Monday, 22 March 2010

The euro and the Portuguese slump

   Can we blame the euro for the current economic crisis? Can we really be sure that we will never face the decision of having to leave the euro? Pedro and Rui seem skeptical about these possibilities. I will address these questions in more detail in forthcoming posts. Meanwhile, I would like to reiterate some ideas.
   First, do we have evidence that belonging to the euro played an important role for the current Portuguese slump? Absolutely. If we survey the literature and the existing empirical evidence (including work done by Fernando and his coauthors), it is hard not to attribute at least part of current ailments on the adjustment of the Portuguese economy to the euro.
   Second, is the euro really the main culprit for the “lost decade” in the early 2000s? Well, the jury is out on this matter. There are certainly data that support both positive and negative answers. Personally, I think that the data that suggest that the euro played a crucial role seem pretty compelling (I will survey these data shortly). Still, as I said, we must admit that some doubts remain.
   Third, does that mean that we are not to blame for the current situation? No, quite the contrary. The truth is that, when we entered the monetary union, economic policy aggravated our problems by being pro-cyclical (especially in the late 1990s and early 2000s), and by not controlling the growth of labor costs. It is easy to make the euro the scapegoat for the slump. However, if we really look deep, we will be forced to conclude that policy certainly did not help, and, likely, might even have aggravated the situation.
   Fourth, does that mean that Portugal would have avoided the slump if had not entered the euro? Not necessarily.
   What I have argued before is that, even if Portugal were not in the euro, the Portuguese economy registered already several structural insufficiencies (i.e. serious challenges to its export competitiveness), which were mostly associated with the increasing competition in the international markets from China and from Eastern Europe. What the euro did was to exacerbate these problems, forcing an accelerated transition (not yet completed) to a new exporting model.
   Having said that, I do think that the short-term pains associated with the adjustment to the euro will eventually be replaced by long-run gains, mostly in terms of efficiency and potential productivity gains. This is at least what some of the literature on dollarization in Canada seems to suggest, and some of its conclusions might be relevant to us.
   A final word on abandoning the euro. I strongly believe that leaving the euro will solve none of our problems, at least in the medium and long run. In the short run, abandoning the euro might provide some breathing room to some of our less-productive exporting sectors, but these benefits will likely be offset by a plethora of negative economic and political impacts that I will survey in future posts. In fact, leaving the euro will also generate new problems and new challenges, especially if such a decision were not accompanied by the strengthening of the independence of the Bank of Portugal and by the introduction of more fiscal discipline.
   Nevertheless, if we do not solve our export competitiveness problems, and if stagnation persists for more, say, 10-15 years, I think it is not far fetched to assume that populist voices demanding an exit from the euro will increasingly be heard. Therefore, I also think that not only we should debate the consequences of this possibility (like we are doing in this forum), but also it is important for the public to be informed about the full consequences of such a decision. I believe that if the public opinion is presented with strong (and clearly explained) evidence on the pros and cons of leaving the euro, we will be much better prepared to deal with the potential arrival of populist voices amongst us.

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