E-encyclopedia of banking, stock exchange and finance

Selected letter: P


    The pan-European Automated Clearing House (PEACH) is a business platform for the provision of euro retail payment instruments and basic related services, made up of governance rules and payment practices and supported by the necessary technical platform(s). This definition was given by the European Payment Council (EPC) at its 28 January 2003 Plenary meeting, when the new model was proposed. The main objective was to facilitate and reduce the costs related to euro retail payments in the view of the creation of the SEPA. In particular, the most important feature of the new model is that any beneficiary of credit transfers and direct debits in the Eurozone can be reached by using SEPA instruments. This model, the pan-European ACH (PEACH), is one infrastructure but not necessarily a single system, although it has been defined as a tool to be expanded to other service providers. However, since its introduction, STEP2 has been the only PEACH operating in the Eurozone. It was established by the Euro Banking Association (EBA) in April 2003.

    Editor: Bianca GIANNINI
    © 2010 ASSONEBB



    The Paris Club is an informal group of official creditors whose role is to find coordinated and sustainable solutions to the payment difficulties experienced by debtor countries. It is the major forum where creditor countries renegotiate official sector debts. A Paris Club “treatment” refers to either a reduction and/or renegotiation of a developing country’s Paris Club debts. The origin of the Club dates back to 1956 when Argentina agreed to meet its public creditors. It includes 19 permanent members, the major international creditor governments. To date, December 2013, the Paris Club has reached 429 agreements with 90 debtor countries. Since 1983, the total amount of debt covered in Paris Club agreements, rescheduled or reduced, is approximately 573 billion dollars.

    History and Paris Club Terms

    The origin of the Paris Club dates back to 1956 when Argentina agreed to meet its public creditors in Paris. Since 1956, the Paris Club has remained a central player in the resolution of developing and emerging countries’ debt problems. In 2004, the club agreed to write-off the debts of Iraq. In April 2006, Nigeria became the first African country to fully pay off its debt (estimated $30 billion) owed to the Paris Club. Principles and rules established at the occasion of various debt treatment negotiations proved remarkably efficient in contributing to the resolution of different types of debt crisis. Since the first debt restructuring took place in 1956, the terms, rules, and principles of the Paris Club have evolved to their current shape. There are different kind of Paris Club treatments depending on the economic circumstances of the distressed country. Under “Classic terms”, debtor countries were granted a rescheduling of credits. “Classic terms”, designed for dealing with temporary liquidity problems, were systematically used for debt treatment. In the mid-1980s, growing concerns about the ability of poor countries to repay their debts led creditors to consider new terms of treatment. In 1987, Paris Club creditors adopted “Venice terms” (non-concessional terms that provide debtor countries with longer deferral and repayment periods). In October 1988, Paris Club creditors agreed to implement “Toronto terms”, which introduced for the first time a partial cancellation of the debt of the poorest and most heavily indebted countries. In addition, the Paris Club creditors agreed in December 1991 to raise the level of debt cancellation to 50% (“London terms”). Later, the adoption of “Naples terms” in December 1994 made two substantial improvements to “London terms”. The level of debt cancellation was raised to at least 50% and a maximum of 67% of eligible. Secondly, the Paris Club made the ground-breaking decision that stock treatments could be implemented on a case-by-case basis for countries with a satisfactory track record with both the Paris Club and the International Monetary Fund (IMF).

    In 1996, the international financial community realized that the foreign debt situation of a number of mostly African low-income countries had become extremely difficult. This was the starting point of the Heavily Indebted Poor Countries (HIPC) Initiative. For the non-HIPCs, the club engaged less in debt reductions and moved towards encouraging the absorption of non-HIPCs' financial losses by bondholders and other private creditors.

    Principles and Rules

    The Paris Club functioning relies on 5 key principles

    1) Case by case debt treatment:

    The Paris Club makes decisions on a case-by-case basis in order to tailor its action to each debtor country’s individual situation.

    2) Consensus:

    Paris Club decisions cannot be taken without a consensus among the involved creditor countries

    3) Conditionality:

    The Paris Club only negotiates debt restructurings with debtor countries that: need debt relief; debtor countries are expected to provide a precise description of their economic and financial situation, have implemented and are committed to implementing reforms to restore their economic and financial situation, and have a demonstrated track record of implementing reforms under an IMF program. This means in practice that the country must have a current program supported by an appropriate arrangement with the IMF (Stand-By, Extended Fund Facility, Extended Credit Facility, Policy Support Instrument). The level of the debt treatment is based on the financing gap identified by the IMF program.

    4) Solidarity:

    All members of the Paris Club agree to act as a group in their dealings with a given debtor country; they also agree to be careful with the impact that the management of their particular claims may have on other members’ claims.

    5) Comparability of treatment:

    A debtor country that signs an agreement with its Paris Club creditors should not accept from its non-Paris Club creditors terms of treatment of its debt less favorable to the debtor than those agreed with the Paris Club.

    Countries Members, Observers and Participation

    The Paris Club meets every six weeks (except in February and August) at the French Ministry of Economy and Finance in Paris. Each monthly session includes a one-day meeting called a “Tour d’Horizon” during which Paris Club creditors discuss among themselves the foreign debt situation of debtor countries, or methodological issues regarding the debt of developing countries. The debtor country is usually represented by the Minister of Finance, he generally heads a delegation comprising officials from the Ministry of Finance and the Central Bank. In the Paris Club meeting, not all States are involved, but only permanent members of the Club, which are the main creditors of the debtor State whose situation is examined.

    The permanent membership is composed of Austria, Australia, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Netherlands, Norway, Russia, Spain, Sweden, Switzerland, and the United Kingdom.

    Other official creditors can also actively participate in negotiation sessions, subject to the agreement of permanent members and of the debtor country. When participating in a negotiation meeting, invited creditors agree to act in good faith and to follow the principles of the Paris Club. The following countries have participated as creditors in some Paris Club agreements: Abu Dhabi, Argentina, Brazil, Korea, Israel, Kuweit, Mexico, Morocco, New Zealand, Portugal, South Africa, Trinidad and Tobago, Turkey.

    In addition, observers attend a negotiation meeting but do not participate in the negotiation itself and do not sign the agreement that formalizes the result of the negotiation. This observers are: World Bank, IMF, UNCTAD, OECD, African Development Bank (ADB), Asian Development Bank (ADB), Inter American Development Bank (IDB), European Bank for Reconstruction and Development (EBRD).

    Paris Club and International Monetary Fund

    Debt treatment sessions are organized in close cooperation with the IMF. A debtor country is invited to a negotiation meeting with its Paris Club creditors when it has concluded an appropriate programme with the International Monetary Fund (IMF) that demonstrates that the country is not able to meet its foreign debt obligations and thus needs a new payment arrangement with its external creditors (conditionality principle). Paris Club creditors link the debt restructuring to the IMF program because the economic policy reforms are intended to restore a sound macroeconomic framework that will lower the probability of future financial difficulties.

    Paris Club Negotiation

    For more than 50 years, the Paris Club has played a critical role in the resolution of debt crisis in developing and emerging countries. The restructuring request of the debtor country shall be submitted to the Paris Club during a meeting with the debtor country and the States major creditors. The meeting involved usually also the representatives of the IMF, which illustrate the economic situation of the debtor country and the prospects for growth; then are presented with reports of the representatives of the World Bank and UNCTAD as compared to that of the IMF, have a 'setting predominantly financial character. This statement is followed by statements of debtor country representative while the representatives of creditor countries may then request additional information or clarification regarding the situation in the debtor country.

    The Paris Club does not exist as a formal institution. It is rather a set of rules and principles for debt relief that have been agreed on by its members. Therefore, since the Paris Club is an informal institution, the outcome of a Paris Club meeting is not a legal agreement between the debtor and the individual creditor countries. Creditor countries that participate in the negotiation sign a so-called ‘Agreed Minute.’ The Agreed Minute recommends that creditor nations collectively sign bilateral agreements with the debtor nation, giving effect to the multilateral Paris Club agreement.

    A debtor country that signs an agreement with its Paris Club creditors should not accept from its non-Paris Club creditors terms of treatment of its debt less favorable to the debtor than those agreed with the Paris Club (Comparability of treatment).

    Heavily Indebted Poor Countries (HIPC) initiative: Decision Point, Interim Debt Relief,Completion Point, Cut Off Date

    The HIPC Initiative was initiated by the International Monetary Fund and the World Bank in 1996. The major changes introduced by this measure is to reduce the debt also against the international financial institutions and not only Governments. To be considered for the initiative, countries must adopt reform program supported by the IMF and the World Bank and implement this program for a period of three years. Countries must meet certain criteria, commit to poverty reduction through policy changes and demonstrate a good track-record over time. The Fund and Bank provide interim debt relief in the initial stage, and when a country meets its commitments, full debt-relief is provided.

    1) Decision point:

    To be considered for HIPC Initiative assistance, a country must fulfill the following four conditions:

    be eligible to borrow from the World Bank’s International Development Agency, which provides interest-free loans and grants to the world’s poorest countries, and from the IMF’s Poverty Reduction and Growth Trust, which provides loans to low-income countries at subsidized rates; face an unsustainable debt burden that cannot be addressed through traditional debt relief mechanisms; have established a track record of reform and sound policies through IMF-and World Bank supported programs.

    2) Interim Debt Relief:

    The creditors of the Paris Club may grant interim relief a case by case basis between the decision point and the expected date of completion point, through treatment with a tax of 90%.

    3) Completion point:

    In order to receive full and irrevocable reduction in debt available under the HIPC Initiative, a country must:

    establish a further track record of good performance under programs supported by loans from the IMF and the World Bank; implement satisfactorily key reforms agreed at the decision point; adopt and implement its PRSP for at least one year.

    In addition, when a country requires, for the first time, the intervention of the Paris Club to restructure its foreign debt, it establishes a conventional date, the so-called "Cut Off Date". This divides the debt matured to that time, subject to restructuring, from debt that will mature later. The "Cut Off Date" protect export credit agencies which may not guarantee economic transactions within the debtor country in fear that it will not honor the new debt. The "Cut Off Date" helps the debtor country in crisis in terms of new access to credit and as stimulus to new private foreign investment. In special cases (Topping Up), the Paris Club may decide to restructure a part of debt incurred after the “Cut Off Date”, in order to close any financing gap in the balance of payments of the debtor country (Uganda was deleted 106% of the debt, then tapping, for further 6% to debt accrued in the period following the establishment of the "Cut Off Date").


    BIGGERI M. … VOLPI F. (2006) Teoria e politica dell’aiuto allo sviluppo, Milano, Franco Angeli Editore

    CLUB DE PARIS website, (www.clubdeparis.org)

    MINISTERO DEL TESORO, DEL BILANCIO E DELLA PROGRAMMAZIONE ECONOMICA (2000) Iniziative per la riduzione del Debito Estero dei PVS, Relazione No. 3 (http://www.dt.tesoro.it/export/sites/sitodt/modules/documenti_it/rapporti_finanziari_internazionali/rapporti_finanziari_internazionali/banche_multilaterali_di_Sviluppo/pag47-84.pdf)

    SCISO E. (2012) Appunti di diritto internazionale dell’economia, Torino, Giappichelli Editore (http://www.giappichelli.it/home/978-88-348-2690-4,3482690.asp1)

    SERIEUX J. E. … YIAGADEESEN S. (2003) Debt Relief for the Poorest Countries, New Jersey, Transaction Publishers

    WEISS M. A. (2013) The Paris Club and International Debt Relief, Congressional Research Service Report, December (http://www.fas.org/sgp/crs/misc/RS21482.pdf)

    Editor: Giovanni AVERSA

  • PARONETTO SERGIO (Encyclopedia)

    Sergio Paronetto (1911-1945), economist, industrial manager, social scientist.
    1. Paronetto was born in Morbegno, in the province of Sondrio, Italy in 1911. He did all his schooling in Ivrea. He won a prize as one of the best high-school students in Italy, a trip to Hungary, where he came down with a rheumatic illness which, with cardiac damage, jeopardized his health in the long-term. He enrolled in the Faculty of Political Sciences in Rome, which was founded in 1925. He collected Camillo Manfroni’s Lezioni di Storia delle colonie e politica coloniale, which were published in Rome in 1930 (Manfroni was born in 1863 and died in 1935). Paronetto was influenced by the Federazione Universitaria Cattolica Italiana that he frequented: this organisation was founded in 1896, and from 1925 its ecclesiastical assistant was Giovanni Battista Montini (1897-1978), who went on to become Pope Paul VI, and its president was the lawyer Igino Righetti (1904-1939). The review Studium … the vehicle of the publishing house of the same name founded in 1927 by Montini and Righetti with the aim of fostering an ethical awareness in young people in view of their future professional commitments … published Paronetto’s first articles: Ambiente e metodo nelle scienze sociali (1930), Il pensiero sociale cattolico in rapporto alla Rerum Novarum (1931) and Le celebrazioni del quarantesimo della Rerum Novarum (1931). In 1931, some Fascists attacked Paronetto, attempting to tear his FUCI badge off his jacket. This incident left him maimed for life. In 1932, he graduated with an economic history dissertation on customs and excise in the Italian states before the Unification, his supervisors being Alberto De’ Stefani (1879-1969) and Gioacchino Volpe (1876-1971). Paronetto reflected on the different forms that state intervention in the economy took in Europe and in the United States: he published Roosevelt il demiurgo in Azione Fucina in 1933. In the FUCI, Paronetto assisted Giulio Pastore (1902-1969), a Catholic trade unionist, operating after the Fascist regime had annihilated trade unions, in the years before Pastore went underground.
    2. 1934 was the year when Paronetto moved from the world of science to the world of business. On
    Pasquale Saraceno's (1903-1991) recommendation, who also came from Morbegno, Paronetto joined IRI, which had been founded in 1933. As head of the Institute’s technical secretarial staff, directly responsible to the Director-General Donato Menichella (1896-1984), Paronetto’s contribution to the restructuring of national interest banks (1934-1936), the drafting of the banking law (1936), the constitution of the Finmare (1936) and Finsider (1937) holdings, and the transformation of IRI into a permanent corporation (1937) was highly valued. In 1937, he wrote Note sull’attività dell’IRI nel momento attuale in rapporto alla sua struttura e alla sua organizzazione. He studied the knowledge-evaluation-diagnosis of the Italian economic system’s problems from the point of view of a national strategy. According to him, the crucial issue was the accumulation of capital: how to start, maintain and revive this process in Italy. Giving continuity to and perfecting the accumulation process was left to the institutionalised doctrine in the form of regulations, laws, institutions, programmes and economic plans. The objective, following the line taken by Nitti, Beneduce, Menichella and Carli, was to slacken external constraints, with the overall aim of making the system cohesive and efficient. Paronetto worked with IRI’s top managers: the Chairman Alberto Beneduce (1877-1944), the Vice-Chairman Francesco Giordani (1896-1961), and external consultants such as the jurist Alfredo De Gregorio (1881-1979), an expert on industry, and Ezio Vanoni (1903-1956), an economist and future cabinet minister, who was also from Morbegno. Paronetto worked mainly with Menichella and Saraceno: he "studied", Saraceno "saw" and Menichella "acted", he wrote at the time. At Montini’s insistence, he supported the young Guido Carli joining IRI (Carli was born in 1914 and died in 1993). Paronetto acted as a very useful bridge between different circles and different traditions: on the one hand, the radical, Masonic circle, linked to Nitti’s ideas;and on the other, the Roman Catholic circle. Paronetto identified with Menichella’s teachings on the economy and with Montini’s on philosophy, and he recognised that their inspiration was inexhaustible.
    3. In 1940, Paronetto began to reconsider seriously the ethical foundations of human action within the world of business because of his own personal experience. He was indignant at Italy’s entering the war in 1940, and he felt the weight of freedom as a responsibility. This was all the stronger in those who, like him, felt that, perhaps through default, they were "men of action" (Ascetica dell’uomo d’azione is the title of his memoirs, published posthumously by Studium in 1948, with a preface by Montini). The change is evident in the shift in Paronetto’s articles published in Studium from 1940 onwards: a coherent group of articles, inspired by an original view on commitment in the modern world for those with Christian ethics, which include Burocrazia e personalità (1940); Profilo del banchiere e dell’uomo di finanza (1940); Profilo del capo di azienda (1941); Morale professionale del cittadino (1943); Professione e rivoluzione (1943); Lettere al direttore sulla coscienza e la tecnica (1944). Paronetto reflected on the consequences of technology parting company with morals, politics and the economy, and on its becoming a self-propelling sub-system; he grasped the advent of the managerial society, and showed interest in the nascent science of management; he saw early on the importance of competence and responsibility which those called to "act" in enterprises and institutions must have (ethical management). Paronetto was a close friend of Guido Gonella (1905-1992) who was the Vatican presses’ advisor for Italian affairs. Gonella asked Paronetto for his help in formulating the economic subject-matter in Pius XI’s speeches, and the concepts of "justice" and "just peace" in Pius XII’s broadcasts (1941, 1942).
    4.The year 1943 saw Paronetto shift his attention from the world of business back to wider national issues. He addressed questions that involved reorganising Italy, not only Italy’s industry. He was primus inter pares the author and the compiler of the Codice di Camaldoli (1943), a new ethical, political and economic constitution for Italy.
    The FUCI held seminars regularly in the monastery of Camaldoli in the province of Arezzo: the participants included Amintore Fanfani (1908-1999), Giorgio La Pira (1904), Aldo Moro (1916-1978), Giuseppe Spataro (1897-1979), Giuseppe Capograssi (1889-1956), Paolo Emilio Taviani (1912-2001), Giulio Andreotti (1919), Vanoni and Saraceno. The Codice was adopted by the Christian Democrats for reference during the sessions of the Constituent Assembly (1946-1947). The Camaldoli conference ended on 25 July 1943: Paronetto left immediately for Merano where he married Maria Luisa Valier. On the morning of 8 September 1943, Menichella went in secret to Paronetto’s home with a document appointing him Director-General of IRI. Paronetto refused the appointment, settling for the post of Deputy Director-General, provided this was shared with another director, and at a lower salary. On Menichellla’s explicit orders, Paronetto was at the helm of IRI, and, especially during the bitter parenthesis between 8 September 1943 and June 1944, he contributed to saving many of Italy’s industrial assets. Alberto Asquini (1889-1972), the IRI commissioner appointed by the government of the Italian Social Republic, and an eminent jurist, accepted Paronetto’s advice, and this latter became co-responsible for the Ufficio Stralcio (liquidation office) in Rome. From the IRI head office in Milan, Asquini worked in close agreement with Paronetto to save the industrial and technological assets which were under threat of both the allied bombardments and the partisan action, and of the Germans’ desire to destroy totally any production capacity that was not immediately employable to the Reich’s advantage (other industrial plants were dismantled and taken to Germany). Both Paronetto and Asquini were convinced that it was vitally important to think about "afterwards", even in a climate that was not without suspicion. At great personal risk, in his home in Via Reno in Rome, Paronetto hid several people that were wanted by the Germans and by the supporters of the fascist Social Republic; he was in contact with the head of the Resistance movement in Rome, Colonel Giuseppe Cordero Lanza di Montezemolo (1901-1944), who was shot by the Germans.
    5. Paronetto began a useful work of pedagogy through which he gave ‘shape’ to the Italian economy. At his home in Rome in the 1940s, he gave private "lessons in economy" to the members of Italy’s future ruling class, in particular to Alcide De Gasperi (1881-1954). The years from 1943 to 1945 were spent persuading Italy’s entire future top management about the usefulness of keeping alive IRI and the enterprises with state holdings in view of the reconstruction programme, contrary to the opinion of Luigi Sturzo (1871-1959) at Confindustria and, at least in the early stages, contrary to the American opinion; he also tried to persuade them that specific Roosevelt-type state intervention in Southern Italy was advantageous, as was the perspective of relying on an aid programme organized by the victorious powers in order to consolidate economic freedom and democracy in Italy. These ideas were put to Palmiro Togliatti (1893-1964) by a friend of Paronetto’s, Franco Rodano (1920-1983), who was persuaded by Paronetto to change the name of the movement he led from Comunisti Cattolici to Sinistra Cristiana. Paronetto spent his last years working on the rough draft of the reform of IRI (the new statute was launched in 1948). Paronetto died in 1945, at the age of 34, when he was already considered a ‘maestro’, but had not yet been absolved from the false accusation of collaborationism, which happened in the following year. Italy was hugely indebted to Paronetto: modernity and the internationalisation of the future ruling classes’ (Andreotti, De Gasperi, Fanfani, Gronchi, Gonella, La Pira, Moro, Vanoni, Saraceno, Spataro and Taviani) approach to the economy, to industry and to finance; the presence of inspiring principles in the Constitution of the Republic of Italy which, without Paronetto, were unlikely to have been included; the importance of planning rather than public administration for direct state intervention in the economy which was necessary after IRI for inventing future special intervention in Southern Italy (1950), and Marcello Boldrini’s ENI … Boldrini (1890-1969) was explicitly inspired by the Camaldoli principles …; bodies which, like IRI, were able to promote markets, competition, economic freedom and hence democracy in Italy; the need to practise the principle of inclusiveness.

    (On Paronetto, M. L. Paronetto Valier, Sergio Paronetto. Libertà di iniziativa e giustizia sociale, Edizioni Studium, Roma, 1991; S. Baietti, G. Farese, Sergio Paronetto. La forma dell’economia italiana published by Rubbettino, Soveria Mannelli, 2011.)
    Editor: Giovanni FARESE e Stefano BAIETTI
    © 2010 ASSONEB


    International economists usually call pass-through period the interval within which the domestic price of foreign goods adjusts to the exchange rate changes. The pass-through period is consistent with the existence of the so-called J-curve. Indeed, empirical evidence suggests that prices of imported goods, expressed in local currency, display some rigidity with respect to exchange rate variations. That is because producers prefer to keep stable quantities and to decrease their mark-up rather than raise the price. This suggests the existence of non-competitive markets.
    Editor: Lorenzo CARBONARI
    © 2009 ASSONEBB


    The ability to establish a branch or offer investment services in another (host) Member State of the EU on the basis of an authorisation granted in an investment firm’s home State.

    ©2012 Editor: House of Lords


    The PP is the number of years for a project to break even, i.e. the number of years for which discounted annual net cash flows must be summed before the sum becomes positive and remains positive for the remainder of the project’s life.

    © 2010 ASSONEBB


    Pension plan is a fund financed by the contributions of the employer for the eventual payments of retirement benefits. Employers can also share with employees the amount invested in the fund. Pension plans are managed by different categories of pension plan sponsors. These can be either public or private entities operating on behalf of their employees. A private pension plan sponsor is generally referred to as corporate or private plan. Alternatively, a public sponsor can be either a state or a local government. In case the sponsor is a union offering pension plans to its members, the sponsor is called Taft Hartley plans. Despite their low level of liquidity, pension funds represent the major investors in the international financial system. There are several reasons for the development of pension plans. The most important is the favourable tax treatment associated to the investment in pension contracts. Indeed, contributions are tax exempted during the whole working life of the employees, or in general until the funds are withdrawn. From employers' perspective, there is also a strong incentive to pay contributions that are tax deductible. However, in order to benefit from tax exemption, the fund must be a qualified pension plan, which means that it has to meet some federal requirements. There are two types of pension plans: defined-benefit plans and defined-contributions plans. There is also another type of pension plans called cash balance plan that is a combination of the two basic types.
    In defined-benefit plans, the retirement benefits are paid regularly (in general monthly) by the plan sponsor to employees for life beginning at retirement. In case of death before retirement, the same payments are paid to the employees’ beneficiaries. According to this method, the pension plan sponsor is fully responsible for the employees’ benefits that are determined in advance. The formula for the calculation of retirement benefits takes into account the employees' earnings and years of service. The benefits are then paid when the employees meet some requirements, such as a certain number of years of service, while the continuation with the employer or the union is not relevant. Typically, pension plan sponsors can protect themselves against the risk of being unable to provide the amount agreed by the pension contract by purchasing an annuity policy from a life insurance company. Defined … benefit plans guaranteed by insurance are called insured benefit plans. In recent years, we have assisted to the decline of defined-benefit plans. Many pension plans have been frozen by the most important firms in the USA, like IBM, while others like Microsoft have not adopted defined-benefit plans at all. The competition with firms offering defined-contribution plans imposed too high costs on defined-benefit plan sponsors and they became unsustainable. Most generally, all pension plan sponsors, either private or public, are still facing a crisis today. In essence, this crisis consisted of an accumulation of large deficits by pension funds that threatened the solvency of corporations and governments. The crisis was caused principally by the lack of appropriate regulation and the misleading accounting rules that resulted in the underestimation by firms of pension fund liabilities.
    In defined-contribution plans, the sponsor makes contributions on behalf of the employee in the fund and does not pay any retirement benefit. In general, contributions made by pension plan sponsors reflect a portion of the employee's salary. The retirement benefits are not known in advance and they depend on the contributions made to the fund and on the performance of the investment option selected by the employee. In this case, pension plan funds have no debt obligations for the retirement period and so they do not face any investment risk as it occurs in case of defined-benefit plans. In general, the most selected investment option is represented by mutual funds. In any case, according to the U.S. Department of Labour regulation, firms must ensure a different range of investment possibilities between families of mutual funds that serve specific investment objectives. The broader sector of defined-contribution plans is the 401(k) plan in the private sector, the 403(b) plan in the non-profit sector and the 403(b) plan in the public sector. These plans equally offer the lowest costs as compared to other legal forms of defined-contribution plans such as money purchase pension plans or employee stock ownership plans (ESOPs), and several investment options. Similar to the 401(k) in the private sector, the largest public defined-contribution plan sponsor, the Federal Retirement Thrift, offers a range of investment opportunitiesto federal employees. Finally, to overcome the shortage related to both basic types of pension plans described above, hybrid pension plans have been created, resembling some of their basic features. There are several categories of hybrid pension plans (floor-offset, pension equity, etc.), but the most common is the so-called cash balance plan. In essence, in a cash balance plan, benefits are fixed in advance, following a formula that takes into account different factors as in defined-benefit pension plans. However, as in contribution plans, the employee has an account that is credited with an amount, resembling an employer’s contribution, monitored in a regular statement. Moreover, in many cash balance plans, vested benefits can be taken as a lump sum and rolled into an Investment Retirement Plan (IRA) when the employee terminates employment.

    Fabozzi F., Modigliani F., Jones F. (2010), Foundation of Financial Markets and Institutions, Pearson International Edition.

    Editor: Bianca GIANNINI
    © 2010 ASSONEBB


    In 2019 the Government approved new provisions on social security matters, introducing for the years 2019-20121 the possibility of early retirement with 62 years of age and at least 38 years of contributions. Against this advance, there is a reduction in the social security allowance which also reaches 25%.
    Social security contributions can be accumulated from different pension schemes and the pension is not cumulative with any earned income received for any reason, except for occasional collaborations of less than 5,000 euros gross per year.
    The civil servants who request the pension check with Quota 100 will receive the end of service treatment (TFS / TFR) upon reaching the statutory requirements (i.e. 67 years); it is possible to request an advance payment to the institution that will apply subsidized interest rates.
    The text of is available at this link http://www.gazzettaufficiale.it/eli/id/2019/01/28/19G00008/sg



    The People's Bank of China (PBOC), founded in 1948, performs the function of the central bank, through the control and supervision of the domestic financial sector and the China's Banking System. The PBOC represents China in an official international financial organizations such as the International Monetary Fund - IMF, the World Bank and the Asian Development Bank (ADB). As a result of the reforms, the PBOC carry out its tasks according to Western models of autonomy, control and supervision of the banking system. The main PBOC functions include: formulation and direction of monetary policy to maintain financial stability and stimulate economic growth; formulation of the credit plan; setting of interest rates; financial market regulation; regulation of financial markets; issuance and administration of the circulation of Renminbi; regulation of interbank lending and interbank bond market; management of foreign official exchange; recording of transactions in foreign currencies and management of the State treasury.

    Evolution of PBOC functions. The main reforms

    The PBOC is established on December of 1948 after the victory of the Chinese Communist Party and the creation of the People's Republic of China. Until 1978, the People’s Bank of China is the only institution authorized to carry out financial transactions. Controlled directly by the Ministry of Finance, it coordinates the entire Chinese banking system with the role of the central bank and commercial bank. The granting of credit is driven by political power and until the eighties the PBOC's main task is to support the Government's national planning, through the management of more than 90% of total financial assets.

    Since 1979, the Deng Xiaoping reforms for the development of a Socialist Market Economy, help to reshape the functions of the PBOC. It’s for this reason that in 1984 the PBOC is formally recognized as the central bank and private of its commercial institution functions. These functions are assigned to the four State commercial banks (so-called Big Four): Bank of China (BOC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Industrial and Commercial Bank of China (ICBC). It’s permanently deleted the system single bank and PBOC responsibilities concern now has control of the money supply and the management of foreign exchange and foreign exchange reserves. Moreover, in those years, the PBOC becomes the main instrument for funding public companies, previously funded directly by the State through a grant transfers. The Reform of replacement of grant credit of 1984, in fact, assigns the task of financing public enterprises through provision of credit and stopped transfers to State grant. These functions are now performed by SOB (State Owned Bank) operating under the direct supervision of provincial and local offices PBOC.

    In 1995, with the law of the People's Bank of China, which was adopted by a decision of the State Council1 on the reform of the banking sector, the PBOC is invested with new powers modeled on the Federal Reserve System see Shomali (2010) .

    The PBOC should take responsibility for his actions only to the State Council. Therefore it becomes free from the interference of other financial institutions and local governments. The 1995 changes, therefore, ensure the PBOC formulation and implementation of an independent monetary policy. Also, are governed relations with commercial banks which are subject to the PBOC control and supervision.

    The Law of the People's Bank of China extends some of the powers of the PBOC and restricts other, such as the prohibition of granting facilities for banks and to extend loans to local governments and departments. It’s just at the cities and provinces level that the power of fixing credit quotas is distorted by local branches tendency to orient it according to its own independent criteria, although these powers are the prerogative of the Central Bank and the government. For these reasons, in 1998 are replaced branches in the provinces and cities with nine regional offices exclusively, in order to loosen the influence of local authorities in the conditioning of the decisions of PBOC credit policy.

    In 2003, after the entry into the World Trade Organization (WTO), the supervision functions of the PBOC are "eased" by creating of China Banking Regulatory Commission (CBRC). The CBRC activities provide control and regulation of the banking system according to the criteria of Basel I. The establishment of ad hoc Surveillance Agency has the intent to provide certain institutional references for local actors and foreign producers. Also in 2003, the amendment of the Law of the People's Bank of China in 1995, changes the status of the PBOC. This changes attribute primary task of macroeconomic management, particularly with respect to exchange rate policy and reserve management and strengthens its role in the implementation of monetary policy and in the provision of financial services. They are definitely limited the PBOC functions explained in the statute in 14 points:

    - Drafting and enforcing relevant laws, rules and regulations that are related to fulfilling its functions;

    - Formulating and implementing monetary policy in accordance with law;

    - Issuing the Renminbi and administering its circulation;

    - Regulating financial markets, including the inter-bank lending market, the inter-bank bond market, foreign exchange market and gold market;

    - Preventing and mitigating systemic financial risks to safeguard financial stability;

    - Maintaining the Renminbi exchange rate at adaptive and equilibrium level; Holding and managing the state foreign exchange and gold reserves;

    - Managing the State treasury as fiscal agent;

    - Making payment and settlement rules in collaboration with relevant departments and ensuring normal operation of the payment and settlement systems;

    - Providing guidance to anti-money laundering work in the financial sector and monitoring money-laundering related suspicious fund movement;

    - Developing statistics system for the financial industry and responsible for the consolidation of financial statistics as well as the conduct of economic analysis and forecast

    - Administering credit reporting industry in China and promoting the building up of credit information system;

    - Participating in international financial activities at the capacity of the central bank;

    - Engaging in financial business operations in line with relevant rules;

    - Performing other functions prescribed by the State Council.

    Organizational structure

    The PBOC implement monetary policy under the leadership of the State Council and shall perform his duties in an independent manner, free from the interference of local government, public bodies or any other public or financial. The PBOC, in fact, directly relates only to the State Council decisions on interest rates and exchange rates. The PBOC is also required to submit to the Committee of the National People's Congress a report on the conduct of monetary policy and the performance of the financial sector.

    The internal structure is composed of the governors and deputy governors. The PBC candidate governor is proposed by the State Council and approved by the National People's Congress. Subsequently, the governor of the PBC is appointed and may be removed from his duty by the President of People’s Republic of China.

    The deputy governors of the PBC are appointed and may be removed from their office by the State Council.

    The governor responsibility is to supervise the overall work of the PBC while the deputy governors provide assistance to their governor to fulfill its responsibilities.

    The PBOC is composed of 18 departments:

    - General Administration Department: Responsible for organizing and coordinating the daily work of the PBC head office;

    - Legal Affairs Department: Responsible for drafting financial laws and regulations related to the functions of the central bank; providing interpretation for the orders and rules issued by the PBC; providing financial legal advisory services, handling relevant financial legal affairs; handling administrative appeals and responding to legal complaints against the PBC;

    - Monetary Policy Department: Responsible for setting the intermediate target of monetary policy and coordinating efforts to achieve the target;

    - Financial Market Department: Responsible for formulating administrative rules on the inter-bank lending market, inter-bank bond market, inter-bank foreign exchange market and gold market;

    - Financial Stability Bureau: Responsible for studying the issues concerning coordination of development of banking, securities and insurance industries, and in cooperation with relevant authorities, drawing up reform and development plans of the financial industry; assessing systemic risks in the financial sector, and proposing and implementing policy measures to prevent and resolve systemic financial risks;

    - Financial Survey and Statistics Department: Responsible for collecting, compiling and analyzing financial data and other economic information; developing the overall statistics system for the financial sector;

    - Accounting and Treasury Department: Responsible for examining the accounting standard and system of the banking sector; coordinating the implementation of PBC's financial accounting system;

    - Payment System Department: Responsible for the design of the financial accounting system of the PBC and the construction of China National Advanced Payment System (CNAPS);

    - Technology Department: Responsible for technological services in the planning, design, construction and maintenance of the PBC's office automation system and business operation system;

    - Currency, Gold and Silver Bureau: Responsible for the production, storage, transportation, renewal and disposal of banknotes and coins;

    - State Treasury Bureau: Responsible for managing the State treasury.

    - International Department: Responsible for official contacts and business cooperation between the PBC and the international financial organizations, foreign central banks, and financial authorities in Hong Kong and Macao SARs and Taiwan province;

    - Internal Auditing Department: Responsible for establishing working procedures, rules and practices for internal auditing of the PBC;

    - Personnel Department: Responsible for the formulation and implementation of the PBC policies and rules on personnel management;

    - Research Bureau: Responsible for research into China's industrial policies and following up development of economic activities in the industrial, agricultural, fiscal and trade sectors;

    - Credit Information System Bureau: Responsible for managing credit information system;

    - Anti-Money Laundering Bureau: Responsible for anti-money laundering activities in the People's Republic of China; conducting studies on and establishing anti-money laundering rules and policies for financial institutions;

    - Education Department of the CPC PBC Committee: Responsible for the publicity and education of the CPC doctrines and principles in the PBC, promoting staff morale and the construction of spiritual civilization;

    1The main administrative authority of the People’s Republic of China and is the executive power.


    BAGELLA M. … BONAVIGLIA R. (2009) Il risveglio del Dragone. Moneta, banche e finanza in Cina, Venezia, Marsilio editori

    BAGNAI A. … MONGEAU OSPINA C. A. (2010) La crescita della Cina. Scenari e implicazioni per gli altri poli dell’economia globale, Milano, Franco Angeli

    MADDALONI D. (2008) Investimenti diretti in Cina. Politiche pubbliche e valutazioni economico-finanziarie, Milano, Franco Angeli

    MIRANDA M.-SPALLETTA A. (2011) Il Modello Cina. Quadro politico e sviluppo economico, Roma, L’Asino d’oro.

    SHOMALI H. (2010) The Federal Reserve and The People’s Bank of China, Research Paper.

    THE PEOPLE’S BANK OF CHINA, http://www.pbc.gov.cn

    Editor: Giovanni AVERSA



    The People’s Republic of China (PRC) was established in Beijing by Mao Zedong in 1949. Since 1971 it’s part of the United Nations system and it’s a permanent member of the UN Security Council. The PRC is also a member of several international organizations such as World Trade Organization (WTO), Asia Pacific Economic Cooperation (APEC), Association of Southeast Asian Nations (ASEAN), Shanghai Cooperation (SCO). In the PRC coexist authoritarian government led by Chinese Communist Party (CCP) and a mixed economic system with typical elements of a market economy and elements of economic planning. For these reasons in a short time the PRC has become, by size of Gross Domestic Product (GDP), the second largest economy in the world after the United States. In the international relations the economic prestige, achieved thanks to the rapid growth in recent years, is the principle means to attract under his influence the developing countries.


    The Chinese Constitution defines economic system like Socialist Market Economy. A system where the socialist regime becomes compatible with market economy. China has initially focused on the Soviet model of development with industrialization planned to ensure the political independence, then in the eighties starts transition to market economy. In twenty years, the PRC has achieved impressive economic development, with annual average GDP growth near 10%. The growth has transformed China from third world country in leader of the world economy. In recent decades, the PRC has been able to overcome serious global economic crisis. The economic development of China is one of the most important phenomena of the world economic history since World War II. Today, China is the first holder of the United States Bonds and the largest funder of its debt.

    The Table 1 shows the major economic indicators of the PRC:

    Source: Intelligence Unit-Country Report China May 2013.

    In the economic structure, the low labor cost and the enormous amount of labor help to give effect to foreign investment in the country by encouraging the relocation of foreign companies. The companies with foreign capital participate in one-third of total industrial production. Among developing countries the PRC is the first that receive Foreign Direct Investment (FDI). Since 2013, the PRC is the largest exporter and importer of goods in the world with the balance of trade in surplus of about $ 200 billion. These factors have "forced" some countries to rebuild their economies adapting to the needs of "Made in China". Many countries, seeing the deterioration in their deficit and the loss of market share in key productive sectors, they lower production costs to remain competitive in the international market. In addition, the possibility of collaboration with multinationals and foreign companies in China, has enabled the Chinese public companies to exploit the models of Western management, Corporate Governance, organizational and market strategies. The industrial sector has the greatest impact on GDP, followed by the services sector and agriculture. The latter is the sector that employs the majority of the workforce. Despite the expansion of the private sector and the profound transformation of state enterprises thanks to the economic reforms of 1978, they continue to play a key role in China's economic policy.

    The China's financial system is characterized by the public ownership of banks (State Bank Owned - SOB), and is regulated by People’s Bank of China (PBOC), which manages the monetary policy, it emits the official currency (Renminbi Yuan) and regulates other financial institutions. In addition to the PBOC the main institutions of the China’s Banking System are the Bank of China (BOC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Industrial and Commercial Bank of China (ICBC).


    The Constitution is the fundamental law of the PRC and defines it as "a socialist state of the people's democratic dictatorship led by the working class and based on the alliance workers-peasants." The Constitution gives political leadership of the country to Chinese Communist Party (CCP). The CCP is characterized by the National Congress, convened every five years.

    The China is a People’s Republic with authoritarian system of government. In contrast to many forms of Western government based on a separation of the three powers (legislative, executive, judicial), the Constitution establishes the National People's Congress (NPC) as the supreme body of state power. In addition to ANP the other fundamental institutions of China are the Council of State, the President of the PRC, the Supreme People's Court, the Supreme People's Procuratorate and Central Military Commission.

    1.National People's Congress (NPC).

    The National People's Congress (NPC) of the PRC is the highest organ of state power. The term of office of the NPC is five years. The NPC is empowered with the rights of legislation, decision, supervision, election and removal. The main functions are: To elect members of the Standing Committee of the NPC; to elect the president and vice president of the People's Republic of China, and decide on the choice of the premier of the State Council upon nomination by the president, the choice of other members composing the State Council upon the nomination by the premier; to elect the chairman of the Central Military Commission; to formulate and revise the Constitution and supervise its implementation; enact and revise basic laws and other laws of the state; to examine and approve the plan for national economic and social development; to examine and approve the state budget and the report on its implementation; to approve the establishment of provinces, autonomous regions, and municipalities directly under the Central Government. ANP is also formed by the Standing Committee, the body that carries out the functions of the Assembly when it doesn’t meet.

    2. State Council.

    The State Council of the PRC, namely the Central People's Government, is the highest executive organ of State power, as well as the highest organ of State administration. The State Council is composed of a premier, vice-premiers, State councillors, ministers in charge of ministries and commissions, the auditor-general and the secretary-general. The State Council is responsible for carrying out the principles and policies of the Communist Party of China as well as the regulations and laws adopted by the NPC, and dealing with such affairs as China's internal politics, diplomacy, national defense, finance, economy, culture and education.

    3. President of RPC.

    The President of RPC is the Head of State, as well as the supreme representative of China both internally and externally. It’s subordinate to the NPC. The main functions are: promulgating laws, appointing and removing the premier, vice premiers, state councilors, ministers of ministries and state commissions, auditor-general, and secretary-general; appointing or recalling China's plenipotentiary representatives abroad, and ratifying or abrogating treaties and important agreements concluded with foreign countries.

    4. Supreme People’s Court.

    The Supreme People's Court is the highest trial organ in the country and exercises its right of trial independently. It is also the highest supervising organ over the trial practices of local people's courts and special people's courts at various levels. It reports its work to the NPC. The right of appointment and removal of the president and vice presidents as well as members of the trial committee of the Supreme People's Court lies with the NPC.

    5. Supreme People's Procuratorate.

    The Supreme People's Procuratorate are the legal supervision organs of the state. The prosecution system consists of the Supreme People's Procuratorate, local people's procuratorates and special people's procuratorates such as the military procuratorate.

    6. Central Military Commission.

    The Central Military Commission of PRC is the highest state military organ with the responsibility of commanding the entire armed forces in the country. Led by a chairman and consisting of vice chairmen and members, the Commission is elected for a term of five years and can stand for reelection.

    PRC’s international relations

    China is considered the country with fastest-growing in international system, both economically and politically. The PRC is, in fact, a permanent member of the UN Security Council, it’s part of several regional organizations (ASEAN, SCO, APEC) and thanks to the entry into the WTO and participation in the G2, has decreed its seamless integration even in world economy. In a short time the extraordinary economic results define the PRC as the most dynamic and largest economy in the world after the United States, with the possession of the majority of U.S. government bonds. In addition, the Chinese government uses the Soft Power1 (see Nye 2004), as "means of pressure" for developing countries. These factors contribute to the discussions about real PRC capacity to offer different developmental model from Wahsington Consensus and about the admissibility of the term Beijing Consensus. Other authors of international relations theory consider the Chinese foreign policy declined in the "Five Principles of Peaceful Coexistence" (respect for territorial integrity and sovereignty, non-aggression, non-interference in internal affairs, equality and mutual benefit in trade and peaceful coexistence) developed and codified since 1954 in a trade agreement between China and India. Since then, in the ideas of the CCP these principles were intended to govern the relations between the other States and China. According to this view the priority of China seems to consist in maintaining the political stability necessary for the pursuit of their own economic development and the rejection of any hegemonic pretension.

    1Term used for the first time by Joseph Nye in international relations theory to indicate the power of persuasion of a state using intangible assets such as culture, values ??and political institutions. This term is opposed to Hard Power that is the power exercised by military coercion.


    BERGERE M. C. (200) La Repubblica Popolare Cinese (1949-1999), Bologna, Il Mulino

    MARCHETTI R. … MAZZEI F. … PETITO F. (2010) Manuale di politica internazionale, Milano, Egea Editore (www.egeaonline.it/editore/catalogo/MANUALE_DI_POLITICA_INTERNAZIONALE.aspx)

    NYE J. S. (2004) Soft Power. The means to success in world politics, Tampa, Foreign Affairs Pr. (www.foreignaffairs.com/articles/59732/g-john-ikenberry/soft-power-the-means-to-success-in-world-politics)

    MAZZA M. (2010) Le istituzioni giudiziarie cinesi. Dal diritto imperiale all’ordinamento repubblicano e alla Cina popolare, Milano, Giuffrè (http://www.giuffre.it/it-IT/products/305674.html)

    PICCININI I. … RINELLA A. (2010) La costituzione economica cinese, Bologna, il Mulino (http://www.mulino.it/edizioni/volumi/scheda_volume.php?vista=scheda&ISBNART=13982)

    ROSSI G. (2011) Stato e società in Cina. Comitati di villaggio, organizzazioni governative, enti pubblici, Torino, Giappichelli Editore (www.giappichelli.it/home/978-88-348-2000-1,3482000.asp1?)

    SHAMBAUGH D. (2013) China Goes Global: The Partial Power, New York, Oxford University Press (http://tinyurl.com/n4ysd6p)

    THE PEOPLE REPUBLIC OF CHINA, (http://english.gov.cn/)

    Editor: Giovanni AVERSA

  • PIGS

    Acronym of Portugal, Ireland, Greece and Spain describing the state of crisis of these countries. Two of them have been close to bankrupt in 2010 (Ireland and Greece). The use of this acronym is limited because of its being perceived as racist.
    Editor: Chiara OLDANI
    © 2010 ASSONEBB

  • Poisson process

    It is a stochastic process, where the value of the random variable in continuous time, has always the same increase/amplitude jumps.


    Economic risk associated with a pool of investment (portfolio). It is composed of two components: unique risk and market risk. Market risk (also called systematic risk, undiversifiable risk) is the single security’s sensitivity to market movement and is generally measured by the beta coefficient: if the beta coefficient is greater than 1, it tends to amplify the overall movements of the markets. By contrast, the unique risk (also called specific risk, residual risk, unsystematic risk) expresses the degree of securities’ correlation and is not associated with market returns. The portfolio risk of diverse individual securities differs from the average of its components, provided that the risks associated to each security are not perfectly correlated. As a consequence, an appropriated diversification can reduce the variance of the portfolio returns.
    Editor: Bianca GIANNINI
    © 2010 ASSONEBB


    Restrictions on the holdings (long or short) of an investment firm in a financial instrument.

    ©2012 Editor: House of Lords


    A general assumption in international macroeconomics is that the same good must sell for the same price, adjusted for exchange rate, throughout the world: the so-called law of one price (LOOP). Pricing-to-market theory (PTM) provides an explanation of the deviation from the LOOP. The PTM has been developed in the strand of economic literature that emphasises the role of imperfect competition in trade. According to this theory, there are some classes of goods (e.g. cars) for which producers can charge different prices in different countries. Hence, firms take advantage of their market power and discriminate by charging a destination-specific mark-up on the marginal cost. Consistently with the theory of price discrimination, the mark-up tends to be higher where the elasticity is lower.
    Editor: Lorenzo CARBONARI
    © 2009 ASSONEBB


    The financial market is usually divided into two sub-markets:
    - primary market (i.e., where the issue of financial instruments takes place);
    - secondary market (i.e., where these instruments are traded after being issued).
    We think about the primary market as the aggregate of trades in which investors underwrite financial instruments (bonds, stocks, etc.) at issue date, actually giving cash to the issuers.
    An issue of financial instruments can take place via different techniques. The most important are:
    - auction mechanism;
    - capital increase;
    - underwriting via syndicated counterparties.
    With an auction, financial instruments are assigned to investors according to their underwriting proposals. Usually, the quantity of instruments is fixed, whilst the underwriting price is subject to variation according to the demand/offer mechanism. Focusing on the Italian financial market, we have two types of auctions for government bonds:
    - marginal auction (for all the Italian govies with the exception of BOTs);
    - competitive auction (only for BOTs).
    With a capital increase, stocks are issued and primarily offered to current shareholders of the company (pro quota according to the number of shares hold by each one).
    Focusing on the Italian experience, we distinguish between capital increases:
    - for free (when the new shares are offered for free to the shareholders, without any payment);
    - with payment of a specific price;
    - mixed (i.e., partially for free and partially against the payment of a certain price).
    With the underwriting through syndication, the issuer gives a mandate to set up the issue to a group of counterparties in order to reach the highest number of investors. This technique is mainly adopted by issuers different from the government (banks, corporations, etc.).
    Editor: Ugo TRENTA
    © 2009 ASSONEBB


    Private Banking is a service offered to clients who have considerable assets and who, being characterised by financial needs that are not easily classifiable, turn to a bank (even a specialized bank or a non-banking intermediary) for a "tailor made" service that is built around the specific requirements that are called for1. There are completely different logics behind private and retail banking: a private banker (or a personal banker who usually acts as a partner to an investor who qualifies with lower levels of capital) builds up a one-to-one relationship with the client, recommending solutions that fit the client’s profile (in respect to the band of assets held) and that are characterised by different levels of sophistication according to the specific needs shown. On the contrary, retail bankers work with well-defined types of clients -with differing needs and expectations- and to whom pre-packaged services (mass customization) are directed. A solution that is somewhat standardised can also be offered by a private banker in the initial phase of the relationship, if his/her counterpart has not already demonstrated a certain autonomy in evaluating his/her own financial needs. In general, clients who resort to intermediaries usually give an unconditional authorisation for the management of the assets entrusted (passive investors). This does not exclude the presence of "active investors", who still keep under control their investments; and of the so-called "self confidents", for whom a private banker is merely an executor of previously taken financial (or non-financial) decisions. Especially in the case of an "active investor", where the intermediary has to reach an agreement on the investment ideas that are proposed, the levels of professionalism and competence required of the employee who establishes contact with the client are considerably important. Owing to the variety of issues involved, normally intermediary banks that carry out this service (especially commercial banks who reserve a specialised area of business for this activity) or very big groups work through a product company. Even small or medium-sized intermediaries can provide a service. These normally look to external professionals to find solutions that they can then adopt to fulfil the requirements of their clients.
    The very nature of private banking does not allow the exhaustive number of services that this business offers to be fully listed. There is usually a service that offers a management of financial investments and the related advice (a service typically provided by European banks). It can also include real estate management and advice in buying or selling works of art (as in America), and in markets characterised by a high cultural awareness in finance, they even go as far as to provide assistance with taxation issues, trusts and inheritance matters (carried out in off-shore centres). It is possible to divide the main services offered into two generic categories (even if incomplete):
    a) Services that mostly include the management of financial or property assets and advice in matters of investments;
    b) Secondary services that are offered in connection to those above and that include functions such as financial intermediaries, investing in foreign currencies, in commodities, advice in inheritance or fiscal matters and in the trading of works of art.
    It is just as difficult to establish the target clients who could qualify for private banking if we need to give a clearer definition of "investors with considerable assets". Even if there is no apparent relationship between the sophistication of a client and the amount of assets he/she has, for obvious operational reasons, banks tend to associate the level of personalisation of the service offered to "how much" a client has. Providing a service means the bank has to create a structure and offer clients the numerous resourses it makes available. Given that a client with very small assets is unlikely to be interested in accessing services that are too highly specific, the "cost" of the service has to be taken into consideration. A segmentation of theses clients, with the related allocation of services, has to undoubtedly be made according to the amount of assets the client has, in such a way that the profit margins correspond to the resources put on offer.
    Clients can be classified as follows:
    - Ultra High Net Worth Individual (UHNWIs);
    - High Net Worth Individual (HNWIs);
    - Affluent.
    The so-called "affluent" clients, who belong to the lowest quantitative band, generally have a " wealth" that exceeds one million dollars. These clients usually entrust the total of their savings to a single bank. "High Net Worth Individuals" usually have assets worth more than 10 million dollars but do not qualify for the 25 million dollar band, which is reserved for "Ultra High Net Worth Individuals". Both the "high" band categories of clients have a tendency to split their savings up between more than one private banker, also to obtain the best possible mix of investments from their financial resources. This characteristic is generally considered to be a stimulus for the intermediary to maximise the efficiency and service he/she provides in view of customer satisfaction. Another indication that helps in assigning the client to one of the above segments is the level of income of the potential investor. The quantitative bands are also formed by taking into account both the expected value of new wealth and the work done by the individual, which are used to measure the potential growth of this variable.
    1Resti A., (2003), "Il Private Banking", Bancaria Editrice.
    Editor: Mirko IORI
    © 2009 ASSONEBB

  • PRIVATE GOOD (Encyclopedia)

    Private goods are characterized by rival consumption and the ability to exclude non-payers. These are one of four types of goods differentiated by consumption rivalry and nonpayer excludability. The other three goods are public (non rival consumption and non-payers cannot be excluded), common goods (rival consumption and non payers cannot be excluded), and club goods (non rival consumption and non-payers cannot be excluded). Rival consumption and the ease of excluding non-payers means private goods can be efficiently exchanged through markets even though society may change the status quo according to its economic, political and cultural choices.

    Adam Smith first articulated the concept of public and private goods. From then on, economists have studied systematically public goods and distinguished them form the opposite case of private goods.

    This table 1 shows as privates goods are one of four types of goods … private goods, public goods, common goods, and club goods … differentiated by consumption rivalry (rival or non rival) and nonpayer excludability (excludable and non-excludable). Private goods are in the top left cell of the matrix, with rival consumption and the ability to exclude non-payers.

    Private goods have also well-defined property rights that can be transferred to others, but only if others pay to acquire ownership.

    It is almost as if society created markets for the expressed purpose of exchanging private goods.
    In fact, in a market transaction a buyer gains access to a private good (or service) in exchange for money or, sometimes, in exchange for another good (or service). Buyers and sellers meet through the price mechanism, and if everything works well, the economy can reach a state of maximum efficiency in which resources are put to their most productive uses. A key condition for a market transaction, however, is that the ownership or use of a good can be transferred or denied conditional on the payment of its price. So private goods are ideally suited for efficient market exchanges.

    Examples of private goods range far and wide, from candy bars to cars, to comic books, to corduroy sport coat. In fact, not all but most goods traded through markets are private goods.

    Non-payers can be excluded from consumption and they should be. This way efficiency is achieved if those who consume a private good pay a price equal to the marginal cost of rival consumption imposed on others.

    Rival consumption

    Because private goods are rival in consumption, the consumption by one person prevents simultaneous consumption by others, and thus prevents others from receiving the benefits of consumption. This means consuming a private good imposes an opportunity cost on others who are not able to consume.

    Suppose, for example, that an individual is pondering the consumption of a sandwich. When he consumes this sandwich, he and he alone receives the satisfaction and the benefits provided. Moreover, when he consumes the sandwich, no one else, can consume it. Other people, in other words, foregoes the satisfaction that they could have received from the sandwich, and thus incur an opportunity cost.

    Non-payer Excludability

    Private goods are also characterized by the ability to exclude non-payers from gaining ownership and control, and thus from receiving the benefits of consumption. In other words, private goods have well-defined property rights.

    The owner of a private good can set and enforce the term by which the ownership of the good is transferred to another.

    Again, let us turn to the example of the consumption of a sandwich. The producer has ownership and control of the sandwich and also the ability to transfer that ownership and control on his term. Suppose the term the producer has set is a 2 euro price. If an individual wants to gain ownership of the sandwich, presumably to eat, then he must pay the 2 euro price. No payment means no sandwich.

    Private goods as social constructs

    The conventional approach to defining a private good is to identify a good’s rival and excludable properties (table 2), then define the good as private based on those properties, But the problem is that the properties of goods do not always correspond to this standard definition. The main reason is that society can modify the rivalry and excludability of a good’s benefits. In this way goods often become private as a result of deliberate policy choices.

    This is the reason why in many if not most cases, goods exist not in their original forms but as social constructs, largely determined by policies and other collective human actions.

    As said before, rival benefits mean that one person’s consumption of a good diminishes its availability for others. For example, if one person consumes a glass of milk, it is no longer available for others. Although the link between rivalry in consumption and excludability of benefits is not always automatic, the example of the glass of milk shows that by consuming a rival good, a person can exclude others from its enjoyment. In this sense milk is both a rival and an excludable good, and so falls into quadrant 1 of table 2. It is a private good.

    Another example, land, is also both rival and excludable in its original state. Land has been a source of conflict throughout history. Many struggles over land continue, but many societies have introduced property rights regimes that regulate land ownership, minimize uncertainty, and reduce the need for constant vigilance to defend territories against potential claimants.

    Thus property rights make excludable goods, such as land, a private good of recognized and reliable stature. Private goods usually have clear property rights specifying who has the exclusive right to determine how they can be used, including the ability to trade them in the market.

    Even though land is a rival and excludable good, many traditional societies maintain open, nonexclusive grazing and hunting grounds. And some communities still manage as commons such natural resources as land, forests, water, and plant and animal species. These approaches reconfirm that excludable resources do not necessarily have to be made private or exclusive. Doing so is a policy choice, and often a societal choice to ensure the sustainable use of certain goods (quadrant 1, table 2).

    If we compare the standard classifications in table 2 with those in table 3, we may notice an important difference: in table 3 goods are settled primarily according to their socially constructed status. The main difference between the two sets of classifications lies in where, in terms of “private” and “public”, goods fall when assessed according to their basic properties and their socially determined status (quadrants 1 - 2A - 4A are referring to the "private domain", while quadrants 2B - 3 - 4B to the "public domain").

    To better understanding we may consider the example of the atmosphere. In table 2 it is in quadrant 4 as a rival, non-excludable, open-access good. Table 3 also lists the atmosphere in quadrant 4, but with a difference. In quadrant 4B, which is part of the public domain, the atmosphere is listed in its familiar form, as a common pool resource. But today there is a deep debate on how atmosphere’s status should be assessed. Because of policy debates on global environmental issues, the atmosphere is increasingly linked to new, human-made private products-namely, permits (allowances) for pollution (especially carbon dioxide) emissions.

    Such permits do not turn the atmosphere into a private good, but they limit some actors’ use of it in a particular way. If an international agreement were to enter into force what would become a private (national) entitlement is a specific aspect of this resource: the right to use the atmosphere as a “pollution sink” or, more precisely, to emit certain types and amounts of gases into it. Limiting its use in this way would preserve the atmosphere so that all actors could enjoy it more broadly. Hence the atmosphere appears twice in table 3: in quadrant 4A because of national and international arrangements to preserve it and in quadrant 4B because-clean or not-it is available to be consumed by all people.

    Non-rival goods have experienced similar policy-induced shifts. Some scholars have expanded the standard definition of non-rival goods to include those that can be made available to additional users at minimal or no cost. For example, a new chemical formula could be shared with the concerned professional community simply through an email.

    Yet many knowledge elements are made exclusive and private through property rights. In the form in which society often likes to see them, they fall into quadrant 2A of table 3 in the private domain, as non-rival but exclusive goods. An example is manufacturing procedures protected by process patents.

    Rival goods can also be kept or made nonexclusive; see quadrant 4B of table 3. As said before for land, one policy option for doing so is to create a management regime that maintains broad public access. Public parks and nature reserves are examples. Another is to make rival goods available in such plentiful quantities that there need not be any competition over who gets to use them. Many societies have chosen this policy route for basic education and health services.

    This approach is usually taken for two reasons. First, goods such as education and health are often seen as human rights and as having intrinsic value. Societal notions of fairness might require that education be made available to all in the spirit of commodity egalitarianism. Second, an educated and healthy population generates important private and public benefits. Educated people tend to be more productive and to contribute more to economic growth and development. Thus many countries have made basic education not just free and universal but compulsory as well.

    If basic education is assessed only in terms of its natural properties, it falls into quadrant 1 (as private good, rival and excludible). But when judged on its actual form, as in table 3, it must appear three times. In quadrant 1 it tables as a private good of educated individuals. In quadrant 4B it appears as a universally available, nonexclusive service. And in quadrant 3 it shows up as having added to a country’s overall productivity and economic growth potential. Two of its dimensions (in quadrants 4B and 3) are in the public domain.

    Moreover, goods can change their positions if new technology develops. Television signals are a case in point. There was no question of public or private television before it became possible to scramble television waves and to restrict transmission through cables. Now some channels can be viewed only for a fee. As a result television falls partly in the private domain (quadrant 2A in table 3) and partly in the public (quadrant 2B).

    Returning to quadrant 3, the main goods are policy outcomes or overall conditions such as peace, law and order, financial stability, efficient markets, and communicable disease control and eradication. Once these conditions exist, all people can-and sometimes must-consume them. The goods’ benefits are indivisible, so they exist for all in the same amount and with the same characteristics. These goods are often more evident when undersupplied. For example, conflict is more noticeable than peace, which is often taken for granted. Similarly, people realize that they are “part of the market” much more when a stock market crashes and the value of their investments tumbles.

    Hence table 3 illustrates that in most if not all cases, privateness - and plubicness as well - are social constructs.
    According to this analysis we can say that too often it is assumed that a rival and excludable good must be private and is best left to the market.

    That approach misses a basic point. Before goods appear in the market, policy choices have been made or norms established to make the goods private in the sense of being exclusive or public in the sense of being nonexclusive. And even if these decisions have already been made in the past, that does not preclude rethinking them in light of new realities.


    Corner R. and T. Sandler (1993), "Private Provision of Public Goods under Price Uncertainty", Social Choice and Welfare, Vol. 10, No. 4.
    Epple D., R. E. Romano (1996), “Public Provision od Private Goods”, Journal of Political Economy, Vol.104, No.1.
    Kaul, I., Grunberg, I. and M. A. Stern (1999), Defining Global Public Goods, New York, Oxford University Press.
    Kaul, I., R. U. Mendoza (2003), “Advancing the Concept of Public Goods”, in I. Kaul, et. al, Providing Global Public Goods: Managing Globalization, New York, Oxford University Press.

    Editor: Francesca BERTI


    Program trade is a type of institutional trading or, in other terms, a trading arrangement used by institutional investors. Program trade refers to the transaction of a large number of stocks simultaneously. In the definition given by the NYSE, program trade is any operation that involves the purchase or sale of a basket of at least 15 stocks with a total value of $1 million or more. Program trades are also called basket trades because they involve a basket of securities. Institutional investors can use program trades for different purposes. Program trades can be used to rebalance the composition of a stock portfolio, to transfer funds from the bond market to the stock market, and all activities commonly referred to as asset allocation. Another typical use of program trade is index arbitrage, which allows to profit from temporary discrepancies between the prices of the stocks comprising an index and the price of stock index futures. Many traders use computer programs, but in the definition of program trades this is not a decisive feature. Instead, program trade includes the purchases or sales of stocks that are part of a "coordinated" trading strategy, even if the purchases or sales are neither entered nor executed contemporaneously, nor part of a trading strategy involving options or futures contracts on an index stock group, or options on any such futures contracts, or otherwise relating to a stock market index. It must be noted that the key component in determining whether the purchase/sale of a large amount of stocks may be classified or reported as "Program Trading" is whether the trading strategy is "coordinated", and not the condition of being a computer-driven ("CD") trading strategy (strategy executed through a computer model or "black box").


    Fabozzi F., Modigliani F., Jones F. (2010), Foundation of Financial Markets and Institutions, Pearson International Edition.

    Editor: Bianca GIANNINI
    © 2010 ASSONEBB


    Property and casualty insurance companies (P&C) and life insurance companies are the most important type of insurance companies. P&C in particular indemnify damage (destruction, loss, etc.) to properties such as houses or vehicles. Such damages is the result of an identifiable event that is sudden, unexpected or unusual. Examples of such risks are natural disasters such as fire, earthquakes, floods; other unexpected events referred especially to vehicles are theft, collision or third party liability.

    Fabozzi F., Modigliani F., Jones F. (2010), Foundation of Financial Markets and Institutions, Pearson International Edition.

    Editor: Bianca GIANNINI
    © 2010 ASSONEBB


    According to the new public finance and accounting law (Law No. 196 of 31 December 2009), the Government submits to Parliament the Public Finance Decision (DFP) which is a three-year spending review superseding the Economic and Financial Planning Document (DPEF). Pursuant to Art. 10 of Law No. 196 of 31 December 2009, the DFP outlines the international economic and financial situation, both for the current year and the following years of the forecast period, as well as Italy’s macroeconomic projections based on both unchanged legislation and policy scenarios, for each year of the forecast period. In addition, the DFP illustrates the main economic parameters used for the public finance projections consistent with macroeconomic trends (based both on unchanged legislation and policy scenarios). The Government must submit the DFP by 15 September. The new date for the submittal to Parliament is now closer to that for the submittal of the draft Stability and Budget Law, whose deadline is October 15.

    Editor: Giovanni AVERSA

  • PUBLIC GOOD (Encyclopedia)

    Economists use the term Public Goods to refer to products (goods or services) that are difficult to keep nonpayers from consuming (no excludability), and of which anyone can consume as much as desired without reducing the amount available for others (no rival consumption). Examples include national defence, a clean environment, and air for breathing. Public goods are usually provided by government because a private business lacks the incentive linked to the profitability to produce them. Private businesses can't sell public goods in markets, because they can't charge a price and keep nonpaying people away. Moreover, businesses shouldn't charge a price, because there's no opportunity cost for extra consumers. For efficiency, government needs to pay for public goods through taxes.

    The modern concept of public goods has its roots in 18th century scholarship and it can be traced back to classical economics. David Hume discussed the difficulties inherent in providing for “the common goods” in his Treatise of Human Nature, first published in 1739. Some 30 years later Adam Smith analysed similar questions in his Inquiry into the Nature and Causes of the Wealth of Nations. David Hume and Adam Smith agreed that government intervention is needed to supply goods and services characterized by collective benefits. If left to the spontaneous action of individuals or organizations, these goods would not be adequately provided.

    After a pioneering contribution by Richard Musgrave in 1939, a modern and comprehensive theory of public goods was developed with the publication in 1954 of Paul Samuelson’s seminal paper “The pure theory of Public Expenditure”. Since then, research interest in the topic has grown rapidly. In his classic paper Samuelson defined a public good, as a good which all enjoy in common in the sense that each individual's consumption of such a good leads to no subtractions from any other individual's consumption of that good. This is the property that has become known as non-rivalry.

    A public good is “a commodity that can be provided to everyone as easily as it can be provided to one person”, note economists Paul A. Samuelson and William D. Nordhaus (Samuelson and Nordhaus, 1992, p. 53). According to them the case par excellence of a public good, is national defence.

    National defence, differs completely from a private good like bread. Ten loaves of bread, for example, can be divided up in many ways among individuals, and what you eat cannot be eaten by others. But national defence, once provided, benefits everyone equally. It matters not at all your way of life, your age or your religion you will receive the same amount of national security from the Army as does every other resident of the country. To the extent one person in a geographic area is defended from foreign attack or invasion, other people in that same area are defended also.

    So public goods are ones whose benefits are indivisibly spread among the entire community, whether or not individuals desire to purchase the public good. Private goods, by contrast, are ones that can be divided up and provided separately to different individuals, with no external benefits or costs to others. Efficient provision of public goods often requires government action, while private goods can be efficiently allocated by markets.

    The Main Characteristics of Public Goods

    Public goods have two distinct aspects: non-excludability and non-rivalrous consumption. Strictly speaking “non-excludability” means that the cost of keeping non-payers from enjoying the benefits of the good or service is too high so no one can be effectively excluded from using the good.

    On the other hand “Non-rivalry” means that consumption of the good by one individual does not reduce availability of the good for consumption by others.

    For example, if one individual visits a doctor there is one less doctor's visit for everyone else, and it is possible to exclude others from visiting the doctor. This makes doctor visits a rival and excludable private good. Conversely, breathing air does not significantly reduce the amount of air available to others, and people cannot be effectively excluded from using the air. This makes air a public good, albeit one that is economically trivial, since air is a free good. Another example is the exchange of MP3 music files on the internet: the use of these files by any one person does not restrict the use by anyone else and there is little effective control over the exchange of these music files and photo files.

    Impure Public Goods

    In the real world, there is hardly any “pure” public good, that is absolutely non-rival and non-excludable. Most public goods possess mixed characteristics. Goods that only partly meet either or both of the defining criteria are called impure public goods. Because impure public goods are more common than the pure type, economists usually use the term “public good” to encompass both pure and impure public goods. That is considered a useful simplification because many of the implications of publicness remain very noticeable even when a good is only partly non-rival or partly non-excludable. According to this definition we may look at “pure private” and “pure public” as the extremes of a public-private continuum. Even an activity such as consuming a nutritious meal, which at first glance seems to be highly private, upon closer examination has public benefits. Indeed, a good meal adds to people’s good health, and good health improves their ability to acquire skills and work fruitfully. This, in turn, benefits not only them but also their families and society as a whole. The immediate benefits, however, are mostly private.

    Impure public goods fall into two categories (Figure 1). Goods that are non non-rival in consumption but excludable are called “Club Goods”. Goods that are mostly non excludable but rival in consumption are “Common Goods”. Such goods raise similar issues to public goods: the mirror to the public goods problem for this case is sometimes called the tragedy of the commons. For example, it is so difficult to enforce restrictions on deep sea fishing that the world's fish stocks can be seen as a non-excludable resource, but one which is finite and diminishing.

    Supply Problems

    Because they are non-rival in consumption and non-excludable, public goods typically face supply problems, and so are often referred to as a case of market failure. Public goods problems are also closely related to externalities.

    Externalities arise when an individual or a firm takes an action but does not bear all the costs (negative externality) or all the benefits (positive externality) of the action. For example, educating women has positive effects on child survival and on slowing population growth. Releasing pollution into a river, by contrast, can harm nature and human beings. Put differently, externalities are by-products of certain activities, spillovers into the public sphere.

    Corner and Sandler argue that public goods, notably pure public goods, “can be thought of as special cases of externalities”. For most of economists, positive and negative externalities are distinguished by their positive or negative utilities to third parties. So the term “public good” is usually used for goods and activities with positive utilities, including positive externalities. If a public disutility is involved the term we will use is “public bad”.

    Public bads are considered public goods that impose costs uniformly across a group. “These are unintended by-products of consumption or production activities” (Samuelson and Nordhaus, 1992, p. 30). Examples are air and water pollution that results from chemical production, energy production, and use of automobiles, and radioactive exposure to atmospheric tests of nuclear weapons or to accidents like the ones occurred at the Soviet nuclear plant in Chernobyl in 1986 or in Fukushima in 2011. Perpetrators of the “bads” do not intentionally try to hurt anyone so the externalities may be considered the unintentional but harmful side effects of economic activity.

    Actually many problems that are often perceived as public-goods problems are of a different nature, and markets handle them reasonably well. For instance, although many people think a television signal is a public good, cable television services scramble their transmissions so that nonsubscribers cannot receive broadcasts easily. In other words, the producers have figured out how to exclude nonpayers. Both throughout history and today, private roads have been financed by tolls charged to road users. Other goods often seen as public goods, such as private protection and fire services, are frequently sold through the private sector on a fee basis. In some cases excluding nonpayers is possible. In other cases, potentially public goods are funded by advertisements, as happens with television and radio.

    Partially public goods also can be tied to purchases of private goods, thereby making the entire package more similar to a private good. Shopping malls, for instance, provide shoppers with a variety of services that are traditionally considered public goods: lighting, protection services, benches, and restrooms are a case in point.

    Charging directly for each of these services would be impractical. Therefore, the shopping mall finances the services through receipts from the sale of private goods in the mall. So the public and private goods are tied together.

    The main problem affecting the provision of public goods is known in economic literature as “free riding” or “easy rider” problem.

    The free rider problem depends on a conception of the human being as a purely rational homo economicus selfish, extremely individualistic and considering only those benefits and costs that directly affect him or her. Public goods give such a person an incentive to be a free rider. For example, consider national defence, a standard example of a pure public good. Suppose the homo economicus thinks about exerting some extra effort to defend the nation. The benefits to the individual would be very low, since the benefits would be distributed among all of the millions of other people in the country. There is also a very high possibility that he or she could get injured or killed during the course of his or her military service.

    On the other hand, the free rider knows that he or she cannot be excluded from the benefits of national defence, regardless of whether he or she contributes to it. There is also no way that these benefits can be split up and distributed as individual parcels to people. The free rider would not voluntarily exert any extra effort, unless there is some inherent pleasure or material reward for doing so (for example, money paid by the government, as with an all-volunteer army or mercenaries). The free riding problem is even more complicated than it was thought to be until recently. Any time non-excludability results in failure to pay the true marginal value, it will also result in failure to generate proper income levels, since households will not give up valuable leisure if they cannot individually increment a good.

    Corner, R. and Sandler, T. (1993), "Private Provision of Public Goods under Price Uncertainty", Social Choice and Welfare, Vol. 10, No. 4.
    Kaul, I., Grunberg, I. and M. A. Stern (1999), Defining Global Public Goods, New York, Oxford University Press.
    Musgrave R. A. and P. B. Musgrave (2003), Prologue in Providing Global Public Goods: Managing Organization, New York, Oxford University Press.
    Samuelson P. A. (1954), "The Pure Theory of Public Expenditure", Review of Economics and Statistics, Vol. 36, No. 4, pp. 387…389 (http://www.jstor.org/discover/10.2307/1925895?uid=2&uid=4&sid=21102466212311)
    Samuelson P. A. and William D. Nordhaus (1992), Economics, Sydney, McGraw-Hill.

    Editor: Francesca BERTI



    The main challenge the traditionally developed countries have to face today is competition from the newly industrialised countries. As the engine of development and the means for infusing and diffusing technological progress, and therefore for the growth of productivity in the system, levels of investment are crucially important. This article considers the tools for public intervention that can affect business investment decisions. It underlines the importance of interventions that reduce the tax wedge and the quasi-fiscal burden on labour costs.
    The main difficulty lies in finding cover within public budgets to compensate for the loss of revenue and/or the additional expenditure required for these incentives. The answers are to be found in reducing the less productive parts of the public expenditure, in modifying the composition of the fiscal and parafiscal levy, and in interpreting the constraints of the Stability Pact in a less “accounting-orientated” way based more on economic effects.

    1. Background

    In growth models a key role is played by capital and investments, whether to increase manufacturing capacity, infusing technological progress or enhancing skills (human capital).
    Reflecting on the causes of the great crisis of 1929-1930, Keynes warned that it is difficult to identify the determinants of investment decisions since they are linked to the subjective expectations of entrepreneurs (“animal spirits”). Whilst he recognised the influence of capital costs on these decisions, he also warned that manipulating the interest rate may not be sufficient to stimulate recovery of investment if the expectations of investors remain negative.
    The recent economic crisis, which hit hard the traditional industrialised countries1 and holds out for them the prospect of greater difficulties as growth resumes, makes Keynes topical again2. But his neoclassical synthesis (the well-known IS/LM Model) offers no explanation for the fact that although interest rates in the European Union today have fallen to historically extremely low levels, and the recovery of investment we would expect to occur when there is a normal relationship between investment and the cost of capital is not taking place.
    Without doubt, this is a question whose relevance goes beyond theoretical debate. The governments that are attempting to promote a recovery of investment are encountering difficulties in finding ways of doing so, other than the solution already attempted: reducing interest rates. As is well known, Keynes suggested that as a way of restarting the expenditure-manufacturing-income mechanism and encouraging a more favourable outlook on the part of the private sector, governments should implement programmes of direct public investment and/or to sustain levels of domestic consumption.
    But under today's conditions, when public finance tends to go out of balance due to inbuilt factors that relate to increasing public expenditure for purposes of redistribution, in many countries the Keynesian prescription (public investment and government support for consumption) looks dangerous for the monetary and financial balance of the system3. Furthermore, experience suggests that as and when the economic recovery gets under way, political decision-making mechanisms will make it difficult to reduce many categories of public expenditure (such as transfers to households and business, net remuneration to employees, and “tax expenditures”)4. Nor can it be overlooked that in recent decades the prevailing economic ideology has tended to take an unfavourable view of expanding public intervention in the economy and has counted instead on liberalising private markets by allocating resources more efficiently, in the expectation that this would favour a higher rate of economic growth5.
    Naturally it has to be added that whilst in Keynes's time the model of the substantially closed economy might have been an adequate representation of reality, in today's global economy a recovery of internal demand will not be enough to increase levels of manufacturing and income within any one country if differentials in manufacturing costs make it cheaper to shift manufacturing abroad.
    In this picture it would appear difficult to identify what instruments would be appropriate for publicly sustaining investment in a TI country; we therefore need to reconsider the variables affecting decisions about which types of public investments can be encouraged.
    The literature offers numerous schemes, some of them very sophisticated, for economically assessing investments, and any modern state should certainly take these into account when deciding its direct investment programmes. On the other hand in the operational real world of private entrepreneurs, above all of small and medium enterprises (and also some large enterprises6 where the ownership is centralised and retains control over company decisions) the schemes used for assessing the advisability of investments are frequently structurally simple and even crude, but suitable enough for synthesising the entrepreneur's intuitive reasoning process, based on just a few essential points of reference and using whatever information the entrepreneur believes s/he can master and use sufficiently well.
    Normally the intuition of the entrepreneur (and this is a characteristic of Keynes’s “animal spirits”) concerns the probability (subjectively estimated) that within a given time span, after deducting direct and indirect manufacturing costs, repayments of loans in relation to the desired amortisation period for the investment, and all related taxes and charges, a given initiative will generate a revenue stream that will make it possible to realise returns on the (financial and entrepreneurial) capital invested such as will be likely to cover normal return on the capital, and compensate for the risk.
    As a way of identifying what opportunities exist for public intervention to inventivise entrepreneurs to invest, the decisional variables generally taken into consideration by entrepreneurs are highlighted below.

    2. Investment decisions and public intervention

    The literature offers many sophisticated and also evaluation schemes convenience of investments, of which the modern State certainly should be taken into account to establish their own programs for direct investment. On the other hand, in real operations of private businesses and especially small and medium-sized enterprises (and even some large when the property is centralized and retains control of the decisions of the enterprise) is common to use patterns of investment appraisal structurally simple, even crude formally, but that can be adapted to synthesize the intuitive reasoning of the entrepreneur, which takes a few essential points of reference uses information it considers to possess and to use in appropriate measure.
    Normally intuition (an aspect of the "animal spirits") of the likelihood of the entrepreneur (assessed subjectively) to achieve a given initiative and on a given period of time a stream of revenues, minus the direct production costs and indirect depreciation as a function of the recovery period required investments, and all taxes related, realize returns on invested capital (financial and human) that it finds, to cover the normal return on capital and to compensate for the entrepreneurial risk.
    We highlight the following decision variables generally considered by entrepreneurs summarized above, so as to identify opportunities for public interventions that encourage investment decisions.

    2.1 Prospects for generating revenue

    In the normally accepted terms of Keynesian economics, the advisability at the “macro” level of increasing market sales, and thereby justifying new investments, is a function of the expected level of demand, which can be controlled by governments7 via the well-known instruments of macroeconomic policy. By taking a disaggregated intersectoral approach, information about trends within particular manufacturing sectors and their interdependencies makes it possible to calibrate the action to be taken.
    As mentioned in the introduction, the present difficulties derive from the fact that an increase in domestic demand, induced by fiscal policy and aimed at some or all manufacturing sectors, could prove largely ineffective for stimulating domestic investment, particularly in the TI countries, if business predicts that the resulting increases in internal demand are likely to be met mainly by producers located in other countries8.
    In this situation, which is new as compared to what Keynes was able to observe, we need to ask what instruments for public intervention in a TI country are still available for improving the prospects for business to achieve adequate returns from new investments.
    In debates around this issue the responses are usually worried with the high manufacturing costs in the already industrialised countries as compared to those in the emerging countries. These issues are examined below in the section dealing with manufacturing costs.
    But so far as the returns expected by business are concerned, there is in fact considerable other space (particularly in the EU countries) for intervening on the net revenues from VAT and other taxes on consumption. Taxes on final consumption introduce a tax wedge between the prices paid by domestic consumers and the net revenues received by entrepreneurs. But since VAT and other excise duties apply equally to imports, a reduction in VAT and other taxes on final consumption would reduce the tax wedge not only to the benefit of domestic producers but also to that of foreign producers exporting to the country of reference. All the same, it is possible to suppose that when consumers at the upper end of real purchasing power in countries with a long industrial tradition weigh up the relationship between price and quality, they will give more weight to the quality factor, since there is a tendency to presume that the quality of their own national products is higher9. Reducing taxes on final consumption could therefore encourage such consumers to choose national products and thus stimulate internal investment.
    Since VAT is an indirect tax whose revenue goes partly to finance the EU budget10, any reductions in VAT would need to be agreed at the EU level (where currently the expected standard minimum rate is 15%). Since with a certain degree of diversity the current economic difficulties are shared in common by all EU countries, it might be worth considering manipulating the standard rate of VAT at the European level.
    But as part of a strictly national public budget, "funding” a reduction in VAT is quite a different matter. In theory, the possibilities are: increase other taxes; reduce public expenditure (or some items thereof); or widen the public deficit. Since this affects any proposal to encourage public investment that involves reducing the tax levy or levy and/or increasing public spending, at least in the short term until the economy recovers, this aspect of financing incentives to encourage investment will also be considered in paragraph 3.

    2.2 Incentives for innovation

    In debates about the outlook for manufacturing and as a consequence, for investment in the TI countries, which have to face growing competition from the emerging countries, it is often asserted that these countries (in particular those in the EU) ought to orientate their strategic investment decisions towards products that use more advanced technologies. It is believed that technological innovation ought to give these countries a competitive advantage both in their manufacturing processes and in their ability to offer new products which (in the perceptions of consumers) will be of better quality. In pursuing these objectives it is held that the more industrialised states should increase and coordinate their expenditure on basic and applied research, and should incentivise decisions that encourage any innovative outcomes from this research to be infused into the manufacturing system. This strategy offers considerable scope for public intervention to support and organise research, support investments that incorporate innovative outcomes from this research, and demonstrate to business the advantages of making use of these outcomes.
    These are certainly important indications but as experience is showing, they are far from simple to put into effect. Before looking for spaces in which to finance, to any significant degree, new public spending on research and as support for investment to incorporate its outcomes, there are other public budget decisions that have to be taken under conditions of constraint on balances in which the most important items of expenditure11 (staff costs, pensions, interest on the debt) remain inflexible.
    Furthermore, particularly in Italy, there are efficiency problems within the agencies that are responsible for basic and applied research and for disseminating it into the manufacturing system, not least the frequently unjustifiable complexities of the procedures, and overlapping or interference between public agencies or between one programme and another.
    Bearing in mind that by now the major emerging countries (for instance China and India) have reached a level of scientific knowledge comparable to that in the countries of traditional industrialisation, a second critical aspect is the amount of capital required for major programmes of innovative research. Whether for reasons of cost or the effectiveness of this research, it seems plausible to assert that major research programmes ought to be organised and promoted, including financially, at the scale of large geographical areas, (e.g. the EU as a whole)12.
    Another critical aspect is that scientific and technological innovation is only infused into the industrial system after it has been accepted by entrepreneurs.
    For a long time business theory has recognised that entrepreneurship is a scarce factor that is difficult to divide. Some innovations can be immediately incorporated into a manufacturing process or product that already exists and that the entrepreneur can therefore recognise, evaluate, and accept positively and quickly. But in the case of an innovation that would require major changes to a manufacturing process or an existing product, or the immediate creation of new business activity, the (scarce and indivisible) “entrepreneurship” factor can become a limit that prevents the innovation from being absorbed into the manufacturing system at the right time.
    It must also be considered that if an innovation has been created as a result of investment, in some situations this would require the obsolescence of previous investments, not yet fully depreciated, to be brought forward; but in the absence of any public form of compensation, to the entrepreneur it might seem anti-economic to reorganise a manufacturing process to accommodate the innovation.
    Finally, public schemes that incentivise investment in technological innovation and increase business productivity might come up against the well-known difficulties that derive from information asymmetry (between principal and agent) and moral hazard13.
    In conclusion, the route of stimulating and promoting basic and applied scientific research, and incentivising investments whose outcomes can be infused into the manufacturing system, is certainly an obligatory one for the TI countries … but is not so much to be pursued separately by individual countries as based above all on strategies that take in extensive geographical areas. This is the road to take if those countries intend to maintain their historic position of primacy in the world economy and along with it, their pre-eminent levels in the average standard of living of their inhabitants. But it does not seem like an easy or obstacle-free way to go, and the outcomes that can be expected will only come over the medium/long term. So in a situation of economic crisis it seems necessary, not least for reasons of political and institutional stability, that nation states should also use other tools to incentivise other types of investment that can generate short-term effects.
    I mentioned earlier the advisability of manipulating VAT and other taxes on consumption to create positive revenue expectations. In the next section I consider the advisability of incentivising investments by manipulating the structure of the costs that entrepreneurs take into consideration when considering an investment.

    2.3 The prospects for reducing costs

    Even in the most favourable hypothesis that public policy can succeed in raising the rate of technological and organisational innovation in the manufacturing system of the TI countries, it is unlikely that the outcomes could suffice (at least in the short term) to resolve the crucial issue of the differentials between the manufacturing costs in the economies of the TI countries and those in the economies of the emerging countries.
    In fact in today’s global economy and global information transfer, technological innovations tend to spread rapidly from their country of origin to the others whilst as experience shows, the legal protections afforded by patents tend to be quickly circumvented.
    This means that any competitive advantages generated by technological innovation often prove to be of short duration. Not only: the fact that firms are aware of the high risk that innovation in one country will be quite quickly transmitted to the manufacturing systems of other countries means that when firms based in the TI countries decide to invest in innovation they also consider whether it would not be more opportune to make this investment directly into the other countries where costs are lower.
    Apart from the hypothetical case of a highly significant technological innovation, when the entrepreneur, comparing expected costs with expected revenues to determine the profit margin in relation to capital invested, assesses the advantages of making an investment referred to manufacturing costs at normally expected levels, the crucial variable of reference will be whether this can be considered satisfactory.
    As previously mentioned, in today's ever more internationally integrated economy a Keynesian stimulation of internal demand within an IT country may not be sufficient to promote growth in that economy if the demand is largely to be met by manufacturing located outside that country, where costs are lower.
    In almost all the manufacturing sectors of the TI countries, labour is the most important cost item; and in open international markets the differential between this cost in the TI countries and in competing manufacturing sectors in the emerging countries is the main factor that contributes to the loss of competitiveness of the TI countries.
    So in the TI countries, what instruments can a state use to reduce labour costs? As can be seen from Tables 1 and 2, simple observation of the structure of labour costs in the TI countries shows that the fiscal and quasi-fiscal levy is an essential component of these costs, represented in the EU countries respectively by the “tax wedge” in the average wage and the implicit rate of the levy on employee incomes.

    Table 1 … Total (average) tax wedge, single worker; 100% average wage

    Source: European Commission

    Table 2 … Implicit tax rate on wages (%), 2006

    Source: European Commission
    Note: data for Romania (RO*) refers to 2005

    To use language that is familiar to entrepreneurs, these tables suggest that in order to pay a worker a given wage or salary, the entrepreneur has to bear a cost that is increased by the extent of the fiscal and quasi-fiscal levy. Since as shown in Table 1, the wedge for most EU countries is between 40% and 50% (or more) of the average wage, it is evident that reducing this could have a significant effect on the competitiveness of firms in the TI countries as compared to those in the emerging countries. Noting that “the average tax (and quasi-fiscal) burden on labour is very high in Europe”14, the previously mentioned recent report of the European Community deduces that heavy taxation “is one of the factors underlying the poor occupational levels in Europe in recent years, which take the form of high rates of unemployment, low rates of participation, and low numbers of hours worked” adding that other significant factors may be the minimum wage and poor flexibility in the labour market.
    The main conclusion that can be drawn from this is that if in governmental budgets there were no difficulties in finding cover for reducing a significant part of the proceeds of the fiscal and quasi-fiscal levy on labour, thus reducing the public components of labour costs in the TI countries, there would be immediate prospects for effectively improving the competitiveness of their national products.
    In this regard, which is crucial for the recovery of competitiveness in the TI countries and thus for the prospects of investment in them, it is worth reiterating that with respect to the emerging countries (but also with respect to the other industrialised countries) the EU is a high tax area (measured in relation to GDP)15. Unfortunately, the difficulty for governments of covering such operations to reduce taxes and levies on labour costs would seem to preclude their widespread use16.

    Table 3 - Total taxes (including social security contributions), % GDP, 2007

    Source: European Commission
    Note: data for Romania (RO*) refers to 2006.

    As can be seen from Table 3, in the EU as a high tax area (in which the average total tax take for all 27 Countries is 39.5% of GDP) Italy, specifically, is one of the highest taxing countries (at no. 4 with France).
    In this regard it has been noted that the relatively high level of the tax and quasi-fiscal take in the EU reflects the greater robustness and extent of the systems of social protection in those countries as compared to countries outside the EU. The solidity and wide coverage of these systems of social protection, it is argued, have provided decisive support for the social coherence of the EU as a community against the effects of the recent severe economic crisis.
    It should be added that the purpose of levying social welfare contributions is to fund the costs of social security (pensions, subsidies, social benefits)17 and that reducing these contributions would pose with great immediacy the problem of financing these expenditures. One option might be to reduce inefficiencies and abuses caused by information asymmetries and social resistance, but this in any case would encounter technical difficulties. And the social importance of these expenditures (which include expenditures for social safety nets) is well known.
    From a methodological point of view this issue is similar to that raised earlier in relation to proposals for reducing VAT and other taxes on consumption; such operations have to be covered by reducing some items of public expenditure and/or increasing other forms of taxation. Thus, see once again paragraph 3 below.
    It should be noted that arguing here in favour of reducing the fiscal and quasi-fiscal burden on employed work may appear to run counter to a theoretical (and fiscal policy) approach that has come to the fore in recent decades, on the basis of which it is thought that income from capital should be taxed to a lesser extent18 than income from work, as is in fact the case of the Nordic DIT and of the significant reliefs on income from capital that are permitted under the laws of most TI countries19.
    Whilst the theoretical debate on the merits or otherwise, in terms of fairness and efficiency, of taxing income from capital at a lower rate remains open20, so far as tax policy is concerned - and as has been recognised by the creators of the DIT model - the winning argument has been that in today's highly integrated international economy and its high capital mobility, taxing income from capital at a higher level in one country than in competitor countries would provoke a substantial outflow of capital from the higher-taxing country.
    But in my opinion this argument is gradually losing the power it has had over the past twenty years. Fundamentally this is because cooperation between states, above all within the EU, to enable the authorities to track international capital movements, is being strengthened and expanded, and this is also opening up new possibilities for states to apply the "principle of residence”, and to more effectively combat tax avoidance and evasion.
    Furthermore, in the European Commission report previously referred to21, the statistics show that the far-reaching economic integration that has taken place in recent years, and the great increase in the international mobility of capital associated with it, have so far not led to any significant reduction of the tax take on income from capital.

    Table 4 … Tax revenue from corporate tax against percentage of tax revenue from capital gains and corporate income

    Source: European Commission

    This is explained by other three other factors (in addition to those given above in relation to the extension of controls as a result of the greater international cooperation between states). The Commission notes, in fact, that the observed reduction in the rates of business income has been accompanied by enlargements of declared taxable income. Furthermore, the reduction of business tax rates appears to have incentivised an increase in taxable business income at the expense of personal incomes. In its role as a backstop to compensate for reduced personal income, business taxation has begun to lose its strength.
    In particular, increasing global competition should induce us to consider that whilst on the one hand because of its lower international mobility, labour cannot to any significant extent avoid higher internal taxation levels by moving out of the country22, on the oher hand it is equally true that if firms in countries where labour is taxed at higher rates find their costs are not competitive, this will push them to reduce their activity in the higher-taxing country and/or move it somewhere else.
    This consideration, which seems necessary to support proposals that favour DIT or similar schemes, is not intended to immediately mean that financing the detaxation of work has to be done by increasing capital gains tax.
    The proposal here is to reduce labour costs in the TI countries, for obvious reasons that relate to their competitiveness with the emerging countries. As to how this can be covered financially, see paragraph 3 below.

    2.4 Other possible action

    Revising the current tax system to improve the competitiveness of firms in the IT countries should also extend to other taxes, as a way of reducing the tax burden on the manufacturing costs of firms within each of those countries.
    It is not possible here to go into specific technical issues as they apply to each tax.
    With specific reference to the Italian system, let it suffice to recall the taxes that would be candidates for any such revision:
    -IRAP [Imposta Regionale sulle Attività Produttive, or Regional Tax on Manufacturing]. This tax on manufacturing bears directly on the user cost of the manufacturing factors (capital and labour) by introducing the tax wedge between the gross and net remuneration of these factors;
    -A whole range of other tax charges levied on a variety of documents required for business transactions and business life (registration tax, stamp duty, and other similar charges).
    Obviously these proposals for review should be balanced by giving some indication of how the losses of revenue would be covered (par. 3).
    It is generally accepted, particularly in Italy, that there are ample margins for increasing the efficiency of the action of the public administration (whose inefficiencies have a negative knock-on impact on business costs and business activity). But as experience so far has shown, there are technical difficulties associated with reorganising the workforce and departments within the public administration; frictions can be generated by resistance to innovation and vested interests representing particular groups and categories have the power to block efforts to increase the efficiency of many of the actions the public administration could take to increase efficiency.
    Of course there remains the crucial matter of increasing overall productivity in all sectors of the economy. This will depend on technological innovation and on effectively diffusing it throughout the industrial system. The question of the inefficiency of the public administration cannot be addressed here.

    3. Financial cover for the lower revenue and the higher public expenditure required to fund a programme of significant investment incentivisation

    In relation to the proposals outlined in previous paragraphs for incentivising investment in the manufacturing system by reducing the fiscal and quasi-fiscal levy and/or greater public expenditure, we have had to point out that the current conditions of the public finances in most of the TI countries appear to place insurmountable obstacles in the way of finding new financial resources for such public incentivisation programmes23.
    In fact any programme of public incentivisation of significant size that would be effective for reaching the goal of recovering economic growth does not appear feasible unless the conundrum of how to cover it financially is resolved.
    In particular, I noted above that the high level of the fiscal and quasi-fiscal levy on incomes from employment offers very ample margins for relaunching the competitiveness of the TI countries by taking measures to reduce it. But the preponderant weight of these levy items as part of the total revenue of the public administrations highlights the difficulty of substituting a significant proportion of these revenues with increases in revenues from other taxes, and/or with corresponding reductions of certain items of public expenditure (and so far as social security expenditure is concerned, the relationship between social contributions and expenditure spending is institutionalised).

    Table 5 … Income of the public administration under existing legislation. Final 2008 and forecasts 2009-2013

    Source: Programme and forecast report for 2010 - Chapter 4. Balances of public finance for 2009 and 2010… Table no. 8 … p. 15.

    The European Commission24 recognises that “shifting the levy from employment taxation to taxes on consumption could have positive effects on employment and development.” And yet it also affirms that these effects “tend to be modest in size”; warns that they may create inflationary pressures; and finally that in the current macroeconomic situation it would not be advisable to impoverish the purchasing power of low-income families, and that therefore any increase of taxation on consumption should be accompanied by compensatory measures in favour of low incomes. The Commission goes on to express a (cautious) preference for greater reliance on environmental taxation, to which less importance has been given in the EU in recent years, and on property taxes, which are also mentioned as an instrument for introducing taxation based on its benefits at the local level25.
    Currently, economic experts and the governmental authorities responsible for the economies of the various countries are in discussion about the difficulties of identifying financial cover for reductions to the various types of levy (taxes on consumption, business income, and company documentation) and for increasing expenditure on incentives (grants and “tax expenditures” for investment, research costs, and similar).
    One argument that is put forward with great force by some countries but not others26 concerns the possibility of recovering sufficient revenue from fiscal and quasi-fiscal evasion and avoidance, and using it to finance the types of incentivisation programmes mentioned above. Certainly, since avoidance and evasion are perpetrated by violating or exploiting loopholes in laws that ought to be respected by everyone, it is the duty of individual countries to combat them. As the European Commission also underlines27, combating avoidance and evasion is beginning to produce appreciable outcomes because (a) the state of their public finances has made it necessary for them to make greater efforts in this regard (b) information technology is offering new instruments to finance ministries, and (c) the growing cooperation between Member States to improve the effectiveness of investigations, and with states outside the EU, is beginning to produce its first results. The prospect of increasing the efficiency of tax investigations, thereby finding new fiscal and quasi-fiscal resources that can be used to finance incentivisation programmes, introduces a potentially optimistic note to the future possibilities for public incentivisation of the competitiveness of firms in the TI countries.
    However for some countries and some particular manufacturing sectors, and for many SMEs, we should warn that the emergence of this “submerged fiscal activity” will have to be accompanied by simultaneous rate reductions and a start to the incentivisation programmes. Many entrepreneurs (above all SMEs) even warn that this “submerged economy” must be maintained not only because levels of taxation are excessive but more generally because of the pressure of competition due to the lower costs sustained by firms in the emerging countries. This is to say that in a situation of global competition the danger must be avoided that a rapid emergence of tax revenues from the hidden economy, if not accompanied by lower rates of taxation and other incentives, could price firms in the TI countries out of the market, inducing them to cut back their activity, shut it down, and/or outsource it to countries where manufacturing costs are lower and where in general, taxes and levies are also less onerous (and where there are fewer regulatory constraints on manufacturing and on care for the environment).
    Even with those qualifications, the prospect of covering the costs of future incentivisation programmes by clawing back avoided or evaded taxes is not an insignificant one.
    There is a further argument in favour of programmes for reducing the fiscal and quasi-fiscal cost of labour, which I suggest has not been brought to the debate with sufficient insistence. In entrepreneurial decisions about the organisation of manufacturing, the high labour costs caused by taxation and the quasi-fiscal wedge are also a disincentive to occupation. As economic theory already highlighted many years ago28, in the economic accounts of governments, the lower revenue resulting from reducing the fiscal and quasi-fiscal levy on labour, to increase employment, is at least partly offset by costs that are lower than those that the public administration, for obvious socio-political reasons, would have to bear to support the unemployed (various forms of unemployment subsidy, implicit or explicit subsidies to firms to encourage them to retain jobs, free social services for the poor, and pressure on public offices to hire unnecessary staff who would otherwise be unemployed). So in accounting properly for social costs the greater “tax expenditures” to reduce labour costs must be compared with the consequent lower need for public expenditure in favour of the unemployed and for providing assistance to the poorest segments of the population.
    Furthermore, the current economic crisis has given new voice to those who warn that the “new orthodoxies” concerning the relationships between public debt and GDP29 must be interpreted according to economic logic and not merely in accounting terms. It is well known that the performance of the relationship between public debt and GDP depends not only on the performance of the numerator but also that of the denominator. The economic recession tends structurally to increase this relationship. So in economic terms the proposal of using budget policies to incentivise and stimulate investment so that this relationship is allowed to further increase in periods of crisis would appear to be correct so long as later on, additional public intervention generates recovery of investment and growth of GDP.
    It can be argued that - mutatis mutandis and thinking essentially in terms of a closed economy - Keynes in his time was lucidly opposed to the orthodoxy of balancing the public budget, and (despite the limitations of his model) showed that investments would themselves generate the savings necessary to finance them.
    Taking up the Keynesian lesson again and adapting it to the new constraints imposed by competitiveness in a global economy, it would appear that adhering too formally to the rules of the new orthodoxy of public finances, and in conceptual terms too statically, could prove to be highly negative for the economic prospects of the TI countries.
    So whilst not underestimating the difficulties discussed above, margins do exist for a fiscal strategy that improves the competitiveness of products manufactured in the TI countries. In any case there do not seem to me to be any viable alternatives for intervention if the goal is to stimulate the recovery of rates of growth in the TI countries in such as way as to (at least) maintain the current average living standards of their citizens.
    1Hereinafter referred to as TI Countries.
    2See the considerations set out in The Economist (18/07/2009).
    3Above all because of the high levels of public and private indebtedness already built up in most countries (particularly in Italy, so far as public debt is concerned).
    4In reality even a significant reduction in public investment, where economic recovery has been initiated, may face political obstacles due to rigidities and frictions in the processes of reconverting firms that previously served the public demand to obtaining commissions from the private demand. These rigidities include not only a production - product sector content but also a territorial location content.
    5See ALESINA A. et al (2006); HOI et al (2006); even after the outbreak of the world financial and economic crisis, in advancing its recommendations on fiscal policy within the "European Economic Recovery Plan" (ERRP) the European Commission still refers back to the Lisbon Strategy, which aims at improving the functioning of markets (including the labour market) in a pro-competition sense. See EUROPEAN COMMISSION (2009).
    6This excludes firms in the financial and insurance sectors, which operate structurally using schemes for analysing financial investments that can be very sophisticated.
    7As already warned, this affirmation holds true for an essentially closed economy or for an open economy whose businesses are sufficiently competitive to meet the bulk of the increase in domestic demand.
    8This includes domestic entrepreneurs who relocate their manufacturing to companies based abroad.
    9Well aware of this argument, firms in the TI Countries including Italy are calling for greater protection of trademarks, quality certifications, and secure indication of the actual country of manufacture (such as requests for protection of the “Made in Italy" mark).
    10If the rate reduction has to fall below the levels provided for by Community agreements (currently 15%). One of the fiscal stimuli to economic recovery provided by the European Commission (2008) is “ temporary rate reductions” to sustain consumption. But if (as that text says) we take into account the investment decisions of enterpreneurs, it appears unlikely that temporary restrictions with no certain end date can have any significant effect.
    11In public budget decisions, allocations for scientific research that can be used by the production system also encounter the obstacle of the natural reluctance of researchers to work "on commission" or in any case on themes and for purposes declared as priorities by government authorities; it can in fact be argued that research should be free and funded in all directions as an instrument of cultural progress, not made to serve shorter term objectives aimed at improving the competitiveness of the manufacturing system. This is a very complex issue because it involves ideological aspects that concern the nature of social organisation and the meaning of individual freedom within it.
    12See MONTI (2010).
    13On this issue, see in particular the work of LAFFONT, J.J., MARTIMORT,D. (2001); LAFFONT, J.J., TIROLE, (1993).
    14EUROPEAN COMMISSION (2009) pp.43- 44. The Commission also notes that taking together the aggregate rate of tax on labour and the benefits offered by social assistance schemes, in the EU countries there are high disincentives to employment, to participating in the world of work, and to any increase in working hours and effort. It therefore calls on Member States to reform their disincentivising institutions: pp. 50-54.
    16In relation to this issue, see par. 3.
    17In countries such as Germany that have maintained the insurance-based healthcare system (the “Bismarck model"), social contributions also fund most expenditure on health.
    18Indeed there is a school of thought that has been arguing since the 19th century that ordinary income from capital should not be subjected to income tax at all. For a discussion of these topics and the “intermediate” solution represented by the Nordic DIT, I refer to my previous article (BERTUCCI, 2007) and the references cited therein.
    19On this issue of the preferential treatment of capital gains as compared to those from work, including in jurisdictions that have not explicitly adopted the Nordic DIT, see EGGERT (2005) and the references cited therein (see bibliography).
    20See SORENSEN (1994; 2005a; 2005b; 2006), BOADWAY (2004) and my article, Irene Bertucci (2007).
    21EUROPEAN COMMISSION, (2009), pp. 57-60.
    22See GORDON (2000).
    23Recalling the constraints on the deficit ratio imposed within the EU by the Stability Pact, and recently reaffirmed and strengthened to defend the value of the Euro.
    24EUROPEAN COMMSSION (2009), p. 47, and see also EUROPEAN COMMISSION (2008).
    25In Italy, as compared to the past and in the prospect that federalism is likely to be implemented, it would make sense to pay more attention to tax contributions that are commensurate with the principle of benefit and those that are commensurate with the principle of scope.
    26In Italy, controversies about the high levels of tax evasion and avoidance have become an historical fact. In a brilliant article in “Il Corriere della Sera” the economist Alberto Quadro Curzio recently reiterated that as well as generating efficiency savings in public spending, the new Italian option of fiscal federalism, if used properly, could also mean that submerged revenue and income would be brought to the surface in sufficient quantity to produce very large new revenue streams for the public purse, thus making it possible to cover incentivisation programmes for economic recovery.
    27As evidenced by Quadro Curzio (2009).
    28For all of these, see STEVE (1976).
    29As in the EU Stability Pact.

    ALESINA A., ARDAGNA S., TREBBI F. (2006), “Who Adjusts and When? On The Political Economy of Reforms”, in NBER Working Papers 12049, February.
    BERTUCCI, I. (2007),“Tassazione unitaria versus tassazione duale del reddito”, in Economia, Società e Istituzioni, LUISS University Press, anno XIX / n. 3, Settembre … Dicembre.
    BOADWAY R. (2004), “Dual Income Tax”, CESifo DICE Report 3.
    EGGERT, W. and B. GENSER (2005). “Dual income taxation in EU member countries” CESifo DICE Report 3 (1).
    EUROPEAN COMMISSION (2009), “Monitoring revenue trends and tax reforms in member states 2008” in European Economy, n° 4.
    GORDON, R. H. (1986), “Taxation of investment and savings in a world economy”, in American Economic Review, n. 76.
    GORDON, R. H. (2000), “Can capital income taxes survive in open economies?” , in Journal of Finance, n. 47.
    Gordon, R. and J.R. Hines (2002). “International taxation”. In A. Auerbach and M. Feldstein (eds.), Handbook of Public Economics IV, North-Holland.
    HOI J., GALASSO V., NICOLETTI G., and THAI-THANH DANG (2006), “The Political Economy of Structural Reform: Empirical Evidence from OECD Countries”, OECD Working Paper 501.
    LAFFONT, J.J.; MARTIMORT, D. (2001); The theory of incentives: the principal-agent model, Princeton.
    LAFFONT, J.J.; TIROLE, J. (1993); A theory of incentives in procurement and regulation, Cambridge.
    MONTI, M. (2010); “Una nuova strategia per il mercato unico al servizio dell'economia e della società europea”, rapporto al Presidente della Commissione Europea José Manuel Barroso.
    QUADRO CURZIO, A. (2009); “Le tasse? Il federalismo le farà scendere”, in Corriere della Sera, No. 207.
    SALMON, P. M. (2009), “What went wrong with economics - and how the discipline should change to avoid the mistakes of the past”, in The Economist.
    STEVE, S. (1976), Lezioni di Scienza delle Finanze, VIII ed., Padova.
    SÖRENSEN, P.B. (1994). “From the global income tax to the dual income tax … Recent tax reforms in the Nordic countries.” International Tax and Public Finance No 1.
    SÖRENSEN, P.B. (2005a). “Neutral taxation of shareholder income”. International Tax and Public Finance No 12.
    SÖRENSEN, P.B. (2005b). “Dual income taxation … Why and how?” FinanzArchiv, No. 61.
    SÖRENSEN, P.B. (2006), “Can Capital income Taxes survive? And should they?”, CESifo.
    TREMONTI, G. (2009), “L’economia italiana nel 2010 … relazione previsionale e programmatica”, Ministero dell’Economia e delle Finanze.

    Editor: Irene BERTUCCI*
    *PhD Student in “Economics and Local Development” … Università degli Studi della Tuscia


    What we know and what we do not know: PPP as a key way to try to get out from the crisis
    Implementation of Long-Term investments and optimal risk sharing

    1. PPP: a public and private sector cooperation tool available to optimise the value for money of public projects and services

    A public private partnership (PPP) is a long-term contract and/or legal entity built up by a public authority and the private sector for delivering a long-term (or less frequently short-term) asset or a service. The principal features of a PPP are:
    - Provision of a service involving the creation of an asset that requires private sector design, construction, financing, maintenance and delivery of ancillary services for a specific period;
    - a contribution of the public sector through land, capital works, risk sharing, revenue diversion, purchase of the agreed services or other supporting mechanisms.
    Before analysing in depth the financial issues relating to the implementation of PPPs, it must be noted that there are wide-ranging models of PPPs across the world. Although there is no preferred or standard model … as it is determined by a number of factors such as the definition of core services, the value for money and the public interest - it is possible to identify two main broad frameworks:
    - DBFM (Design-Build-Finance-Maintain): the private sector is responsible for the design, building, finance and maintenance of an asset. This incentivises the private sector to design the asset taking into account the long-term maintenance required;
    - DBFO (Design-Build-Finance-Operate): the private sector designs, builds, and finances a new facility under a long-term contract and operates the related asset during the term of the contract.
    The public sector purchases services that flow from the asset in this period and the ownership is usually transferred back to the public sector at the end of the contract.
    PPPs are now particularly prevalent in economic sectors where they have proved their worth by increasing value for money and improving the service provided: transport, utilities and amenities.
    There are opportunities for governments looking to develop PPP programs beyond infrastructure and to consider it in the service areas: healthcare, education, prison, innovative sectors etc. at a national or local level.

    2. Why it is important to develop PPPs

    In advanced countries, PPPs can contribute to solving the difficulty of building infrastructures or replacing ageing ones in a context of budgetary pressure.In emerging countries, PPPs can contribute to accelerating the answer to citizens’ demand for ongoing improvements in infrastructure and public service. The shortage of infrastructure in developing countries is an important obstacle to meeting the population’s needs and to developing enterprise. Recognised key benefits of PPPs notably induced by an increased competition are the capacity to bring about improvements to public services, shorter delivery times, better value for money and increased innovation. Moreover, from the public sector point of view, a PPP is a possible opportunity to reduce the risk and therefore to reduce financial contributions, which can alleviate the fiscal constraint the governments have to deal with. Lastly, in PPPs, the risk retained by the public sector is more explicit, thus increasing the confidence of its different partners and stakeholders among which are the citizens.
    The main issues relating to PPPs that should be taken into account are:
    - Risks related to the delivery of assets and services have to be clearly determined; the definition and combination of complementary skills and expertise from the different partner, the arrangement of an appropriate value chain and optimisation of the value for money are key in that respect;
    - The different types of risks must be appropriately allocated between the different players involved (savers, financial intermediaries, enterprises, public entities);
    - PPPs concerning "Innovation" - infrastructures involving alternative sources of energy, new outsourcing areas within public services (healthcare, education or prisons) must be particularly cautious on risk identification and allocation in order to facilitate the access to finance.
    Nowadays, many governments obtain financing for PPP projects from organisations such as the World Bank, the Organization for Economic Co-operation and Development (OECD), the European Investment Bank (EIB) and the European Bank for Re-Construction and Development (EBRD). However, in the future, if the conditions explained below - transparency, optimal risk sharing and development of adequate financial tools - are gathered, private savers, investment funds and others will be involved in this business.

    3. Risk allocation between private parties and the public sector

    a. What is at stake

    A bedrock for an optimal risk transfer is an accurate risk assessment, as risk should be allocated to whoever is best able to manage it. Transferring too much risk to a private provider that has little control over it can lead to delays, cost overruns and eventually discourage their participation to PPPs. The reverse behaviour is also true. Risk allocation seeks to assign project risks to the party in the best position to control them and therefore minimise both project costs and risks. The party with the greatest control of a particular risk has the best opportunity to reduce the likelihood of the risk eventuating and to control the consequences if it does. This implies that risk that can be mitigated by the private partner (e.g. operational efficiency, etc.) should be borne by the private sector, whereas risk of a public-interest nature (e.g. specific public demands including non-commercial objectives, etc.) should be born by the public sector. This suggests that an appropriate risk allocation requires beforehand an effective clarification of the actual public interest, and that assessing risk is a case-by-case exercise. Lastly, certain risks are outside the total control of both parties to some degree. Even in this case, the basis of the assessment of the likelihood of the risk eventuating, the related likely cost to the public party, and its ability to mitigate the possible consequences by testing different scenarios of risk allocation would enable public parties to understand whether the private party prices the risk and whether it is reasonable for the public party to pay for it.

    b. Risk assessment methodologies

    To assess the opportunity to start a project involving the private sector, it is relevant to perform the so-called Public Sector Comparator (PSC). It provides a financial benchmark for the quantitative assessment of the value for money brought by the different answers to the request for proposal (RFP).
    - The PSC represents the net present value of the total whole-of-life cost required for the public party to meet the specified output in the case of a self-procurement;
    - RFP responses are therefore ranked according to their risk-adjusted Net Present Cost ("NPC") and compared to the risk-adjusted PSC;
    - The financial impact of the risk retained by the public party is added to each RFP response to show the total project delivery cost. Adjustments may be made to the NPC of individual RFP responses according to a preferred risk allocation scenario.
    Nevertheless, identifying the best outcome requires a flexible valuation process and a complete value for money assessment requires also considering the qualitative factors of each RFP response.

    c. Public Sector Challenges

    Long-term commitment from public parties to PPPs is important for business confidence. Hence, political stability is key to PPPs’ continued success. Lenders will be reluctant to enter and invest in PPP markets if there is no clear and reliable political support. Investors will be unwilling to put capital at risk unless their rights and responsibilities … vis-à-vis the public sector, other enterprises and the general public … are firmly established and enforced by independent entities.
    In an environment where laws and agreements cannot be effectively enforced, most other success criteria are of secondary importance. A sound and stable legal and institutional framework is a vital precondition for the success of any PPP market. This situation does not preclude governments from exercising their right to regulate in the public interest, including by changing legislation bearing on the viability of infrastructure projects. However, they should do so in a transparent and, as far as possible, predictable manner, including prior consultations with the private sector participants. Moreover, transparency on the procurement process and on the performance of existing PPPs etc. means an easier access to private investors.
    An example of how to construct political stability and transparency is provided by the UK experience:
    - The creation of The Office of Government Commerce (OGC) has provided a sound and certain framework to guide procurement actions;
    - The creation of the National Audit Office (NAO) responsible for scrutinising government spending and conducting regular investigations on the performance of PPPs, has provided transparency on PPPs.
    Among the Public Sector challenges, the resolution for the lack of efficiency and experience in the risk management cannot be omitted and, moreover, the innovations that have been experienced in the traditional public service provision. This can incentive governments to partner with the private sector, in order to utilise their experience and resources. The private sector can offer skills and experience that bring innovation and efficiency to services and will improve outcomes. In order to remove barriers in developing the PPP model, it is considered essential to improve public procurement through skilled professional public managers who need expertise in project management, contract management, market management and model design. Procurement and commercial skills are considered essential ingredients as they lead to positive partnership relationships with providers. To fully develop these skills, the public sector should build links with the private sector by sharing best practices in order to deliver increased value for money in public services, and if necessary by setting up sector specific procurement ‘academies’ to pool procurement and contract management expertise. Lessons in this field come from the UK: here the Treasury has developed guidance particularly with respect to the risk management techniques, a field in which the public sector tends to have limited experience. Moreover, governments should develop partnership models for public authorities to demonstrate how successful partnering relationships look like and the skills required to make them successful. These bodies can act as a source of procurement and contract management excellence. An example comes from the experience of the Czech government, which has entered into partnership with the UK and The Netherlands through a EU twinning project. These countries provide PPP expertise to the Czech Ministry of Finance to help increase efficiency and develop PPP methodology and standards.

    4. PPP access to finance

    a. Cost of financing a PPP

    Compared with the risk free rate of government-debt that applies to public procurement procedures, PPPs bear an additional risk premium because they explicitly allocate risks to the private sector. These risk premiums represent as such value for money. Indeed, they provide a quantification of the risk related to the project. These risks are different but they exist when the project remains within the public sector. Unfortunately, public-dept rates do not reflect underlying project risks as the Government-borrowings are virtually considered as risk-free because of the taxpayers’ backing. The comparison of the spreads of the public and private debt does not adequately capture the differences between public and private specific risks, nor they reflect their respective value for money or the attractiveness of sharing risk within a PPP. On the contrary, risks become more explicit in a PPP approach. Risks and value for money are in this case priced individually for each procurement option that can be appropriately compared.

    b. Role of the public sector in financing PPPs

    The key role of the Public sector is to appropriately set the terms of the competition in a RFP for a PPP project, in order to give to the private sector the right incentives and to obtain the best value for money. The terms for the financing of the PPP are part of these terms. The public entity has in particular to define the type of financial counterpart it wants: the PPP contractor, credit providers, specialised insurance companies. The public sector may also define in advance some restrictions on the financing options which will be accessible to the PPP contractor, e.g. fixed income, mix of fixed and index linked bond issues, involvement of bank finance etc.
    The public sector should also precise the use or not of hedging instrument to mitigate interest rate risks as the public sector may prefer to consider its exposure to interest rate risks as a whole.
    Lastly, the public entity may prefer to be directly involved in the financing architecture in order to provide PPP contractors with a favourable standing and reduce financing costs.

    c. Conditions for accessing financial markets

    c.1 Impediments

    A specific OECD recommendation asks for phasing out any restriction in access to local and private financial markets and obstacles to international capital movements. Access to capital markets to fund operations is essential to private sector participants.
    In all cases, giving full access to capital markets bolsters the efficiency of PPPs. Where currencies are fully convertible and capital can easily move in and out of the host country, infrastructure operators fund their operations at competitive international rates and consequently need to shift no "financing premium" onto the domestic infrastructure users. When infrastructure projects are set in countries without fully convertible currencies or with uneasy repatriation of the profits and of the redemption of the capital invested, projects find it difficult to mitigate exchange risks and have a strong incentive to fund themselves locally. Countries with well-functioning domestic capital markets find it both easier and cheaper to involve private operators in their infrastructure. On the contrary, the experiences made so far by public authorities accepting infrastructure tariffs linked to foreign currency to compensate investors’ exchange risks have been far from encouraging.

    c.2 Areas for progress

    In order to phase out restrictions in access to local and private financial markets and obstacles to international capital movements two approaches should be adopted:
    - Facilitating access of local small-scale projects to financing: to facilitate assistance to overcome the challenge of preparing bankable projects, support linkages with bigger operators and promote more SME(P) (small and medium enterprises/Project) friendly banking and financial systems. The aim would be to provide a faster, cheaper funding solution, which maintains the benefits of private bank finance but reduces its inefficiencies when applied to smaller schemes. In this regard, several strategic partnership models have been developed which provide umbrella organisations to procure smaller PPP projects. An example of this model is the Local Improvement Finance Trusts (LIFTs) in the health sector performed in the UK since 2004. LIFTs were an innovative approach to meet the challenges of investing in small health scheme projects. The individual projects undertaken by LIFTs were structured in similar ways to PPP projects: the individual contracts were grouped together and standardised terms were used. Contract batching benefits come from the use of a coherent strategy, economies of scale and repetition of contracts. Moreover, batching attracts larger construction companies into the market and private sector partners bring expertise in terms of project delivery and property development. The key benefit of such a model is that it can offer improved flexibility: financiers are able to spread risk across a number of small-scale projects, allowing more scope for flexible development and innovations, and recycle in a easier way capital into funding new projects. Further benefits include a more streamlined procurement process and the ability to drive value from working with a consistent supply chain for sequential projects, therefore building expertise and better understanding between project partners over time. To strengthen the availability and optimality of this model, the NAO report on the LIFT programme found that it is effective and it offers value for money, a suitable route for smaller projects that would be unsuitable for standardized PPP infrastructural projects.
    - Loans to infrastructure projects can be securitised: private participation in infrastructure can also help develop financial markets. Loans to infrastructure projects can be securitised with the double benefit of lowering the funding cost and adding depth and liquidity to domestic capital markets, and moreover removing obstacles to international capital movements. Despite some concerns about the role played by monoline insurance companies involved in PPPs projects, there are equipped financial intermediaries such as banks, private sector companies and public sector clients who are gaining a greater knowledge of the PPP market and are better and better able to accurately reflect the long-term costs of the project in the initial contract. PPP schemes are now financed largely by long-term bonds: in this regard, the financial resources for purchasing such instruments could be available in the insurance and pension sectors of most countries. Once the risks associated with the set-up … such as construction risks … are overcome, these assets offer large and reliable returns matching the increasing the demand for investments with very long duration and with yields better than those offered by government securities, as required by insurance and pension sectors. So PPP contracts could be also considered as a proper way to create new and attractive sources of long-term investment.
    Despite some concern about the secondary market in PPP assets, there is a limit to how much financial gain can be generated for private investors through financial engineering. The focus of the secondary fund manager is the long-term performance of investments. A good management of the PPP project in which they have invested is in their interest, in order to effectively maintain assets and meet service specifications. A valuable benefit is that the sale of the asset allows to recycle the capital in order to fund other projects. Moreover, from a macroeconomic point of view, there is an opportunity for governments to encourage the development of a virtuous circle between pension investment needs and public service funding. To the national economy, the benefit of recognising and encouraging this symmetrical market could be a greater overall long-term financial stability.
    The Private Finance Initiative …October 2003 - Research Paper 03/79 House of Commons UK.
    Building on success: the way forward for PFI … June 2007 … CBI.
    Private Sector Participation in water infrastructures … 2009 … OECD.
    OECD Principles for Private Sector Participation in Infrastructure … 2007 … OECD.
    The world of public private partnerships …July 2007 … CBI.
    National Public Private Partnership - December 2008 - Australian Government.
    National Public Private Partnership Guidelines …December 2008 - Australian Government.
    Editor: Alberto Maria SORRENTINO
    © 2011 ASSONEBB

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    The purchasing power parity (PPP) is a non-arbitrage condition. It states that a basket of identical goods should have the same price, adjusted for exchange rate, across different countries. Although this idea has a history dating back at least to scholars at the University of Salamanca in the 15th and 16th centuries, the term purchasing power parity was first used by Gustav Cassel (1922, 1928), co-founder of the Swedish School of Economics together with Knut Wicksell and David Davidson. In particular, Cassel studied the gold parities of the currencies of WWI participating countries with the specific purpose of estimating the equilibrium exchange rates (Colombo and Lossani, 2003).

    1. Purchasing power parity (PPP) and the law of one price (LOOP)

    The PPP is a generalization of the law of one price (LOOP). The LOOP says that the same good sold in different countries should have the same price when expressed in common currency. In short: if one unit of domestic currency could buy a larger amount of good x than it would be affordable within the national economy, then it would be profitable to buy x abroad and sell it inside, making profits on the difference between the prices. This arbitrage (repeated over time by multiple subjects) implies the convergence of international prices of the goods considered. In the real world, the PPP is not always verified. However, this theory provides a benchmark for monitoring exchange rate movements. For example, suppose that, based on the comparison of prices for the U.S.A. and the Eurozone, the exchange rate consistent with the PPP is equal to 0.85 (euro for one dollar), but in reality the exchange rate determined on the Forex market is 0.75. In this case, it is possible to conclude that the euro is overvalued against the dollar. Over the next few paragraphs, we will have the opportunity to clarify what can determine this discrepancy and how the values of the PPP can be restored.

    Formally, the PPP implies that:

    - is the price index for the domestic basket of goods ( is the weight of the j-th item in the domestic basket);
    - is the price index for the foreign basket of goods (is the weight of the i-th item in the foreign basket);
    - St is the nominal exchange rate (NER) that indicates how much one unit of foreign currency is worth in terms of the domestic one.
    Equation (1) defines the so-called absolute purchasing power parity to distinguish it from its "soft" version known as relative purchasing power parity. Indeed, the relative PPP is said to hold when the rate of depreciation of one currency with respect to another is proportional to the difference in terms of inflation rates. The Relative PPP can be defined as follows:
    where c is a positive constant.
    Whether it is considered in its absolute version (1) or in its relative version (2), the PPP theory shows an interesting dynamic relationship between exchange rate and price level. By using the logarithms and differentiating with respect to time yields:

    - is the nominal depreciation rate;
    - is the domestic inflation rate;
    - is the foreign inflation rate.
    From equation (3) it is easily seen that, if the PPP holds, the greater is the spread between domestic and foreign inflation rate, the higher the depreciation of the domestic currency will be.

    2. Purchasing power parity (PPP) and the real exchange rate (RER)

    Starting from the PPP, we can define the RER as a measure of the number of baskets of domestic goods necessary for the purchase of a basket of foreign goods, in formulas:
    Looking at equation (4), it is clear that if the PPP is respected, and therefore the NER moves in the same direction of inflation rates differential, then the real exchange rate (RER) remains constant. If the price of the currency (represented by the NER) reflects the purchasing power, then the RER remains constant over time. In formulas, using logarithms and differentiating with respect to time:
    Hence, if the PPP holds, then the RER is constant, so that movements in the real exchange rate represent deviations from the PPP.

    3. The Big Mac Index

    An index widely used to determine whether a currency is appreciated or depreciate with respect to another
    is the so-called Big Mac Index, based on prices of the famous sandwich. Published by The Economist since 1984, this index, based on the LOOP, is used to calculate the PPP for a large number of exchange rates using the Big Mac as reference good.For example, let's consider the table in figure 2 (source: Economist May 8th, 2009). From the comparison of the Big Mac prices in the U.S.A. and in the EU, it emerges that the European currency, traded at 0.96 against the dollar, is overestimated. Indeed, the (average) price of the sandwich in Europe (U.S. $ 4.38) is more than 24 higher than the price paid in the U.S.A. (US$ 3.54).
    As clearly shown by the figure, the index provided by The Economist indicates a significant misalignment of nominal exchange rates.

    Data concerning the Big Mac Index suggest that the LOOP is not verified. This failure is due to the fact that both the LOOP and the PPP assume the existence of competitive markets and the absence of transaction costs. Thus, to evaluate properly the appreciation or depreciation of a currency, it would be necessary that the goods traded were produced by using only inputs that can be easily traded on international markets and that there were no trade barriers, transport costs and differences in tax regimes. The real world is, unfortunately, very different. Indeed, despite the fact that the weight of intermediate inputs has been significantly reduced through globalization, strong differences remain in the cost of those inputs that are not (easily) traded internationally - eg. labour and physical capital - and that play an important role also in the production of standardised goods, such as the Big Mac. While input prices traded on international markets (such as onion, for example) converge rapidly towards the theoretical values of the PPP, this is not the case for the cost of labour and other non-traded inputs that contribute significantly to the formation of the Big Mac price.
    More generally, it is possible to identify four factors that can determine deviations from the PPP.
    1) Transaction costs: the presence of transport costs and insurance costs, tariff and non-tariff barriers, etc. implies that the LOOP does not hold and reduces the chance of profit arising from international trade.
    2) Differentiation: the LOOP, upon which the PPP is based, assumes that the good traded on different national markets is homogeneous. The real world instead provides many examples of differentiated goods. This differentiation prevents prices from equalising across countries.
    3) Fixed capital formation: the presence of high fixed costs (distribution contracts) prevents the trader from taking advantage of arbitrage opportunities (Sarno and Taylor, 2002).
    4) Non-traded goods: the LOOP implicitly assumes that all goods are tradable, but in fact a very significant part of the income is spent on the purchase of non-traded goods on international markets, or for which it is not possible to perform arbitrage operations (e.g. housing, medical services, education, etc.).

    4. Empirical evidence

    There is extensive empirical literature on the LOOP and the PPP. Generally, these econometric studies suggest a rejection of the LOOP for a wide range of goods.
    The PPP implies that the change in the exchange rate in a certain period of time offsets the difference between domestic and foreign inflation. This implies that the RER is mean reverting, or, in other words, that any shock … such as a sudden change of the NER … is absorbed over time. In formal terms, many studies tried to verify whether the relative price index followed the trend described by the equation:
    or that described by a random walk.
    A systematic survey of the empirical studies on the PPP should be organized according to the econometric methodology applied.1
    1. Papers based on co-integration analysis have provided heterogeneous results (Enders, 1988; Mark, 1990). By
    using the so-called "two-step Engle-Granger method", a co-integration analysis is usually applied to the following equation:
    if st, pt and are integrated of order 1, then the relative PPP exists if is stationary. The absolute PPP requires also that the parameter restrictions = 1 and = -1 be satisfied.
    Early co-integration studies have generally shown the absence of significant mean-reversion of the exchange rate towards the PPP for the recent floating rate experience, but they have found support for the reversion towards the PPP for the inter-war float and for high inflation countries (Sarno and Taylor, 2002).
    2. Another approach to test the RER mean reversion hypothesis is provided by the Augmented Dickey-Fuller (ADF) test for a unit root, which is generally based on a regression:
    where is a p-th order polynomial in the lag operator L and is a white noise disturbance. Testing the null hypothesis that = 0 would imply no long-run equilibrium level for the RER. A further approach proposed by Meese and Rogoff (1988) tested the alternative hypothesis .
    These empirical studies generally can not reject the random walk hypothesis for the RER.
    3. An alternative method to test the non-stationarity of the RER is based on the variance ratio test (VR) developed by Cochrane (1988).
    According to this approach, the persistence of the RER is measured by using a simple non-parametric test, :
    where k is a positive integer and var stands for variance.
    If the RER follows a random walk, then the ratio (10) must be equal to 1; on the contrary, if the RER is mean reverting then 1. By using VR, Huizinga (1987) found that the permanent component of the RER is around 60% (Sarno and Taylor, 2002).
    4. A way to circumvent the problems of low power shown by the standard unit-root test is to infer from the panel data. The first attempt in that direction is due to Hakkio (1984) who employed Generalized Least Square (GLS) on data from the UK, France, Germany and Japan. Also in this case, the random walk cannot be rejected.
    In conclusion, three observations can be drawn from this brief review. Firstly, it is evident that the empirical results on the validity of the PPP depend substantially on the econometric technique used. Secondly, the literature provides empirical support to the PPP only in the long run, confirming the existence of a slow mean reversion of the RER. In the short term, the dynamics of the real exchange rate are linked to fluctuations of the NER and therefore they exhibit a high volatility. Finally, although many studies have highlighted the tendency of the real exchange rate to converge in the long run towards the values of the PPP, the low speed at which they converge after the shocks raises some theoretical doubts. In other words, even if in the long run each currency reflects its purchasing power, empirical evidence indicates that a period from 3 to 5 years may be required before the exchange rate converges to the equilibrium established by the PPP. Along this line, Rogoff (1996) pointed out that there is a purchasing power parity puzzle due to the contrast between the volatility of short term revealed by the exchange rates and the extreme slowness with which they adjust after shocks.
    For further details, see Giovannetti (1992), Sarno and Taylor (2002) and Arese-Visconti (2002).

    Arese-Visconti G., (2002), "Tassi di Cambio Reale: Teoria ed Evidenza Empirica," Econometrics Working Papers Archive, wp n. 2002/11, Università degli Studi di Firenze, Dipartimento di Statistica "G. Parenti".
    Cassel G., (1922), Money and Foreign Exchange after 1914, Macmillan, London.
    Cassel G., (1928), Post-War Monetary Stabilization, Columbia University Press, New York.
    Cochrane J. (1988), "How Big is the Random Walk in GNP?", Journal of Political Economy, Vol. 96, pp. 893-920.
    Colombo E. and Lossani M. (2003), Economia Monetaria Internazionale, Carocci editore, Roma.
    Frenkel J.A. (1978), "Purchasing Power Parity: Doctrinal Perspectives and Evidence from the 1920s", Journal of International Economics, Vol. 8, pp.169-191.
    Giovannetti G. (1992), "A Survey of Recent Empirical Tests of the Purchasing power parity Hypothesis," BNL Quarterly Review, Vol. 180, pp. 81-101.
    Hakkio C.S. (1984), "A Re-examination of Purchasing Power Parity: a Multi-Country and Multi-Period Study", Journal of International Economics, Vol. 17, pp. 265-277.
    Huizinga J. (1987), "An Empirical Investigation of the Long-Run Behaviour of the Real Exchange Rates," Carnegie-Rochester Conference Series on Public Policy, Vol. 27, pp. 149-214.
    Mark N. (1990), "Real and Nominal Exchange Rates in the Long-Run: An Empirical Investigation," Journal of International Economics, Vol. 28, pp. 115-136.
    Rodrik D., (2008), "The purchasing-power parity doctrine: A reappraisal" Brookings Papers on Economic Activity, Fall 2008, Vol.2, pp. 365-412.
    Rogoff K., (1996), "The purchasing-power parity puzzle" Journal of Economic Literature, Vol 34, pp. 647-668.
    Samuelson P.A. (1964), "Theoretical notes on trade problems", The Review of Economics and Statistics, Vol 46, pp.145-154.
    Sarno L. and Taylor M.P. (2002), The Economics of exchange rate, Cambridge University Press, Cambridge, UK.
    Editor: Lorenzo CARBONARI
    © 2009 ASSONEBB


    Putable bonds are a basic type of bonds that can be sold back by the owner to the issuer before the maturity date at a fixed price. Putable bonds are complex financial assets resulting from the combination of a straight bond and a put option.
    Fabozzi F., Modigliani F., Jones F. (2010), Foundation of Financial Markets and Institutions, Pearson International Edition.
    Editor: Bianca GIANNINI
    © 2010 ASSONEBB

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