A Little Common Sense

In the last few days, we witnessed dramatic reactions to the downgrade of the rating of the Portuguese public debt and to the volatility in the financial markets. Some analysts and politicians went as far to alert us that we were pretty much on the edge of an abyss and that the country has no future. Some have even argued that the spreads are increasing so much that soon enough we will not be able to repay our debts and we will have to declare bankruptcy. They might as well be right (although I suspect, and I hope, that they are not). Still, in spite of all the hype and drama, shall we have a little common sense here? How can anyone honestly say that 6%-7% interest rates are unprecedented and that will make the repayment of our public debt unsustainable? Really? It might worthwhile remembering some things from our recent past then. When the IMF came to Portugal in 1983, Portuguese public finances were also in very bad shape, and thus the IMF imposed some draconian measures in order to put things back in shape. A couple of years after, the IMF was praising Portugal for being so successful in correcting its fiscal imbalances (there are important lessons to learn from this period, in fact). It is also interesting to remember that, at the time, the government was paying more than 20% interest rates in order to finance its debts (see table below). In fact, we don’t even have to go that far in time. In the 1990s, before we started the process of nominal convergence on the way to the euro, the interest rates on government bonds were still hovering around 10%.

What has changed since then? Well, we stopped growing (our biggest problem) and the country’s external indebtedness increased substantially. Thus, the risks associated with our debt are now greater. Still, this does not mean necessarily that we are on the edge of the abyss. As long as the government is responsible enough to follow some good policies (i.e., cut expenditure, suspend the large public works projected, and stops increasing future public debt through the PPPs), we will certainly be a lot more prepared to convince the markets that we don’t deserve their wrath. The big question is thus whether this government can, for once, stop behaving irresponsibly. After the latest news, I am not so sure.

An Investment Opportunity?

For everyone blaming the markets: it seems we have a great investment opportunity here. How about investing their own personal wealth in Portuguese government bonds? This should pay out handsomely, given that the high spreads are not justified by the risk of default. Is anyone doing it? Some food for thought ;-)

How far can we go?

   Globalization is good for the World. Europe may be loosing a few positions in the race for prosperity, but China, Brazil and India, have gained a lot. Only Africa is not playing the game (because it is too poor to take advantage?). But Globalization is also mad and needs to be somehow controlled. Otherwise it implies that the haves get a disproportionate share of the gains from it, in comparison to the have-nots. It is bearable, because it is not about the transfer of income per se, but about the distribution of the gains of the more global economy (look at Africa, again, but also at the gains of the financial system around the World). Globalization also needs to be governed because it is a source of instability and this is even more important. We should worry about that, because Globalization is certainly reversible.
   The European periphery in the eurozone is now facing a tremendous crisis, which ultimately affects the whole monetary union. The crisis is the consequence of three intervening factors: the international crisis, which originated in 2007 in the US; the performance of peripheral governments; and consumer preferences. These are the direct causes, of course. It is relevant to ascertain the relative importance of those factors, but that requires research with an appropriate analytical framework for which we are still waiting for.

Shame on Europe

   Even though I do strongly believe that the current financial instability is largely our fault, it is hard to believe the lack of leadership that, once again, is plaguing Europe. The current turmoil is partly our fault because our governments have not understood the unsustainable path that they have been undertaking (spending and increasing future expenditures as if there was no tomorrow, or, at least, as if we did not have to pay the bill sooner or later), and because our current government has behaved in a reckless and irresponsible way when all the symptoms that we could be facing this situation were all there at least since the end of 2009. What have our political leaders done? Instead of acting decisively trying to persuade the markets that we were in control of the situation, our political leaders decided to point fingers at the financial markets (bad, bad markets!), and to pretend that only the Greeks were at risk, not us. Instead of designing a credible plan that could be sold to our European partners and to the financial markets, we opted for a so-so plan that promised much, but did not deliver enough. Instead of focusing on our grave economic problems, our political leaders preferred to spend their time arguing about political scandals and the looming prospects of new elections. Simply regrettable. We might end up paying a very hefty price for this carelessness and for this irresponsibility. Let’s hope not. Let’s hope that today’s meeting between the Prime Minister and the leader of the opposition marks the start of a new beginning, in which we are able to design an improved plan that is able to convince the markets that we are committed to sounder public finances and more realistic economic policies.

On the funding of university education

   In the current period of tightness in public finances and economic difficulties, one would expect most important areas of public spending to come under scrutiny. One area that has seldom made it into the headlines in Portugal is the funding of university education. This is not common to some other countries, where the issue receives substantial interest.
   Publicly funded education has been argued for as a matter of fairness and efficiency: the quest for equal opportunities for all together with perceived high public returns to the investment in terms of crime, health or democratic participation are the most common arguments. But common agreement finishes at the end of secondary school. For public returns are more difficult to be perceived and private returns seem to be very substantial. Short-run credit constraints were scrutinised has a potential explanation for underinvestment and the need for subsidies aimed at making university studies affordable to all in developed economies. However, results are far from clear and no consensus has been achieved.
   Despite all the funding that goes into education at all levels, the common wisdom is still that university graduates come from comparatively better off backgrounds, are more competent academically and possibly in the labour market, and move to enjoy the returns from their investment. If this is the case, how fair and efficient is it to transfer the much sought after funds to this comparatively advantaged group? And if private returns are so high, why isn't private investment higher as well?

Photos of Lisbon, 1957-1974

You can't really understand growth without looking into the past. And there are many ways of looking back. Photography is of course one of them and yesterday I stepped into a fantastic book by Eduardo Gageiro on Lisbon in the years from 1957 to 1974. Sometimes we look back only to be reassured that some regimes or policies are better than others. Although that certainly is an interesting exercise, we also need to look back just to know where a country - or, for that mater, an economy - comes from and what it has achieved in the years since.
(Lisbon, Bairro Alto, 1969)

Rescuing Portugal from the wrath of the markets

   In the last few days, several prominent economists and international organizations expressed their fears that Portugal might be the next European country to be targeted by the markets in the sovereign debt saga. Portuguese politicians protested and contested such an assessment, but, up to now, all has been in vain. The wrath of the markets has, indeed, turned on us with a vengeance, and the next few weeks will be crucial to see how we can weather the storm. Therefore, one of the most important questions that we face currently is: what will it take to calm down the markets and avoid substantial damage? How can we restore the confidence of the markets in Portugal? So far, our policymakers have argued that things are under control and that everything is going according to plan. The main problem is that the markets are not so certain about how controlled things really are and, even worse, they seem to believe that the plan is not so good, or, at the very least, not comprehensive enough. In fact, arguing that markets are irrational and/or that we don’t deserve this fate and/or that there is even a conspiracy against us (or the euro) is more often counterproductive than not and a road to nowhere. Therefore, it would be probably wise if our policymakers started designing a Plan B to prevent bigger harm to the country and to the Portuguese economy.

A one-page summary of Portugal's problems

   The Economist has just come out with a 1-page summary of which are, and which are not, the problems of the Portuguese economy. Get it here. I agree with 90% of what is in it, and from their writings here, I think most members of this blog do too.
   Informed Portuguese readers of Portuguese newspapers will find this article boring---it just states succinctly what many economists (including some that write in this blog) have been writing in the Portuguese press for a long time. The article will only be useful to those insufferable people in the country who are continuously criticizing the Portuguese press and its hard-working journalists, but then bow uncritically to anything that comes out in a foreign publication. (The term for them, in Portuguese, is "parolos".)
   English-speaking readers, however, get a lot of noisy signals. In the past week, these have included the blank statement: "Portugal is the next Greece," which is always mysterious, sometimes misleading, and in some contexts either spot on or just plainly factually incorrect. For those, this article might be useful.

The Portuguese Low Income Maintenance Program

   A few figures (and thoughts) on the Portuguese low income maintenance program, the "Social Integration Income''. Firstly, it is very low, by any standards. The reference individual income amounts to 187 euros a month (the minimum wage is equal to 450 euros). As usual, the transfer is equal to the difference between the reference value and the total household income. Appropriate equivalence scales are applied. The average individual transfer, as of 2008 (last available detailed data, can be found here in Portuguese) was as low as 86,74 euros a month. The total budget of the program was roughly 425 million euros in 2008 and 507 million in 2009. For 2008, again, this represents around 2% of the total Social Security expenditure. The S&GP defines a ceiling for the total spending with this (arguably modest) program. The ceiling aims at putting the program back into its 2007 expenditure by 2013 (370 million euros).
   True, the total expenditure with the program has been increasing since its introduction in the late 90's. There are (at least) two reasons for this. The first is just the natural evolution of a transfer program. Initially, potential beneficiaries are not aware of their entitlements and it takes time for the program to reach its steady state. The second one is obvious: the pervasive crisis that has hit the country and the ever-increasing unemployment levels.

The Health of the Portuguese - a note on copayments

   In the Health Care jargon, the term “copayment” means the amount paid by the patient (usually out-of-pocket) each time he/she uses a health care service. The main objective of copayments is to control the demand for health services i.e. to restrict the (ex-post) moral hazard due to insurance. Copayments are not restricted to private insurance. The Portuguese National Health Service is one example where copayments were introduced to control the demand for public health services. One concern with the introduction of copayments in a NHS is the reduction of Equity since typically copayments are not a function of income but a fixed amount per service. The other major concern is the potential postponement and interruption of necessary health care, which may result in worse health outcomes and more expensive treatments.
   Copayments tend to vary across health services to account for differences in demand elasticity. Services where demand is less elastic should face lower copayments because there is not much moral hazard to start with.
   From the beginning of 2010, the Portuguese stopped paying a copayment for hospitalizations in public hospitals. Although not much publicized in the media, this decreto-lei probably affects positively the health of many. Up to the beginning of the year a hospitalized patient would pay 5.2 Euros/day during the first 10 days of stay, which represented more than 10% of the national (monthly) minimum wage. Bare in mind that physicians, not patients, decide on hospitalizations. Demand for hospitalizations represents, therefore, most of the time, necessary treatment and hospitalizations are one of the least elastic (to price) services. The now abolished copayments on hospitalizations were probably reducing the level of necessary care. Good news then.

Growth and Debt and Miracles

In a recent paper - "Growth in a Time of Debt" - Carmen Reinhart and Kenneth Rogoff make use of their deep empirical knowledge of financial crises and their aftermath to establish some relations between real growth and debt. Their general findings are important though not altogether surprising. Briefly stated, they find that there is no strong link between real GDP growth and public debt below the threshold of 90 per cent of GDP. Only when public debt goes beyond that threshold does growth suffer with accumulating debt. For emerging markets, and as far as external debt (both public and private) is concerned, the threshold for the appearance of a strong relationship between weak real growth and debt is at 60 per cent of GDP.

Before the current crisis, Portuguese public debt was little above 65 per cent of GDP. Since then, things went out of control. Large budget deficits coupled with zero nominal GDP growth, to say the least, here as well as in Greece, which had a far larger public debt to start with, forced - and are forcing - public debt way up. According to the Portuguese government's own projections, public debt will reach Reinhart and Rogoff's threshold by 2012. (And don't forget Portugal's huge demographic problem.) Also, it is a widely known fact that Portuguese external debt has already gone beyond the 100 per cent of GDP threshold.

According to Reinhart and Rogoff's findings, emerging economies with external debts exceeding 90 per cent of GDP have had, in average, negative real growth. Unfortunately, the authors's paper does not analyse the problem of external debt in advanced economies for lack of data (we may assume that the corresponding threshold is a little bit higher for reputational reasons).

It is difficult to decide whether Portugal is on the side of advanced or emerging economies. That question notwithstanding it is a safe bet to say that growth perspectives in Portugal look grim. Not only the economy-wide deleveraging process is going to be costly, not only do we have the historical-empirical evidence against us, but try to take a few percentage points of GDP off aggregate demand each year - due to deficit contraction - with investment down, consumption going nowhere and exports weakened by everything else - real appreciation, relatively high labour costs, weak foreign demand (keep in mind that miserable Spain is our biggest trade partner). Put on top of that insignificant nominal GDP growth in the next few years which will make it even more difficult to reduce our public debt.

Did anyone ask for a miracle? "Miracle" is nowadays a code word for "surge in productivity" among Portuguese economists and other people of good faith. Fortunately, the Pope will be visiting us next month.

International debt in a signalling game

   The current discussion on the macroeconomic conditions, in particular public debt, of Portugal, Greece and Spain, is a heated one. Articles appearing in press have argued that Portugal is next to Greece in the spotlight of problems; at the same time, the Greek officials declare they are in a similar situation of Portugal and Spain. Portuguese officials deny it and declare the Portuguese economy to be totally different from the Greek.

   This parade of official statements and newspaper articles suddenly brought to my mind the setup of a signalling game: the Greeks want to pool with the Portuguese to get an "average" spread on their debt interest, while the Portuguese want to play the "good risk" type, and aim for a separating equilibrium, with a lower spread in their debt.

   The big question is whether international investors will settle for the pooling or for the separating equilibrium, and whether any credit rationing may appear in equilibrium to sort countries out.

   At this light, one should look for those commitments (and not only words) of the Portuguese Government that only a "good" type would make, without the higher risk country wanting to imitate. Looking at the Portuguese promises so far, if one would want to interpret the current measures as a signal, which ones would not be followed by Greece?

   Playing the "soft"card is tricky - saying that Portugal does not need to such hard measures as Greece does is what essentially is happening, but this relies in the absolute necessity of the Greeks to adopt the current hard measures. Still, does not preclude that if this signal works, then countries in trouble will refrain even further from adopting corrective, hard, measures in their economies. Adopting very harsh measures in Portugal could be read as a signal of trouble, as the countries with "bad types" need to take them as well, and pooling at the "bad" type may follow.

   So, an interesting question, at least to me, being largely ignorant in international monetary economics, is which measure would work as a credible signal, in the sense that only a country with relatively good conditions would take it?

   ps. I know I mostly ask questions, I am taking this blog as a learning tool :D

The elusive source of Portugal's depression: privatizations?

   A common topic in this blog has been the Portuguese depression of the past decade. Economic growth has been close to zero, and the last decade already shows one of the largest cumulative divergences between living standards in Portugal and the rest of Europe.
   As with all depressions, figuring out why this happened is both terribly important, as well as maddenly elusive. One can do simple and more sophisticated growth accounting exercises, and they point to that mysterious "TFP residual" that economists like to call productivity. But beyond telling us that growth in Portugal didn't reach a halt because the working population left, suddenly lost their skills, threw their machines into the ocean, or buildings were eaten by Godzilla, I'm not sure this tells us that much more.
   One hypothesis that I have been entertaining, and which as far as I know has not been very explored, is that the blame is in the privatizations of the late 1990s. Wait, before you recoil in horror, I am not about to defend a nationally-planned economy filled with public companies. Give me the benefit of the doubt and read to the end.

Business Groups in Portugal

   Last week I read an interesting paper about business groups. Business groups, or conglomerates, are firms that have divisions operating in very different sectors of economic activity. For example, General Electric in the U.S. operates in several sectors, such as machine manufacturing, finance, and also electric power generation, transmission, and distribution. In Portugal, the most prominent example is Sonae, with businesses in retail, telecommunications, and wood product manufacturing.
   The paper uses Canadian data to document some stylized facts about business group activity. The most salient one is that business group divisions are larger (e.g. supermarkets owned by Sonae tend to be large compared to local supermarkets, say) , and also more productive. This is interesting because many people complain that business groups are too large and inefficient, whereas the evidence seems to point in the opposite direction.