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For several decades, innovation has been considered to be a key element of progress, industrial change and competiveness, and its determinants are carefully studied. In this context, the collaborative activities between companies and academia (universities, research institutes, etc.) are one of the most analyzed factors. The main interest in analyzing these collaborative activities lies in the fact that in order to concretize innovation projects companies need knowledge they generate internally or that they adopt from universities or research institutions (Tether, 2002).

The importance of the connection between academia and companies has been fully recognized and documented (for example, Suárez, 2013; De Fuentes and Dutrénit, 2012). The subject has been analyzed from the perspective of the companies and researchers, and it has been seen that collaboration has benefits for both groups, especially for three reasons: 1) a significant proportion of the high level innovations is the result of cooperation agreements (Tether, 2002); 2) the acquisition and assimilation of new knowledge is encouraged (van Rjinsoever, et al., 2008); and 3) the level of human and social capital of researchers increases (Boardman, 2009).

Since there are several reasons to encourage these collaborative activities between universities and businesses, for the past two decades numerous studies have been published that analyze factors such as the characteristics of different types of partners, the channels of knowledge transfer, the characteristics of the connected companies, as well as the advantages and barriers. Figure 1 shows the main factors of the analysis and the authors who have studied them are cited.

Figure 1. Factors of analysis in the collaborative activities between business and academia.

The Collaboration of Companies in Mexico

Every two years, INEGI conducts a survey on Research and Technological Development (ESIDET) for CONACYT. One of the main advantages of this survey is that it collects a large and representative national sample, since 3,124 companies were surveyed in 2006, 2,818 in 2008 and 4,118 in 2010.

The ESIDET has two units of analysis: the company (production sector) and the institution (sectors of higher education, government and non-profit institutions). In this study the company was considered as a unit of analysis and the three data sets corresponding to ESIDET 2006 (2004-2005), ESIDET 2008 (2006-2007) and ESIDET 2010 (2008-2009) were used, for which we have six years of information (2004-2009). In the databases, information was collected on the collaborative activities of academia and business and the data was analyzed with the Excel and Access programs.

Table 1 compares the participants that offer products or services and those that have created processes or methods. It is noted that despite the importance of the connection between the business and academia, companies carry out almost 70% of the innovation activities, without any type of collaboration.

Table 1. Development of products, services, processes and methods.

In general, it is shown that the collaboration between companies is considerably greater (between 12 and 17%) than between companies and research institutes, universities or other institutions of higher education, which is less than 10% in the three periods, for both product and process innovation.

Another important aspect that emerges from the table is that the data is uniform and varies little over time. For example, the percentage of the companies that collaborate with research institutes was less than 10% in 2006 and continued until 2010.

According to the data in Table 1, companies do not entrust the development of their innovation projects to universities or research institutes. That applies both to products or services as well as for processes or methods, since in both cases the percentage is virtually zero, which indicates that companies do not change their strategies of collaboration, since the figures are very similar in all three periods.

The Need for Collaboration

Thus, despite the proven importance of the collaborative activities between academia and business, the index of these activities is extremely low (about 5%, approximately) in Mexico.

Collaboration is important because factors such as the acquisition and assimilation of new knowledge and the increase in the level of human and social capital of researchers and entrepreneurs amply justify the promotion of these activities. It is also important that in Mexico activities recognized as determinants of innovation are encouraged, especially because a good system of innovation is essential for technological change, increased competitiveness and economic growth.

REFERENCES

Boardman, C. (2009), “Government centrality to university-industry interactions: University research centers and the industry involvement of academic researchers.” Research Policy, 38, 1505-1516.

De Fuentes and Dutrénit, G. (2012), “Best channels of academia-industry interaction for long-term benefit.” Research Policy 41:1666-1682.

Numprasertchai, S., Kanchanasanpetch, P., Numprasertchai, H. (2009), “Knowledge creation and innovation capability in the public university.” International Journal of Innovation and Learning 6, 568-580.

Suárez, D. (2013), “Dynamic innovative strategies at the firm level: The case of Argentinean manufacturing sector.” Document presented at the DRUID Academy 2013, in Comwell Rebild Bakker, Rebild, Aalborg, Denmark, 2013.

Tether, B. (2002), “Who co-operates for innovation, and why. An empirical analysis.” Research Policy 31, 947-967.

A frequently asked question is why the vast majority of individuals who have access to the Mexican financial system channel their savings to instruments or short-term vehicles that offer low yield savings options in the long term. Even though the habit of saving money exists, they do not opt for vehicles that allow them to achieve better medium or long-term goals.

To Rudiger Dornbusch, in the modern theory of consumption, income and savings, the latter plays a critical role in the life-cycle hypothesis, as individuals plan their consumption and savings for extended periods, with the intent to distribute their consumption throughout their lifetime. ¹ The life cycle theory links the habits of consumption and savings to demographic considerations, especially the age of the population. Individuals accumulate savings during the working stage of their lives and then, when their ability to earn an income starts to decline, they begin the stage of “dissaving” or “dis-accumulation,” in which they spend more than they earn and have to use their savings.

On the other hand, individuals are impatient and prefer to spend rather than save for the future. Under these conditions, they should set a goal on their desired level of wealth. The economist Christopher Carroll says that the goal or level of wealth is the point at which impatience is balanced with the motivation to save as a precaution. If wealth is below the target, the motivation for precautionary saving will be greater; if wealth is greater than the goal, impatience is stronger and the individual does not save.² Dornbusch also notes that interest rates or the returns on savings play a key role in the so-called substitution effects, from what follows is that as higher interest rates make future consumption more attractive, they end up generating a permanent increase in income and stimulating consumption.³

If we project this to Mexican savers, we see that allocating the available resources to more profitable and efficient vehicles would represent greater well being in the future, although in the present the amounts saved may be less. The endogenous growth theory, incorporating the variable of savings to the neoclassic theory, highlights several opportunities for the growth of physical capital and knowledge. The idea of increasing investment in knowledge is key to linking higher savings rates to higher rates of growth. In this model, savings are intended to increase capital reserves assuming that the population growth is constant and that capital does not depreciate. Therefore, the higher the savings rate, the higher the growth rate of output and per capita income, i.e., the economic welfare of each individual in the economic system.

Voluntary savings of individuals is concentrated in the financial system, mainly in the traditional banking vehicles, with interest rates that do not generate a real interest, that is, that do not exceed the levels of inflation. However, the penetration of investment companies or investment funds has grown significantly in recent years. These products have a high concentration in fixed income funds or very short-term debt with immediate enforceability, to levels that reach 70% of the total investment funds.

Why are these savings in long-term products not more diversified? It does not seem to make sense when compared to the results of having invested in an investment fund that mixes different alternatives between fixed and variable income. However, it is premature to draw this conclusion, as the reasons behind this behavior are very diverse, from the lack of knowledge or financial literacy, to the perception of risks, distrust or the fear of returning to cycles of economic crisis. Although they happened several years ago, these crises remain in people’s memory.  Individuals make their decisions based on available information, and it seems that a big task ahead is the promotion of financial literacy, which is not only the responsibility of the consumer of financial products, but also market participants and the authorities. Among market participants, entities that provide all these services fail to explain clearly and simply the benefits of investment funds in another asset class or long term, demonstrating that they have not deepened the customer’s knowledge. With regard to the authorities, they should direct their efforts to promoting financial literacy campaigns and training schemes of the most basic, which means including these items in the official educational programs.

In recent years, the country has made progress in the convergence of the main macroeconomic factors and it has been found that whoever made long-term decisions obtained returns that were higher than those who opted for traditional products.

In Mexico, the indicators of financial savings measured as a percentage of GDP show a positive evolution, although they are still far from those of similar economies. Compulsory savings channeled to the SIEFORES (Sociedades de Inversión Especializadas para el Retiro) managed by the AFORES (Administradores de Fondos para el Retiro) represents about 14% of GDP, while voluntary savings allocated in investment funds or investment companies amounts to almost 12% of the same indicator.

To understand the phenomenon of savings in inefficient vehicles in real terms and how it contributes to the generation of wealth of households and individuals, let us turn to macroeconomic theory.⁴ The value of financial savings channeled through the Mexican financial system can be defined as the balance between the financial assets and securities in the hands of individuals and of corporations (both residents and foreign) that are intermediated by regulated financial institutions in Mexico in order to be directed through financing to the private sector, the public sector or the external sector. The total financial savings is defined as the sum of the internal and external financial savings. The latter includes those securities issued in Mexico that are in the hands of non-residents, credit from abroad received by the Mexican public and private sectors, and the securities issued by these sectors in external markets.

The Mexican financial system has undergone a series of changes over the past 15 years which, together with the changes in the macroeconomic order, have laid the foundations for generating vehicles and sources of savings that constitute a long-term solid base of funding for the needs of the various sectors of the economy and that improve the welfare conditions of individuals. According to the most recent indicators, the evolution of financial savings has been favorable. This trend highlights the vehicles called SIEFORES, which are a compulsory contribution, and the societies or investment funds, which sell various market entities. The annual compound rate of growth in real terms of these two vehicles is 16% and 15%, so they are the fastest growing instruments in the last decade. In 2000, these vehicles accounted for just 2% of the total financial savings and are now at 14% and 12%, respectively.

While the penetration rate of financial savings to GDP is lower compared with other countries (Brazil, 78%, Chile, 94%), this indicator has increased in recent years. Among the factors that have led to this improvement are macroeconomic, structural and public policy changes, such as the following:

• Macroeconomic convergence

• Convergence toward the inflationary target set by the Bank of Mexico
• Stability of nominal interest rates
• Exchange rate stability

• AFORES (1997)
• Investment companies) (2001)

Macroeconomic convergence is based on three major closely related variables: the level of inflation, interest rates and the exchange rate, which have brought stability to the population. However, on the other hand, this change has been rapid and a large part of the population has not changed their savings habits. In previous decades, especially the 1970s, 1980s and 1990s, most of the individuals involved in the financial system placed their savings in traditional banking vehicles, all very short term, given the economic circumstances of the country. In other words, the same fragility of the system did not allow the opening of a longer-term horizon. However, although the economy stabilized after the crisis of 1994-1995, individuals still allocate their resources in short-term investments with immediate availability or high liquidity.

The structure of interest rates is used as a reference to indicate this radical change in their conditions and levels in the last 10 or 12 years, because in the late 1990s the one-year CETES were the longest fixed rate instrument of the system. In the years following 2000, there was a significant drop in benchmark rates and inflation, which led to an offer of government securities for periods of three, five, ten, twenty and thirty years, which had the effect of widening the market for debt instruments generated by the demand of the nascent private pension system and by the emergence and the widespread growth of voluntary savings through vehicles such as investment funds.

The changes to the Investment Companies Act, approved in 2001, have helped to modernize and adapt these vehicles, which have advantages over other alternatives such as voluntary savings collectors. Thus, we have seen that even new figures emerge in the distribution and services to the saving public. In addition to transparency and clarity, one of the most important changes in the law is the generation of new products (different classes or series of shares in each fund) and the new possibility to acquire other types of securities or assets, as in international markets.

There has been important and profound progress, and the groundwork has been laid so that savings vehicles, other than the traditional banking channels, become part of the alternatives. However, there are pending issues that should be included in the government programs that encourage the development of these long-term instruments so that households and individuals generate wealth in real terms. Among the factors to be considered include the following:

Education and financial diffusion

The benefits should be part of frequent and mass communication programs by the government in its capacity as the regulator of the financial institutions that serve the Mexican market. Participants must assume their responsibility of expanding the coverage of the supply of products according to the needs of the market.  It seems that this offer is directed at only certain segments and certain interests. How many times have we seen an advertising campaign aimed at long-term savings and its benefits?

Long-term tax benefits

A pending task in economic policy is the granting of long-term tax benefits that are clear and with legal certainty.  For example, the solution to the problem of the low tax base of the Mexican economy could be linked to a program that fosters long-term savings.

Footnotes

¹ Rudiger Dornbusch, Stanley Fischer y Richard Startz, Macroeconomía, México, McGraw-Hill, 10a ed., 2009, p. 321.

² Ibíd., p. 329.

³ Ibíd., pp. 78-84.

⁴ Robert J. Barro, Macroeconomics, Hoboken, John Wiley & Sons, 1984, pp. 151-173.

Bibliography

Dornbusch, Rudiger, Stanley Fischer and Richard Startz, Macroeconomía, Mexico, McGraw-Hill, 10a. ed., 2009.

Barro, Robert J., Macroeconomics, Hoboken, John Wiley & Sons, 1984.

“Ahorro financiero y su intermediación en México 2000-2010″, Notas Técnicas de la CNBV (NT/01/2010), Dirección General de Estudios Económicos-CNBV.

“Información estadística del mercado de sociedades de inversión”, Series AMIB (Asociación Mexicana de Intermediarios Bursátiles), consulted at www.amib.com.mx

“Información estadística”, Carpeta de Sociedades de Inversión CNBV-Portafolio de Información, consulted at www.cnbv.gob.mx

Introduction

The imperfections of financial markets, such as taxes, asymmetric information, the risk of bankruptcy, and transaction costs, reduce economic efficiency and thus impair the welfare of society as a whole. Financial derivatives, consisting of forward contracts, futures, swaps and options, have served to increase this economic efficiency in the financial markets by allowing, among others, a better management of financial risks, as well as structuring a relationship between risk and return that is more appropriate to the idiosyncratic needs of each participant, both in investment and in financing.

This article focuses on finance options and examples of how the authorities of the sector have justified a greater regulation of derivatives. Examples are specifically related to the fall of the New York Stock Exchange (NYSE) on October 19, 1987, an event known as “Black Monday.” The regulators ended up blaming mainly the derivatives market of Chicago and not the New York Stock Exchange, when it was actually Wall Street itself that prompted it. On that date alone, the New York stock market fell 508 points, which corresponded to a drop of 23%, the maximum that had ever been recorded in a single day of operations.

Although there are different reasons why an investor might use financial derivatives and, in our particular case, options, The Economist classifies them in five groups: 1) manage risks to reduce or eliminate some, but not others; 2) reduce or eliminate the risk of an asset losing value; 3) take advantage of possibilities for arbitrage, to profit without the associated risk; 4) obtain additional income through the sale (short position) of a put option, taking advantage of an investment (long position) in the underlying asset; and 5) take a leveraged speculation, i.e., try to magnify a gain, for example, to speculate on the appreciation of a common stock or a stock index, by taking a long position in a call option on any such stock or index, paying therefore only the option premium, rather than directly buying stock or the portfolio of stocks that would replicate that index in the stock market, paying the full value of each.

It is important to highlight this fifth and last reason, because it does not exonerate the derivatives market for the fall of October 1987, which became the mechanism that increased losses on the New York Stock Exchange through what is known as “portfolio insurance.”

Basis for the Regulation of Financial Markets

George Stigler, a professor at the University of Chicago and Nobel Prize winner in Economics in 1982, proposed in The Theory of Economic Regulation, of 1971, which is considered a pillar of the modern theory of regulation, that there be a change in the focus of regulation, from a normative economy to a positive economy. Thus, this has involved not focusing regulation on the search for possible causes of failure of markets, such as monopolies, externalities and asymmetric information, but finding the recipients of the benefits and the recipients of the costs generated by a regulation of the markets. Stigler explained that the regulation comes from the very industry it regulates and its purpose is to benefit some industry participants.

Merton Miller, a professor at the University of Chicago and Nobel Prize winner in Economics in 1990, noted that, unlike other areas of economics, finance has not focused the key issues from a public policy perspective, so it has stressed positive economics rather than normative economics and, therefore, the field of market regulation. Professor Miller also has postulated that it is possible that the regulatory agencies are dedicated to very different objectives than those that they claim to serve.

The foregoing has been shown repeatedly in recent times, when it was revealed that some of the key players in the regulatory entities in the United States came from Wall Street, and even more, once they concluded their professional activities in the public sector, they returned to Wall Street (with seven figure salaries, professional fees and performance bonuses). The name “revolving doors” has been applied to this collusion between regulators and the entities they regulate. This conflict of interest was also evidenced, for example, in Charles Ferguson’s documentary, Inside Job (2010).

Effects of Black Monday

Merton Miller wrote in “The 1987 Crash Five Years Later: What Have We Learned” that when recalling Black Monday, the fall of the stock market is usually specifically highlighted, without mentioning other financial instruments which are also listed in the Chicago Board of Trade (CBOT), such as the 30-year United States Treasury Bond in the futures market, an instrument that did not fall but, on the contrary, rose in value at the time. An even greater increase in the price of debt instruments occurred that day in the London market.

In the debt market, said phenomenon originated when investors tried desperately to get rid of their common stock to buy securities that offered greater security. Given this scenario, the net drop of value during Black Monday was much smaller than what public opinion thought. Something similar happened with other investment alternatives, such as real estate, which did not suffer negative consequences on that day.

Another of Miller’s arguments – corroborated by the research of Richard Roll of the University of California, Los Angeles, and showing the little understanding of what really happened on Black Monday – is that the crisis in the financial markets that was triggered in the NYSE, actually started that day, October 19, in Asia, with a significant drop in the stock market in the region, which spread to Europe, in particular to the United Kingdom, before the NYSE opened.

When this commotion that originated in Asia finally came to the United States, it happened simultaneously in the derivatives market of Chicago (CBOT) and the New York stock market. What is relevant is that the effects on the prices of financial instruments in both locations were asymmetric, because the CBOT and the NYSE had different microstructures: What is called “discovery” of prices in financial markets was much more efficient in the CBOT than in the NYSE. Thus, the price decline was greater in the Chicago market than in the New York market, where the continuous fall occurred with a delay.

The cause of this inefficiency in the price-discovery process on the NYSE is that this market has traditionally followed the objective of giving continuity to prices through participants known as “specialists,” who have had the power not only to stop operations once the auction floor bidding has already started, but also to delay the opening of operations while trying to obtain an opposite operation to reduce or cancel the initial exposure. However, since it was essential for the NYSE to report a price that Monday, as it did on any other day of operations, the last reported prices had to be those of Friday, October 16, which were higher than those on the following Monday.

The microstructure of the derivatives market of Chicago allowed the presentation, almost instantly, of the marginal price, i.e., the most recent price, while the NYSE, as a result of the powers of its specialists, smoothed out the common stock prices using moving averages that did not reflect the true fall.

At the moment when operations finally had to start that Monday, the delay in the opening of the NYSE caused a differential to appear with respect to the prices of Chicago, estimated at 7%, between the lower prices given by the CBOT futures market (price of 262) and the higher distorted prices  of the S&P-500 index of the NYSE (price of 282). This differential was particularly unusual, given that normally the futures price is above that NYSE index.

In addition, the reduction in the differential and the convergence of prices between the two markets tends to occur rapidly, but that October 19 it took about an hour and a half, and to complicate matters, the convergence was short-lived, as the representative prices of both markets distanced themselves again,  closing that afternoon on the NYSE with a record differential of 10% with respect to the CBOT. The reason was that the market for each of the common stocks that make up the S&P-500 index opened at a different time, so that its downward adjustment was gradual.

Allan W. Kleidon, then a professor at Stanford University, as well as other colleagues, showed that the fall of the NYSE was not caused ultimately by the derivatives market of Chicago, but by major shortcomings in the mechanisms and internal infrastructure that were operating in the NYSE. Since 1983, the NYSE was in the process of radically changing its infrastructure to an electronic registration system for buy and sell orders, called SUPERDOT (Super Designated Order Turnaround System), which was intended to replace the traditional system of paper ballots and phone calls.

However, in October 1987, the SUPERDOT was not yet functioning fully. Only market orders were operating, but not the limit orders, of which 80% still used paper ballots and phone calls. Therefore, the entry and removal of limit orders in the system was slow, produced bottlenecks and gave the misleading impression that the operations stuck in the system were not closed yet, but in fact many of those were already closed.

These different microstructures caused the erroneous perception that the commotion had started in the futures market of Chicago and spread to New York, where it brought down the prices. This unfortunate erroneous explanation was the mainstay of the Brady Commission, which was responsible for studying the fall in equity markets, to justify greater regulation of the derivatives market of Chicago.

Portfolio Insurance

Another angle of the justification given to strengthen the supervision of the U.S. regulatory authorities on the derivatives markets in Chicago, rather than concentrating it on the stock market of New York, is based on “portfolio insurance.”

Portfolio insurance used by the institutional investors and fund managers is a technique created by Hayne Leland, a professor at the University of California, Berkeley. It consists of creating a long position in a put option. This position is justified in that if the value of a common stock portfolio begins to decline as a result of a fall in the corresponding stock market, a financial instrument is required that increases its value with the fall, to compensate for the loss of value of the portfolio. On the other hand, if the price of the common stock begins to rise, unlimited earnings are sought by not limiting the portfolio earnings, except by a cost derived from the payment of the premium of the financial option. However, in 1987, there was no market of financial options on common stocks large enough to satisfy that requirement; in addition, the cost of the hedging instrument was very expensive.

In 1976, Leland had shown the financial markets how the long position of a put option on a common stock could by reproduced by the cloning of the option. This concept was applied in 1973 by Fisher Black and Myron Scholes, who published the formula for valuing options in the Journal of Political Economy. Coincidentally, a month before publication, the CBOT launched the first market of financial options, the Chicago Board Options Exchange.

To create this synthetic put option , the underlying asset is sold, in this case the common stock, and simultaneously, risk-free financial instruments are purchased, i.e., instruments of the U.S. Treasury. This pattern is repeated until the value of the synthetic option is equal to the value of the correspondingput option available in the market.

A serious problem with this strategy is that if the prices of the common shares in the secondary market (in this case, the NYSE) continue to fall, the value of a true put option automatically increases. The explication is that the option used as insurance is a clone of the true opotion available in the financial options market, so that if the price of the common shares fell, fund managers would have to artificially increase the value of the synthetic option. To meet this objective, more common shares are sold, and with the monetary resources thus obtained (long position), more instruments of the Treasury are purchased. It is obvious that this activity of the managers of large investment funds, such as the pension funds, created a vicious circle that magnified the fall of the NYSE. This was the main argument used by authorities of the financial system to justify increased regulation of the derivatives market.

It is fair to point out that the fall of the NYSE was facilitated by some of its major participants; what the incorporation of the portfolio insurance did was magnify the fall. The characteristic model of portfolio insurance postulated at that time that in response to a drop of 10% in the market of the underlying asset, i.e., of the price of the Standard and Poor’s 500 Index, 20 % of the shares of a supposedly secure investment portfolio had to be sold. The trading floor of the NYSE opened that Monday, October 19, with this strategy and since everything indicated that the market had already fallen 10%, it was urgent then to immediately sell 12 billion dollars in shares, as the total value of the market was 60 billion.

For portfolio insurance to work, the change of prices must be continuous, which means that the stock market must be very liquid at all times. However, since all the participants in the market who had secured their investment needed to sell their common shares, but the participants who had not implemented the insurance were reluctant to buy shares because of the uncertainty of those times, the New York Stock Exchange turned illiquid and, therefore,  portfolio insurance ceased to function as a protective strategy.

In addition, except in the extreme conditions of a globalized economic crisis caused by systemic risk, the losses of some participants are the gains of others, as in financial markets the concept of a zero-sum game also applies. Thus, not only in financial derivatives, but in general, the heavy losses perceived as financial disasters¹ have beenactually a simple transfer of wealth from some participants to others, with no damage or with minimal damage to society as a whole. In addition, financial derivatives are not always the cause of these problems, but they are also a consequence of failures in the controls established by the organizations that use them, in conflicts of interest, in lack of judgment and knowledge of some participants, as well as simple frauds.

Conclusion

Managing risks does not mean eliminating them. It is a question of separating the varied economic risks that affect businesses and governments, selecting those that these entities are willing to take and minimizing or eliminating the impact of the risks they do not want and that another entity is willing to absorb.

Many analysts have drawn a parallelism between the crises of the NYSE in 1987 and in 1929. This assessment is incorrect, because although in both cases there was great volatility, the 1929 crisis brought on the collapse of the banking system in particular and the economy in general, and it took several years for the markets to recover. The 1987 crash did not have these negative effects.

It is a difficult task to regulate financial markets because, among other reasons, they offer a participant the possibility of making huge monetary gains in a short period. Therefore, these markets attract the most prepared, brilliant and creative minds.

Unlike public opinion and participants in the financial markets, experts from universities and especially prestigious economists and Nobel Prize winners, agree that financial derivatives have not led to greater volatility and uncertainty in financial markets; rather quite the opposite. They have made the markets safer by allowing them to reduce and control both financial and business risks.

Recent history has shown that self-regulation of the financial markets is not the solution to the crises that have occurred in these areas. However, a lot of regulation has not been beneficial either, especially if the real cause of the problem is not tackled.

Footnotes
¹ Like those of Lincoln Savings and Loan (1991), Metallgesellschaft (1993), Orange County (1994), Procter and Gamble (1994), Barings (1995), Gibson Greetings (1995), Eastman Kodak (1995), Salomon Brothers (1995), Daiwa (1995), Sumitomo (1996), The Government of Thailand (1997), Long Term Capital Management (1998), Enron (2001), Tyco (2002), QWest (2002), WorldCom (2002) and Bear Sterns (2008).

References

Miller, Merton H., Merton Miller on Derivatives, John Wiley & Sons, 1997.

Bernstein, Peter L., Capital Ideas: The Improbable Origins of Modern Wall Street, The Free Press, 1992.

Hull, John C.; Options, Futures and Other Derivatives, Pearson, 9th. Ed., 2015.

Siems, Thomas F., Policy Analysis: 10 Myths about Financial Derivatives, Federal Reserve Bank of Dallas, September 11, 1997.

The Financial Economists Roundtable, “Statement on Derivatives Markets and Financial Risk,” Journal of Applied Corporate Finance; Vol. 7, No. 3.

Froot, Kenneth A., Scharfstein, David S., Stein, Jeremy C., “A Framework for Risk Management,” Harvard Business Review, November-December 1994

Shireff, David, Dealing with Financial Risk;  The Economist Newspaper, Ltd. and Bloomberg Press; 2004

Levinson, Marc, Guide to Financial Markets, The Economist Newspaper and Bloomberg Press, 3rd. Ed., 2003.

Roberts, Richard, Wall Street: The Markets, Mechanisms and Players, The Economist Newspaper, 2002.

“Of Butterflies and Condors,” The Economist: Schools Brief; Economics: Ten Modern Classics, November 1990 to March 1991.

Ghosh, Dilip K. and Khaksari Shariar (comps.), The 1987 Crash Five Years Later: What Have We Learned?, New Directions in Finance, Rutledge; 1995.

Roll, Richard W., “The international crash of October 1987,” in Robert W. Kamphuis Jr., Roger C. Kormendi, J. W. Henry Watson (comps.); Black Monday and the Future of Financial Markets, 1989.

Kleidon, Allan W., “Arbitrage, Nontrading and Stale Prices: October 1987,”  Journal of Business 65, 4, October 1992.

“Cracking the Derivatives Case,” Fortune, March 20, 1995.

ITAM

In recent years, private equity (PE) funds have grown exponentially. According to the Mexican Association of Private Capital (AMEXCAP, for its acronym in Spanish), by the end of 2015 there were more than 140 funds in Mexico, with cumulative capital commitments since the year 2000 of more than 29 billion dollars. The sector has doubled in the past seven years, but it is still incipient, as it represents less than 0.1% of GDP, below countries like Chile, Colombia and Peru. In the United States, this figure is close to 1.3%, according to the Emerging Markets Private Equity Association.

According to numbers of AMEXCAP 43% of capital commitments have been invested in real estate funds, 35% in private equity funds, 15% in infrastructure funds. The remainder corresponds to venture capital funds and funds that invest in other funds. Part of this exponential growth is explained by the fact that since 2007, following a change in regulation, pension funds (known as AFORES in Mexico) can invest in private equity funds through dedicated instruments called development capital certificates (CKDs), and public real estate trusts (FIBRAS).

One restriction of the CKD is that 100% of the resources allocated must be invested in Mexico, which significantly reduces the number of private equity funds in which an AFORE can invest and increases the risk by having all private equity investment in Mexico. Most of the resources invested in private equity funds in Mexico come from foreign investors. This is because some of the funds are international and because there are local funds that have foreign investors.

At the end of July 2016, the AFORES had allocated more than 155 billion pesos to CKDs and FIBRAS (5.5% of the total resources managed). However, the growth potential is still high, as the pension funds can invest between 25% and 30% of the total resources in CKDs and FIBRAS (except the less risky pension funds, which may invest only 5% in FIBRAS). Because of the need of long term investment vehicles, the demand for this type of instruments by the AFORES is very high. Out of the total amount issued by more than 55 CKDs, the AFORES own over 80%. The AFORES are willing to invest more but supply is still limited.

Since the end of 2015, AFORES can also invest in private equity funds through a new instrument, known as Project Investment Certificates (CERPI, for its acronym in Spanish). The instrument is similar to limited liability companies LLCs that is the vehicle used by investors in the United States, Canada and some European countries to invest in private equity funds. The main difference is that in the CERPI the technical committee formed by investors is not required to approve the investments, since this power rests within the investment committee of the private equity fund, which is normally formed by the partners of the fund and their investment team.

PE funds are managed by a team of professionals who, thanks to their career and reputation, obtain resources from institutional investors, such as insurance companies, pension funds, foundations, sovereign funds, ultra-high-net-worth individuals, family offices, banks and other financial institutions.

In general, the intention of a PE fund is to invest and then improve the company during five years. After that they will try to sell it and get an internal rate of return between 25% and 30%, and a multiple over invested capital above 2.5 times. The fund may sell the company to a strategic investor (competitors, suppliers, etc.), to a financial investor (private equity funds, family offices, etc.) or to the public via an initial public offering (IPO).

The private equity industry can be divided according to the type of company in which the fund will invest.

1. Venture capital funds. They try to invest in recently created companies (startups). These companies have a high growth and high risk profile. Depending on the stage of development in which a company is, this sector can be subdivided into the following:

• Seed capital. They invest in an idea or project. Normally these companies have recently been incorporated and do not have a proven business model. Their income is very small or non-existent. Angel investors and online crowdfunding platforms are in this segment. The amount of the investment may be up to 500,000 dollars.
• First round or Series A. The amount of the investment is between 500,000 and two million dollars. In general, resources obtained are used to cover the operating costs of the next six to 24 months.
• Second round or Series B. The amount of the investment is between two and five million dollars. The objective is to obtain the resources to consolidate and grow a company. At this stage, the companies have already reached breakeven.
• Growth capital. This is the last level of venture capital. The investment amounts exceed five million dollars. The goal is to grow companies and improve their profitability.

2. Private equity funds. They invest in mature companies that are already established. The funds of this segment are classified in accordance with the investment strategy.

• Leveraged buyouts (LBO). A high percentage of debt is used to finance the acquisition granting the shares of the company and its assets as collateral. The idea is that for a period of between five and seven years the company grows and pays down the debt with the cash flow generated by the operation.
• Expansion capital. It is invested in companies that require resources to continue growing rapidly, either through acquisitions of other companies, with new products or in other markets.
• Distressed. It invests in companies that are going through a difficult time. Normally they carry out a financial and operational restructuring to avoid bankruptcy.

3. Real estate funds. Financing of real estate projects.

4. Infrastructure. Financing of projects such as power plants, roads, water, telecommunication, etc.

Private equity and venture capital funds help companies in which they invest to strengthen their competitive advantages by making the most of their financial, operational or institutional opportunities. Generally, the companies in which they invest benefit from better corporate governance, financial and operational analysis, accelerated value creation and improved decision-making.

In conclusion, the objective of PE funds is to create value in the companies in which they invest in order to generate attractive returns for their investors. This brings significant benefits to entrepreneurs, society and the government because it favors growth in companies, creates job opportunities, boosts the economy and by professionalizing and institutionalizing the companies it makes payment of taxes transparent, and strengthens the enforcement of labor, environmental and social responsibility standards.

References

AMEXCAP (2015). Capital privado y emprendedor. México, RiskMathics.

EY (2015). Estudio sobre la industria de capital emprendedor en México.

KPMG (2015). El impacto del capital privado para las empresas en México. 17 casos de éxito.

Introduction

In many countries, leasing has been one of the most important financing options that companies frequently use. The explanation is that in this way companies have a factory and equipment without incurring cash flows that might affect them; they do not have to carry out bureaucratic procedures for authorizing purchases that delay the acquisition of assets; and they can renovate assets that are subject to rapid technological changes and obsolescence more quickly and efficiently, in order to have state-of-the-art technology. In addition to these operational incentives, the current International Accounting Standard (IAS) 17 “Leases” model has meant that in many cases lease contracts are not reflected in the assets and liabilities on the lessee’s statement of financial position, i.e., they are “off balance.” This has a positive effect on key financial ratios to assess the risk of the company, such as debt, leverage and performance on total assets, which can be very important when the company has a contractual commitment to maintain certain financial ratios.

With this background and for greater clarity and transparency, the International Accounting Standards Board (IASB)¹ issued on January 13, 2016, the new IFRS 16 “Leases,” which will replace, beginning 2019, the IAS 17 standard used for almost 40 years.

This article briefly discusses the antecedents of the change from the current IAS 17 to the new IFRS 16. It explains what the new model of the IFRS 16 consists of and indicates the main changes and effects for lessees and lessors.

Antecedents

Although the need for reform in lease accounting has been discussed for some time, the detonator to launch it occurred in 2005, when the Securities and Exchange Commission (SEC)² reported that public companies in the United States would have approximately 1.25 billion dollars in payment commitments for off-balance sheet leases, which were not reflected in the assets and liabilities of these companies (IASB, 2016 (b)).

These off-balance sheet leases are accounted for in a manner similar to an income expense, so that investors and analysts cannot compare the financial information of companies that borrowed to buy assets with that of companies that lease them, and to make them comparable they have to make adjustments and estimates (according to common practices of investors).

Because of this lack of transparency, the IASB and the Financial Accounting Standards Board (FASB)³ launched a joint project to improve lease accounting and concluded that, despite the fact that with the signing of a lease, an asset (right to use of the good) and a liability (for the obligation of future payments) are generated automatically in the majority of the contracts, this asset and this liability were not reflected in the statement of the financial position, even though they were disclosed in the notes. This conclusion was the guide for developing the new accounting model for leases, under which the lessees must handle the accounting in the same way as almost all their lease contracts, with the goal that the leases that fall off balance are the exception (Morales, 2016).

The IASB report found that according to the annual reports of 2014, out of a sample of 30,000 public companies that used IFRS or US GAAP, more than 14,000 revealed 2.9 billion dollars in payment commitments for leases that were not reflected in the statements of financial position (IASB, 2016 (c)). This figure shows the growth of the off-balance sheet leases with respect to the figures published by the SEC in 2005.

Although the new IFRS 16 emerged from a collaborative project between the IASB and the FASB, the FASB standard has its differences with the IFRS 16 (which fall outside the scope of this article).

The new IFRS 16 “Leases” will be effective for annual periods beginning on or after January 1, 2019. Earlier application is permitted only if the company also applies in advance the IFRS 15 “Income from Contracts with Clients.”

New Model of IFRS 16

With IFRS 16, the “right of use” model emerges, which replaces the “risks and rewards” model of IAS 17 (PWC, 2016).

With IAS 17, leases should be classified into one of two categories: finance or operating leases. Finance leases are those in which the lessor has transferred substantially all the risks and rewards of ownership (of the asset) to the lessee, which in essence is assimilated to a financed purchase. All other leases are classified as operating leases and the lessor remains the economic owner of the property. Only those classified as finance leases are accounted for and are reflected in the assets and liabilities of the statement of financial position. In contrast, in the new IFRS 16 there are no finance or operating lease classifications and all (with some exceptions, such as short-term leases or “low value” property)⁴ must appear in the statement of financial position, and not only those with IAS 17 are considered finance leases.

A key point of IFRS 16 is the identification of a lease in order to register it accountable as such. For a contract to be considered as a lease it is now based on a right of use model. The standard defines a lease as a contract, or part of a contract, which gives the client the right to control the use of an identifiable⁵ asset during the period of use, which is the total time that an asset is used to fulfill a contract with the client, including any non-consecutive period. It is understood that the client controls the use of an identified asset, if throughout the period of use he/she has the right to the following: 1) obtain substantially all of the economic benefits from the use of the identified asset, and 2) direct the use of the identified asset (how and for what purposes it is used). All contracts that meet this definition are considered leases and shall be registered in accordance with the new IFRS 16. Although in the majority of cases it is easy to establish whether a contract contains a lease or not, there are complex situations in which it is necessary to exercise value judgments; for example when both the client and the supplier (the entity that provides goods or services covered by a contract) make decisions with regard to the use of an identified asset or when the supplier has the substantive right to replace the asset during the period of use.⁶

Lessees must initially register a right of use of the asset and a liability for lease, based on the present value of the future payments of the lease and the term of the lease estimated in accordance with the new standard. IFRS 16 defines the term “lease” as “the non-cancellable period for which the lessee has the right to use the asset in question, including optional periods, when the entity is reasonably certain to exercise the option to extend (or not terminate) the lease.” To do this, “the lessor must consider all relevant information and circumstances that may create economic incentives to exercise the option” (PWC, 2016).

IFRS 16 does not apply to contracts for services, so there is no need to settle them in the statement of financial position. If a contract includes leasing and services, they must be separated; but if it is decided to leave them together for practical reasons, everything is capitalized, i.e., it is recorded in its entirety as a lease contract.

Main Changes and Effects for Lessees and Lessors

Lessee

• They must recognize, in all leases, a new leased asset (which represents the right of use of it during the term of the lease) and a lease liability (representing the obligation for future payments), recorded in a similar way to the financial leasing of IAS 17.
• Changes are expected in the financial statements of the lessee as follows:
  • Statement of financial position: The main effect is to increase the assets and liabilities of the lessee. No significant changes to the equity of most companies are expected.
  • Income Statement: It changes the nature of the expenses associated with leasing, replacing the operating expenses by straight line rent , for operating expenses by depreciation and financial expenses, expecting that the latter are increasingly less over the life of the contract. Although it is expected that the total effect on the profits or losses of many companies may not be significant, a higher EBITDA⁷ and increased income from operations can be anticipated. The magnitude of the increase in the income from operations and financing costs will depend on the importance of leases for the company, the length of leases and the discount rate applied (PWC, 2016).
  • Cash Flow Statement: Although there is not expected to be any impact on the total amount of cash flows transferred in the lease (IASB, 2016 (b)), there will be changes in the presentation of the lease payments (principal and interest), to be reported with IFRS 16 within the section of finance activities, instead of the operating activities section. This must be considered in the analysis and interpretation of the net flows from operation and financing.

• Performance metrics and key financial ratios of the lessee are expected to change, including: leverage (increases), asset turnover (decreases), current ratio (decreases), EBITDA, interest coverage (depends), net profit or net loss (depends), earnings per share(depends), return on equity (depends) and net cash flow from operation (increases) (IASB, 2016 (b)).

• In general, it is expected that the companies most affected will be those that lease high-value assets, such as houses, apartments, machinery, aircraft, trains, ships and technology. For companies that lease assets of low value, such as telephones, office furniture, personal computers, etc., the impact is expected to be less, because as we saw, in accordance with IAS 16 (as an exception), they need not be recognized in the assets and liabilities of the statement of financial position.

• Although the new standard will affect virtually all companies that lease assets, it is expected that the impact will vary significantly by industry, by region and even among companies. The industries that are expected to be the most affected are the airlines, shops, travel and leisure, and transportation. The regions with more companies identified with off-balance sheet information and where the greatest impact is expected are in North America and Europe, followed by Asia Pacific, Latin America, and Africa and the Middle East (IASB, 2016 (b)).

• Another impact for the lessee is the cost of implementation and maintenance that will be incurred for having an information system of their leases that will enable compliance with the new standard. Among the costs of implementation are the following: 1) the establishment of systems and processes; 2) the determination of discount rates applied in the valuation of the lease obligation; and 3) communication and education (all market participants must understand the reasons for the change and its effects). The implementation costs for the company will depend on the size of its lease portfolio, the terms and conditions of its leases, and the accounting systems they have for the leases (IASB, 2016 (b)).

Lessors

• Their accounts will remain unchanged for the most part. Their leases will continue to be classified as finance and operating, based on the transfer of substantially all the risks and rewards of ownership of the underlying asset, and they will be recorded in much the same way as they done now with IAS 17.
• Some additional disclosures will be imposed, including the separate statement of assets subject to operating leases and how to manage the exposure to risk of residual value.
• It is expected that adjustments will be made for the changes in the needs and behavior of their clients, as the new standard will have an effect on their business model and on the leased products (PWC, 2016).
• It is very likely that existing and future leases will have to be renegotiated or restructured, and their legal structures and support reassessed to see whether they remain effective (PWC, 2016).

Conclusion

The statement by IASB president Hans Hoogervorst, that “the new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligations” (IASB, 2016 (a)), expresses the essence of the change.

Although the new IFRS 16 will not be effective until January 1, 2019, the sooner the investors and managers understand and assimilate the impact that this standard will have on their company and its business model, the more prepared they will be to deal with the change and lower the cost of implementation.

It is expected that the fact that now the lessees will have to present virtually all leases in the statement of financial position translates into benefits for creditors and investors by having greater clarity and disclosure of the lease commitments of the organization and a better assessment of the risk. However, the implementation of the new standard will not be easy, and the entire business community must be educated and become aware of the reasons for the change and its main effects.

FOOTNOTES
¹ Issuing body of the International Financial Reporting Standards (IFRS)
² Regulatory body for the securities markets in the United States
³ Issuing body of financial regulations in the United States
⁴ Short term means 12 months or less. Assets are set as “low value” assets with a máximum value of $5,000 dollars or less when new (IASB, 2016 (b)). The concept of low value does not depend on the volume of assets; for example, tablets, personal computers, small pieces of furniture, office equipment, telephones and others.
⁵ An identifiable asset can be a specific part of a larger asset; for example, a floor or a comercial establishment of a building.
⁶ As a general rule, in accordance with the IFRS 16, if the client cannot easily determine whether the supplier has a replacement of substantive rights, it must be assumed that he/she does not have it. (IASB, 2016 (b)).
⁷Earnings before interest, taxes and depreciation.

REFERENCES

EY, 2016, “IFRS Developments Issue 117 (January 2016) IASB issues new leases standard,” consulted on June 15, 2016 at .

IASB, 2016 (a), “IASB shines light on leases by bringing them onto the balance sheet,” consulted on June 15, 2016, at .

IASB, 2016 (b), “IFRS 16 Leases. Effects analysis,” consulted on June 15, 2016, at .

IASB, 2016 (c). “IFRS 16 Leases. Project summary and feedback statement,” consulted on June 15, 2016, at .

Morales Díaz, José (2016). “La nueva revolución en la contabilidad de los arrendamientos. Efectos contables y económicos,” consulted on June 10, 2016, at .

PwC, 2016, “IFRS 16: The leases standard is changing. Are you ready?” consulted on June 10, 2016, at .

Changes in the labor market as a result of phenomena such as the globalization of the economy and technological advances have become more turbulent and competitive. To cope with these changes, which are increasingly more rapid, companies have chosen to adopt models of flexibility, in which the horizontal mobility and multitasking of workers have been gaining ground.

Given this panorama, one may wonder what the appropriate parameters for the full development of professionals are since traditional notions of a job for life and vertical career advancement have lost their meaning. In this context, the concept of employability has special relevance in order to respond to the functional flexibility that organizations adopt to thrive in a working environment full of insecurities and unexpected events.

What is Employability?

Traditionally, the term “employability” has been defined as the degree to which a person has opportunities to get or keep a job or to improve what he/she has (Gamboa, Gracia, Ripoll and Peiró, 2009). However, today the term is related to the promotion of attributes, skills or competencies. Thus, some authors define employability as “a form of work specific active adaptability that enables workers to identify and realize career opportunities” (Fugate, Kinicky and Ashforth, 2004) or “the continuous fulfilling, acquiring or creating of work through the optimal use of competencies” (Van der Heijde and Van der Heijden, 2006).

According to Van der Heijde and Van der Heijden (2006), the following four generic competences are important distinguishing components of people’s employability: 1) anticipation and optimization, i.e., they have the ability to prepare for and adapt to future changes in a personal and creative manner, striving for the best possible results; 2) personal flexibility to adapt easily to the changes in the internal and external labor market; 3) corporate sense, i.e., the ability to participate and perform in different work groups (such as entire organizations, work teams, occupational communities and other networks); and 4) balance between the sometimes opposing employers’ and employees’ interests.

The concept of employability comprises two ideas: internal and external employability. The first refers to the competitiveness of a worker who is already part of the company and is based on the skills that he/she should learn within the company. External employability focuses on the competitiveness of the person in the labor market and highlights their skills in the environment of the company, as required by the demands of the labor market.

The increase in internal employability offers advantages for individuals and for the entire organization. At the individual level, people who feel more employable are more satisfied and motivated by their work, which makes them more productive and innovative in their position and in the organization (Fugate, Kinicky and Ashforth, 2004; Gamboa et al., 2009). At the organizational level, to have competitive, motivated workers who have a highly solicited profile in the labor market improves competitiveness, productivity and the sustainability of the organization over time (Van der Heijde and Van der Heijden, 2006).

Employability and Human Resources Management

As we saw, due to the rapidly changing labor market, organizations tend to be more flexible and look for people who have key and transferable skills, and who can adapt and perform in a flexible context. Therefore, although the term “employability” is used infrequently in organizations, it is becoming increasingly important because of its relation to areas of human resources such as the development of skills, learning, commitment, psychological contract or identity, among others.

The current processes of socialization and training in organizations face discrepancies between the skills that people have and the changing needs of the market. Human resources policies designed to enhance the employability of workers focus on improving and maintaining the competitiveness of companies through recruitment strategies, selection and training of personnel.

In connection with recruitment, currently there is a “war for talent” in which a distinction is made between persons of high and low employability. Those with greater employability, in addition to having the basic skills and knowledge to perform the work, are more visible in the labor market. This is because they perceive the turbulent work contexts as opportunities and they are highly valued by employers and human resources managers. In addition, the recruitment of the best talent there is in the environment gives the organization greater possibilities of growth, as it makes their internal processes very competitive.

When selecting personnel, those who can provide strength to the business project are singled out. From the point of view of employability, the selection begins by determining the labor experience and the responsibilities in previous job positions using the following quantifiable elements: 1) technical skills necessary for independent problem solving; 2) ability to perform tasks effectively; 3) general and social skills (anticipation, flexibility, corporate sense, balance, teamwork, initiative, decision, among others); and 4) clear and consistent career identity throughout the working life.

Another important aspect of human resources is training. In the current context, lifelong learning is essential for organizations. However, the training of workers is often based on technical training that is not conducive to their full professional development. In some cases, businesses fail in continuous training, which gives rise to problems of knowledge obsolescence. Therefore, it is important to promote the internal employability of the company by adjusting training efforts and developing more competitive management strategies. The training of workers focused on employability is associated with learning skills that are relational, strategic and metacognitive, rather than the possession of specific knowledge. It is providing people skills that are transferable and consistent with the strategies of the company. Many of these skills are based on effective communication and awareness of the sector, as well as on aspects inherent to the person, such as assertion, confidence and motivation (Van Der Heijden, 2002).

Apart from these aspects, there are still others related to human resources that should also be taken into account to enhance the employability of employees. The promotion of a culture of strengthening the capacity of organizational learning on the part of human resources will facilitate the employability of workers, as well as a transformational and constructive leadership style, in which supervisors provide the resources and necessary support (Van der Heijden, and Bakker, 2011). Similarly, the design of jobs with tasks with a high learning value will also promote the employability of workers, as these complex tasks promote learning and encourage initiative, determination and creativity, and improve self esteem (Van der Heijden, and Bakker, 2011)

In conclusion, the concept of employability in human resources has implications in the recognition of workers as their own managers to cope with the rapid changes that occur in organizations, taking into account the opportunities for growth. It is important that these individualized processes are based on participatory management, personal development and adaptability to increase the competitiveness of the employees.

References

Fugate, M., Kinicki, A.J. and Ashforth, B.E. (2004). Employability: A psycho-social construct, its dimensions, and applications. Journal of Vocational Behavior, 65, 14-38.

Gamboa, J.P., Gracia, F., Ripoll, P. and Peiró J.M. (2009). Employability and personal initiative as antecedents of job satisfaction. The Spanish Journal of Psychology, 12, 632-640.

Van der Heijde, C.M. and Van der Heijden, B. (2006). A competence-based and multi-dimensional operationalization and measurement of employability. Human Resources Management, 45, 449-476.

Van der Heijden, B. and Bakker, A. (2011). Toward a mediation model of employability enhancement: A study of employee-supervisor pairs in the building sector. The Career of Development Quarterly, 59(3), 232-248.

Van der Heijden, B. (2002). Pre-requisites to guarantee life-long employability. Personnel Review, 31(1), 44-61.

June 23, 2016, is considered to be a historic day. Citizens of the United Kingdom voted to leave the European Union, which has led to a series of analysis with respect to what will happen in the trade bloc and in the United Kingdom. This article examines the effect on trade, migration, regulation and tax contributions, which has an impact on the markets (products, labor relations and capital) and on the economy (production and productivity, jobs and public finances).

Introduction

Exports from the United Kingdom to the European Union accounted for approximately 55% of its total exports in 1999, but this percentage decreased to 45% in 2014. The United Kingdom receives approximately one tenth of the exports from the European Union. In addition, the United Kingdom is the fifth largest economy in the world and continues to benefit from a significant foreign direct investment which, as it is long-term, is unlikely to fall immediately.

The free movement of labor in the European Union led to a greater net migration to the United Kingdom than to other states of the EU in the last decade. In 40 years, the UK has experienced a significant increase in its population, about 15%, distributed in 40% by population growth, 40% by migration from outside Europe and 20% by migration from the European Union. Thus, according to the laws of free movement of the European Union, migration has represented an increase in the UK population of approximately 3% since 1973.

Being a member of the European Union has had very different effects on the structure and the magnitude of the regulations in the United Kingdom by means of legislative instruments.

From 2010 to 2015, the average gross contribution of the United Kingdom to the European Union was 16.8 billion pounds; however, the UK also received tax transfers from the UE in the form of public receipts worth approximately 4.4 billion pounds per year, which are mainly paid to the private sector, but are redirected by means of government departments of the United Kingdom. The country received a rebate based on the difference between its contributions and what it received. This means that the net UK contribution to the budget of the European Union during those years was approximately 8.8 billion pounds per year, or 0.5% of GDP (the net contribution of the United Kingdom in 2015 was estimated at approximately 8.5 billion pounds).

Between 2010 and 2015, the net contributions remained stable at an average of 0.5%. However, in 2009 the net budgetary contribution from the United Kingdom was much lower, at 0.3%. The increase in the following years was mainly due to the reduction of the rebates in the differential. The public sector budget of the European Union was approximately 4.7 billion pounds between 2009 and 2015.

Possible Effects of Leaving the European Union
Trade and Investment

There are a number of mechanisms by which the exit of the United Kingdom from the European Union may affect its trade: increase of trade barriers, increased non-tariff barriers, opportunity costs of subsequent reductions of non-tariff barriers within the European Union and the impact on future trade agreements with countries outside the European Union.

The exit of the United Kingdom from the European Union would cause it to run the risk of paying additional taxes or fees applied in other countries so that they can access other major European markets.

In some sectors, local regulations act as non-monetary barriers to cross-border trade. These non-tariff barriers are in addition to the costs of trade in goods and services. Non-tariff rates are the costs of crossing borders, such as the time devoted to revisions in customs and the management of imports and exports. These costs will rise when the United Kingdom leaves the European Union. According to Ciuriak (2015), cross-border costs will represent 1.2% of GDP in the United Kingdom if it fails to negotiate a favorable trade agreement after its departure. However, one should bear in mind that the characteristics of the non-tariff rates on goods and services differ significantly.

One of the main benefits of being part of the European Union market is that it has helped reduce non-tariff rates within the UE. For example, it standardized the regulations of the 28 member states to comply with a single set of rules. Therefore, non-tariff rates applied to the exchange of goods and services between the United Kingdom and the rest of the European Union can increase with the departure of the UK, due to the gradual regulatory divergence.

There is academic research that supports the fact that the costs of the non-tariff rates in trade are greater than the cost of the tariffs. Looi Kee, Nicita and Olarrega (2009) argue that, on average, non-tariff rates contribute an additional 87% to the trade restriction level imposed by tariffs. In a similar manner to the increases in tariffs, the increase in these rates would also elevate the costs of exports from the United Kingdom to the European Union.

Ottaviano and Peri (2014) estimate that the increase in non-tariff rates of the European Union and the United Kingdom will result in a reduction of GDP of the UK of between 0.4% and 0.9%, depending on whether it is able to negotiate a favorable trade agreement with the EU.

Foreign trade

One of the potential benefits of the United Kingdom leaving the European Union is that it would establish its own trade policy, independent of the interests of other member states of the EU. For example, it could make trade agreements with other major emerging economies or rapidly growing markets without having to negotiate as a trade bloc. Ciuriak (2015) emphasizes that a free trade agreement with the major economies of East Asia, including China, Japan, India and the Association of Southeast Asian Nations, would generate about 0.6% of GDP for the UK.

On the other hand, leaving the European Union means giving up the trade agreements that the EU has established with other countries. It currently has preferential trade agreements with 53 countries and is negotiating with another 72. Therefore, in practice, the UK would have to renegotiate 125 trade agreements.

Migration

Migrants from the European Union contribute to the UK economy by propping up the workforce, so that they have an important role in the economy and account for about 6% of the total active working population.

Migrants from the EU also tend to be younger than the native population. The average age of a migrant from the EU is 32.5 years, according to the statistics of 2011, compared with the average age of 40.8 years of British workers. In addition, migrants from the EU have lower levels of economic inactivity than the British.

Several studies have sought to understand the effect of migration on the economies and, in particular, on the labor markets. When migration increases the workforce of an economy, the possibility of increased economic output opens up. In the context of the EU economy, the free movement of labor within the European Union allowed companies to take advantage of a larger pool of workers. If the UK fails to retain the principle of free movement of labor, the immediate impact will be the reduction of the workforce.

There are still no solid estimates of the impact of migration on GDP of the United Kingdom after the departure, but a study by Di Giovanni et al. (2014) estimates that the recent reduction of international migration brought a loss of general social well being of the United Kingdom, which remained at less than 1.5%.

In general, economic theory does not predict any negative long-term effect. However, there could be several short-term results, depending on the economic context and the combination of skills of the workforce in sectors where migrants compete with native workers, i.e., where they are direct replacements in the market.

It is likely that there will be restrictions on migration both in the European Union and the United Kingdom. However, there may be conditions for migrants of the EU to continue working in the UK, with or without the status of permanent residence. In practice, this means that European migrants who are already in the United Kingdom could stay, while restrictions on future flows would be imposed.

Regulation

In the beginning, upon its departure from the European Union, the United Kingdom can revise or remove some or all of the regulations to which it has been subject. However, in some cases, the United Kingdom has introduced regulations that go beyond the minimal standards required by the EU, and it is possible that British lawmakers may not be willing to reverse these regulations.

An analysis of the politically viable regulatory changes in the United Kingdom due to its exit from the European Union points to a potential savings of 12.8 billion pounds per year. This is just a little more than the potential savings it would have in an extreme case without political constraints, in which the calculation of the annual savings would be 24.4 billion pounds.

A review of the regulations of the financial services notes that it is unlikely there will be major changes in many policy areas because the United Kingdom must adhere to international regulatory commitments in any event. Most EU regulations would continue to be applied in the UK, which would also make it possible to apply parliamentary or statuary proceedings so that they would be included or would remain within British law. Meanwhile, the guidelines that the application of national legislation requires will remain in force until they are amended or deleted.

Tax contribution

Upon leaving the European Union, the United Kingdom will no longer contribute to its budget, although that depends on the conditions of its departure. If the UK joins the European economic area like Norway, it would still have to make a contribution to be able to participate in this single market, albeit in a smaller proportion. On the other hand, if the United Kingdom negotiates a free trade agreement or does not pact a trade access agreement, it would not have to contribute to the European budget.

Conclusions

The decision has already been made: the United Kingdom will leave the European Union. From the date of the referendum, two years must pass before the exit from the bloc will materialize. There will be changes in trade, migration, regulations and tax contributions, and in some areas they could be drastic and change the position of the United Kingdom in the global economic context as well as establish precedents in labor relations and capital, production and productivity, employment and public finances, which would have an impact on the social sphere. It is a fact that not everything that was negotiated and established to be part of the European Union will be eliminated. However, it will have to be reconsidered, and this will change the relations not only of the United Kingdom with the European Union, but of each one inside and outside its borders.

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