NIC Undergrad Review | Volume 3 | Issue 2

NIC Undergrad Review Volume 3 - Issue 2 SPRING 2017

INTERVIEW: Teixeira dos Santos ex-Finance Minister, and current CEO of Banco BIC Português

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NIC Undergrad Review Volume 3 - Issue 2

Contents 04 The Team 05 Welcoming Remarks 06 Is It Enough?

10 Will Humans go the way of Horses?

12 Why is Blockchain an issue?

14 DIY: ML Algotrading 16 Snap 18 Taxing Robots 20 Dominating the clouds? That would be AWSome 23 Interview with Fernando Teixeira dos Santos 30 Nonperforming loans 32 Nun of your business 35 Profits without prosperity 38 Semper ubi sub ubi 40 Auto loans and the 2008 Financial Crisis 42 Chao Gupiao 45 M&A waves 48 Flat Taxes 51 George Soros 52 Political scenario in Europe 55 The Arab Winter 58 How China is paving the way to be the next World leader 61 Demographics: “It’s a trap!”

64 Hunter-Trader-Thinker-Voter

NIC Undergrad Review Volume 3 - Issue 2

The Team

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Andrey Dmitriev

Kyriacos Inios

Anna Averina

Leonardo de Figueiredo

António de Pinho

Madalena Ruivo

Carlos Gonçalves

Manuel Oliveira

Catarina Castela

Manuel Vassalo

Diogo Conceição

Maria Pinto Mesquita

Diogo Neto

Maria Pocinho

Eduardo Gameiro

Mariana Ruivo

Filipe Berjano

Miguel Amaral

Francisca Anselmo

Miguel Garção

Francisca Vera

Miguel Moita de Deus

Francisco Gonçalves

Miguel Monteiro

Francisco Logrado

Pedro Gonçalves Sousa

Gonçalo Marques

Rita Silva Marques

Henrique Cardoso

Tiago Louro Alves

José Alberto Ferreira

Tomás Ambrósio

NIC Undergrad Review Volume 3 - Issue 2

Welcoming Remarks It is with great pleasure that we present you with another issue of the Nova Investment Club Undergrad Review, the first undergraduate student-run business magazine in Portugal. Just like the previous editions, Volume 3 Issue 2 is a result of our commitment and hard work from this semester. Like in the past, we have given our members the freedom to write about what truly interests them. As such, we invite you to go through the various articles not just on finance, but also macroeconomics, politics, tech, and a variety of other topics which are currently shaping our world. W e have a variety of topics, with each article representing the position not of the club as a whole, but of its authors. New this semester to the issue is an exclusive interview with Professor Fernando Teixeira dos Santos, a former Finance Minister and the current CEO of Banco BIC. A special note of thanks to the Professor for taking time out of his schedule to meet up and provide us with some valuable insights into Banking, Portuguese economy and the European project.

As usual, NIC-UD has aimed for the stars. More than ever before, it seems that what is written in the stars is that the advent of automation, artificial intelligence, and machine learning is irrefutable.

According to an Oxford study conducted by Carl Frey and Michael Osborne, "around 47% of total US employment is likely to be automated relatively soon, perhaps over the next decade or two". Moreover, within the last few years, almost every major technological mammoth of our times - from Google to Facebook, Amazon, and now Apple - is investing and pushing out products that have some virtual or augmented reality component to them. It is in this spirit that we took a decision to create a cover page for this semester's volume on the topic of technology. We would also like to express our gratitude to Margarida Gouveia for creating the cover for this edition of the NIC Undergraduate Review.

This year was a watershed year for our club. Our team has never grown so fast over the past semesters, not only in size but also in quality and breadth of interests - a consequence of the inquisitiveness, enthusiasm, and motivation of our members to learn as much as possible from one another. As always, with the academic year coming to a close, we would like to express our gratitude and say our goodbyes to our departing members, whom we would like to thank for the passion they have shown and the hard work they have put in over the years at NIC-UD. Last but certainly not least, we would like to thank our founding members. Thank you for building this unique platform. NIC-UD, above all, is a place for like-minded students to come together to discuss events that go beyond the scope of financial markets and economics. So thank you: you may not be here at the university anymore, but know that your good deeds continue to permeate throughout the community at Nova SBE, and more importantly, throughout the members that have stamped this club with their mark.

Francisco Gonçalves, Maria Pocinho and Miguel Garção

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NIC Undergrad Review Volume 3 - Issue 2

Is it enough?

A post-mortem on the banality of the student experience

Carlos Gonçalves

Our story begins with a big little lie.

If you were to search for a description of the Undergraduate Division of the Nova Investment Club, you would find that we are “a student-run organization that promotes finance-related activities among the Nova undergraduate student community.”

Our omission? We go beyond finance.

To us, interest in finance is both a prerequisite and a form of bait. It is how we search for common ground. Yet, our goal is to develop ourselves as much as possible using a bottom-up approach that relies on finance as a platform for the exploration of other interests, whether these are finance-related or not.

“What else have we got?”

This is a question that requires thought - a lot of which, in our opinion, is not very abundant. Note that lack of abundance does not imply failure. On the other hand, what it does imply is a much more serious consequence, one which emerges every single year during the Spring Semester.

It is that time of the year: the final-year student wakes up from her or his prolonged slumber, 6

finding her or himself lacking work experience.

"G.P.A.?"

Check.

"Résumé?"

Check.

“Extracurricular experience?" Some? "Have I practiced enough?" More or less? “O.K., I think I am ready.” Check?

You ‘think’ or you ‘know’ you are ready? How ‘ready’ are you? How did you prepare for this opportunity? When it is time to face the music, this is the scenario we come across most frequently. The fact of the matter is that ‘facing the music’ entails a lot of preparation. It demands networking, résumés, motivation letters, case studies, and interviews - but there is much more to than meets the eye.

Would an interviewer want to be stuck in an airport with you? How well do you fit into the culture of the firm? Are you interesting - or, at the very least, interested? These are the same questions we ask ourselves on a daily basis.

“How can we prepare ourselves for the jobs of today and the jobs of the future?”

We have made a conscientious effort to transmit this idea throughout Nova. In fact, it is one of the tasks we set forth at our inception. One of the things we look most forward to is to have the privilege to work with students outside our

NIC Undergrad Review Volume 3 - Issue 2

things we look most forward to is to have the privilege to work with students outside our 'borders' that are capable and, above all, willing and who request our assistance. There is nothing we enjoy more than to feel their trust and your trust in us - to get to know you, and understand you, and try to determine where you stand and where you want to stand. More often than we would like to, however, we have found ourselves in the company of unfounded and unhelpful frameworks. We have found ourselves faced with the banality of the student experience.

Too often has this approach failed students students as capable as those in target schools.

Better yet, too often has this approach ‘delayed’ students. After all, ‘delayed’ is all you are when you do not reach or pass an assessment centre.

Too often has this approach left students to pick up the pieces of what was once their conviction and their spirit. For every student who is accepted, there are several others finding themselves in need of unnecessary meditation about their self-worth; instead, these students should be seeking to do a post-mortem of their performance.

“What did we do right? What was a waste of time? What did we miss?”

This is not a story of how and where the recruitment process falls short. We are not

criticizing it; we are criticizing, however, our 'box.'

We are criticizing the ill-informed opinion that bland résumés, subject to above-average G.P.A., are a sufficient condition - that they are the way to go. As students, we limit ourselves to what is conventional, to what has worked for others, to not aiming above and outside our own expectations. Whilst there are various parties guilty of this crime, our only goal is to address the things we can change.

First and foremost, we must face reality head-on the moment we enter Nova. From then on, you have two choices: either you decide you are content to be just another average Jane or Joe, or you start working toward your seemingly unattainable goal.

How? Find your areas of interest, particularly through internship programmes. Build your own personalized and purposeful path; change it if necessary, but follow it to the very end. Use your journey to discover and develop your niche - your competitive position.

What would you like 'your thing’ to be? Whatever ‘it’ is, you must immerse yourself in ‘it.' You must live the experiences and stories you want to tell.

You must develop the know-how and skills you want to show. Involve yourself in as many (interesting) initiatives and projects as possible.

Read widely.

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Most importantly, do not settle - and, respectfully, do yourself a favour: forget Nova. By virtue of the brand equity surrounding some international institutions of higher education, Nova is not and cannot fool itself into thinking that it is the 'crème de la crème.’ In order to move on, we must truly pinpoint, understand, and accept the very few things we cannot change.

Do not find consolation in the Financial Times’ Business Education Rankings. It is a trap. At best, we are a 'hidden gem'; our case is that of a whole that is not greater than the sum of its parts.

Instead, get to know Nova's people to understand how and where you can extract value added.

Do not find consolation in domestic comparisons.

Instead, find your role models. Find your mentors.

Find your partners - those who in their pursuit outside of the box for something else push you to become someone more.

Nova is what you make it: everything else is superfluous. Everything else, every other framework marked by some notion of entitlement, of rights, of normalization of what a student is and what a student ought to be - abandon it.

Even so, do not mistake our view as singular. It is not. This is a story that is applicable to Nova, ourselves, and any other club or society. As a club, you cannot possibly be satisfied with the barest of minimums. You cannot be satisfied with the fact that you are continuing the tradition of previous years. You cannot be okay with ‘O.K.’.

As the Portuguese proverb goes: "good is the enemy of great." Having said that, our outlook is that ‘O.K.’ is the greatest enemy of them all. In doing the bare minimum, you are merely ensuring

some form of short-term safety. By not preparing for the foreseeable unforeseeable, you are effectively backing yourself into a common path whose returns are unknown; in fact, they are more volatile and susceptible to injury when market conditions inevitably change. Over the course of our existence, it has not been uncommon for others to define who we are, what we do, and what we care about. We, however, like to focus on our defining feature: our intrinsic motivation. What insight we hold as priceless today, we stumbled into by following our curiosity yesterday.

“Is it enough?”

Over the course of our existence, it has not been uncommon for others to complain about the theoretical nature of lectures and classes at Nova; but to live within Nova’s means is to live blindly and without passion. As a club, there is nothing that can keep us from what we want to be good at. We want to be engaged; we want to leap toward opportunities to discover the new among the familiar - without Nova scaffolding.

“Is it enough?”

To us, it never is.

Your time is limited, so do not live trapped within the orbits of other people. Commit yourself to the long haul. Trust your sense of wonderment - trust your work.

That time of the year is every day of the year.

Today is no exception.

Follow Us On Club Activities Breaking News Selected Articles

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NIC Undergrad Review Volume 3 - Issue 2

Will humans go the way of horses?

The impact of automatization on the labour Market

José Alberto Ferreira and Manuel de Oliveira The idea that new technologies replace workers can be traced back to the Industrial Revolution and is acknowledged, for instance, by Keynes as “technological unemployment”.

This has been counterweighted by growing jobs and real wages throughout the industrial economies, proving that labour demand is historically dynamic: the so-called “Lump of Labour Fallacy”, embodied in mainstream economics. Behind it is the notion that the productivity gains of technological progress generate high enough incomes to surmount the loss in labour. Its principle, however, started to be questioned by Nobel-laureate Wassily Leontief, in his famous comparison between humans and horses: throughout the 19th century, the horse labour demand did not react to technological innovations such as the telegraph or wide spreading railroads; indeed, the horse population in the US kept increasing, reaching about 21

10

million in 1900; nevertheless, by 1960, there were only 3 million horses left.

Why so?

The internal combustion engine paved the way to cars and tractors to fill urban and rural landscapes, imposing a fatal blow on the once impervious horse population.

This leads us to the question: are we, humans, to go the way of horses? At first sight, one may argue that no – at least in the foreseeable decades, say.

Indeed, the social nature of our being makes the case for human labour, whether it is in the form of a waiter or an inspiring teacher. Nevertheless, jobs where human labour can be substituted away are likely to break the industrial-age premise of ever-growing employment and wages in the long run, as they are likely to represent the most economically efficient alternative. Those are the cases of legal workers,

accountants, or technical writers, exposed to near extinction by growingly complex algorithms for big data.

Many academics argue that the effects of such transition dynamics - from labour to capital – are already visible, being through stagnant wage incomes (in the US, UK or Germany) or in the form of growing inequality among employed, which cannot be separated from the spreading of “low- and mid-level screensitting [jobs] that serves simply to occupy workers for whom the economy no longer has much use” (The Economist, 2014).

One of the most curious aspects of this shift, however, regards its impact on ownership and distribution of capital. The substitution of human labour, which has been felt since the 1980s, will undoubtedly translate into decreasing labour income, while rising capital income - historically more unevenly distributed in capitalist societies – may raise new social concerns regarding equity and how to reward human effort and initiative.

In this context, educational attainment becomes increasingly relevant: in a 2013 paper, Carl Frey and Michael Osborne, from Oxford, presented evidence that highskilled jobs, demanding more qualifications, are less prone to computerisation, and, therefore, to substitution by capital.

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Erik Brynjolfsson and Andrew McAfee wrote in their 2011 book The Race Against the Machine: “If technology decreases the relative importance of human labour in a particular production process, the owners of capital equipment will be able to capture a bigger share of income from the goods and services produced.”

In fact, a reduction in the payroll costs and an increase in capital investments, which are justified by an increase in efficiency – which generates more capital income (the company can produce more, faster, more reliably and at a lower cost).

Meanwhile, underqualified people become unemployed, largely reducing their income, aggravating the level of inequality.

However, we should also take into account that the simple fact that a job can be automated does not assure that such will happen, as such decision is always dependent on a costbenefit analysis (with that being said, it makes sense for Nissan to use robots when assembling cars in Japan, while taking a labour-intensive approach in their factories in India). This summarises the duality of threats posed to the average worker since the 1970s: competing low salaries and automatization (with the latter often being accelerated by the former).

In any way, the various studies recently conducted concerning this topic point to a similar future: a labour-light economy,

where many of the jobs currently held by uneducated people have been taken by some form of technology. The resulting growth in income inequality throughout society cannot be ignored for much longer, as it has been until now, since politicians all seem to avoid this topic, even though automatization is already responsible for more loss of jobs in the USA than foreign trade or immigration (former President Barack Obama mentioned the threat of automatization stealing American jobs at his farewell address in Chicago).

But what does a society with such high unemployment look like? Without much discussion from those holding public office concerning this topic, it becomes hard to speculate regarding specific measures, but it would be reasonable to include education and immigration reforms, as well as policies towards entrepreneurship, research, and innovation.

Nevertheless, and despite the grim picture painted in many of the studies recently conducted, (Frey & Osborn (2013), for example, predict that 47% of the US labour force is in high risk of becoming unemployed, with their jobs becoming obsolete) it is important to underline the idea that even the researchers with views favouring automatization acknowledge that humans have some qualities which we are still far away from being able to replicate with technology, such as being far more dexterous and nimble, comparatively

lightweight and energy efficient and our senses provide fast and multidimensional feedback allowing for precise movement/control, and that’s only from a physical standpoint.

From a mental point of view, having a common sense, and simply being able to formulate goals and work out how to achieve them are still human advantages in which progress in technology is not being made at the same hasty pace. However, the most convincing argument for the persistence of human labour may instead lie on innovation and creativity – the increasingly important drivers of growth in our societies, upon which the ideas of risk-taking and entrepreneurship are built.

For now, the main goal should be to raise awareness and spur discussion in this field, as only that way can we move past this problem.

Soon enough, continuing to avoid talking about this issue will become impossible, as more and more people start to be unable to find jobs and leave the labour force.

It might not be a coincidence that the most labour-intensive industrial regions of the UK and France voted predominantly for the protectionist alternatives in the Brexit referendum or the French presidential election.

Indeed, the main difference between the human and the horse is that when horses became nearly irrelevant, that was it, but humans can vote, protest and voice their opinions, forcing those in charge to make changes – deciding whether or not those changes are appropriate is up for electorates.

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NIC Undergrad Review Volume 3 - Issue 2

Why is Blockchain an issue?

How could it change the entire banking system?

António Pinho and Manuel Vassalo

The banking system as we know it today is in constant mutation to fit the evolution of the internet era. Fintech is now the fastest growing and second biggest stake of total venture capital investment around the globe, data from Crunchbase global innovation investment report 2016 - and this fact is substantially affecting banking.

While credit cards, online services and ATM’s facilitate transactions not possible in the past, the deep roots of the banking system have remained unchanged for long. We keep trusting the bank our money, we are subject to taxes, interest payments and, more than ever, we are exposed to online fraud with no possibility of tracking.

Bearing this in mind, an increasing number of early birds are supporting a new concept that represents a whole new base structure for the way we do banking. This concept is Blockchain, a decentralized ledger system idealized in 1991, 12

but only conceptualized in 2008, through Bitcoin - the most widely known and accepted cryptocurrency.

It was introduced in October by the pseudonym Satoshi Nakamoto - whose identity remains unknown – with the goal of creating a peer-to-peer currency, not exposed to central banks policies, transaction costs or fraud risk.

“Every informed person needs to know about Bitcoin because it might be one of the world’s most important developments.” Leon Louw, Nobel Peace prize nominee.

Bitcoin is the first decentralized cryptocurrency (working with no single administrator or repository) and is seen as the main one, representing about 55% of the cryptocurrency market. One unit of Bitcoin today is worth close to $2000 and, although it has been known for its wild fluctuations and usage in black market transactions, it’s experiencing

exponential growth, rising 122% last year. The increasing interest in Bitcoin is mainly connected to the reputation that cryptocurrencies have been building, as a new safe haven.

Moreover, the recent demonetization in India and the explosive growth on the Japanese Bitcoin industry have significantly increased the demand for Bitcoin and the number of direct transactions executed through it. This is feasible by using a blockchain backed structure to support and record the flow of the currency value.

Blockchain is a ledger built with blocks, publicly stored in a worldwide chain of servers.

Each action executed between two final users represents a new block to be added to the chain, and is only executed if the new entrance is accepted in the majority of servers - hosting the ledger - spread around the globe.

This means that every single

NIC Undergrad Review Volume 3 - Issue 2

transaction will leave a worldwide spread track, impossible to hide and impossible to re-write. By allowing digital information to be distributed but not copied, blockchain structure becomes impossible to hack. Altering any ledger entry invalidates instantly the subsequent transaction, since the servers network would not be in accordance. Also, the entire flow is processed automatically and instantly, which means there’s no need for intermediate entities or delays.

Applied to cryptocurrencies, this means the money is transacted directly peer-to-peer, without any transaction costs, and becomes available in the very same moment the payment occurs.

“I’m reasonably confident (…) that the blockchain will change a great deal of financial practice and exchange, 40 years from now, blockchain and all that followed from it will figure more prominently in that story than will bitcoin.” - Larry Summers, US Former Treasury Secretary.

As Larry Summers states, the Blockchain goes beyond Bitcoin: Currently, it is being used to create and store databases, transact cryptocurrencies, and some others. New usages are surging often, but the most developed so far is banking with special attention to commercial banking. So, how can blockchain deeply affect the banking system as we know it today?

Firstly, the commercial banks’ transactions model (B2B2C) would become obsolete: It takes longer and is more expensive than a Blockchain structure.

Second, client’s deviated and untracked transaction that are common in traditional digital banking (hackers intercept the channel of communication and change the information without being noticed) would be impossible since the info is transported by multiple channels simultaneously, and recorded everywhere. Thirdly, trust would not be an issue: Today, customers choose their banks by the level of trust they have on it. As blockchain stores the information publicly (although codified), all the back

office processes would indirectly monitored.

be

A study report from IBM Institute for Business Value, surveying 200 banks, indicates that 90% of the entities surveyed are actively investing in this technology and, 15% (called Trailblazers) plan to have blockchain backed operations working in 2017.

Concluding, Blockchain is a wave of new opportunities, although the most evident usage so far is still Bitcoin. This is not a flawless model but is an incredibly simple and efficient structure that will probably be a widely spread standard in the future. Fintechs love it, central banks hate it, but it’s important to understand that it doesn't invalidate the commercial banks’ role in the economy; it re-defines, instead. A model combining the typical, more familiar, bank institution storing and managing individual’s wealth, backed by a transparent blockchain structure to execute operations, would mean a great development in reliability and efficiency.

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NIC Undergrad Review Volume 3 - Issue 2

DIY: ML Algotrading An initiation to machine learning powered stock pickers

Carlos Gonçalves, Diogo Conceição and Tiago Alves Imagine you are participating in some sort of assessment and you have first-mover advantage.

In this first instance, however, we are not addressing technological leadership per se; instead, you have access to the prompt before anyone else. Most importantly, this form of information asymmetry is now your competitive advantage. After all, knowledge is immensely valuable, but unavailable knowledge is priceless.

At its best, “algotrading” (i.e., algorithmic trading) is the epitome of this form of competitive advantage within financial markets. However, algotrading is not defined by human observational capacity; indeed, it requires something more - something else - other than what the human eye can detect.

When approaching algotrading, one must first break down its components. First of all, what is trading? Trading is active participation in the financial markets, which “seeks to outperform traditional buy-and-hold investing.” On the other hand, an algorithm is a lists of steps or instructions that start with inputs and end with a desired output.

We have completed the first two pieces of the puzzle. Now comes the hard part - the underlying concept behind it all. A rather unnecessary concept in the light of simple algorithmic trading but one that, in our view, represents the true competitive advantage not only in the context of trading, but in the context of algotrading as well.

Our focus pertains almost exclusively to the intersection between it and machine learning that is, by definition, the best version of algorithmic trading (i.e., “ml-algotrading”). We are interested in how computers are taught to program themselves - specifically, algorithms to be used in algotrading - such that basic characteristics of algotrading are leveraged: (1) the lack of developers; and, (2) the abundance of data.

For the purpose of this article in which our goal is to gain a simple grasp of what algorithmic trading entails, let us place ourselves in a situation where 14

we want to design a trading simulation involving long-term investment strategies. In this scenario, trades are performed on a daily basis.

Accordingly, let us assume our model will use the daily closing price to determine the buying/selling price for when orders are placed on that given day - assuming as well that orders can only be placed once a day. We should include small fees to simulate the effects of slippage and trading commissions.

To develop a trading model, thus, one should: (1) conceptualize the model; (2) identify all available opportunities; (3) develop the model; (4) backtest the model; and (5) use the model or abandon and move to a new model. Having said that, it is necessary to always be prepared for failures and restarts; as it is also fundamental to ensure some form of risk management by building in ‘what-if’ scenarios.

The techniques used to ensure a model’s proper functioning are mostly statistical (e.g., linear regression, k-nearest neighbours algorithm or kNN, decision trees, and regression trees) - all interesting topics for any mathematics enthusiast.

HOW TO START? We have got the basic concepts covered.

Excited? Now that your goal becomes that of building your own algorithmic portfolio, you just need three things: programming skills to build the stock picker, data, and money. Easy, right?

To begin with, there is no secret formula for the programming languages that can potentially lead you to great returns on your portfolios.

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Nevertheless, the most recommended are C++, Java, Python, SQL and MATLAB. If you are just starting, however, we recommend learning Python and SQL, since these languages are developed under an open source license. This means that Python and SQL are free to use; moreover, said languages have an endless and engaging community of developers willing and ready to help those who seek help.

Secondly, your model could use, for example, 4100 days of trading price and volume data for backtesting data - including various currencies, precious metals, agricultural products, etc. This data could come from a vendor (e.g., Commodity Systems Inc., a low-cost information vendor of summarized world financial market data) for approximately $300 per year. This is the best approach to avoid survivorship data; after all, the data that is readily available online does not pertain to those companies that have defaulted and whose data is not around.

Lastly: money. As for the “traditional” forms of trading, there is no minimum amount to start your activity with the exception of the amount required to open a brokerage account. Moreover, we do not recommend your model to perform highfrequency trading because the fee costs would be excessively high (at least, to begin with).

WHAT’S NEXT? After you have managed to set your own model and (hopefully) consistently beat the markets, you have a handful of options.

First, sell it. Sell your model. If you have managed to intrinsically outperform the competition, there will be people willing to buy your machine learning powered stock picker.

If you can avoid the temptation of selling it, then step it up. Another option is to design your own hedge fund; get a couple of partners with training in algorithm, machine learning, and computer science to fine tune your model. Redefine it by increasing its complexity (i.e., the model’s breadth) or more strictly delineating its inputoutput response (i.e., the model’s depth).

benefit society. Go to academia, research and develop the next generation of artificial intelligence techniques within and outside the realm of finance. As David Ferrucci (i.e., IBM Watson’s researcher) once said: “how cool is it to imagine a machine that can combine deductive and inductive processes to develop, apply, refine and explain a fundamental economic theory?”

WHY NOT? Even though there seems to exist a great potential ahead for pickers fuelled by machine learning, there are opponents of both the amount of data available and the usage of technical indicators.

Using historical price and technical indicators based on price and feeding those into a classification or regression algorithm to predict future movements is potentially problematic. There is, after all, limited amount of data per equity available - especially if you are trading daily. After all, years of data amount to only a few thousand data points. The usage of machine learning at higher frequencies has its own set of problems, as the information/noise ratio is significantly worse at the higher frequencies.

On top of that, backtesting is yet another potential issue due to the existence of black swan events.

After all, backtesting refers to existing historic data, so any algorithm is automatically biased to give better results that it would in potential realworld applications.

All in all, this article is an introduction to a hot topic. Hundreds of established trading concepts exist and are growing daily with the customizations of new traders. Warren Buffett arguably the world's greatest stock investor famously stated that the rules for investing are: "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1."

What this article presents you, therefore, is not an infallible way of making money. Ultimately, it might even be a complex way of (probably) losing it.

Last but not least, think about how you can 15

NIC Undergrad Review Volume 3 - Issue 2

SNAP Snapchat isn’t as scary as the icon depicts

Rita Marques and Kyriacos Inios investors that have given them money along the way to keep the business going. It's a good way for founders and executives to actually cash out some of the stock that they have earned during their time working there.

It's also a way for the company to raise money from interested investors. They can use that money to do things like acquisitions, international expansion and new product growth, things that Snap would love to do.

Don’t let the deceive you.

ghost

icon

Snapchat has become one of the most commonly used messaging apps for its convenient and entertaining way of sending photos and videos without occupying your phone’s memory.

Snapchat is a photo and video messaging application, which was the result of Evan Spiegel’s project at Stanford University under the name “Picaboo”.

Evan Spiegel and Bobby Murphy founded the technological and social media company on September 16, 2011, and on September 24, 2016, it was rebranded as Snap Inc. in order to include the "Spectacles" product under a single company.

The selling point of Snapchat, apart from the newly launched [February 20, 2017] product "Spectacles", is that it allows 16

you to become the storyteller through pictures and videos which can only be seen for a limited amount of time.

How is Snapchat different from Facebook, Twitter, Instagram and other social apps you may ask? Well, it is different from the above-mentioned social media for some reasons.

The content you post has a limited time span; it’s more intimate and very engaging; it’s authentic and unsophisticated.

Snap Inc., as of March 2, 2017, is a publicly held company under the symbol SNAP and is traded on the New York Stock Exchange. A question, however, which arose as the IPO day was approaching, was whether Snapchat was going public too soon.

Why would a company go public? First, to pay back their

Why would Snap Inc., though, go public? If you are a Snap skeptic, you will point to Snapchat's decelerating user growth and the $750 million incentive clause Snap's investors gave Spiegel to go public and make a simple argument: Snap is going public now because this is as good as it's going to get. Sell the story when there's still a chance of a hopeful ending. On the other hand: Spiegel is smart. And with co-founder Bobby Murphy, he has full control of his company.

If he was worried about exposing Snap's flaws in public, he wouldn't go public. Which means he believes Snap's story, too.

Snap opened at $24 a share on March 2. Despite an increase of 44% on the first day of trading, the shares fell 17% to under $20 a week after its $3.4 billion public listing. Several disclosed sell ratings on the stock highlighted analysts' views that

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the Company’s valuation might have been too high for an operation with a profit yet to come. Snap made history at the time of its initial public offering, being the first company ever to have issued only shares with no voting rights on a US stock exchange. Although other tech companies, like Google, have offered not voting shares, Snap was the first only issuing this type of shares in its IPO. Snap' stock structure consists of three different classes. Class A shares are the ones traded in NYSE and do not include any voting rights, though stockholders who buy them will be entitled to attend the company’s annual shareholder meeting. Class B stocks are reserved for early investors and Snap’s executives. Each of these shares come with one vote apiece. Snap’s co-founders are two exclusive holders of the super-voting class C stocks, each one coming with 10 votes apiece.

This structure enables Spiegel and Murphy to hold a combined 88.5% of the company’s total voting power. This means that every major decision for Snap,

from appointing board members to a possible future sale, will be controlled by just two people.

reported an increase of 33% from the 150 million daily active users it had in January.

Skeptics are growing in number. Every analyst who has started covering Snap's stock has issued a negative rating. They question not only its high valuation but also the underline challenges the company is facing.

Analysts have also been concerned with Snap’s losses. A research conducted by Pivotal Research Group reported that these could rise from $515 million last year to a whopping $3.7 billion in 2017 not even including huge stock grants to employees.

Additionally, in 2016, Snap had stock-based compensation expenses of around $1.7 billion, or roughly $1.4 million per employee, compared to Facebook's average of $230,000 and Google's $144,000 per employee . These grants dilute investors.

Needham analyst Laura Martin reported that Snap´s total addressable market is estimated to be 80% smaller than Facebook’s and it already has 50% penetration among its potential user base in America.

Last April, Facebook announced that more than 200 million people a day use its Instagram stories, a feature that, like Snapchat, lets users and businesses post a string of photos and videos that disappear after 24 hours. Ahead of the company’s initial public offer, Snapchat had 161 million daily active users at the end of last year, which, despite the decelerating user growth, was the largest by a technology firm in three years. Instagram Stories' daily active users

It’s been tough for some of the big tech IPOs over the past several years. Snapchat is no exception. Its future, growth prospects, and ability to make money off its users are still uncertain. Skeptics wonder if Snap’s valuation remains too high, given that it’s still unprofitable and geared primarily toward teenagers, a notoriously fickle audience.

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NIC Undergrad Review Volume 3 - Issue 2

Taxing robots Betting Against the Odds

Miguel Moita de Deus and Francisco Gonçalves

1. A robot may not injure a human being or, through inaction, allow a human being to come to harm; 2. A robot must obey the orders given by human beings except where such orders would conflict with the First Law; 3. A robot must protect its own existence as long as such protection does not conflict with the First or Second Laws.

In case you didn’t know, these are Isaac Asimov’s Three Laws of Robotics.

They were assembled in 1942 and display an early concern for conflict of interaction between men and 18

their robotic subjects.

However, humankind is not yet wondering whether a Skynetlike A.I. might suddenly resolve to obliterate us, but whether the closest things we have to robots these days are eligible to pay taxes.

At first glance, one could argue a robot must obey human beings after all, and only their masters could complain if an income tax was incurred on robotic machinery. However, if such a policy somehow harmed human labourers’ pockets, would it not violate Asimov’s first law?

To be truthful, this subject wasn’t a large topic for debate

until Microsoft Co-founder Bill Gates stated his opinion on the matter: “Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, social security tax, all those things. If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level”. Mr. Gates’ underlying topic – machines taking jobs from humans– although infamous among many economists, is not new. In 2013, The Economist released an article showing the probability of different occupations being substituted with computers and A.I.s. The data suggested that jobs such as telemarketers, accountants or retail salespeople had their

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days counted while professions such as dentists or priests were fairly future proof.

Therefore, from here on out, it’s important to make two statements on the issue of taxation on robots:

1. Given what was said above, it’s important to understand which industries would be most vulnerable to a Robo Tax; 2. For the purpose of covering as many industries as possible, Artificial Intelligences – and not necessarily physical robots – would also be considered for taxation, due to wide varieties of professions being affected more by the software side, rather than the hardware side.

For the average college student who tends not to have prospects of working as a Starbucks barista or a factory labourer, this doesn’t seem like a big deal. However, for the working class (and Labour Economists), robots taking away these jobs for their frugal properties implies a complete change in their job prospects.

After all, companies try to minimise costs, and salaries for humanely inefficient people are among the biggest costs firms can have. So, a solution which increases performance and reduces costs seems like a nobrainer for any rational agent in a free enterprise system, yet one of the backbones of consumption-based economies – the working class – could be severely damaged.

This is where we introduce the Robot Income Tax and Mr. Bill Gates’ scepticism on whether

freely substituting humans with robots would truly bring about greater societal welfare. To Mr Gates, the automation industry brings negative externalities to the job market, that is, it incurs a social cost on labour to increase economic output.

However, today this isn’t a classic “Capital vs Labour” discussion, but a growing concern among the various sectors of activity, as indicated above.

For example, BlackRock, Inc. has been investing vast sums of money to build stock trading A.I.s with the sole purpose of increasing returns while reducing labour costs. Yes, perhaps it’s time you consider the present value of that Master in Finance you were thinking of signing up for, as well as the opportunity cost of not learning some Computer Science (CS) and Data Science (DS) while you’re at it.

Back in the dawn of the Industrial Revolution or the Marshall Plan Era, talking about Capital being a priority over Labour was a matter of giving or taking away jobs from the working class. Today’s debate includes potentially taking away jobs from MBA prodigies who didn’t see the Machine Learning and A.I. insurrection coming.

might be synonymous to calamity for an increasing crowd in the next years, many economists are still against the idea, citing that that a tax on automation would slow down innovation and put countries at risk of losing investors towards other jurisdictions with lower taxes. Economist Garett Jones from George Mason University goes beyond the problem of innovation, citing the ChamleyJudd Redistribution Impossibility Theorem: “under standard, pretty flexible assumptions, it's impossible to tax capitalists, give the money to workers, and raise the total long-run income of workers.” In short, taxing labour will always be more efficient than taxing capital. Whatever happens, one thing seems likely: with the advent of automation near us, regardless of whether robots are taxed directly, there will come a time when we will have to consider how we would go about redistributing wealth, if at all.

Just as Foxconn –a Taiwanese electronic component producer with 1.3 million employees– replaced 60,000 human jobs with robots, J.P. Morgan recently created an A.I. which does in seconds what J.P. lawyers took 360,000 hours to do: the legal interpretation of commercial-loan agreements.

Yet, even though automation 19

NIC Undergrad Review Volume 3 - Issue 2

Dominating the clouds? That’d be AWSome Amazon’s preferred child

Mariana Ruivo and Maria Pinto Mesquita Amazon Web Services is the market leader of cloud services platforms. The reason that justifies this is Amazon’s constant release of new features and innovation ranging from a new contact centre service, Amazon Connect, to a Simple Network Setup for Internet Access in 2017.

Chris Pinkham and Benjamin Black in 2003, when they explained their vision of the future “Amazon’s Retail Computing Infrastructure”. In 2010, all Amazon.com retail web services were moved to AWS and by 2015 the company was already making positive profits of $2.1 billion.

AWS provides compute, database, storage, analytics and other functionalities that “help business growth and scaling”.

Among those functionalities we can highlight its biggest product – EC2 – the elastic compute cloud that provides resizable compute capacity in the cloud, which is intended to make web scale computing easier for developers; and S3 - the online storage service that offers practically unlimited data storage space with features that support the creation and running of applications.

Amazon Web Services allows access to all the information previously stored in data centres through its cloud, and provides a wide range of functionalities that help its customers.

One of the advantages that cloud services like AWS or Azure (Microsoft’s cloud service) have is the payas-you-go pricing. With this scheme the customer only pays for the time used, without the need to incur certain costs, turning fixed costs into variable.

AWS’s revenues have been increasing every quarter since 2014, and in the year of 2016 the company was able to reach nearly $12 billion in revenues.

Nowadays, AWS’s annual revenues approach about 10 per cent of the group’s sales.

THE GOLDEN EGG AWS was first launched by 20

AWS sales increased 49% in 2014, 70% in 2015, and 55% in 2016. These results reflect the increase in customers’ usage.

Although Amazon Web Services is a recent company, Amazon.com’s operating income of $4.2 billion in 2016 had an AWS’s huge weight of $3.1 billion. In the same period, the International segment has reported losses of $1.283 billion

and the North American segment had a positive operating income of $2.361 billion.

CUSTOMER EXPERIENCE Organizations that use cloud services tend to be more competitive, increase customer satisfaction and innovate faster.

AWS customers include "unicorns" and Fortune 500 companies. They range from Unilever, to Netflix, Airbnb, Xiaomi, Samsung and even NASA. Amazon Web Services has been making a notable impact in its costumers’ results. Thanks to the scalability and agility provided by the services, businesses were able improve their employees’ productivity while lowering their IT costs.

It is estimated that on average, companies that invest in AWS resources have a ROI of 560%, $1.54M average five-year discounted business benefits and a payback period of 5.5 months.

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COMPETITORS When looking at a firm which is the market leader, it is relevant to analyse its main competitors IBM, Oracle, Microsoft (Azure) and Alphabet. The fact that Amazon was the first mover paid off roughly, with AWS estimated to have a 30% market share. To have a perspective of how much bigger it is AWS cloud, its total storage capacity is reported to be greater than the combination of all other cloud infrastructures.

Like Amazon Web Services, Azure is one of the leading public cloud platforms. It offers a set of capabilities with global coverage and it is able to cover the same categories of AWS Compute, Data Management and Performance, and Networking. Besides, Azure has services and integrations for indepth monitoring and alerting on infrastructure performance logs and metrics. Microsoft could detect a pattern, when a company is moving to the cloud, and responded with support for hybrid cloud configurations. A hybrid cloud allows one to transition between the two in a smooth and continuous way.

Because of that, Microsoft has

gained an advantage in the Hybrid Cloud space. Although Amazon leads in the “cloud space” because of its multi-year head start, Azure still offers a comparable service and is growing at a faster pace.

After the Snap arrangement between Google and Amazon, AWS has remained a strong player and Google made the seriousness of its cloud business very clear. However, running services on different clouds has its risks even if it is something that is becoming common these days. The point is, switching to the cloud system can be difficult to implement, causing a company to incur significant costs and consuming time. Google’s cloud is the winner when it comes to compute and storage costs. It offers a pay-per-minute model, offering a better cost structure.

Furthermore, Google Cloud Platform offers additional discounts for some instances, providing a better approach to discounted long-term usage.

Finally, Google Cloud is more flexible in configuration and offers a $300 credit for 12 months and Free Tier that is not time limited.

Amazon has been showing a

growing dominance in cloud services. Enterprises do not buy as many networks, storage and servers as they did, since they now use Amazon for their data centre needs. By moving to AWS, firms are more likely to buy one of Amazon’s databases. In fact, in 2016 its cloud customers moved more than 18,000 databases from other competitors, namely Oracle. However, Oracle has the advantage of being the only vendor providing a complete and integrated stack for the cloud, being this its biggest differentiator when looking at AWS and Azure. Oracle is also the only vendor that delivers cloud on the client’s terms, giving it the choice and the confidence to follow its path. As the business grows, IT hardware and software providers are being pressured due to the industry’s competition.

CONCLUSION Lastly, AWS can be seen as the golden egg due to its success and growth since its creation.

As a first mover, it had the chance to explore the market of cloud storage – a service that has brought companies several advantages and that it is seen as an essential need for firms these days.

Both elastic compute cloud and online storage are tools that a business cannot live without.

Amazon’s investment in innovation is what led to the creation of this service, and it is what makes the firm a leading market player, being on the vanguard of technology.

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NIC Undergrad Review Volume 3 - Issue 2

Interview with Fernando Teixeira dos Santos Experienced insights on banking, the economy, and other relevant topics

Miguel Garção and Filipe Berjano

This interview occurred on the 20th of April 2017, conducted by Miguel Garção and Filipe Berjano. Fernando Teixeira dos Santos is a former Finance Minister of Portugal from 2005 to 2011. He was also a professor at the Economics School of the University of Porto (FEP) and president of the Portuguese Securities Market Commission (CMVM).

Currently, he is the CEO of Banco BIC Português (soon to be renamed EuroBic). We would like to thank him for the opportunity he gave us. This interview is focused on 2 main topics: his experience at BIC and the current state of European and Portuguese financial systems.

What were the reasons that made you embrace the challenge at Banco BIC Português?

During my life, either academic or not, I always liked to embrace challenges. This one surged in a moment where I felt the need to have an executive role after having political and academic experiences.

Why BIC? Obviously, we are subject to the circumstances. But I chose BIC firstly because it is a bank and secondly because it is a bank with a significant dimension in the Portuguese financial system, representing an interesting challenge. Being medium-sized in a sector that tends to be dominated by large players is a true challenge,

especially when the environment is particularly difficult for the whole sector. I say it is difficult due to the implications the financial crisis has been bringing to the sector since 2008, obliging banks to change their business models, adjusting to a stricter regulatory framework. These institutions are also making an effort to reinforce their credibility and confidence from the economic agents. All these reasons together appeared to me as a sufficiently wide range of challenges and I felt enticed. I thought that my experience over the years in the government, in CMVM and in the university, could be useful for these challenges.

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What are the bank’s differentiation factors and the culture it intends to transmit?

I would not say BIC necessarily differentiates from other similar institutions. I think the biggest concern and the culture of a bank must be trying to deserve the confidence of the clients and obviously delivering a highquality service fulfilling their needs. This must always happen in any economic sector but I think it is further important under the current environment of the sector, in a world that changes constantly.

The economy is changing, the financial system is fluctuating and the technology creates new ways to do business and to establish relationships with clients.

Being CEO of Banco BIC PortuguĂŞs for almost a year, what were the goals achieved so far and what goals are yet to be attained?

I feel that until now we could mobilize our workers. I feel that, during the past months, there was a clear capacity to motivate 24

the teams from the board to the staff in the bank’s branches. We set target objectives in several business areas and we felt a very strong response and those goals were surpassed. I feel I have an institution mobilized and interested in improving the performance of the bank, which is important. I also think we have been building a more proactive and competitive position in some segments, particularly the mortgage loans, where we are developing an activity evolving positively.

Internally, we have been improving the organization, the teamwork and the internal control system (e.g., risk assessment and auditing). And these are important factors because the confidence in a bank needs to be based on the perception people have on the robustness of the governing system.

These areas are elementary pillars for the trust generated by the activity.

What are the big challenges upcoming for the bank? Is digitalization one of them?

That is a big challenge we have.

We set up a strategic plan for the next 3 years and we want to have a strong, if not leading, position in the segment of medium-sized banks in Portugal. For that reason, we want to develop our activity with private clients, especially with mortgage loans. This is a multiproduct operation involving many activities like the loan itself, the deposit account, the services payments, credit or debit cards and insurance contracts. That is why it is so important! Another vital strategic area is the credit to SMEs, which, for a medium-sized bank, is a market niche to explore, since we have a network of around 200 branches, giving us a proliferated geographic presence and notoriety. This network allows us to reach that business segment. To develop all of this, we need an efficient back office helping internal operations and creating the necessary interfaces to serve the clients, following technological innovations. One cannot ignore there are different generations of clients, from the older ones to the millennials, with different postures, and we

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need to have a multichannel approach to offer the best available interface for each different client profile. And nowadays a bank that thinks about the future needs to think about its digital platform.

Currently, BIC does not have a strong presence in this field. In fact, I think this is one of the bank's weaknesses. But that is one of our focuses. We want to improve our information systems internally and for clients, either business or private. But this is not an overnight transformation, it is a continuous process!

Is a phone app planned to be created?

Of course! I hope we can have it in a few months.

What are the big synergies in the relations between Portugal and Angola? How does BIC positions itself in these relations?

Banco BIC Português has a strong relationship with Banco BIC Angola, naturally. They are just like brothers, having the same set of shareholders.

However, they are autonomous from one another – distinct juridical entities, one operates in Angola and the other in Portugal, there are no crossrelationships – existing operational and business relations in some transactions between both countries, given they are partner banks.

Undoubtedly, this relationship with Angola is an important competitive advantage for Banco BIC Português, in the sense that it creates a closer connection with the economy in

Angola, supporting companies that wish to operate, invest or establish commercial activity in the country. These companies recognise Banco BIC Português as a bank with leveraged relations with Angola. This synergy is important and was even more important in the first years of the bank here in Portugal. However, through the acquisition of BPN, we are much more than that. We have now a broader network that goes far beyond companies with relations with Angola exclusively.

Despite recent difficulties in the country, due to the low oil price, Angola has a huge economy with very important resources and, for centuries, Portuguese companies have a presence there. I believe this relationship is to keep and develop. BIC wants to be present in this.

Moving on to the banking system in Portugal, what is your opinion about the high exposure of the banks to foreign investors in their shareholder structure? What are the risks of this situation?

I must confess that, personally, I would like to see more Portuguese money involved in the Portuguese banks.

However, given the lack of that kind of capital, I see no problem in having foreign capital in the banking sector or in any other sector. What I think is

paramount is that the entities, independently of the nationality of the capital they have, are Portuguese from a juridical point of view and respect a legal framework set by the country, according to European rules. We need capital and the important part is that they comply with the rules and pay their taxes. About regulation, we know that, after the creation of the Banking Union, we are supervised by the ECB following the Single Rulebook, a unified regulatory framework applied in the Euro Zone. So, whoever is present in Portuguese enterprises – being Chinese, Spanish, American or Portuguese – must comply with those rules. In that sense, I do not see risks arising from this exposure.

We would like to talk about the recent events in the financial sector in Portugal.

What is your opinion about the resolution strategies followed to solve recent problems (namely with Banco Espírito Santo, Caixa Geral de Depósitos and Banif)? Do you believe they could be solved differently?

I reckon all those situations are different. Starting with Caixa, the institution did not have solvability issues.

They suffered, as other banks did, from a high volume of impaired losses that forced the bank to

“Whoever is present in Portuguese enterprises – being Chinese, Spanish, American or Portuguese – must comply with [the] rules. (…) I do not see risks arising from this exposure.”

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raise capital to keep the required solvability levels. The problem surges because Caixa’s shareholder is the Portuguese State and it has to do with competition rules and implications in the Government Budget. Being a state-owned bank, it is necessary to ensure that the capital raised does not put Caixa in a more favourable position than other banks (i.e., competition rules need to be complied with). On the political side, this transaction must not burden the government budget.

It will increase the public debt but there was a concern from European institutions about the government budget deficit. I believe that raising €1 billion through debt is a way to test the solution found. I mean, the bank is trying to assess the market perception of the solution negotiated between the government and Brussels.

Banif’s operation has to do with a distressing bank, in a situation that urged to be solved. In my understanding, taking into consideration the dimension of the bank, the effects on the banking sector would be minor.

So, I think that the resolution did not create systemic risks. The BES case is more complicated.

We had, similarly to the BPN case, a set of operations that were hidden from the regulator and undermined the financial strength of the bank, reaching a situation where bankruptcy was close.

That forced the separation between the “bad” [Banco Espírito Santo or BES] and the “good” bank [Novo Banco], which ended up looking “not so good”. Nevertheless, the weight of the bank in the banking system created a clear systemic risk. I must confess I still have many doubts about the kindness of the solution found.

The country adopted a strategy but the resolution fund did not have enough money to finance the bailout. That required the involvement of government money. It was a big risk creating a newly born model, that was not conveniently robust, to solve a difficult situation in a very important bank. This creates an onus over the remaining banks in the country, compromising the competitivity in comparison with other countries. Putting it in simple numbers, we have €4.9 billion in the first resolution stage. Then, Banco de Portugal transferred €2 billion in senior debt from Novo Banco to BES, at the end of 2015. And now the

“I have many doubts about the kindness of the solution found [for BES/Novo Banco]. (…)

We have €11 billion that are or may be weighing over the resolution fund.

Who is going to pay this?”

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State is selling the bank and Lone Star can still demand €3.9 billion. Thus, we have €11 billion that are or may be weighing over the resolution fund. Who is going to pay this? Someone has to pay…

You already spoke about the Banking Union. What is the role of this union? Can it bring confidence towards European banks?

The Banking Union was announced in 2012, if I'm not mistaken. It was important because it allowed for a relief from the tension that was felt by that time in the Euro Zone, with a serious risk of fragmentation.

Combined with Mario Draghi's statement "we will do whatever it takes to preserve the Euro", the Banking Union alleviated the pressure over sovereign debt and the euro, mitigating the redenomination risk (i.e., countries could leave the Euro Zone). It is having another merit: uniform regulatory and supervisory framework, which is favourable to market integration and money circulation.

However, the financial crisis affected different countries in a different way and we do not see

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surprise for me that, even though deficit has been reduced, Portuguese bond yields are still very high. Overall, I think this monetary policy helped but is not sustainable for long.

What is your vision of the current state of the Portuguese economy? What are the main risks and opportunities it faces?

yet a perfect financial markets integration. The Banking Union would be a way to avoid the “balkanization” of the EU. But, for the aforementioned reasons, Portugal still has to pay a higher risk premium than many other countries. The goal to reduce the differences in financing conditions is still to be achieved.

I think the Banking Union is still missing a pillar to support resolutions of banks like Banco Espírito Santo. The intervention at an European level is not yet operationalized.

A two-speed Europe is also reflected in the banking system…

Exactly! That is one of the problems.

We know that monetary policy (asset-buying programme, benchmark interest rate and others) affects banks. Do you believe these initiatives have worked properly? Are we about to face a shift in the strategy?

I think ECB’s intervention in the secondary markets allowed government bonds yields to decrease until historically-low

levels. After the economic recession and facing a low inflation rate, BCE has been implementing dovish monetary policies, injecting money into the economy, lowering interest rates and implementing the Quantitative Easing.

That controlled the deflation risk but has been insufficient to spur aggregated demand at an European level. I do not want to deny the positive effects of economic recovery and rising inflation. In my perspective, the effects are very slow and it has lasted for too long, creating a terrible environment for the banking activity, cutting the spread margins. This lowinterest rates environment is bad for banks’ profitability. This situation combined with high levels of Nonperforming Loans (forcing banks to clean up their balances and to recapitalize), makes it difficult for banks to attract capital. We just got out of a sovereign debt crisis and are creating a risk where the States can be asked to intervene in the recapitalization process, potentially increasing their public debt levels. And that is a risk factor for those who assess the financial situation of the States. That is why it is not a

I think the Portuguese economy is very sensitive to external conjuncture. As we tend to say, we are a small open economy.

But at the same time, I see great potential in a significant group of companies focused on the external market, being able to fight against internal problems and lack of internal demand. The recession was mitigated due to these firms.

That makes it very important to reinforce competitiveness.

Improvements in the companies' organization and management are important. Innovation also happens in organization models to improve results. In terms of the labour market, I think we have a labour factor with a huge

“[Monetary policy] is creating a terrible environment [for banks], cutting the spread margins”

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adaption capacity. I would appreciate changes to increase flexibility but, most importantly, to end with the dualism in the labour market. I think this market is very dual, as we have contracts with a big degree of protection and some situations of precarity. I would like both regimes to converge. In a medium to long-term perspective, focusing on education, where we are clearly behind against our European peers, is fundamental. That is the real structural deficit of our country. From the end of the 19th century, we have always been “in the tail” of education levels. A country aiming to be rich needs to enrich its human capital.

The positive impact of education on the country is obvious. Taking into account your professional and academic experiences, what are the advices you give to management and economics students in our country?

The biggest advice I would give is to never stop learning. My degree in economics was just the first step. When I was your age I thought graduating was 28

more than a starting point. In the US, when they graduate from university, the celebration is called "commencement". It is a starting point, not the end. I learned a lot at university but what I am using is what I learned during my career.

However, I would have never been able to learn if I did not have the skills I absorbed at uni.

Secondly, we learned a lot from looking at others. Teamwork and listening skills are a great source of learning. And do not learn merely hard skills. You should know the details of a model but you should have the so-called soft skills.

Communication, negotiation, debate are essential factors and valuable to any professional career. In your particular case, you will most likely start in a very technical role but you will climb up to leadership and team management positions.

To conclude, what keeps motivating you daily? What are the main factors you appreciate more in this new career stage?

What I appreciated the most during my career was to feel that, despite having a certain

routine, facing new situations, being prepared and feeling confident and capable of solving them is what motivates me. I would be bored if I was to do the same thing every day. Feeling that today we can have a problem to solve or good news is what gives us adrenaline and will to be permanently in action.

“The biggest advice I would give is to never stop learning.

My degree in economics was just the first step.”

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Nonperforming loans One of Europe’s current headaches

Catarina Castela and Gonçalo Marques Since the 2008 financial crisis, Europe has struggled to shrug off the value of nonperforming loans and this has become a severe issue in the recent years. In fact, the high levels of nonperforming loans are not only affecting the banking sector but also negatively impacting the overall economies of the member states.

Before we jump into this issue, we would like to clarify this term for those who are not familiar with it. A nonperforming loan is a loan whose probabilities to be repaid are significantly low.

Generally, loans are qualified as nonperforming when the borrower fails to pay the agreed instalment or interest for a period superior to 90 days, but a loan can still qualify if there are clear signals it will enter in default.

Obviously, nonperforming loans are not desirable. Even though they are inevitable by nature, the values Europe currently faces are alarming.

Nonperforming loans have summed up to €1.06tn, representing 5.4% of the total value of gross loans, which is the triple of the level of the banking sectors of Japan and US. This year, sales of nonperforming loans are even expected to get to as high as €200bn, a record amount, and almost the double of last year’s value of just over €100bn.

The graph in the next page is an 30

accurate picture of this issue.

The problem is not evenly severe throughout the member states, which hinders the creation of a shared solution.

One of the biggest problems is Italy, which alone accounts for more than one quarter of the “bad debt”. Also troublesome are the economies of Cyprus and Greece, with half of the total loans being toxic, which also equates to one third of their total bank assets.

The consequences of nonperforming loans are clear.

To start with, banks with many toxic loans no longer receive the interests and the repayment of these loans or at least the entirety of the amount, which decreases the revenues from the credit businesses and hence the banks’ profitability.

Moreover, banks need to put money aside as a safety net to protect themselves from the event of not receiving the value of the loan back. Combined, these factors result in a lower capacity to lend money to the

economy, further weakening the profitability and hurting the economic growth. There is also the possibility of recapitalization through public intervention, which may lead to the worsening of the public debt problem.

In addition, this interferes with the European monetary policy.

The ECB sets the interest rate influencing the cost of credit as a tool to move inflation to its mandate level of 2%. If the bank’s capacity to lend is undermined by nonperforming loans, the banks will not respond as expected to the ECB’s incentives and thus the mechanism of monetary policy loses some of its effectiveness.

It logically follows that to ensure the sustainability and success of the banking system, banks would need to keep their level of nonperforming loans at a minimum. So, considering all the factors that weight for the current situation, what can the banking system and the EU do,

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in order to overcome the excess of toxic loans, both nationally and internationally?

One implemented solution in Europe is the transference of Non-Performing Loans from the existent financial institutions to “Bad Banks”. In fact, whereas in normal cases NPLs are sold to private equity firms, in the past years this type of debt is being transferred to “bad banks” as a consequence of the wider gap between price expectations of buyers and sellers of the loans.

Currently, we face a reality of several “bad banks” coexisting independently, each one dealing exclusively with regional NPLs. However, this might not be the right solution for the long term.

Conversely, the European Central Bank suggested the creation of a wide “bad bank” that will aggregate a relevant slice of the current European €1 trillion in NPLs. In other words, the partial solution of the

Enria, chairman of the European Banking Authority, problem, according to Andrea would pass by setting up a common Asset Management Company (AMC), that would manage the sell down of NPLs. Specifically, the AMC modus operandi would be: first, identify toxic assets and estimate their respective real economic value; then acquire the targeted assets (note that NPLs will be bought above market prices, but below book value, implying a loss for the selling bank); hold the assets for a certain period with the objective of maximizing recoveries and then sell the holdings. If the AMC fails to meet the targeted recovery from a loan portfolio, it would have to resort to claw-back some of the shortfall from the selling bank.

Through the taxpayer-backed company, it would, hence, be possible to increase transparency around the true value of the NPLs piling in the

balance sheets of many banks and increase the size of the nascent market for such assets.

Banks would then be alleviated and able to concentrate on driving productivity growth.

Nevertheless, the implementation of this measure would be challenging. One of the hurdles regards the valuations (transparency would illustrate each country’s structural inefficiencies) which may not be viewed with receptivity, but many others like the need for expertise in dealing with the non-uniform insolvency frameworks, languages and loan structures of each member states could risk the application of this solution. In fact, Fitch publicly stated that these measurements would be “politically difficult” and “unlikely in the near term”.

The financial crisis is almost a decade old and Europe has not been able to solve the issue of the nonperforming loans yet. If the challenges for the implementation of this solution could be overcome and this idea put into practice, this might well translate into relief for the credit business and consequently a possible spur of growth for European economies.

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NIC Undergrad Review Volume 3 - Issue 2

Nun of your business An investigation into churches’ portfolios

Anna Averina and Francisco Gonçalves

It seems that even Churches cannot escape the search for yield.

Take the recent example of a nunnery in Mariendonk, Germany. In the past, the nuns there would have sold milk, candles, and embroidered vestments – all of which, in addition to the accrued interest from their accounts, would have sufficed to make ends meet.

Today, Sister Lioba is a serious “cellerarin” – a sort of chieffinancial-officer for her convent.

She manages a portfolio of nearly €2 million.

The Mariendonk nunnery was feeling the squeeze from the ultra-low and negative rates that so many other pension funds were experiencing.

Before, with interest rates above zero, Sister Lioba was happy with her deposits: the interest accrued allowed them to be 32

self-sufficient.

There is, however, another side to this story. Mammoths like the Vatican Bank and the Church of England had already pushed into equities, fixed income, real estate and currency operations – embarking on the search for yield way before interest rates had hit the zero bound.

The aim of our article is simple: to decompose the portfolios of some of the world’s biggest churches, taking into consideration other aspects such as return, risk, and ethics.

The finances of these religious institutions, however, are highly secretive - akin to “trying to find one’s way through a labyrinth.”

The lack of data and the rough guesswork places obvious limitations on our work. We will speculate only where needed, and try our best not to go full “Dan Brown”.

THOU SHALT INVEST IN AN INCLUSIVE SOCIAL MANNER Most religious institutions employ an ideology of social responsibility – where morality takes the centre-stage in the decision-making process. As an example, in the 1950s, the Vatican Bank considerably reduced the exposure of its investments to a pharmaceutical firm producing contraceptives.

Though profitability, low risk, sufficient liquidity and ethics are all leading criteria, profits can be compromised in favour of sustainability and morality. You would not find sin stocks in the respective portfolios, although investing in prisons would be very Dostoevsky-Christian of them. Religious, racial and gender equality, as well as conservation of the environment, are all important considerations. A tendency to flood blue chip stocks in Russia, however, would violate conservation concerns - with 70% of blue chips representing the oil and heavy production sector. Is this ethical? It’s not hard to spot the contradiction.

At times, however, churches prioritize profits over ethical conduct. For example, the Vatican Bank carried out currency operations, using the lire to buy weak dollars and converting them back into lire.

This activity may have been reflected in the different rates of exchange offered by the Vatican, as compared with Italian banks and currency

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dealers outside its walls.

In the next sections, we take a closer look at the different asset classes that make up the portfolios of religious institutions.

EQUITIES Historically, Churches are extremely secretive about their finances. According to “The Finances of the Vatican”, an article published by Ernst Lewin in 1983, the Vatican Bank had already moved parts of its investments outside of Italy by the 1980s, leaving 8% of its investments, roughly $40 million, inside the country. We gain little from inspecting the Vatican Bank’s annual reports, which have been published since 2013, under pressure from the new papacy. Excluding deposits and non-managed portfolios, the Vatican Bank actively manages a discretionary portfolio worth €3.2 billion, with 22% allocated to equities.

There is hardly any mention of the composition and exposure for the Vatican’s equities investments. In the 1980s, the Vatican had allocated investments towards “blue chips” such as General Motors, General Electric, Gulf Oil, Shell, IBM, Bethlehem Steel, Nestle, and TWA, among others.

Assuming the Vatican Bank is essentially conservative and unwilling to rebalance away from a similar “blue chip” structure and assuming equal weights to all securities, we calculated an annualized return of the Vatican Bank’s general equities portfolio of around 13.6% YoY (counting from May

4th, 2015-2016). Meanwhile, S&P 500 returns would round up to 16.43%, implying that the Vatican Bank had, effectively, unrealised potential gains of around 20% when compared to the overall market performance.

Note that the Vatican Bank has no financial derivatives on their balance sheet, although most religious institutions do invest in them primarily for hedging purposes, not to reap higher returns from options and future contracts.

With regards to equities, the Church of England, for one, has come a long way after their disastrous decision in the 1990s-bull market to channel 100% of investments from its pension scheme into stocks.

Shaun Ferrell, chief executive of the Church of England Pensions board, justified the strategy, claiming “[in the long run] equities will give you the highest returns”. As of 2015, the Church of England funds were valued at just over £7 billion, nearly £300 million higher than at the end of 2014. Returns for the year of 2015 were 8.2%, with a 23% exposure to Global Equities, 9% for UK equities, and 8% in defensive equities. Overall, the equity portfolio generated positive returns of 4.4%.

FIXED INCOME In line with the long-term investment ideology, it is natural for religious institutions to have a large exposure to fixed income. Interestingly, this is one area for the Church of England where one can see a push into higher yields. Their fixed interest portfolio, which also includes investments in global high yield bonds and emerging

market debt, returned -1.6% in 2015. Collapsing commodity prices were cited as a root cause of underperformance.

In 2015, the Vatican Bank slightly decreased (-2.1%) its investment share in debt securities issued by governments, especially emerging markets, increasing its exposure by 10.5% to corporate bonds. The Vatican Bank’s fixed income portfolio is almost entirely composed of investment grade bonds, with high exposure to Italy (34.6%), and similar exposure levels between Spain (13.4%), North America (10.9%), and France (7.9%).

Over the last years, the Russian Orthodox Church has opened bank deposits and purchased short-term government bonds.

However, Russian short-term bonds, (already adjusted for currency risk) are rated Ba1 by Moody’s, and BB+ by S&P, with both rating grades falling into “non-investment grade” category.

REAL ESTATE Investments in real estate and in the real economy also account for a considerable part of churches’ portfolios. More than that, these investments sometimes are made into exotic and unexpected property types.

As such, the Church of England, apart from typical investments in residential and commercial property, devotes a significant part of its real estate profile towards forestry estate, timberland, and wind farms, yielding overall 13% return in 2015 - outperforming the 2015 FTSE250 (9.1%), even though 33

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forestry is a highly illiquid asset.

The Vatican Bank also owns large holdings in real estate, albeit no profit is made on such property; it is usually let as apartments and religious buildings. A curious story, however, broke in the 1980s when the Roman magazine Europeo published its investigations into the Church's property. Europeo stated that a quarter of all the real estate in the city of Rome (roughly 40 million meters squared) was owned by the Church.

Consequently, the Vatican was the only state in the world which owned more property outside its borders than inside.

In 2012, the Church of Jesus Christ of Latter-day Saints, also known as the Mormon Church, also completed a $2 billion ambitious project: a megamall across the street from its temple in Salt Lake City. Commenting on the investment choice, the Church leader Keith B. McMullin said: “We look to not only the

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spiritual but also the temporal, and we believe that a person who is impoverished temporally cannot blossom spiritually”.

RETURN-ETH TO NORMALCY? Today, religious institutions boast diversified portfolios. This is largely explained by a lowrate environment, which for nearly a decade has constrained religious institutions in their search for yield, low risk, and moral acceptability. A push for accountability has also played a small part in this trend - after all, it would be most unwise for any transparent and good-doing institution to place all of its eggs in one basket.

Attitudes are changing, and the church no longer only answers to God, but also to regulators.

Religious institutions are also becoming much more financial savvy. Where would their investments go? Will they increase their exposure to fixed income in detriment of riskier

assets like equities? In the US and Europe, investors believe that sooner, rather than later, interest rates will increase to pre-crisis levels. There is no way to be sure. What we do know is that if interest rates do indeed recover, Sister Lioba and the other nuns can go back to simpler times, when milk, candles and embroidered vestments were all that was needed to make ends meet.

“We look to not only the spiritual but also the temporal, and we believe that a person who is impoverished temporally cannot blossom spiritually”.

NIC Undergrad Review Volume 3 - Issue 2

The real effect of buybacks Why US taxpayers may be paying the salary of Intel’s CEO

Eduardo Gameiro and Francisco Logrado “There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds - cash plus sensible borrowing capacity - beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”

What are in fact share buybacks? Share buybacks are simply the use of a company’s cash flows to repurchase its own stock; this leaves investors who already own stock in a company with a larger portion of that same company without having to expend their own money to buy more shares of the company.

Warren Buffett, 2000

This article, as the above quote suggests, is not meant to criticise the use of share buybacks.

Instead, the aim is to help investors reassess the true impact of share buybacks on a diversified equity portfolio. The media overemphasizes the recent impact of buybacks as that of being a simple additional yield: if in 2014 buybacks represented 2.9% of the S&P500’s market capitalization, if we were to add that to a 1.9% dividend yield on the S&P 500 we would have a dividend-plus-buyback yield of 4.8% on an equity portfolio.

The repurchasing of shares on the open market with little regulation began in 1982 when the Security Exchange Commission instituted Rule 10b.18 of the Securities Exchange Act. It allowed the corporation’s board of directors to authorise senior executives to repurchase up to a certain amount (maximum of 25% of the previous four weeks’ average daily trading volume), with the company being forced to publicly announce the specific program. However, the SEC only requires companies to announce quarterly repurchases, and not daily ones, making it easier for senior executives to breach this law and to manipulate stock price without authorities noticing.

But that is simply an exaggeration. To explain why we need to first answer a few questions.

If buybacks weren’t offset by the new stock issuance and the companies didn’t have a better

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Historical Timeline - Mean Dividend and Stock Repurchases versus S&P500 Index Performance

use for its profits, then this would be a very easy game to play. There would be no investor who would be voting against the use of stock repurchases.

Problems arise when buybacks are used as a means for executives to have multimillionaire unjustifiable compensations. Most top executive compensation is based on the exercise of stock options. What are these stock options, how are they exercised, and how do they relate to stock repurchases?

For instance, in the the graph above, from 1981 to 2014, note that when the stock market prices were higher, the average value of stock repurchases by the S&P 500 companies was also much higher than when they were lower, invalidating the argument that companies have mainly chosen to do stock buybacks when their stocks were being sold below intrinsic value. One can also note the magnitude to which stock buybacks have grown during the last decades, from being almost negligible when compared to the average company’s earnings in the early 80’s, to representing around 54% of the S&P 500’s company’s average earnings between 2003 and 2012. When considering that dividends, during this period, were on average 37% of earnings.

This means that only 9% of earnings were left for productive reinvestment.

It is an undeniable fact that the larger companies 36

nowadays have many more competitive advantages than before and are also much better established, and as such, do not need to have very large capital expenditures to maintain their competitive advantages and grow their revenues.

But it is also an undeniable fact that most of these buybacks do not benefit shareholders. The reason these normally happen, mostly during boom years, is mainly because executive compensation is much higher during these periods, with companies and businesses performing better. Considering executives are mainly compensated through stock options, what they effectively do is increase the number of stocks publicly traded when exercising such options. Shares are repurchased so as to avoid diluting investor holdings.

In fact, according to a study by S&P equity analysts Todd Rosenbluth and Stewart Glickman, for the year of 2007, 423 companies in the S&P 500 repurchased almost 20 billion shares of stocks despite the fact the number of outstanding shares was only reduced by 4.4 billion. The study concluded stock buybacks had been conducted to offset dilution of employee/executive stock and option grants. Therefore, there is a large proportion of a company’s net income which isn’t used to benefit common shareholders, and is simply ineffectively spent with the goal of increasing the managing board’s income.

If we were to add the possible dilutions from the

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issuance of shares for M&A and the net increase in a company’s debt that normally arises, as companies normally use debt for repurchase of shares, one would conclude that for investors in the U.S. public equity market, buybacks were simply a mirage. Just in 2014, for example, net debt issuance of $693 billion was almost the same as total buybacks of $696 billion. In fact, looking at the following graph and making use of the Bernstein and Arnott method, one can conclude that there has even occurred share dilution, which is calculated by computing the difference between changes in total market capitalization and the individual price level of stocks. The former has increased at a rate that is on average 1.7% lower than the total market capitalization during the last 80 years, so we should be in fact adding a -1.7% yield on the net buyback effect, and not the almost 3% yield normally publicized.

One of the main problems to society arising from the ineffective buyback operations and the destruction of companies’ profits, is the fact that in some industries, in which we see the managing boards incurring in the same type of operations,

the taxpayers are funding it for research and development, instead of the companies in question. While Intel is being heavily financed by the US State for the development of its nanotechnology operations, whose national programme spends around $1.5bn each year, Intel alone has spent four times that amount on buybacks. US citizens are indirectly paying salaries for the Intel CEO.

What’s the best way to avoid all this?

What could be done in the first place is to have new metrics to measure senior executive’s performance, rather than emphasizing the EPS ratio, which incentives buybacks programmes we could use what Bernstein and Arnott proposed which is a much better way to evaluate a company’s management team, as it examines the real stock dilution and helps shareholders better evaluate a company. We should also not be handing out money to almost everyone who intends to do research and development because it creates a vicious cycle which promotes inefficiency and the bad use of taxpayers’ money.

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NIC Undergrad Review Volume 3 - Issue 2

Semper ubi sub ubi An essay on Universal Basic Income and the future of societies

Tiago Louro Alves

On the front-page of Utopia, the humanist Thomas More identified himself as a citizen of the famed city of London. He was a 16th-century-citizen living two centuries before the industrial revolution and at a time when one was unlikely to find any real income advantage of living in a more developed nation. Several pages on, the author raised a fundamental issue: the relationship between imagination and experience.

The objective of this article is to describe a utopia. One ought to clarify that utopian thinking must not stipulate to exhaustion how a perfect society should look like. It must formulate proposals for reforms to the current social order, justify these by reference to principles to which one is willing to commit, and subject the proposals to nonindulgent critical scrutiny.

With that, I shall describe the simple real utopia commonly

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known as Universal Basic Income - hereinafter referred to as UBI - defined as an income unconditionally paid to every member of society, on an individual basis, without means testing, and without a work requirement. Diachronically, this idea has been advanced by Thomas More, in 1516, by Johannes Ludovicus Vives, the humanist regarded as the true father of the idea, in 1520, and by such figures as John Stuart Mill, Thomas Paine, Friedrich Hayek, and Milton Friedman.

As with every controversial idea, the debate is intense.

THE CASE FOR UBI At the outset, UBI appears to stand as the best of all practical solutions: a welfare system that is simple, almost impossible to corrupt, and does not contravene freedom of choice.

Nowadays, the central case for

UBI is that it would lessen the consequences of a new automation revolution driven by robotics and artificial intelligence that will unquestionably affect the jobs of the future. It is a solution that offers a strong protection to citizens facing the loss of their jobs as the productivity of technology increases.

Managing the transition to the fourth industrial age would encompass economic, political, and moral dilemmas but a system where the increases in productivity are taxed and then distributed could resolve some of the conflicts.

The implementation of UBI can also be seen as a way to simplify the welfare system of both developed and developing countries.

Eliminating the myriad of social programmes and replacing inefficient subsidies with cash transfers would ensure at the very least the poorest are getting the

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intended monetary benefit. Not only that, it would empower them with the option of choosing how to spend their money.

On top of that, an argument for countries with commodity-driven economies is that UBI would allow for an efficient use of natural-resource rents. It is a fact that corruption is a driving force for the misallocation of the resources of many sub-Saharan oil-rich countries. By having oil revenues go directly to the government, citizens never get to scrutinize the magnitude of revenues coming from that public good.

Greater accountability and efficiency would be achieved if, instead, such revenues were to be firstly transferred directly to citizens in the form of basic income and then taxed by the government to finance public spending.

However, as The Economist stated: “If the need for a basic income is unproven, the costs are certain.�

THE CASE AGAINST UBI The path to guaranteed basic income comes, undeniably, with costs that are not only social and economic but also political.

The first concern with UBI is straightforward.

It is the conservative case. It states that UBI eliminates the incentive to work. Firstly, the elimination of the incentive will lead to a decline in economic activity and ergo, aggregate output and income. Secondly, the lack of incentive to work erodes society by driving individuals into state dependency; this is an argument that has been tested in pilot projects all over the

world and that is as simple as economically and morally dubious.

On the public policy side, while UBI might cut down on the complexity of current forms of welfare systems, it is not certain that it would guarantee that some specific needs would be satisfied. Granted that both systems reduce inequality of condition, the current welfare state does so with greater efficiency as it takes better account of inequalities due to differences in needs.

Accordingly, citizens would be better off with a satisfactory selection of governmentprovided merit goods such as health services (e.g., singlepayer healthcare), subsidized housing (e.g., rent supplements), and nutrition support (e.g., food stamps).

Moreover, the idea of UBI being financed by companies is, in part, flawed. In a globalized economy where companies are free to move to wherever they may find the lowest costs, a tax

to finance a basic income programme would incite companies to simply move out of that country. Firms operating from low tax regimes would have a competitive advantage as they would have greater ability to invest and innovate. Countries, where such a tax was to be implemented, would not only lose the ability to pay for a UBI programme to its citizens, as well as the beneficial effects of having the company in its domestic economy.

AT A CROSSROADS In toto, UBI might not ever get to be anything but a utopia. As Lawrence Summers put it: "a universal basic income is one of those ideas that the longer you look at it, the less enthusiastic you become." But rest assured: technological progress will not stop nonetheless. The citizens of tomorrow will encounter the problems of inequality and growing unemployment that we have not thus far been able to solve. If this is not yet a concern of yours, maybe it should be.

An egalitarian city: all equally non-rich and unemployed

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NIC Undergrad Review Volume 3 - Issue 2

Auto loans and the 2008 Financial Crisis Can auto financing be the source of a new crisis?

Francisca Vera and Pedro Sousa shouldn’t we worry?

On the aftermath of the 2008 financial crisis, investors turned to auto loans, a safer investment, since people would be less prone to default on car loans than they were on mortgages.

In the following years, there was a boom in the car sales industry. Accompanied by looser credit standards, this increasing competition and lower recovery rates on defaulted loans led to a rise in the demand for auto financing. It might not be possible to picture this scenario after one of the worst credit crisis in history. However, it happened.

According to Forbes, in 2013, a record of $22 billion new US subprime auto were sold, and sales remained strong in the following years. In 2014, according to Reuters, the number of U.S. consumers taking out loans to buy cars, especially to purchase used vehicles, reached a record. In the end of 2015, the total of outstanding car loans summed up to $1.1 trillion.

Due to the worrying trends, rumors have it that car loans will drive us to the next financial crash, just like subprime mortgages did. Actually, there are some similarities between sub-prime mortgages and car-leasing loans: the latter are being sold to people with bad credit scores [Exhibit 1], and they are also being packed into asset-backed securities (ABS) and rated as investment-grade by credit agencies. So why 40

Exhibit 1

The truth is borrowers are falling behind their payments. According to S&P Global Ratings, losses of lenders were at its highest since the post-crisis period in February of this year. These deals are a highly relevant part of the UK debt and, in December 2016, according to the New York Fed Consumer Panel, 9.2% of the household’s debt in the United States.

But cars are not houses, consequently, auto loans are not similar to subprime mortgages. First of all, auto car loans have a considerably shorter repayment period than mortgages. Secondly, the foreclosure of a house is a much harder process than the repossession of a car. Especially, nowadays, cars can be equipped with technology devices that are able to track and disable the vehicle. On the other hand, although the car loan market is $1.1, trillion it is only a fraction of the $10 trillion mortgage market. Lastly, particularly in rural areas in the US, cars represent the only means of getting to work, therefore people are unable to afford its repossession.

Adding to the deteriorating credit quality in car loans and ABS, the outlook for the US auto sector in 2017 and beyond is increasingly negative. After having hit a record high of 17.55 million units in 2016, US sales of new cars and trucks are expected to decline in 2017, according to

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Moody’s. Parallel to this, the used car market looks gloomier as days go by, with Morgan Stanley recently projecting a 50% fall in prices over the next 4-5 years. An increase in consumer preference for leasing vehicles since 2009 is expected to culminate in a used-car glut in 2017, as leases end and cars are returned to the stands.

Lower used-car prices mean auto financing companies have to sell foreclosed vehicles for less, adding to losses related to nonperforming loans. With rates expected to rise in the near future, those who more vividly recall 2008 may remember the consequences negative equity had on the housing market.

However, it is unlikely we will be seeing vehicles being abandoned, for the reasons detailed above.

Besides auto loans, the car rental sector has been the most affected. Hertz, the car rental and financing US Company, has attracted the most negative sentiment, with its 2022 bonds hitting a record low in April [Exhibit 2].

the company has increased, with corresponding 5-year credit default swaps rising as much as 60% between March and April, reaching 800 basis points [Exhibit 3].

Exhibit 3 - Hertz Corp. 5y Senior CDS (Source: Bloomberg) Hertz derives 75% of its revenues from the US market so that if Morgan Stanley's projections materialize, the company might be in deep trouble. Besides market risk, Hertz is seen as being over-leveraged, with net debt to EBITDA of 4.4x, and the fact that its maturity wall coincides with the period of the expected downturn in the used car market doesn’t help either - most of its debt matures during 2020-2024 [Exhibit 4].

As the situation in the US car market unfolds, companies such as Hertz will certainly make its share of headlines in the financial press, and it will be interesting to follow along. But if both financial and market analysis favor a bet against Hertz, short sellers should beware - one of the major holders of the company is activist investor Carl Icahn, who doubled his stake to 33% in November last year.

Exhibit 2 - Hertz Corp. 2020 senior bond price and the Manheim Used Car Value Index (Source: Bloomberg)

Rental car companies usually hold their vehicles for 8 to 20 months, and after this period vehicles are sold through auctions or to a used-car dealership. This resale process exposes the company to market risk related to the price of used cars. Vehicles are also the constituent of Hertz’s inventory, and one of the main assets being used as collateral in its bonds and loans, so it is no surprise lenders seem worried with the increasing liquidity and default risk of the company. Besides a drop in the value of its bonds, the cost of protecting against the default of

Exhibit 4 - Debt distribution of Hertz Global Holdings Inc. in million USD (Source: Bloomberg)

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NIC Undergrad Review Volume 3 - Issue 2

Chao Gupiao Stir-frying stocks

Leonardo Figueiredo and Miguel Monteiro

The Good Book plainly states that: no man can serve two masters. However, it appears to be that those participating in the hedonistic razzmatazz that is the 21st-century stock market domain have been missing their Sunday congregations. Stock exchanges serve two masters: both the publicly listed companies, often desperately in need of financing and the investors that provide them with financing. The revered system represents a dichotomy of sorts in which intermittently the interests of one of the parties are so often impaired in order to benefit the other. If a balance between the interests of the two can be procured then the result is prosperity all round, barring the occasional shake-out of a bear market. Get this balance wrong and your economy is potentially deprived of a fundamental support of prosperity.

Simply put; the reason that stock markets work at all is due to high levels of trust. Trust is a large—if not the largest—contributor to what separates the stock exchange from the casinos; the abiding belief that the companies in which you invest your money owe you a duty of care with your money.

This concept of trust in the stock market as well as a stock exchange’s similarities and dissimilarities with a 42

The Chinese refer to playing the stock exchange as “chao gupiao”— “stir-frying stocks” (...) – it's easy, tasty, requires little thought and often comes at a cost! betting house are discussed and exemplified in greater detail in Burton Malkiel’s book “A Random Walk Down Wall Street” where the author goes on to explain that it is trust that guides the markets and ultimately allows for both profits and losses. Theoretically, the removal of trust would expel demand, this would be troublesome. Companies are obliged to recognize that investors trust them and conversely investors have to recognize that the listed companies recognize their recognition in them. Albeit a muddled definition, this is the basis of trust in today's markets. If this definition fails in any one given market, then all you have is a casino.

Investing then becomes purely a gamble, an exercise in cynicism, based on the greater fool theory that greater fools than you exist and thus

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you can perhaps wait a little longer before cashing in. The result—an unstable market based solely on speculation and immeasurable manipulation.

disgruntled gamblers to the next best alternative—a highly leveraged and volatile stock exchange that is in every respect controlled by the totalitarian Chinese government—dulcet.

In China, the stock market is considered to fit the aforementioned description of a market without trust, ultimately a casino; it serves as, what can only be described as a form of entertainment for private Chinese investors, a get rich quick scheme for the fortunate few (quite a few, really) that have insider information and as an economic tool for the Chinese government. Both Speculation and manipulation are at gross levels.

The Chinese refer to playing the stock exchange as “chao gupiao”— “stir-frying stocks” because just like stir fry, it's easy, tasty, requires little thought and often comes at a cost! What is most worrying about this form of gambling is that the government and the CSRC (China Securities Regulatory Commission) allow players to leverage their bets. This is advantageous to the government because their SOE’s raise more capital but is disastrous on those who have to foot bill should their bets mature unfavourably.

Analysts have noted that this is a prime example of a government not protecting its people and that it comes down to a matter of ethics, all of which the Chinese government is choosing to ignore.

Perhaps the most pertinent cause for the blatant gambling taking place on the Chinese stock exchange is the law that makes non-approved forms of gambling a crime in mainland—Article 303 of the Criminal Law of the People’s Republic of China. This law states: “Whoever, for the purpose of profit, gathers people to engage in gambling, runs a gambling house or makes gambling his profession shall be sentenced to fixed-term imprisonment of not more than three years, criminal detention or public surveillance and shall also be fined.”

Although a substantial amount of illegal (quasicasino style) gambling still takes place in the homeland, Article 303 serves as a sufficient deterrent for most Chinese gamblers that have their minds set on making (or most likely losing) a quick buck. As implicit above, this leads many

The main objective of any stock market is to give companies a way of financing themselves, while also giving investors the opportunity to amplify their capital by buying stocks of the companies which they believe will do better in the future or are undervalued at the moment. Although this market is overviewed by the SEC, it is the law of demand and supply that rules prices, which will make investors take into account the price of each stock when compared to its risk, with shares prices generally having an inverse relation to their risk.

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On the other hand, China, which is one of the biggest emerging markets, has a socialist market economy which means that the majority of its companies are stated-owned. This way, raising capital for these state-owned enterprises will be directly giving the government capital, the main objective of the Chinese stock market.

Although Government’s intervention instruments have varied a lot during the past years, the ultimate goal is to have a stable growing equity index, following the fast growing GDP of the country.

From 2014 up until the middle of 2015, propaganda was released in order to encourage the population to invest in the stock market, convincing them that Chinese companies were strong and that the State was ready to intervene to keep their value high if needed. The “fake certainty” of a no risk investment made the people eager to invest, being registered the opening of more than 38 million investment accounts, leading to a rally in the stock index. The constant encouragement for individuals to buy equities led to a peculiar composition of the stockholders in the country, in which small investors represent 90% of all trades as opposed to a dominance of institutional investors in other countries.

As a way to stop heavy declines in the stock market, the government also imposed a lock-up rule for whoever had more than 5% of a company’s tradable stock, banned one-day short selling and instituted circuit breakers (mechanisms that halt trading in order to diminish panic-selling).

Both the ban on short selling and the circuitbreakers may seem to decrease volatility but in reality, they can have the opposite effect. In times of steep declines in the stock indices, short selling will have the effect of attenuating the falls in stock prices since even though investors are predicting the stock will plunge, they will need to buy securities before selling them, thereby increasing demand. Circuit-breakers are supposed to give time for investors to think rationally about what is happening and adjust their behaviour accordingly but in the past this mechanism did not work as people believed trades were halted because the stock would decline more in the future, the 44

majority of investors tried to sell as soon as the market opened again, increasing volatility and the fall in prices as opposed to the objective of the instrument.

Even though the main reason for Government intervention was to reduce volatility and spur the economy, the constant rule changes and different approaches from the state create uncertainty, ultimately resulting in higher volatility. Moreover, since new rules always benefit the country, China’s financial systems credibility has been affected, lowering the interest of foreign investors.

Furthermore, combining the lack of transparency, limits on trading by foreign investors and the need of approval from Chinese regulators before offering investments related to the country's equities as well as the difficulty related to capital repatriation makes it extremely difficult and not appealing enough for foreigners to invest their money.

In spite of the fact that the Chinese economy is still one of the fastest growing emerging markets, it’s over-regulation and difficulties imposed by the Government to foreign investors hamper it from being included in MSCI index. It is widely believed that China would benefit greatly from entering this worldwide index, as it would give the country’s companies more exposure and therefore greater access to financing. However, the State is not willing to do it overnight. As stated by Fang Xinghai, vice chairman of the China Securities Regulatory Commission “It’s not that we totally object to it, but we believe it needs to be done step by step”. This most probably implies that we will not see China entering the MSCI this year (2017), but hopefully, in the near future, the country will lower its regulation in order to meet the requirements to join. Ultimately this would lead not only to a more prosperous Chinese economy but perhaps also to a healthier global economy.

Stock markets work (…) due to high levels of trust. Trust is a large (…) contributor to what separates the stock exchange from the casinos.

NIC Undergrad Review Volume 3 - Issue 2

M&A waves Toshiba took a hard blow.

Carlos Gonçalves and Diogo Conceição 2016 was a not a great year for M&A crossing the $3.2tn mark, -18.1% vs. 2015. Buyer acquired Monsanto ($66 billion), British American Tobacco already owned 42% of Reynolds American so it acquired the remaining 58%($47 billion) and China National Chemical Corporation acquisition of Syngenta ($46 billion). Morgan Stanley, leading in deal volume, and Goldman Sachs, leading in a number of deals, dominated on the largest deals of the year.

The magnitude of M&A deals goes way beyond the final value of the acquisition. The possible added value of the synergies can be immense by reducing costs, optimizing sales and distribution channels, gaining market power or just eliminating competition. However, the repercussions of a failed deal need to be taken into account by the risk management division.

The aftershock of a bad deal can be financially devastating. Let’s take as an example Toshiba and Westinghouse deal.

Founded in 1886, Westinghouse Electric Company is a Pennsylvania-based nuclear power company whose technology forms approximately half the world’s atomic units.

nuclear energy. With its AP1000 pressurized water reactor, Westinghouse’s wanted to make plants cheaper and simpler to install, operate and maintain.

That is, the assembly of components of the nuclear plants would save money and time by requiring, for example, less skilled labor.

Moreover, the AP1000 is less vulnerable to earthquakes, as well as a cutoff of electricity (i.e., what set off Fukushima’s triple meltdown).

The year was 2006. Japanese companies had lost competitiveness to rivals in businesses (e.g., consumer electronics).

Toshiba saw in Westinghouse and nuclear power, to a certain extent, a better bet than other businesses - or so they thought. After a bidding war with General Electric, Toshiba bought Westinghouse in 2006 for $5.4bn. Around the same time, Southern and SCANA, big utilities based in Georgia and South Carolina, respectively, chose the AP1000 design.

Ultimately, it was a deal that proved to be expensive and ill-timed.

In 2015, Toshiba’s skeletons came out of the closet when it found itself in the midst of an accounting fraud: the Japanese conglomerate had inflated its profits by $1.2bn over seven years. In fact, a number of its divisions, such as nuclear power, overstated gross profit.

The US nuclear power industry currently consists of 99 nuclear reactors in 30 states. Moreover, it supplies approximately 20% of US electricity needs.

Westinghouse was ready to lead a revolution in

Toshiba’s health improved in the aftermath of the accounting scandal; in fact, at the time, Toshiba claimed Westinghouse was more profitable that when it was purchased. A year later, the Japanese conglomerate announced impairment charges to Westinghouse’s assets, equivalent to an annual operating loss of write-down of $6.2bn after writing down the value of its stake in Westinghouse.

The excessive costs to finance and construct and missed deadlines for Westinghouse's US projects 45

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meant that the sum of estimated future cash flows would be significantly less than expected, resulting in a decline in their fair value (below their book value) that Toshiba seems to be unrecoverable. Toshiba's nuclear unit dragged its financial health back down.

Truth be told, some of what went wrong were beyond either Toshiba's or Westinghouse's control.

To some extent, the unexpected delays were to be expected. A combination of factors, in particular, the nuclear accidents at Three Miles Island in 1979 and Chernobyl in 1986, left the American nuclear construction dormant for a long period of time. This discontinuation meant that American companies lacked the required equipment and expertise - especially taking into consideration the novelty of the AP1000.

nuclear plants, contributing to delays and downsizing and eroding nuclear power’s economic rationale.

Paradoxically, the (untested) regulatory system, intended to simplify and accelerate their development, blocked or delayed most all the US projects in their attempt to square the trade-off between the desire for greater safety and the need to contain costs. Ultimately, and despite government subsidization, in the form of loan guarantees and tax credits, it is daunting for the private sector to build nuclear plants. Projects take decades to complete and safety requirements change along the way, leading to new regulations, design alterations, delays, and spiraling costs.

Even the dirt used to backfill excavated holes at the Georgia site did not measure up to Nuclear Regulatory Commission standards, resulting in increased costs and a lawsuit.

Accordingly, few companies are taking on the complex and expensive process of nuclearreactor building. For one, General Electric has scaled back its nuclear operations. Areva, the French builder, is undergoing a large-scale restructuring. For now, the main stage for nuclear development will move overseas, either to China, India, the Middle East, Russia, and South Korea, where Westinghouse will have to find partners eager to turn growing nuclear technical abilities into a major export - to build its designs.

Moreover, demand for electricity slowed (against expectations), natural-gas prices decreased, and alternative-energy sources are rapidly maturing and coming down in price. Coupled with the global financial crisis and an accelerating revolution in shale oil and gas extraction, cost of more traditional substitutes to nuclear power decreased.

Toshiba's Hiroshima, however, emerged in 2011 when the Fukushima Daiichi nuclear disaster renewed worries - to say the least - about the safety of nuclear power. As per procedure, regulators revisited health and safety standards, slowing the approval of the Westinghouse designs . In return, construction delays, given that manufacturing orders had to be changed, brought about cost overruns.

All of these factors reduced global demand for 46

Having said that, absolution is not necessarily warranted for Toshiba and Westinghouse. Indeed, the devil is in the detail. It all started with a fight.

Specifically, a fight between the utilities, Westinghouse, and its nuclear construction contractor, CB&I Stone & Webster (i.e., CB&I’s subsidiary), about who should bear additional costs and delays from unexpected new requirements from American regulators. Thus, to push the projects forward, Westinghouse acquired CB&I Stone & Webster for $229m, which was having its own internal difficulties after a merger. Soon after, possible synergies proved obsolete as Westinghouse became embroiled in litigation over the deal’s terms.

To make matters worse, Westinghouse agreed to shoulder unanticipated costs (i.e., $5.9bn) in new

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contracts with a consortium (a combination of financial institutions, capitalists, etc., for carrying into effect some financial operation requiring large resources of capital.) led Southern and SCANA. Subsequently, costs mounted and construction swallowed more labor and time.

Nuclear business has imperiled Toshiba’s future; write-downs could mean that losses in 2016 will exceed $9bn. Morgan Stanley anticipates that the total costs (if completed) would be twice Westinghouse’s original estimate. This means that the recognition of CB&I Stone & Webster goodwill will be significantly greater than the original December 2015 estimate of $87m. In fact, CB&I Stone & Webster was worth less than nothing when Toshiba bought it. The goodwill is greater than the $229m that Westinghouse paid to acquire CB&I Stone & Webster).

Toshiba is currently unable to rule out the risk that all or part of the impairment charge would wipe out Toshiba's shareholder equity. As of last quarterly financial results, Toshiba's results showed losses impacted by write-downs at Westinghouse; its operating loss for the nine months ended on December 31 hit $5.2bn and the company says it had negative shareholder equity of $2.07bn.

On one hand, banks would be saddled with losses if they were to push Toshiba into bankruptcy; instead, they decided they will keep lending money to Toshiba so that it can pay its bills. Moreover, the conglomerate is looking to sell a majority stake of its profitable flash memory chip business for $9 to $13bn to offset its losses.

Furthermore, the microchip business is expensive; Toshiba spends $3 to $4bn a year on R&D and capital investments - costs it can no longer afford on its own. Shrinking might help Toshiba focus on its strength, for example, as a specialist in the design and production of heavy machines).

Foxconn, a Taiwanese electronics contract manufacturer, has reportedly offered $27bn for Toshiba’s semiconductor division. Regardless, the process will be painful. Pioneered nearly 40 years ago, NAND flash memory is one of the building blocks of modern electronics. Toshiba’s microchip business is viewed as a more valuable asset than TV screens, which made Japan lost

most of its market share to South Korea and China in TV screens.

Toshiba’s decision also places broader national interests at stake. Despite being the world’s second-biggest producer, Samsung of South Korea has overtaken Toshiba in NAND. Giving a competitor - likely a foreign one - a competitive position in the market is not particularly savvy.

Though it is desperate for cash, an aura of uncertainty is not helping Toshiba. Japanese companies frequently band together to rescue domestic rivals rather than let them be acquired by foreigners or fold. However, none of the early suitors for Toshiba’s microchip business are from Japan. To add insult to injury, Toshiba’s auditors, PricewaterhouseCoopers, refused to certify Toshiba’s books - a highly unusual move. Even more unusual is Toshiba’s decision to release its twice-delayed financial results without an auditor endorsement. One way or another, it all points to doubt over Toshiba’s ability to recover.

In March of 2017, Westinghouse filed for Chapter 11 bankruptcy protection. It has secured $800m in financing, which it will use on its core businesses: “supporting operating plants, nuclear fuel and components manufacturing and engineering as well as decommissioning, decontamination, remediation, and waste management."

Westinghouse is to go through a "strategic restructuring.” More than three years late and billions over budget, Westinghouse will complete the projects it already has underway, including two in China. The fate of other projects particularly in the United States - are in doubt; indeed, so is the role of the United States in the future of nuclear energy President Trump’s development policy in this field is unclear, which has implications for economic development (e.g., tax and trade policies) and national security.

Goodwill impairment charges do not hurt current year cash flows; instead, they show mistakes made in the past by management teams. In Toshiba’s case, the decision to purchase Chicago Bridge & Iron’s (CB&I) Stone & Webster - and Westinghouse, at least to a certain extent - without sufficient due diligence was a serious lapse in judgment.

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NIC Undergrad Review Volume 3 - Issue 2

Flat taxes The missing ingredient for economic growth?

Diogo Neto and SimĂŁo Serrano levels. For instance, if one tax code has a low rate of 5% for poor individuals and a high rate of 40% for wealthier one, and another tax code has income tax rates ranging from 5% to 60%, it's appropriate to say the latter is more progressive than the former.

Is a global tax reform long overdue?

Restructuring the taxation system is a byzantine endeavour as modern tax codes complexity entails problems of all shapes and sizes, from who to tax, to how much to tax, should it be more progressive, less progressive, can taxes be more efficient and what will the taxes be used for. Undeniably, fiscal policy is one, if not the main source of revenue for governments around the globe, with taxes being essential to provide a stable and functional administration that finances the taxpayer's fundamental benefits, such as education, healthcare or housing subsidies. Thus, it is vital we discuss how we - as individual consumers - are taxed.

Today, most governments apply a progressive tax system as their fiscal policy. This construct is grounded on the concept of fairness, which implies multiple tax rates, or in other words, a different tax rate for each income bracket. Henceforth, high-wage earners are taxed at a higher rate than lower income earners.

In addition, the degree of "progressiveness" is thus dependent on the flexibility of rates according to the income 48

The intrinsic fairness from a social point of view associated with progressive taxation as mostly to do with the notion of disposable earnings (income minus deductible expenses). On one hand, wealthier individuals theoretically have a greater capability to pay, as they have higher disposable incomes because even though they have fewer deductible expenses, their income is a lot higher in comparison to their poorer peers. On the other hand, less affluent taxpayers, low to middle class , in addition to having a lower tax rate, the lump sum on which they are taxed is lower, as they have more deductible expenses. M ore disposable income leads to a tax decrease on the middle class, resulting in an overall economic stimulus.

Moreover, this system lets the people with the greatest amount of resources to fund a greater portion of the services society depends on.

Government-wise, a progressive tax also suggests greater revenues as it allows to collect more taxes than flat taxes or even regressive taxes (e.g. VAT) since tax rates are indexed to increase as income climbs.

A flat tax is a taxation structure whereby taxpayers get charged the same rate, regardless of their income. However, some flat tax supporters leave space for certain deductions or exemptions, while others propose that no exemptions should exist. Nonetheless, most agree the tax should dismiss income from dividends, distributions, capital gains and other investments.

Yet, questions arise from this tax plan. Is it accurately fair? Is it really the best way to promote economic stimulus and economic growth? Is there a viable alternative? The short, but not so simple answer is yes. It’s called the flat tax.

Fundamentally, the underpinnings behind the plan are the following: with a flat tax rate, individuals would have an incentive to earn more since they are not penalized with a higher tax rate, au contraire of the progressive tax case.

Furthermore, it would massively simplify the whole taxation scheme and tax code, making compliance easier and reducing administrative costs. Additionally, by removing double taxation taxing only income - it would subsequently create incentives to investment if we consider that gains from investments (dividends and interest) are not taxed in a pure flat tax system.

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Moreover, it is important we cover another idea about the flat tax rate. Underlying this tax concept is an essential vision in economic thought that is a consumption tax. Consumption taxes lie on what people spend and not exactly on what people earn. It may see m strange because up until now we've been addressing income as the main idea. Yet, economically speaking consumption plus savings are equal to income. Once we receive our wages plus possible investment gains, we use the money either to purchase goods and assets or we save it. With a flat tax, we are really taxing the money people spend and save today. Thus, we can be much more efficient than what we are now since, currently, we must deal with double taxation. That is, we are taxed once in our income and then again when we buy goods or services which end up being very inefficient and makes people more prone to save instead of spending the money.

Opponents argue that this system promotes injustice and consequentially long-term inequality since it places an inequitable and disproportional weight on low-income individuals in exchange for lowering tax rates on the wealthy, meaning the tax system would transfer the tax burden from the rich to those who are least able to pay.

Conversely, the rationale behind this notion is perhaps inherently erroneous as a flat tax rate promotes equality in the sense that every individual pays the same tax percentage across the board.

Nevertheless, there are ways to shift the burden in favour of the low-income households. In the United States, there are currently

seven states with a pure income flat tax, with tax rate varying between states and between cities and counties within states.

To get around this problem, some of the states evened the odds in favour of distressed households (i.e. those which fall below certain income levels) by offering special exemptions or tax credits.

As we saw earlier, governments prefer to use a progressive tax because it allows them to boost tax revenue. However, Estonia that has a perfectly flat tax system, raises more than 30 percent of its GDP in taxes.

Furthermore, countries that use flat taxes have experienced economic growth since adopting flat tax rate policies.

“Our new Constitution is now established, everything seems to promise it will be durable; but (…) nothing is certain except death and taxes” (Ben Franklin) Right now, there are 38 countries with a flat tax system, including some states of the US, Russia as well as the three Baltic states.

The system was first introduced in Europe in 1994 by Estonia, which had reclaimed independence from the USSR just 3 years earlier. At the time it effortlessly replaced the existing multiple personal income taxes with only one straightforward rate of 26%. The other two Baltic nations promptly followed and a year later the three republics had in place a flat tax system with a rate varying between 25% and

33%.

But how did it perform against socialistic-based policies? Not to our surprise, far better than expected. Some of these nations have experienced strong economic growth of 6% and higher in recent years, particularly the Baltic countries, who experienced exceptional GDP growth of around 10% yearly. However, some do not seem to be convinced of its advantages… Arguing that the advent of capitalist economic systems and rapid market expansion after the Soviet domination explain the rapid growth along with the insouciant feelings towards eastern countries, objectors to free enterprise and, therefore, flat-tax rates, seem to contradict history itself. Even provided better judgment, such remarks allude, at the very least, to an implication of poor former fiscal policies.

Nevertheless, such fiscal policies and its variants do not seem to be feasible regarding its implementation within the EU. Understandably, bureaucrats have no interest whatsoever in studying the potential benefits of flat tax rates nor its counterparts as it would equate to profound changes in the way they operate, which, in our opinion, seems to resemble more of a super-state, rather than an economic union.

Therefore, one can only seem to look back in history, scrutinizing the several components of economic growth and ponder on the boundless possibilities that would arise from implementing free-enterprise-like blueprints.

Will we ever get to witness the effects of one of the pillars of a true, modernized laissez-faire?

Only time can tell.

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NIC Undergrad Review Volume 3 - Issue 2

Political scenario in Europe How populism is changing the political face of the Old Continent

Filipe Berjano

In the past few months, Europe seems to have dodge most of the populist threats that menace the European Integration Project. It seems like the major Brexit defeat hasn´t had much impact on the overall political situation in the remaining 27 countries of the EU. In France, the centrist liberal Emmanuel Macron swept the second-round with 66.1% of votes against far-right populist Marine Le Pen (33.9%), after narrowly beating her in the first round as well. The French elections were of great importance for the future of the Euro and the EU itself due to the nature of its two main

candidates: Mr. Macron, a determined pro-EU contender that defends further integration, vs Ms. Le Pen, a nationalist candidate that was determined to see France out of the Euro and described herself openly as anti-EU. In the first round, four candidates came close to pass on to the second: with Mr. Macron (24%) and Ms. Le Pen (21.3%) claiming the top spots, conservative candidate from the party “Les Republicains”, François Fillon took third, leaving the far-left candidate Jean-Luc Melenchón in fourth place (19.6%). The great disappointment was the candidate from the historic Socialist Party (PSF), Benoît

Hamon, who took a meager 6.36%, an all-time low for the socialists. For the first time since Charles De Gaulle formed the Fifth Republic in 1958, neither the Socialist or the Republican (a.k.a. Gaullist) parties managed to get a candidate through the first round of voting.

In the Netherlands, there was also the fear that the populist candidate Geert Wilders could win the elections and form an anti-EU government in one of the founding countries of the European Integration Movement. With his flamboyant hair and a strong anti-Islam propaganda, Mr. Wilders gave a 51

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hard time to incumbent prime minister Mark Rutte, from the Centre-Right party VVD, which ended up winning the elections with 21.3% albeit losing a significant number of seats in the Parliament. Mr. Wilders’ PVV still managed to reach second place with 13.1%, winning just five seats. Similarly to the scenario in the French elections, the socialist party PvdA was the biggest loser with a record low of just 5.7% (9 seats), losing a total of 29 seats in the Parliament.

These recent defeats do not necessarily mean the weakening of the Populist wave in Europe yet. In France, many political analysts warn that Mr. Macron’s presidency may be the last chance to prove the French and the Europeans in general that the EU still has a future. On top of that, Mr. Macron and his new-born social-liberal party “La Republique en Marche!” will face serious difficulties in the upcoming legislative elections of June. To carry out his ambitious programme, a favorable majority is required. With the PSF shattered in pieces (even the former socialist PM Manuel Valls backs the new President), Mr. Macron will try to convince the pro-Europe voters of Les Republicains. For that, he has already made the right move by nominating Edouard Philipe, a prominent member of Mr. Fillon’s party, as his candidate for prime minister.

The German Federal Elections scheduled for September 2017 are also beginning to attract significant attention. Angela Merkel’s Christian Democrats 52

(CDU) will face off former EU Parliament President Martin Schulz, recently elected Chairman of the Social Democrats (SPD). The far-right party “Alternative for Germany” (AfD), which emanates some Neo-Nazi reminiscences, is set to gain seats in the Bundestag for the first time ever, while the left-wing Die Linke is a possible coalition partner for SPD, along with the Greens, in an attempt by Mr. Schulz to oust Ms. Merkel from the chancellorship, a post she has held for almost 12 years now.

Unappreciated around most of Europe, Ms. Merkel has already claimed the most populous state of Germany, North-Rhine Westphalia, from SPD’s control. Her victory in the Federal Elections will certainly put a few obstacles to Mr. Macron’s pretentions, especially if Wolfgang Schauble retains the post of Minister of Finance.

On the other hand, if Mr. Schulz comes out victorious, a fruitful Franco-German alliance may be accomplishable and will certainly represent change and progress for European Integration as it did in the past.

Next year, Italian general elections will also be critical for the future of Europe as the ruling center-left Democratic Party (PD) will face the populist anti-EU Five Star Movement,

led by the Italian comedian Beppe Grillo. Matteo Renzi, former PD prime minister, who stepped down last December after losing a constitutional referendum, is expected to run for office again as leader of the “Partito Democratico”.

The situation of both Hungary and Poland is also alarming.

Hungarian PM Viktor Orbán has been displaying a series of authoritarian tendencies as he tried to shut down Soros-backed Central European University in Budapest via tighter regulations.

He is also known for oppressing media and erecting a wall along the Hungary-Serbia border to prevent asylum seeking refugees from entering the country. In Poland, right wing conservative Law and Justice Party (PiS) is currently ruling and has been attempting to turn public media into propaganda channels and control influential judges. In March, the Polish government led by the PiS tried to block the nomination of Donald Tusk for President of the European Council simply because the former prime minister of Poland is a member of the opposition party, the Liberal Democratic Congress (KLD). A rather humiliating move as all the other 27 members approved the appointment of Mr. Tusk.

It is surprising that some of the pillars of European Integration like France or the Netherlands (and even Germany) are taking hard blows to their political foundations.

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The current political situation in Europe was hardly expected just a few years ago. While some turmoil in the countries most affected by the Sovereign Debt Crisis wasn´t hard to predict (rise of Syriza and Golden Dawn in Greece, Podemos in Spain), it is surprising that some of the pillars of European Integration like France or the Netherlands (and even Germany) are taking hard blows to their political foundations.

A major trend is becoming more apparent these days: Socialist and Social-Democratic parties which once captured the entirety of the so-called working class are now losing this large sociological group to either far right or far left populist parties.

Spotted for the first time when Syriza swept the Greek general elections in 2015 and reduced the historical PASOK socialist party to bare insignificance, this trend has now repeated itself in the Netherlands and in France, where the PvdA and the PSF have lost the vast political influence they had held since WWII. But while in Greece it seems like the massive crisis led a vast segment of people to opt for populist solutions, in countries like the Netherlands, France, Austria, the UK and even the USA, it looks like Globalization and Automation are finally having significant effects in the political field. Both these factors seem to have outpaced the evolution of education and qualification levels of the workforce of developed nations.

While Globalization allows the offshoring of unskilled labour

from low-wage developing countries, leading to the tertiarization of once great industrial powers, Automation is disrupting labour markets by breaking the job-for-life paradigm and leaving unskilled workers in long-term unemployment or precarious working conditions. Mainstream parties have failed to address this situation as they believed Free Trade and Globalization would provide prosperity for all.

Undoubtedly, Globalization has had a positive impact in overall living conditions and development, not only in the West but in the whole World, with one or two exceptions.

However, it has brought along with it two main problems that are menacing its great achievements, one of them being Environmental Sustainability. The other one, more relevant to this discussion, is Economic Inequality. The real income of western middle classes has stagnated while the so-called 1% have only become wealthier. Overall, the uneducated, rural or suburban individual has seen its living conditions improve little, if anything at all, while the educated, urban and cosmopolitan individual has harvested the best fruits of Globalization.

only uncovered a wave that had been building up for some time and is now being surfed by the likes of Le Pen, Wilders, and Trump , while it threatens to crush liberal democracy as we have known it for the last 70 years. Political forces that promote fear and hate using racism, nationalism and xenophobia are becoming ever more popular among the “victims� of globalization that are desperate and prone to extremist ideologies.

The election of Mr. Macron is indeed a positive outcome for the time being. However, if he fails to produce a significant change in the EU during his mandate, it may be a matter of time before Europe disintegrates and falls back once again into the hands of totalitarianism.

The bottom line here is that mainstream parties and politicians are to blame for the rise of populism. They have failed to stand up for the ones they swore to defend and have been easily influenced by other interests and followed different agendas. The 2008 crisis and the Sovereign Debt Crisis have 53

NIC Undergrad Review Volume 3 - Issue 2

The Arab Winter An outlook on the Middle East state of affairs

Miguel Amaral Seven years have passed since the Arab Spring, for whom the newspapers poured tons and tons of ink. However, contrary to the Quran’s first Sura, the gigantic number of incidents cannot be resumed in seven verses. From governments being overthrown to civil wars, from rises of terrorist movements to the establishment of peaceful democracies (arguably), the Middle East finds itself again in a state of tumultuous chaos a fact that sometimes is hard to believe for those that can still remember the Iraq War. Indeed, from Tunisia to Syria, the historical Arab Spring has affected Middle Eastern states in very different manners. Whether the word “good” is used in its absolute sense, or from the perspective of western civilizations, it is hard to tell whether the uprising that occurred seven years ago was “good” to any of these countries. If we think carefully about it, some dictatorial regimes were and continue to be valuable assets to major world powers. Take the example of Syria, where Bashar Al-Assad endures in power,

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for rejoice of the Russian authorities – for if it was not for their support, the likeliest outcome would have been for Al-Assad to have fallen by now. For those wondering how the Middle East is in its current state, this can be explained by the fact that there are economical and geo-political interests in the region – be it American-European or Russian. Don’t get us wrong, the problems in the Middle East don’t resume themselves to this bipolarity between the Motherland and Land of the Free. However, it’s important that we understand that this kind of Cold War II is crucial for perceiving the friction in the region. Although the aim of this article is to explore some of the outcomes in the region, we need to note, however, that these are dense subjects. The objective is not to go too much into detail – instead, it will be a “what’s up Middle East” kind of catch-up.

Time flies, so let us start with the most dramatic case: Syria. Looking at the Syrian Civil War, things went terribly bad for these people. Today,

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we have war all across the land and not only between two factions. A glimpse of peace appeared in the horizon when the US and Russia agreed that the major threat in the region was Daesh, also known as ISIS, the most mediatic terrorist group nowadays. But as this group is being pushed away from the conquered cities and fundamental economical regions (i.e. oil), the iron arm wrestling between the world’s leading superpowers has only escalated.

Russia claims that US fights one terrorist group (Daesh) while supporting another (the old AlNusra Front, now called Tahrir Al-Sham). The truth is, the US is in fact much more interested in fighting Bashar Al-Assad than the terrorism in the region. It is a bold statement to make but we’ll justify it: in last instance, US benefits from all this mess because this is slowly deteriorating AlAssad government and organization all across the country. As the war advanced, one could realize that the proximity and influence of Russia within the region combined with the Syrian government warfare were enough to defeat the rebels. Well, for the US this cannot be, as a defeat of the Syrian Opposition would perpetuate and strengthen Bashar Al-Assad, expanding Russian geopolitical influence in this crucial region. The parallel wars with the Daesh, Tahrir Al-Sham and the Kurds (Syrian Democratic Forces) – to name some – are in fact giving space of manoeuvre to the Opposition. Bringing the fight to Daesh is an important propaganda tool for the US, as the war in Syria is not so popular among its people. By

stating that Islamic Terrorism is being fought (which is indeed true) more people become sympathetic with the idea of an indirect military intervention. These statements grew stronger in an electoral context, as one of Trump’s stronger cards was security and the fight against terrorism.

These are now being applied as the new American administration tries to make a point from a position of strength in the very beginning of its mandate. It’s important to say that the United States has no interest in having terrorist and radical groups perpetuated in the Middle East: the real interest is in introducing liberal democracies which are easier to deal with in a western perspective – despite the fact that, in the short-term, the more the mess, the more the bless for the United States, as this is a strategy to defeat Assad regime. In fact, the United States takes part in an international coalition made to fight radicalism in the Middle East, so they do have real interest – as we all do – that radicalism disappears in the long-term. Putting things in a very simple way, if the United States defeat Daesh before Assad, the Syrian regime is likely to endure; if they defeat Assad first, they can impose a liberal democracy the way we know them – as we know they work – and after that focus in defeating the Islamic Extremism – which they probably will.

On the other hand, Russia does not seem to be open to let Assad go for the sake of all the people affected by this war. Instead, it is determined to crush both rebels and radicals while diplomatically 55

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stating that the Syrian Regime is legitimate. Yes, the war is also being fought in the field of diplomacy – the war without guns. While in the West the strategy is to attack Assad and the atrocities of its regime, in the East it is the contrary: legitimize Assad and the sovereignty of Syria.

As the war endures and the mess goes on, it is now clear as glass that this conflict will not end without an agreement between the two parts.

Funny thing is that lots of ceasefires were already accorded be it to both factions reorganize their warfare be it to give international aid to the citizens caught in the crossfire. We are then before a true dilemma – Syria is too geopolitically and economically important to anyone to give away any piece of land - the reason why this conflict is being so intense and durable. But it’s also unfair, we realize, resuming this conflict to the Syrian government forces – supported by Russia – and the Syrian Opposition – supported by the United States. As we said, several forces are in the field at this moment. Besides Syrian loyalists, rebels and Daesh, also the called Syrian Democratic Forces – essentially the Kurdish forces – are at arms, controlling most of the Northern country. Funny fact is, the long enemy of the Kurds (a majority in Turkey) as also entered the conflict worried about the security near its own borders and the spread of extremism and man-at-arms to the interior of its territory.

There’s no diplomatic end on sight to this war, so we can just wait for one to overcome the other to see some stability in the country.

Was there nothing good in this Arab Spring? Or is it just a cold harsh Winter in the Middle East? We will get there. But it’s important stating that the war is not just going on in Syria– Iraq also has its troubles. Though easier to explain but not easier to solve, the Iraqi Civil War has as its main belligerents the Iraqi Government, Daesh and the Kurdistan Government Forces. See, Kurdistan is not really a country, not yet at least, but Kurdish culture does exist within the region. These nocountry men and women belonging to the socalled Kurdistan Regional Government can’t be dealt diplomatically as they are not internationally recognized as a sovereign state. Legitimate or not, this conflict will only end in one of two ways: the Kurdish movement is stopped, or an 56

agreement for a creation of a Kurdistan State is made (which at this point does not seem likely).

Talking of Daesh, the situation is the same as in Syria – with major western powers united against them, they are not really likely to endure in the long-term, nor them, nor any terrorist radical movement that might appear in the future for any reason.

Despite all the ongoing conflicts (in Syria and Iraq mostly) and all the uprisings that existed which resulted in the overthrowing of regimes (as in Libya or Egypt) the Arab Spring was not entirely bad: the inspiring example of Tunisia where a new constitution was written opening space to the implementation of a parliamentary republic.

Tunisia is the most successful example of these uprisings, or at least the swiftest of revolts to end in democracy. More will come, even if the transition to democracy is not as swift as we would like it to be.

Democracy as we know is not perfect; we can say that it is the best way found so far to organize society. As Winston Churchill would put it: “Democracy is the worst form of government.

Except for all the others”. Democracy is the best political way to assure that the people can take a part in civil society, in some shape or form.

Islamic countries are going through the same processes that western democracies once did: erupting from wars and/or even dictatorial regimes. This system takes time to implement: giving power to the people, as some would put it, it’s not an easy thing to do, and the transition to this state of things is often slow and non-pacific.

In some cases, where a revolution takes place, the transition to democracy is really fast – though this is not the case for most countries where the Arab Spring occurred: in most countries where the Arab Spring has taken place, we assisted more to small steps towards this system than giant jumps to it. In the end, as the western liberal influence is expected to endure – be it for its own interest or not – these countries are expected to tend more and more to a liberal system, crushing (step by step) the more or less authoritarian regimes of the region. We may state that, as things are now, the Arab Winter has come. It may seem that it will last forever, as war endures in some places and more or less authoritarian regimes persist in others. But they won’t.

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China: paving the way to be the next World leader One Belt, One Road – rediscovering old trade routes

Madalena Ruivo and Tomás Ambrósio Not a long time ago, Europe was destroyed and in desperate need for infrastructure in the aftermath of the World War II. In its help came the world’s superpower at the time, the United States of America. George Catlett Marshall received credit for the initiative that rebuilt the Western Europe in the postwar era, being awarded the Nobel Peace Prize subsequently. The Marshall Plan was a $13bn ($130bn at 2016 dollar value) initiative, which represented roughly 0.3% of the world GDP at the time. Nowadays, a project that counts for 5 to 10% of the world GDP is taking place.

This time, the United States is not behind it. So, who can run such a huge project? The answer is obvious when considering the current economic and geopolitical panoramas: China.

In 2013, Xi Jinping unveiled the Silk Road Economic Belt and the 21st century Maritime Silk Road, a $4tn to $8tn infrastructure network plan focused on connectivity and cooperation between 60 countries. Commonly known as One Belt, One Road (OBOR), this initiative is likely to become the world’s largest platform for regional cooperation.

It can be decomposed into two parts: the belt and the road. The belt refers to a physical road that starts in China, passes through Europe, and finishes in Scandinavia. The road is the maritime Silk Road, which refers to shipping lanes.

Over 2000 years ago, China established the ancient silk route in order to export one of its abundant commodities, silk. Today, China wants to “export” roads, railways,

utilities and power grids. The OBOR strategy targets five areas - infrastructure, trade, policy, finance, and people.

The potential benefits for the countries involved in this initiative, especially the Central Asia ones, which have an underdeveloped infrastructure, low investment rates, and low per-capita incomes, are a boost in trade flows and, of course, infrastructure development.

This initiative is also likely to have a notable impact on China's (and the world's) economy, since one of the main goals is to boost the development of this country's west and central provinces, reducing the regional disparities of the nation. It will allow China's growth model based on investment to remain, Chinese companies to have a greater market access to the economies involved, China's power to be enhanced, and provide secure natural resources to China.

This project’s inflow of investment in the construction industries will benefit the less developed economies along the Silk Road: the latest technologies and creative building techniques improve the quality of the infrastructures, and the standardization of the transportation infrastructures facilitate the trade between countries.

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Trade and investment have already increased, due to the OBOR. Trade between China and the OBOR routes represent ¼ of China's total trade value. Also, China exports mainly to the countries involved rather than the USA or the European Union, which were China's main export destinations.

This is a trend that is expected to keep growing since the investment in infrastructures favours trade flows.

This project indeed promotes China’s influence in the worldwide economy.

The expansion of Chinese firms overseas, the financing of infrastructures

by Chinese institutions, the participation of Chinese researchers and employees, and the improvement in China’s relationship with the more than 60 countries involved contribute to globalization.

One of China’s main development goals is to act in union with the purposes of the EU, which promotes a green and sustainable governance. To do so, the government aims to build an economy with qualitative growth and stability. Also, it aims to solve its environmental problems that already harm the population and develop new methods and technologies that fight against the excess capacity produced.

This project also promotes the development of tourism between China and the countries along the road. The 58

growth in touristic activities could increase GDP and bring new opportunities to the Chinese airlines - by the creation of different routes.

Companies with extensive expertise in sectors such as construction, logistics, aviation, ports and financial services could obviously benefit from such large project.

Multinational consumer products companies can also benefit from the increasing standards of living of the countries involved in the medium-term. The same applies to the technology giants of China, commonly known as BAT (Baidu, Alibaba, Tencent), which are trying to expand its influence outside China and can increase their market opportunities with this improved connectivity.

However, private companies will face several risks, such as political instability, legal and regulatory changes, licenses revocation, currency volatility, ‘crowding-out’ of private sector investment and poor transparency.

Besides suffering pressure from the slowdown in economic growth, China is trying to find new engines to boost its

economy. The OBOR initiative has diversified routes and tries to find new consumption markets where Chinese products, that no longer fit in China’s saturated market, can be found useful. Further, it assures the supply of energy and primary materials that are so important to social and economic stability.

The U.S. position of the world's leading economy has been replaced by the Chinese domination. While the U.S. president, Donald Trump, has signed an executive order to withdraw from the TPP, the OBOR programme aspires to strengthen trade and investment. The TPP was designed to enforce higher standards of trading rules in the Pacific region and its members were key developed economies.

Yet, the OBOR promotes investment and trade along old trade routes, and it covers more than 60 countries, a number that is expected to increase since there are no entry barriers.

Furthermore, this initiative is built on projects, not rules (like the TPP was).

Regarding the SinoEuropean relations, China and Europe are trying to introduce a brand-new economic order that promotes job creation, better international relations, and security. The construction of modern infrastructures facilitates the circulation of products and services between countries, improves the entry conditions to the

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Chinese market, and allows Europe to diversify its energy supply throughout regions that were unreachable. Furthermore, both China and Europe share interest in the stability of regions that suffer from wars and terrorist attacks.

According to CIDOB Barcelona Centre for National Affairs, the OBOR is a great opportunity for China to "familiarize itself with the EU regulations in terms of competition, intellectual property, data protection, labour rights, health, food security, consumer protection and the environment".

As the picture below confirms, experts predict that China will dominate the world in the future, which is in part due to the OBOR initiative.

This strategy has an enormous price tag and there is investment from three financial institutions. There is China’s Silk Road Infrastructure Fund (it is capitalised mainly by China’s forex reserves) of $40bn, the Asian Infrastructure

Investment Bank (AIIB) with $100bn, and the New Development Bank (a BRICS multilateral development bank) with a capital budget that may vary between $50bn and $100bn. Overall, the Economist reported that $1tn in “government money” would be spent on the initiative.

The motivations behind China’s strategy go beyond the economic reasons. In fact, we believe that the South China Sea disputes play an important role here.

Bearing in mind that the Chinese economic miracle was only possible because of both the production and the export astounding performances that relied on the eastern seaboard, it’s easy to understand the importance of the maritime passages.

Nevertheless, China has no direct access to the open seas, being blocked by islands all around. Thus, by building strategically positioned ports, the country will be able to reinforce its

influence over the claimed territories.

However, by doing so, Beijing must assure that an antiChina alliance is not born.

There is the risk that the disputes over the South China Sea territories backfire the OBOR plans, considering that ASEAN countries, members of the AIIB, might give more importance to the geopolitics than to the economic cooperation, which could put at risk the initiative’s success.

As in all investment plans, funding is also a key issue.

The Chinese way seems not seldom to debt-finance a development strategy. A report from Fitch Ratings challenges the Chinese banks' ability to control risks, as they do not have a good record of allocating resources efficiently at home, which may lead to new assetquality problems for Chinese banks that most of the funding is likely to come from.

Overall, we hope that the network effects - benefits to individual nations accrue if each part of the OBOR gets built, in opposition to individual countries moving forward on their own overcome the risks involved.

One of the strengths of the Chinese foreign policy is that the country always looks for a ‘win-win’ (shuangying) strategy, in opposition to the ‘'American First” policy of Donald Trump.

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Demographics: “It’s a trap!”

“When 900 years old you reach, look as good you will not.”

Francisca Anselmo and Maria Pocinho

It is unquestionable: “the demographic realities of the world are being transformed” (George Friedman) and “the first world may become a society of old people, living in old houses, ruminating about old ideas” (Alfred Sauvy).

Meanwhile, such phenomena appear to be likely to revamp financial markets – as practices not predicted in standard models affect the demand for financial assets and, consequently, their prices. Nevertheless, how determinant is the role of demographics? Does it influence the economy that much? If so, how should obstacles be addressed?

“NEVER TELL ME THE ODDS.” In the 1800’s, the birth rate for women in Europe was the same as that of women in Bangladesh today. No wonder Europe’s population is expected to decrease from 728M to about 650M, by 2100, according to the United Nations 2015 World Population Prospects. In fact, the era of the population explosion has come to an end as a dramatic decline and slowdown in fertility rates took place, both in developed and developing countries. Whereas in the 1800’s and mid-1900’s children were seen as a source of wealth - not 60

only in agricultural societies but also in cities, as parents could send them to work at primitive factories -, now they are seen as a source of MBA’s type of expense. Likewise, the economic value of youngsters has diminished alongside an increase in birth control and women’s emancipation. Accordingly, “global fertility is projected to fall from 2.5 children per woman in 2010-2015 (…) to 2.0 in 2095-2100” (UN 2015 World Population Prospects).

Nowadays, people are living longer as significant gains in life expectancy were achieved in the past years - mostly due to improvements in modern medicine, basic public health, and the additional availability of food. Globally, population aged 60 or over is the fastest growing. Moreover, between 2000-2005 and 2010-2015, life expectancy rose by 3 years (from 67 to 70). During this period, major surges took place in Africa, with life expectancy rising by 6 years, to 60. Nonetheless, its value remains low, when compared to 72 in Asia, 75 in Latin America, 77 in Europe, and 79 in Northern America - despite expectations life expectancy in Africa to eventually converge with the other groups. Therefore, there seem to be

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“too few Millennials to take care of too many Boomers” (Bill Gross). “Globally, the number of persons aged 60 and above is expected to more than double by 2050 and more than triple by 2100, increasing from 901 million in 2015 to 3.2 billion in 2100. The number of persons aged 80 or over is projected to increase from 125 million in 2015 to 944 million in 2100” (UN 2015 World Population Prospects). The shift in population demographics is beginning to look like a serious concern - enough to reframe the world economy.

There seem to be “too few Millennials to take care of too many Boomers” (Bill Gross)

UNDERSTANDING THE AFTERMATH Investors, bankers, policy makers and people, in general, tend to ignore this issue since in the short and medium term, asset prices, economic cycles and monetary policy do not seem to be affected by demographic factors. However, the long-run consequences may be disastrous and we are starting to recognise that the continuous decline in the equilibrium interest rate in the US has been caused by longer term factors. More important than that is the impact on the economic growth of most developed countries.

Firstly, unless the retirement age changes accordingly, the size of the workforce will decrease. According to a group of researchers from Harvard, between 1965 and 2005, the average legal retirement age rose by less than six months, while the male life expectancy rose by nine years. Since the capital stock does not change that much as well, there may be an excess of capital per worker, which reduces the return on capital, i.e. the interest rate, making it less attractive to invest in new projects.

Secondly, according to the Real Business Cycle Model, the equilibrium interest rate must be such that the savings rate equals the investment in the economy. Old people tend to save less, as savings become their source of spending. On the one hand, the increase in the dependency ratio (proportion of people of non-working age in the number of those of working age) reduces the savings rate and increases the real interest rate -

the opportunity cost of consumption is lower when people are older. On the other hand, as life expectancy rises, employed people will save more for longer, increasing the savings rate and reducing the interest rate. Despite the contrasting effects, they account for a significant part of the decline in the real interest rate. One explanation may be that a larger group of well-educated older people earn a larger share of overall income, far more than they can spend when they retire. In fact, there are millions of yen earned by old Japanese citizens stagnant in bank deposits, waiting to be invested. Unless these savings find productive investment opportunities, there is not much potential for long-run growth.

The rise in dependency ratio also decreases the disposable income of those employed and, consequently, changes their consumption patterns. If the dependency ratio of a child in a family rises, there is a reduction in the income per capita of that child generation. So, the disposable income per capita of both current and future generations is affected. For example, in Portugal, our parents’ generation is paying for their parents’ pensions, and our generation will not be able to pay for our parents’ pensions alone, without hurting our children’s income. As a consequence, families become less encouraged to have babies, contributing to the fertility rate snowballing effect.

Besides, consumption patterns such as higher health services and lower demand for housing will definitely influence the economic growth of a country. Particularly, an ageing population is affecting government revenue from taxes and increase government spending, especially on healthcare and pensions.

Additionally, unless productivity increases, lower labour supply reduces output. Even though people with higher education tend to keep working for longer, several studies suggest that most physical and cognitive skills decline with age, which influences productivity. And even if one maintains the same level of capabilities, the desire to retire is, generally, inevitable at a certain point in life.

WHAT CAN BE DONE? Many countries have tried to solve the problem by encouraging families to have children. For example, in France, the government was 61

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concerned whether the population was not going to replace itself over time since professional women were choosing not to have children.

Consequently, policies such as cash incentives, reductions on train fares, income tax based on the number of children, years paid of parental leave and subsidies to day-care and full-time school places were put into place. As a result, France has the highest fertility rate of Europe, increasing from 1.74 to 2.08, since 2002.

However, these measures are also expensive and cannot be funded by most governments. So, the question is: what can be done to have the same effect?

THE SOLUTION MIGHT BE JUST UNDER OUR NOSES There are thousands of migrants entering Europe every day through the Mediterranean Sea, running away from war or trying to find a better life. Yet, they seem to be a burden for many people and there is rising concern whether European countries will shut their doors, leading to a collapse of the EU. According to a UN study on Replacement Migration, the annual numbers of immigrants needed to prevent the population of working-age from declining in the EU are about double of the total numbers of migrants for the 90’s. Another conclusion was that, if countries do not wish to maintain their active support ratios at levels closer to what they are currently, without large numbers of immigration, one should consider increasing active participation in the labour force beyond the age 65, which, as was already mentioned, may not result in sustainable productivity. Despite not totally solving the problem, it would definitely be a great help, at least in the near future.

Nevertheless, such a shock is never easy to swallow by societies. It requires acceptance of different cultures, accommodation of families or distribution of “survival” subsidies during the first months, all this coming from European citizens’ pockets; not to mention the rising fear of terrorism. So, the way to integrate immigrants is the key point now, and just refusing to deal with them might not be the solution.

“R2-D2, WHERE ARE YOU?” “It has become appallingly obvious that our 62

technology has exceeded our humanity” – Albert Einstein. Indeed, what we recognize as a civilized society is speedily turning less civilized for the sake of robotization. Meantime, further workers are going to be displaced by robots, as technology is changing the world – major industries are prone to convert into less labourintensive in upcoming years. Moreover, the use of robots appears to be an upward trend as their prices decrease whereas quality improves.

Likewise, even though labour supply inevitably lowers as a consequence of the “new” demographics, one can expect productivity to increase, lifting output skywards. According to a research from the Department of Economics at LSE, robots surged country’s average growth rates by about 0.37 percentage points, raising total factor productivity as well as wages.

Nonetheless, even though the hike in dependency ratios diminishes the disposable income of those employed, robotics seems to support an opposite command. Innovation and technology appear to solve some of the deadlocks related to the shift in the structure of the population.

“R2-D2, IT IS YOU, IT IS YOU!” People are living healthier for longer due to the technology advances in all sectors and we must be celebrating for that. However, the changing structure of the population will shape future economies. Governments are not, and will not, be able to fix the problems by themselves. Immigration is crucial to maintain the activity rates as they are today and the robotics might be the key to accomplishing higher productivity, growth and wages. Even though it is not certain how impactful robotics will become, these will certainly play a decisive role in rethinking the world economy. R2-D2 get ready, C3PO will not be the only one looking for you!

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George Soros Breaking down the Bank of England

Maria Pocinho

George Soros was the man who “broke the Bank of England” on the 16th September 1992. He became one of the most famous investors in the world, by gaining US$1 billion in a single day short selling the British pound. What made this trade one of the greatest trades of all time?

On the 8th October 1990, Margaret Thatcher entered the pound into the Exchange Rate Mechanism at Deutsche Mark (DM) 2.95. If the exchange rate ever reached near DM 2.773, the government would be obliged to intervene. This target would be extremely difficult for Britain to maintain since inflation rate was much higher than Germany’s. Additionally, the unification of the European economies inherent in that decade also put pressure on the exchange rates.

Britain recognised the danger of such bad performance of the sterling

and increased its interest rates above 10% to make pound demand surge. So, speculators began to wonder whether fixed exchange rates could survive to this environment and began to short the sterling. Among them was George Soros, who took a $10 billion short position, by leveraging the value of his fund.

He believed that the conditions at which the UK had joined the ERM were not favourable: the demanded exchange rate was too high; the interest rates were pushing asset prices down and inflation was three times higher than German’s.

BLACK WEDNESDAY On Tuesday, 15th September 1992, Soros’s Quantum Fund begun a massive sell-off of pounds. In the next morning at 8:30 a.m., the Chancellor of the Exchequer (Norman Lamont) and the Governor of the Bank of England (Robin LeighPemberton) started buying

Born in Budapest, Hungary, George Soros is amongst the 30 richest people in the world, with a net worth of $25.3 billion. He emigrated to England in 1947, to escape Germany-occupied Hungary; graduated at the London School of Economics with a bachelor’s in economics and a master’s in philosophy.

Soros is also known by his philanthropic legacy. He used his fortune to create Open Society Foundations, supporting “individuals and organizations across the globe fighting for freedom of expression, transparency, accountable government and societies that promote justice and equality”, giving away over $12 billion to date.

orders to the amount of £300 million ineffectively, since Soros’s Fund was shorting pounds far faster.

At 10:30, the British Government announced a rise in the base interest rate from 10% to 12% and later to 15%, as the previous measure wasn’t working anymore. However, dealers continued to sell pounds and the Bank of England to give up hope. At 7:00 p.m., the Chancellor agreed at an emergency meeting that Britain would leave the ERM and the interest rate would be back to 12%. The estimated loss from that day was around £3.14 billion.

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Hunter-Trader-Thinker-Voter Getting too far ahead of your brains.

Andrey Dmitriev

(Pictured: Two Consider the number that is halfway between 1 and 9. Well, it is 5, this is obvious; the distance between 5 and 9 is the same as the one between 1 and 5. Repeated calculations of this sort may have even popped the number 5 into your mind right after you finished reading the first sentence. What if this ease is not innate to you, but a result of cultural necessity?

If you ask the same question to a member of a highly isolated tribe, he’ll most likely tell you that the answer is 3. Well, the answer isn’t necessarily wrong; mathematics is only a map, not the territory. Primitive tribes, and generally people without any training in Mathematics, such as infants, count logarithmically. This happens for a very good reason, as in an ancestral environment, thinking logarithmically was beneficial: if you and your hunting party suddenly spot a wolf pack, your fight or flight decision will most likely be indifferent between a pack of 3 or 4 64

experts in logarithmic thinking and a Westerner) wolfs, but certainly not between 3 or 9 wolfs, for obvious reasons. As such, natural selection played in favor of logarithmic thinking, leading to a population of innate logarithmic thinkers.

Of course, with the advent of agriculture, trade and subsequent developments in civilized life, arithmetic thinking became much more useful, hence widely propagated, in such a manner that, to a civilized person, logarithms may seem quite counter-intuitive.

From a standpoint of the latest developments in behavioral and cognitive sciences, you could call logarithmic-thinking a heuristic, that is, a mental shortcut that allows you to make a snap decision.

However, as circumstances changed radically, culture has rooted out that heuristic.

Notwithstanding, notice the following: in the last hundred years, a new set of activities gained an increased importance for the general population.

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Financial markets became more accessible and financial services more widespread and diverse.

Along with that, faster communication and an explosion of information brought about a whole new dimension to economic decision making.

One hundred years is surely not enough for natural selection to make innately bad economic decision makers to exit the gene pool (which would include most of us) and these changes are happening at a much faster pace than the spread of agriculture about twelve millennia ago. Also, to operate and understand these innovations takes much more than a shift from logarithmic to arithmetic thinking.

This is where our Paleolithic brain, together with its heuristics, clashes with the age of information and abundant choice. As demonstrated by the groundbreaking research of Amos Tversky and Daniel Kahneman, which laid the foundation of behavioral economics, there is a considerable set of mental biases and heuristics, about one hundred known to date, that impede humans from making decisions that benefit themselves. Many behaviors which were beneficial in a huntergatherer environment are now hazardous for a globalized and fast-paced world.

Take trading, specifically day trading, an occupation which involves buying and selling financial instruments within the same day. The practice nowadays is unimaginable without the latest innovations in communication and information. A trader must follow attentively the movements in the markets, politics, world affairs, any kind of news which he believes relevant for his portfolio. As such, a trader is exposed to a panoply of ancestral mechanisms as well as their

manifestations in all sorts of biases and heuristics. It is not just an occurrence that it is regarded as a highly stressful occupation.

Hence, it is not surprising that individual traders perform consistently worse than a monkey throwing darts (a randomly generated portfolio). A study by Terry Odean, from the University of California, Berkeley, of 163 000 trades over 7 years, showed that stocks traders sold performed, on average, 3.2 percent better than the stocks they had bought. Another, a study also

by Odean, entitled “Trading is Hazardous to your Wealth", showed that the most active traders were the ones who performed the worst.

This happens as individual investors lock their gains by selling “winners” and keeping “losers” while, unfortunately for them, in the short run, recent winners tend to be better than losers.

Given the short time span in which individual traders usually operate, they end up selling the wrong stocks. Also, investors tend to be more aware of the stocks featured in the news, which doesn’t imply that these are outstanding, as pundits are also not free from a Paleolithic brain.

If you’re wondering about professional traders’ performance – don’t worry, they are also human. According to Kahneman, even though they do slightly better than individual traders, they are still just as good as rolling the dice.

The list of occupations and professions for which our brains are inherently maladapted is endless – from all sorts of professions requiring expertise in the social sciences to megaprojects planning, mistakes in which lead to such catastrophes as in Chernobyl and How to spread terror: Availability bias (how easily we can imagine some event) leads us to overweigh small probabilities. The word “terrorism” constituted in 2008 0.00125% of all vocabulary used in books written in American English published in that year; “medical error” only 0.000007%. American fatalities from the former cause since 1995 don't add up to 4000, the latter is estimated to kill around 250 000 Americans yearly (Of course, book mentions is not an indicator of mortality rates, but it shows where our attention.

Sources: Google Ngram Viewer; The BMJ 65

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Deepwater Horizon.

At an annual conference of the CFA institute in 2012, Daniel Kahneman was asked about what could be done in order to overcome behavioral biases, to which he responded: “Very little…”, and added that despite having 40 years of experience in the field, he kept catching himself in the very same errors that he described in the first place.

Although behavioral economists propose various methods to improve decision-making, such as nudging – creating the conditions that will increase the probability that the right decision will be made, as in, for example, putting healthy food at eye level in stores – or techniques to improve corporate decision making, such as the "premortem" – asking the attendees of a meeting in which a project will be assessed to write down the worst-case scenario, given that an open discussion may be highly influenced by a minority of the group – so far there are still no proposals on their behalf of how to consistently improve individual decision-making.

That is perhaps why many of the modern institutions appear to be collapsing, or at least not in a very good state, from the financial markets to democracy. Not only are these not functioning exactly as they should in theory, but our perception of how well or not these are performing is most likely to be distorted as well, as we give much more emotional value to negative events than to positive ones, due to our innate loss aversion (for your survival, you would rather mistake a bush for a bear than a bear for a bush, hence we’re programmed to direct more attention to negative events, or the probability of these taking place than positive ones), hence further deviating the functioning of these institutions away from what an “optimum” would be.

We can suspect all this clumsiness on our behalf to come from an internal struggle of ours, also carved by evolution.

Our brain can be, very roughly, divided into two parts, the so-called "old brain" or "animal brain" and the "new brain" or the cerebral cortex. The old brain refers to the parts of our brain that evolved first, which are located in the inner parts 66

of our brain.

These are responsible for the processes that make survival possible. Apart from movement and coordination, this part of the brain is also responsible for our more primal, yet important, behaviors, such as fear, anxiety, and stress. The cerebral cortex or new brain, developed in the later stages in evolution, and is what gives us, humans, a competitive edge over all other species, as ours is the biggest one relative to our brain size. It is what allows us to delve into logical thinking, memory, judgment and acquiring complex skills, among others.

(Source: Association for Psychological Science)

It is between these more advanced processes in our brain and our primal instincts that the battle is fought. Most of the aforementioned cognitive biases result from the misalignment of the purposes these two parts of the brain serve. In fact, a study conducted by Wharton and INSEAD researchers showed that one of the most wellknown and influential biases, the sunk cost bias (for example, continuing to work on a project for the mere fact that already significant amounts were spent on it), would decrease with an increase in size of the cerebral cortex and a decrease in size of the amygdala (an important component of the “old brain”) induced by several weeks of mindfulness meditation practice.

Complex financial instruments are designed using complex mathematical thinking, that is, using mostly the cerebral cortex, while their abuse and consequent market crashes are caused mostly by the old brain. The state apparatus, as well as any other social and political institution is thought out using mostly the new brain while many times the

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affairs of a country become dependent on the demands and opinions of angry (or euphoric) mobs, on politicians that can channel the emotions of voters or, even worse, on leaders which are overtaken by fear and obsession, that is, the old brain is in charge.

Furthermore, what put us in such a situation (our thinking) might well be what will pull us out of it – many suggestions are being made in order to solve this issue, while evolution hasn’t solved it for us. Some, such as Elon Musk with his new venture Neuralink, are attempting to literally improve how our brain works. Others, such as the prominent computer scientist Pedro Domingos, suggest that we give all the cumbersome and possibly hazardous decision making away to algorithms, and enjoy life through our default settings. Still others, such as the disruptive

philosopher and probabilistic Nassim Taleb, suggest that we get rid of the structures that can collapse and plunge the world into chaos as a result of human error, and live instead a life with the more natural fluctuations to which our brain is more accustomed to. And of course, many others in between.

In the very least, we can confidently say that, whatever our expectations for the outcome of this issue are, they are themselves part of the problem, as these also have their origin in our judgement.

Meanwhile, somewhere in the Amazon forest, a hunting party comes back to their huts with the sad news that their brother, who liked to count things one-by-one, was caught by feral predators…

Daniel Kahneman was asked about what could be done in order to overcome behavioral biases(…): “Very little…”. (…)

He kept catching himself in the very same errors that he described in the first place.

Amos Tversky

Nassim Taleb

Terry Odean

Daniel Kahneman 67