Friday, 5 March 2010

The Portuguese economy is more flexible than the U.S.

Almost all economists agree that European countries have rigid labor markets and nationally protected product markets. But from the analysis of the crisis in Portugal (and it's European neighbors) that is coming out of U.S. academic and policy circles, one might think that instead Europe is by far a more flexible economy than the U.S. Just note:

1. The DC and media consensus is that Portugal should cut spending and raise taxes to eliminate its budget deficit. But isn't that true of California as well? And isn't California closer to collapse, and haven't its problems been there for longer than Portugal's? For the record, Portugal has increased taxes many times in the past 10 years, cut its budget deficit from 6.1% to 2.7% between 2005 and 2008, and raised the retirement age partially solving the underfunding of Social Security. Compared with the legislators in Sacramento, Portuguese politicians are saints of fiscal virtue and flexibility.

2. Portugal would benefit from a depreciation of the real exchange rate to restore its competiveness. Many have said that Portugal can achieve this by cutting wages, and I even recently read that the government should do this by legal decree. Uhmm, okay, but then what is your advice for Michigan? If you worry about Portugal's uncompetitive industries, then Detroit's auto industry should give you nightmares. Enacting a state-mandated 10% cut in wages in Michigan is so out of the realm of what is politically and legally feasible, that no one would risk the ridicule of proposing it. Comparing the evolution of unemployment and wages in Michigan and Portugal, and walking around Detroit or Flint versus Lisbon or Minho, it is some regions of the U.S. that seem like they need some shock therapy.

3. Others have suggested that Portugal leaves the euro for a few months and devalues the currency. Funny, but I don't remember hearing this proposal for Massachusetts woes in the 1990s or for Kansas in the last 30 years. Why not secede from the union for a while? You wouldn't think that the followers of Abraham Lincoln down in DC would mind, would you? European countries must have a remarkable institutional flexibility, compared to the rigidity imposed by the pesky prospect of civil war in the U.S.

4. The final advice that celebrities give when passing by Portugal in their lecture tours is to raise productivity growth. Each one has a different pet-industry on where to bet, from tourism, to microchips, to renewable energy. It is a shame that West Virginia is not as charming as Porto, so it never gets the same attention. If all of this brain power spent its time dreaming industries where West Virginians could become world leaders, it surely wouldn't have the lowest median household income in the U.S. today. Portugal's product markets must be incredibly flexible to allow for these great leap forwards that U.S. states can only dream of.

There is of course a different interpretation. It is not Portugal, but rather theoretical models that are always more flexible than real people and countries. The compromises that democracy forces on you, the suffering of your unemployed neighbor, or the sadness of seeing abandoned houses in the street where you grew up give most academics pause before trying to play social planner when it comes to the U.S. But foreign countries like Portugal have the irresistible allure of a far away land where everything is possible.


  1. Interesting article. I, myself, had a foreign Macroeconomics professor who claimed that one of the major reasons on why he was so attracted to come to Portugal was because of its "pathological status" among economists. It really does appear that Portugal has become some sort of field lab among international (macro)economists, each one advocating his own recipes for the structural problems the country faces. It is also interesting that those very same recipes for structural problems appear to be nothing else than temporary vaccines: the old, tiringly repeated argument of an overappreciated real exchange rate solved by nominal depreciations. I do not want my comment to become too lenghty, but I am not a follower of the "Blanchardian" theory of nominal wage cuts in Portugal either. Some recent analysis of AMECO data also led me to believe that nominal unit labour costs may not be the real cause of the real overappreciation - in fact, their rise when compared to other European countries has not been that acute in recent years (and the overappreciation far exceeds the relative Portuguese rise in ULCs). I am tempted to argue that the problem may lie somewhere else. Don't aske me where, though, I still have a lot to learn :)

  2. Very interesting ‘post’. Quite provocative, I would say.
    Still, don’t you think you are being a little bit to bold? You treat the European Union as if we were talking about USE (the United States of Europe). Who is Barak Obama’s counter-part in this country called the United Sates of Europe? Where is the European Federal Government?
    Talking Berlin rescuing Greece is not the same as talking about Washington DC rescuing some of the states of the United States (except, maybe, for Puerto Rico that is not even a state). Nobody ever discusses Massachusetts leaving the dollar for a few months just like nobody has ever discussed the Azores leaving the Portuguese Escudo for a single week, or Cataluña leaving the Spanish Peseta. At most, we only have seen those types of discussions when East Germany was reunited with West Germany.
    Thinking in terms of theoretic macroeconomic models, I would say that a model for the European Union is rather different than a model for the United States. And I am not just talking about labor mobility.

    P.S. By the way, who is the economist that argued that wages should cut by government decree?

  3. Brilliant!
    Here is one reference for Luís' query

  4. Pedro, I missed the point of that link. How is that an answer to any of my queries?

  5. Luis,
    There are many ways in which people often argue that the US can better respond to shocks than EU countries: labor flexibility, or as you note a common government and fiscal transfers. But my point is that recently I hear too many people implicitly attributing to countries like Portugal a flexibility that is unimaginable in the US. And I hope that pointing to the comparison shows that this supposed Portuguese flexibility is probably imaginary.
    More concretely, on my point 3, leaving the euro is certainly easier than leaving the US. But, it is still *extremely* hard. It took a decade to prepare the introduction of the euro; just the logistics of re-introducing the escudo would takes months or years. And why would the EU let Portugal back in, after a blatant competitive devaluation?

  6. one economist who argues that wages should be cut by decree...

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  8. "one economist who argues that wages should be cut by decree..."

    Pedro, actually, the link you provided is not for someone who favors wage cutting by decree approach, but rather to someone who is against it.
    Second, if we follow the link provided in the linked post, what we read is not someone who defends that for Greece (actually the person even claims to know nearly to nothing about Greece), but someone performing a theoretical exercise about how to devaluate a currency without actually devaluing it.
    Third, I assumed that Ricardo Reis was talking about Portugal, so my Post Scriptum question was about who defended such policy for Portugal in the current situation.

  9. "But, it is still *extremely* hard."

    So hard, that it seems to me nearly impossible, at least as a course of policy action. --- But not so hard to rule out the possibility of being kicked out (even if there is some treaty saying that nobody can kick us out).
    Having said this, it still strikes to me that Portugal is a sovereign independent country, Massachusetts and California are not. So it is normal that the Portuguese government can do somethings that the Massachusetts' Governor cannot.
    In the end, if Portugal decides to leave the Union, nobody will invade us. And History already told us what will happen if the confederate states decide to leave the United States.

    PS This should be obvious, but, still, let me stress it: arguing that Portugal has some policy options that states of USA don´t is by no means the same as defending those options.

  10. I agree with LAC, there are two distinct notions of flexibility being mixed: flexibility (the market flexibility used in the textbooks) and the availability of policy tools.
    In the first case, USA (and its states) are mored flexible, and vice-versa in the second.