technological knowledge.
For this purpose, the prospect of monopoly rents that cover the cost of innovation is essential. As ideas are non-excludable in use, they can spread internationally. Moreover, diffusion of innovations results from international trade of investment and intermediate goods. This process increases productivity in countries in which these new products are used. However, a larger market may open the opportunity for higher returns and therefore promotes innovations.
Furthermore, international trade may raise productivity by increasing the number of international investment goods. However, this occurs only if the elasticity of substitution between these investment goods is small Rivera-Batiz and Romer ; Romer In this section, we analyze the empirical relationship between various measures of openness and labor productivity at the national level. As measures for trade openness, we use nominal openness, real openness, and import and export shares.
To measure financial openness, we use the ratio of gross foreign liabilities to GDP.
In addition, we use different components of this variable because they may have different effects on labor productivity. For example, FDI has a positive effect on productivity whereas external debt has a negative impact Kose et al.
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We therefore use FDI foreign liabilities as well as equity capital and borrowed capital in relation to GDP in the following analysis. As a dependent variable, we use labor productivity as well as real GDP based on purchasing power parity from the Penn World Tables. We use annual data from to For this analysis, we estimate several vector autoregression VAR models for Switzerland. As the aim of this paper is to present evidence for Switzerland, we employ a time series approach using Swiss data. To take stochastic trends in the data into account, we use the VAR in the error correction representation and test for cointegration between openness and productivity.
Similar bivariate approaches have been employed, for example, by Federico et al. Related error correction analysis include additional variables Malhotra and Kumari ; Siliverstovs and Herzer For the financial openness indicators i to iv , we find the expected positive relation with labor productivity. The respective coefficients are highly significant. The interpretation is that productivity adjusts after a deviation from the long-run relationship.
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This indicates that liabilities except FDI are weakly exogenous to the system. The causal interpretation of this result is that capital inflows raise labor productivity in Switzerland. Therefore, the reduction in foreign liabilities in equity capital after the financial crisis is one contributor to the weak productivity growth in Switzerland. With regard to the trade openness indicators, the results are less conclusive. If we look at exports and imports without gold and transit trade, we find a significant positive long-run relation to productivity.
However, the significance of the adjustment coefficients indicate that exports respectively imports adjust after a deviation from the long-run relationship. In this system, productivity is weakly exogenous. In addition to these openness indicators, we test the relationship between the real effective exchange rate and labor productivity and find a significant positive long-run relation. Therefore, a higher real exchange rate is accompanied with higher productivity.
At first sight, a positive relation is not in line with theoretical considerations because an overvalued currency should dampen exports and therefore economic growth. However, Rodrik finds empirical evidence that this reasoning is only true for developing countries. He finds no negative relation for advanced economies. Moreover, the adjustment coefficients indicate that the real effective exchange rate adjusts after a deviation from the long-run relationship, productivity does not.
Hence, an appreciation of the real effective exchange rate may be attributed to an increase in labor productivity. Motor vehicles, trailers, semitrailers, and other transport equipment. While global trade in goods has been gradually liberalized, international trade in services is still heavily regulated. On the one hand, barriers to trade restrict foreign entry and thus dampen imports. On the other hand, restrictions affect competitiveness of domestic firms. Furthermore, services serve as essential links in global value chains and as input factors in the manufacturing process.
It is based on a comprehensive regulatory database, which pools policy measures affecting trade in 18 services sectors. The index is scaled between zero and one, where zero implies complete openness to trade and investment and one implies a completely closed sector. However, a score of 0. The STRI incorporates five policy areas: restrictions on foreign entry, restrictions to the movement of people, other discriminatory measures, barriers to competition, and regulatory transparency.
The STRI considers general core measures which are common for all sectors and additional sector-specific measures that take into account the characteristics of a respective sector. The scoring and weighting procedure is as follows. First, a certain policy measure is assigned a value of zero not restrictive or one restrictive. Within the five policy areas, individual measures have the same weight. However, the policy areas themselves are weighted according to their relative importance in a specific sector Geloso Grosso et al. By setting the value of a specific policy measure to one, a more restrictive scenario can be simulated; by setting the value to zero, a more liberal scenario can be simulated.
It should be noted that the STRI presents a simplified illustration of trade barriers in service sectors. The computation involves the quantification of qualitative characteristics, primarily by a binary scoring system. Further, only de jure policy measures are considered, not how strictly these measures are actually enforced. The index allows for a straightforward comparison of trade restrictions between countries.
For a comprehensive analysis, more detailed information—e. Services Trade Restrictiveness Index for Swiss service sectors. Source: OECD b.
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Despite considerable restrictions to the movement of people, for nationals of an EU 13 or EFTA, state regulations are less restrictive because the free-movement agreement between the European Union and Switzerland applies. This arrangement is supposed to guarantee identical living and employment conditions for foreigners and national citizens of a contracting party. Authorization is regulated by legal quotas and requires labor market tests. Additionally, foreigners have to demonstrate sufficient professional and personal qualification State Secretariat for Migration This legal basis allows for a limitation of the number of first-time short stays and residence permits for work purposes Art.
Openness and productivity of the Swiss economy
The admission to work in Switzerland requires that this is in the interests of the economy as a whole Art. Furthermore, certain personal requirements have to be fulfilled. Only managers, specialists, and other qualified workers may be admitted, provided that their qualifications and professional and social adaptability, language skills, and age give reason to expect a lasting integration into the Swiss job market and the social environment Art.
Restrictions to movement of people in the Services Trade Restrictiveness Index for Swiss service sectors. The scope of services trade restrictions captured in the STRI is markedly greater than average in the sectors legal services, accounting services, courier services, and computer services Fig. Likewise, there are considerable—and above OCED average—constraints in telecommunications and commercial banking. The barriers to trade in these branches and their impact on the STRI are explored in detail in Appendix. In the following, by means of the Policy Simulator, we will analyze potential productivity increases arising from the liberalization of trade in these sectors.
Restrictive policy measures inhibit cross-border trade. On the one hand, trade barriers limit the access of foreign companies to the domestic market and thereby negatively affect imports.
On the other hand, they have an impact on the competitiveness of domestic enterprises by reducing incentives for innovation and opening up new markets at home and abroad. Furthermore, services are an essential part of global supply chains.
They serve as a connection between individual links in the supply chain and as inputs for the manufacturing process. Consequently, trade restrictions in service sectors may also affect trade in industrial goods OECD c. Their analysis is based on a gravity model which takes the Services Trade Restrictiveness Index into account and finds that barriers to trade in services sectors do not only have a negative impact on imports but affect exports as well. In computer services, legal services, air transport, maritime transport, commercial banking, and insurance, the significant negative relation between exports and STRI is even stronger than the one between imports and STRI.
These results support the hypothesis that trade barriers in services sectors impede innovation in the services sector, thus obstruct international competitiveness and constrain exports by domestic service suppliers. In this study, we design two scenarios in order to illustrate the effects of trade liberalization in services sectors on trade flows by means of the STRI policy simulator. The first scenario focuses on the liberalization of the movement of people by removing quotas for independent services suppliers, for contractual services suppliers and for intra-corporate transferees, as well as labor market tests for intra-corporate transferees.
The second scenario assumes all changes made in the first scenario as well as additional sector-specific liberalizations. In legal services and accounting services, the provision that foreign providers have to completely re-do the university degree, practice, and exam in the domestic country is reversed. Impact of services trade liberalization on trade flows in Switzerland. Imports in the respective sector b. Exports in the respective sector b. Note: If estimated elasticities are insignificant, the effect on trade flows is insignificant and therefore not reported. In Switzerland—and in many other countries—trade in services is subject to substantially more regulation than trade in goods.
Hence, trade liberalization may be a means to increase productivity in certain services sectors and thus promote economic growth. According to this index the extent of restrictions in several Swiss services industries is larger than average, which is mainly the result of restrictions to the movement of people. Trade liberalization in accounting services, air transport, commercial banking, computer services, or legal services may increase trade flows by positively affecting imports as well as exports in the respective sectors.
With respect to financial markets, Switzerland is an open economy. On the one hand, in the long run, this leads to efficiency gains due to a better allocation of resources. On the other hand, in the short run, the economy becomes vulnerable to international financial shocks. With increasing integration of international financial markets, the volatility of capital flows, in particular of gross capital flows for which capital inflows and outflows are separately considered , has strongly increased in the recent years Broner et al.
The high volatility of capital flows is particularly destabilizing when capital flows are pro-cyclical and hence amplify domestic developments. Capital flows are defined as the sum of portfolio investment assets and liabilities, foreign direct investments, and other investments. The estimations are based on quarterly data, from the first quarter of to the third quarter of Relationship between the domestic economic activity and capital exports and imports. Pro-cyclicality of capital flows is especially critical when extreme periods of capital flows occur as in the recent financial crisis.
For example, a strong reduction in capital by foreign investors, a so-called sudden stop, can lead to liquidity problems in the affected economy, especially in turbulent economic times. In contrast, a strong increase in capital inflows, a surge, might lead to overheating of the economy during economic booms.
If the surge in capital flows is followed by an appreciation of the domestic currency, price competitiveness of the economy could worsen. It was assumed that investors shifted their capital to Switzerland since it was perceived as politically stable and not directly affected by the European Debt crisis. This hypothesis can be easily verified by identifying extreme periods of capital flows using the approach of Calvo et al. In a first step, moving averages of the respective capital flows are computed over the last four quarters and their annual change is calculated.
A period of pronounced changes in capital flows is identified if three conditions are fulfilled: i the annual change of capital flows is lower than two standard deviations of the historical mean in at least one quarter, ii the period starts when the annual change deviates by more than one standard deviation and ends when the deviation is less than one standard deviation from the historical mean, and iii the period is longer than two quarters. We apply this method to gross capital flows and differentiate between four different kinds of periods: a strong decrease in capital inflows sudden stop , a strong increase in capital inflows surge , a strong decrease in capital outflows retrenchment , and a strong increase in capital outflows flight.
Periods of strong capital inflows surge and low capital outflows retrenchments for selected categories of capital. Periods of surge or retrenchment are indicated by a line for the particular quarter. Source: IMF. Own calculations. In sum, the results indicate that short-run capital inflows and outflows are particularly influenced by the behavior of domestic investors. This is in line with Auer and Tille who find that Swiss banks shifted their capital to Switzerland during the recent financial and the European Debt crisis, which led to a strong appreciation of the Swiss franc. Thus, the home-bias effect was the key driver of the appreciation of the Swiss franc rather than the safe haven effect.
Such developments in capital flows can be influenced by monetary policy only to a certain degree Rey , so that the disadvantages of financial openness have to be accepted in order to benefit from medium-term and long-term positive effects of financial openness on productivity. This paper analyzes the connection between trade and financial openness on the one hand and labor productivity and economic activity in Switzerland on the other. The overall picture emerges that the openness of the Swiss economy has increased in recent years.
We call this assessment into question. Employing the same methodology, we show that in terms of de facto openness, Switzerland is as open as comparable OECD countries. Differences in these two assessments result from a change in the accounting standard: We show that the treatment of transit trade, which is a very important segment of trade for Switzerland, is essential for differences in the assessment of Switzerland's openness. We then analyze the connection between openness and productivity growth in the Swiss economy. Does further opening up the economy increase productivity?
For the aggregate level, we only find weak evidence for co-movement between trade openness and labor productivity. In a second step, we employ a disaggregate analysis. For several branches of manufacturing, we find a positive correlation between real exports and labor productivity. Causality seems to run from openness to productivity. Thus, further increasing international trade in the respective branches might also increase productivity. Using this insight, we simulate two scenarios and thereby show how policies that lower regulation in the service sector could translate into an increased international exchange of services.
With regard to financial openness, we find a positive correlation with economic activity. However, the literature argues that benefits of financial openness in the long run come at the price of higher volatility in the short run due to the volatility of financial flows. We therefore analyze the root of net capital flow volatility in Switzerland. We find that retrenchment of Swiss investments abroad, e. Inflows of foreign investors due to the perception of Swiss being a safe haven were not the dominant factor. Short-run costs due to the high volatility of capital flows might therefore be lower than widely perceived.
This decrease in the index is driven by more variation in tariff rates and more restrictive capital controls. Inter alia, prescriptions on the investment of pension account and restrictions for real estate investment by foreigners the so-called Lex Koller are counted as restrictive capital controls. Alfaro et al. For a table with the estimation results, see OECD b , p.
Trade gravity model estimation results. Estimated over-performance in trade openness. The lag length is selected according to the AIC. To check for cointegration, we test for the rank of the Pi matrix which is equivalent to the number of cointegration relations. Using these restrictions, the system is estimated via maximum likelihood. The long-run coefficients are derived from the eigenvectors of the Pi matrix. Adjustment takes place via y. The results of the testing procedure and for all coefficients of the model are available from the authors upon request.
Hehas published numerous articles in leading academic journals and has three times won the senior teaching award at the Wake Forest Calloway School of Business and Accountancy. His research interests include real estate capital markets and investment, capital market efficiency and stock market predictability.
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Show More Table of Contents Preface. Customer Reviews Average Review. See All Customer Reviews. Shop Books. Add to Wishlist. USD Sign in to Purchase Instantly. Overview This book fills a gap in the existing resources available to students and professionals requiring an academically rigorous, but practically orientated source of knowledge about real estate finance. Written bya bank vice-president who for many years has practiced as a commercial lender and who teaches real estate investment at university level, and an academic whose area of study is finance and particularly valuation, this book will lead readers to truly understand the fundamentals of making a sound real estate investment decision.
The focus is primarily on the valuation of leased properties such as apartment buildings, office buildings, retail centers, and warehouse space, rather than on owner occupied residential property. About the Author G. Show More. Table of Contents Preface. Average Review. Write a Review. Related Searches.