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The aim of this study is to investigate whether openness, export shares or trade balances affect regional growth in Portugal. Human capital is also considered as a conditional factor to growth, expressed by the rate of success in high school education. Thus, we analyse whether the combination of international trade and human capital is relevant to explain regional growth in Portugal and how it affects the convergence process between regions. In the empirical analysis, interaction terms are introduced to explore the existence of different performances between regions of the Littoral and the Interior. As an alternative to the traditional approach that considers the population growth rate, we include the share of sectoral employment aiming to capture labour specialisation in the main sectors of economic activity and measure its impact on regional growth. The empirical analysis estimates the conditional convergence model of the Barro's type, applied to the Portuguese NUTS3 regions for the period 1996–2005. The GMM estimation approach applied to regional panel data reveals that factors associated with external trade, human capital and sectoral labour share (especially of the industrial sector) are relevant to explain regional growth and convergence in Portugal.

Different approaches have been used to test the convergence hypothesis, the most common being the conditional convergence developed by Barro and Sala-i-Martin (1991). According to this approach, growth is conditioned by structural factors such as human capital accumulation, technical progress, innovation, amongst others, with increasing returns to scale characteristics. Differences on these structural factors characterise properly the steady-states of the economies and explain the capability of the backward economies to grow faster than the advanced ones. Several studies have been carried out at the European level to analyse the convergence phenomenon amongst regions, using different approaches, samples and time periods.1 A great number of studies also deal with regional convergence within a given country. Some examples are those by De La Fuente (2002), Vittorio (2009), Michelis et al. (2004), for the Spanish, Italian and Greek regions, respectively. In the particular case of Portugal, Crespo and Fontoura, 2006 and Crespo and Fontoura, 2009 analysed the convergence process at the municipal level. Antunes and Soukiazis (2006) showed that Structural Funds received from the EU had contributed to a higher convergence of the Portuguese NUTS3 regions and Soukiazis and Proença (2008) provided empirical evidence showing that tourism was a factor of regional convergence. In all the above-mentioned studies foreign trade was not considered as a factor of convergence. It is argued that when a region faces an external deficit, capital flows from the central government can solve this problem.2 We do not share this view for several reasons: (i) regional external deficits reflect lack of economic competitiveness which can constrain local growth and increase unemployment (Thirlwall, 1980); (ii) capital transfers from the central government to the deficit regions are not sustainable in the long-term and can create budget deficits that affect the whole economy; (iii) capital transfers from the central government to less competitive regions can be inefficient in terms of the optimal reallocation of resources; and (iv) the reallocation of resources to less competitive regions with the aim to finance external regional deficits can be made in detriment of other regions increasing, therefore, regional inequality. In our opinion, regional trade competitiveness is important for local growth as it is for the whole economy, and capital flows are not a sustainable solution in the long-term. Structural solutions are needed to turn regions more competitive by allocating resources to sectors with increasing returns to scale characteristics and encouraging the production of goods with high income-elasticity of demand in international markets. The aim of the present study is to test the convergence hypothesis of per capita income amongst the Portuguese NUTS3 regions for the period 1996–2005, using different conditional factors. The main contributions of the paper are: (i) foreign trade indicators are introduced into the growth model to measure their impact on regional growth and convergence; (ii) sectoral employment share is considered in the growth equation as an alternative to population growth which is usually used in growth models of the Barro type; (iii) the dichotomy between the Littoral (coastal) and the Interior (in-land) zones is shown to be relevant in the process of convergence in Portugal; and (iv) technology diffusion effects are detected by adding an interaction term between foreign trade and human capital into the growth model. These issues have not been studied before at a regional level for the same country and mostly for Portugal. The study is organised as follows: in Section 2 the growth and convergence issues are discussed and the importance of trade for growth is explained. In Section 3 the convergence model is adapted to include trade as a conditioning factor of growth. Section 4 provides statistical information that allows analysing regional asymmetries with respect to per capita income, foreign trade, educational standards and employment structure. In Section 5 the conditional convergence model is estimated and the results are discussed. The last section summarises the most relevant outcomes from the study.

The basic idea of this study was to show that foreign trade is important for regional growth in Portugal as it is important for the whole country, not sharing the argument that capital flows from the central government to solve the problem of regional trade imbalances. For this reason the empirical analysis estimates growth equations that take into account foreign trade measures (along with human capital and sectoral employment shares) and tests their statistical relevance on regional growth and convergence. The descriptive analysis shows that the Portuguese dichotomy between Littoral (16 coastal regions) and Interior (14 inland regions) is important for understanding regional asymmetries. Regions of the Littoral have generally higher standards of living, are more open to trade and more competitive in international markets. Differences on educational standards are not substantial between the two areas. The descriptive analysis also illustrates a severe structural problem in Portugal, associated with the deindustrialisation tendency that can partly explain the low growth rates of Portugal over the last years. The employment shares in the primary and secondary sectors have fallen between 1996 and 2005 followed by a relative increase in the services sector. The concentration of the economic activity on the latter can be disadvantageous since several activities are associated with the non-tradable sector, produce low value added products and are highly dependent on imports. The empirical analysis based on GMM regressions of the conditional convergence model provides interesting insights for the sample of the NUTS3 regions over the period 1996–2005. Conditional convergence is found and population growth plays an insignificant role in regional growth. The employment share in the secondary sector is shown to be more important for growth relatively to employment shares in the two other sectors, affecting regional growth positively. Another important finding is the confirmation that educational standards are important for regional growth and this is in line with the endogenous growth theory asserting that human capital is the engine of growth. The focus of our empirical analysis is on the importance of foreign trade on regional growth and convergence. In fact our results are robust with respect to this factor. It is shown that different measures of foreign trade, such as the degree of openness, the share of intra- and total-exports to GDP, the trade balance with the EU and the growth rate of the extra-EU exports ratio significantly influence regional growth and contribute to the convergence process. However, trade with the EU countries is more significant than with non-EU members, as expected, since Portugal is a member of this group. The fact that foreign trade measures gain significance only when they are combined with the Littoral dummy (the more competitive and more open area), reinforces the view that external trade is essential for higher regional growth. It also indicates some externality effects from the Littoral area that positively influence global regional growth and convergence. Finally, the significance of the interaction terms between human capital and foreign trade can be taken as evidence of the technology diffusion principle. More qualified human capital is thus required to assimilate modern technologies and to turn the economies more competitive and able to compete successfully in international markets.