Friday, 29 July 2011
1)Improve financial markets and banks stability mainly through the EFSF
2)Strenghten real convergence through the Euro Plus Pact adopted last March
Regarding 1), leaders should enhance the quest of stability with a movement towards further financial and banking integration. I will not engage this argument but point the interested reader to this lucid analysis.
Regarding 2), leaders should be more ambitious on the instruments and instutions needed to achieve the desired level of policy coordination.
Let me change scale somewhat abruptly, and focus on the first policy commitment of the Euro Plus Pact, namely “to foster competitiveness”. The text agreed by the European head of states says that the assessment of competitiveness adjustment needs will be based on “unit labour costs (ULC) for the economy as a whole and for each major sector.” A precise identification of competitiveness as ULC is useful and necessary as it permits to adopt concrete policy measures.
The competitiveness of an economy is a multidimensional idea and economists have constructed several different indices to measure it. This multidimensionality necessarily leads the different indexes to exhibit different patterns. Some commentators interpret negatively the observed difference in the dynamics of these indexes. Their argument is that, if different measures of competitiveness exhibit different patterns, they must lead to different conclusions. Therefore these indexes of competitiveness, such as ULC, are flawed and cannot provide guidance to the unidimensional objective of promoting export growth. I will not dispute that measures of Real Effective Exchange Rate (REER) based on different deflators and/or weights exhibit “unsatisfactory” behavior. However, I believe, the above reasoning on the heterogeneous behavior of the indexes, does not consider the dimensionality of the idea of competitiveness.
I am more concerned by a subset of commentators, who build on the possibly contradictory pattern of the different REER, and shift the focus from relative costs misalignment to composition issues. In simpler words they argue that if Portugal has a trade deficit, it is not because its relative costs are high but because it produces the wrong goods. I bypass the economics of this argument, but I am curious to know what type of good is not produced in Portugal (exclude military submarines). Consider the following thought experiment. Assume Portugal was part of an exchange rate mechanism instead of a currency area. Would we expect a nominal devaluation to improve the trade balance? If the answer is yes, I would defend that trade deficits have more to do with cost misalignment than type of products. (Even after acknowledging the “this time is different” echo in light of China & co access to the WTO.)
The Euro plus pact correctly focuses on intra-european competitiveness. Eurozone members are obviously free to improve their trade balances vis-a-vis the rest of the World. However they must consider that their trade balances respond much more to change in relative costs and external demand within the currency area (“long-term price elasticities for intra-euro area exports appear to be at least double those for extra-euro area exports” ). I could not find estimates of Portuguese elasticites for intra-euro and extra-euro exports. It would be useful to have them.
Let me end with a digression. During the last two years, commentators have changed the designation of euro members that could not anymore access financial markets from “southern” to “peripheral”. I find this labebling both imprecise and misleading. We should relabel the so called peripheral countries as current account deficit countries and the so-called core countries as current account surpluses countries.
Saturday, 23 July 2011
Friday, 22 July 2011
I could not help thinking about this issue when I read yesterday’s statement by the heads of state or government of the euro area and EU institutions, which stated in point 6 that regarding private sector involvement Greece “requires an exceptional and unique solution” and in point 7 that “all other euro countries reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments”.
Didn’t the Greek government commit in the past to fully honour their responsibilities? Nevertheless, yesterday’s agreement requires private sector involvement in terms that some consider a selective default. If Merkel thinks that the political cost of not involving the private sector is too high now, why should markets believe that Germany will have a different view if Portugal needs additional EU financing sometime in the future?
Thursday, 21 July 2011
Saturday, 16 July 2011
Monday, 11 July 2011
Jack. I have lost both my parents.
Lady Bracknell. To lose one parent, Mr. Worthing, may be regarded as a misfortune; to lose both looks like carelessness.
In this initial post, I would like to share a recurring thought. In pondering about the current crisis, I am often reminded of the above exchange in Wilde's The Importance of Being Earnest. Yes, I know that the Portuguese situation has its own very particular (perhaps even peculiar) national dimensions - just like the Greek and Irish crises have their own domestic specificities, echoing Tolstoy's oft-quoted dictum about each unhappy family being unhappy in its own way. Yet I find myself invariably returning to Lady Bracknell’s response above. To paraphrase Wilde, if losing one (Greece) could be considered misfortune on the part of the Eurozone, to lose three really does look like carelessness. With another two or three (Italy, Spain, maybe even Belgium further down the road?) edging towards the brink, it seems that Europe has yet to fully realise the political importance of being Euro.
Like Miguel Lebre de Freitas in the post below, I have also been exploring the Campos e Cunha hypothesis for Portugal's stagnation. And I am growing increasingly convinced. Miguel gives you some numbers: here is the one plot that makes the point for me, where TOT are terms of trade, RER-ULC is the real exchange rate using unit labor costs against 35 developed economies from the AMECO database, and REC-CPI is the real exchange rate using consumer price indices from the CPI database.
Sunday, 10 July 2011
Competitiveness is a rather complex concept. In a broad sense, it refers to the extent to which a nation provides economic agents with (socially-aligned) incentives to produce and invest. For a moment, however, let’s focus on a narrow concept of competitiveness, related to wage costs. In particular, let’s stick with a definition proposed by Olivier Blanchard (2007), who refers to competitiveness as the inverse of unit labour cost (ULC) in tradable goods sectors relative to the corresponding world value.
In its influential paper, Blanchard (2007) argues that competitiveness in Portugal deteriorated significantly since the mid-nineties. According to the author, this reflected a misalignment between wages and productivity growth, which caused profitability in tradable goods sectors to shrink. However, Blanchard did not provide evidence supporting the claimed loss of competitiveness. The author showed that economy-wide ULC increased in Portugal faster than in the EU15, but he did not distinguished tradable goods (T) from non-tradable goods (N). The European Commission (2011) goes along with the same argument: “Since the introduction of the euro, Portugal has experienced significant real exchange rate (REER) appreciation vis-à-vis its trading partners, due to wage growth largely outstripping productivity advances (Graph 3)”. However, Graph 3 in the document only displays economy-wide real exchange rate indexes…
In a contrasting view, Campos e Cunha (2008) argues that “there is no room to claim a loss of competitiveness (...)” (p.158). The author points out that, in a small open economy, the real exchange rate and aggregate demand are two sides of the same coin. As it is well known, in a well functioning economy, an aggregate demand expansion translates into higher N-prices, while T-prices are bounded to remain unchanged. This causes a real exchange rate appreciation that has nothing to do with wage-productivity gaps. Fagan and Gaspar (2007) illustrate the argument is in the context of an endowment economy where, by definition, there is no such a thing as competitiveness.
Competitiveness and the real exchange rate do not necessarily go along.
To illustrate this, let’s look at the real exchange rate index based on nominal unit labour costs. By definition, ULC=W/a, where W refers to the compensation per employee (“nominal wage”) and a refers to Gross Value Added at constant prices per worker (“productivity”). Now, assume that the production function is a Cob-Douglas with labour-output elasticity equal to b and let Z be a variable measuring the wage-productivity gap: Z=ba/(W/P)=bP/ULC. When computed in terms of a base year (the constant b disappears) the index 1/Z is labelled Real Unit Labour Cost (RULC) or “real wage gap”. In a frictionless economy, Z=1. In a world with frictions, in face of a wage push, firms may opt to maintain a higher level of employment than that implied by the textbook wage-productivity rule. When this is so, the producer margin shrinks (Z<1).
Using the definitions above, the real exchange rate index based on nominal unit labour costs (RER-ULC) becomes ULC/ULC*=(P/P*)(Z*/Z). This means that RER-ULC accounts for two effects: wage-productivity misalignments (Z*/Z) and the increase in the relative price of non-tradable goods (P/P*). In a well functioning economy there are no wage-productivity misalignments, so Z=Z*=1. Still, unit labour costs may increase relative to abroad, whenever non-tradable good prices increase relative to abroad. This means that we can hardly rely on RER-ULC as an indicator of competitiveness. Competitiveness a la Blanchard is accounted for by the component (Z*/Z) and in the proportion corresponding to tradable goods, only.
Returning to Portugal, we now look at the data. In Table 1, se see that between 1995 and 2010 there was a
Saturday, 9 July 2011
Friday, 8 July 2011
The adoption of extraordinary measures has become an ordinary behavior of Portuguese governments. The most recent example was the extraordinary income tax announced last week. The events of this week have shown that extraordinary measures are not a solution for the structural problems of the Portuguese economy. There are two aspects to this. First, the markets clearly do not believe that these measures are enough to tackle those problems. Second, to the Portuguese people they convey the idea that the problems are, like the measures, temporary and thus the measures fail to put in motion the process of adjustment of expectations (and behavior) that the seriousness of the problems demands – therefore confirming the beliefs of the financial markets.
Structural measures are therefore required. The unsustainable current account deficit is a reflection of the structural problem of the Portuguese economy. It embodies the disconnect that exists between the structures of consumption and production. Devaluation would be the obvious (easy and non-structural) solution outside a common currency area. Absent this possibility, a significant cut in wages has been suggested as a means to restore the competitiveness of Portuguese firms.
A structural measure that would have the same competitiveness effect as a 7% wage cut would be to eliminate, permanently, the 14th wage payment, for both workers and pensioners. Beside the competitiveness effect, this measure would reduce public expenditure permanently. It should also have an impact on expectations, bringing the behavior of Portuguese consumers closer to our economic possibilities and sending a clear message of commitment to the financial markets and to the European Union (i.e., Germany), on top of the commitment to the memorandum of understanding.
Finally, except for legal problems that would have to be dealt with, this is simpler than other measures that would introduce additional complications into our fiscal system, with uncertain effects on the structure of incentives, such as the much discussed reduction in payroll tax. It should also be noticed that other structural measures, such as those in the memorandum, will take a long time to produce effects – if they do.
This kind of measure should be implemented from 2012 onwards. The Portuguese households should be given time to adjust their consumption plans. Obviously, such a measure will deepen our recession. But there is no way out of our problems without a serious recession, except if the Germans accept to pay the bill for our past excesses. Given the events in Greece, this would appear quite extraordinary.
Thursday, 7 July 2011
To fight the North American ones, more and more politicians are suggesting the creation of an European rating agency. It seems that they are not aware of the several dozens of rating agencies that are spread around the world, including Portugal.
Anyway, if there is going to be a new European credit rating agency, I propose that this new rating agency uses the Greek alphabet instead of Latin. Therefore, instead of aaa we would have ααα, or βββ instead of bbb, and so on and so forth.
Misquoting Kennedy, one would say: “Two thousand years ago the proudest boast was civis Romanus sum. Today, in the world of freedom, the proudest boast is 'Ich bin ein Grieche!'... All free men, wherever they may live, are citizens of Greece, and, therefore, as a free man, I take pride in the words 'Ich bin ein Grieche!'”
Wednesday, 6 July 2011
1. The Portuguese “program entails important risks” (see the IMF’s staff report, page 23, available here), “in particular, refinancing risks”;
2. If the program fails to deliver the results projected, additional official financing will be necessary; i.e. there is an “important” probability that Portugal will need new financing from the European Financial Stability Facility (EFSF), which implies approval from all the Eurogroup governments;
3. It is very likely that France and Germany will apply the principles of the latest Greek program to all future EFSF financing, requiring private creditors to rollover their debts, an event ratings agencies consider to be “default”.
Then, there is “very likely” an “important” probability that an event called “default” will occur, regarding Portuguese debt. That is exactly what a junk rating means, that there is a important probability of default.
This also means that Portugal’s downgrade has nothing to do with Portuguese fundamentals, but it is related to the fact that France and Germany are requiring private creditors to rollover their debts.
The growth and employment "trackers" (see footnote for technical details) give a sense of the dramatic decline in economic activity and employment following the last economic crisis and its tepid recovery (particularly in the labour market) in Portugal between 2000-Q1 and 2011-Q1 (from here up to 2015-Q1 the trackers are based on forecasts - grey shade).
The profile of GDP growth forecasts are somewhat in line with what the new Minister of Finance (Vitor Gaspar) has recently said: “Portugal is expected to have 9 terms of consecutive negative growth” (see here).
Tuesday, 5 July 2011
The EU/IMF/ECB troika didn't ask for it, at least until now. So, the key question is: should the government of a distressed country, such as Portugal, going through an already massive restructuring program, compress further the economy before it is necessary? Or should it have waited and see whether it would be necessary? The more I think about it, the more I get close to the conclusion that the move was in the wrong direction.
I think I still prefer to be ruled by policies set in Brussels then by too imaginative local officials. At least in Brussels they do not follow so closely the electoral cycle, which may be one of the reasons why the Portuguese government acted as it did on this matter. In fact, it looks as if they were following the same old rule of doing the hard stuff at the beginning of the electoral cycle to ease up later one. Unfortunately, in this juncture, that may have considerable negative macroeconomic effects.
Sunday, 3 July 2011
It is very common that the details of an IMF program change during the quarterly reviews. As long as the main objectives of the program are not at risk, the IMF tends to accept any changes of one measure for another that the local government proposes. It is possible that review dynamics are different in the case of euro-zone countries, making changes less likely since many institutions are involved. However, yesterday’s Eurogroup decision to approve the latest review of the Greek program, has proved that even for euro-zone countries the program that is implemented can be quite different from the program initially approved.
Less than two months ago, international experts made a thorough review of Portugal’s budget, and concluded that the 2011 targets could be achieved with implementation of the 2011 budget and a few extra expenditure measures. Nevertheless, the first real decision of the new Portuguese government was the creation of an extraordinary income tax to raise an additional €800 million. Why? My guess is that the government realized that the expenditure cuts incorporated in the 2011 budget will not materialize, and went for the easy option: a tax increase. Given that programs can be adjusted during reviews, I am afraid that this will happen often: having failed to achieve the proposed expenditure cuts, the government will replace them with tax increases. In the end, instead of a program with a reasonable expenditure / revenue mix of measures (two thirds / one third), we may end with a growth crippling one third / two thirds mix.
Friday, 1 July 2011
It is known that employment has taken a deep hit in this last recession, and has been much slower to recover than output (McKinsey Report on jobless recoveries).
This is related to the ongoing debate as to whether the crisis has permanently shifted the level of potential output or whether output will eventually meet the pre-recession trend level. Are we facing structural or cyclical shifts in the labour market? Structural and statistical estimates tend to produce disparate results depending on the country under scrutiny.
If we plot Portugal’s GDP trend growth (see footnote) and corresponding output gap using quarterly data between 1970-Q1 and 2011-Q1 we obtain the figure below.
It is clear that the “golden” days are over and that the so-called “lost decade” seems to have arrived to stay… Not only do we have negative trend growth, despite some mild signs of moderation/reversion(?), but also negative output gap.
Output can be decomposed into a product of population (p), the labor force participation rate (lfpr), the unemployment rate (u), hours per worker (h) and labor productivity (lp): Y=pop*lfpr*(1-u)*h*lp. Let’s just (briefly) analyse some of these components.
Plotting the trend growth of employment, labour force and unemployment we get the following:
One does see a downward evolution of the employment trend growth up to a point where around 2006 it became negative. Evidence seems to suggest than the trend may be reverting and the inflection point reached. A similar, but lagged behaviour, can also be seen in the case of labour force. Simultaneously, unemployment trend growth has been positive (since the early 2000s) having reached a peak in 2009-Q1 and signaling a downward movement. In any case, it seems a “New Normal” has arrived, characterized by higher unemployment and lower employment across all economic sectors and age-ranges which, most likely, won’t go back to pre-crisis levels.
One certainly needs to revert these variables’ behaviour in the short to medium-run for which a sine qua non condition is getting the Portuguese economy back on the growth track, increasing its potential output and closing the gap. All in all, some of these stylized facts should encourage policy-makers and the new government to "do something".
Footnote: For the interested reader, trends were computed by means of a univariate fitted Structural Time Series Model with unobserved components allowing for a stochastic trend, cycle and seasonal and estimated by maximum-likelihood via the Kalman filter. Source: OECD data; author's calculations.