Wednesday, 23 April 2014

Read with perspective the eleventh review

The IMF eleventh review of Portugal is available online (here). The review is balanced and technically sound. It offers a detailed analysis of the macroeconomic developments, the fiscal stance, the debt  sustainability analysis (both public and external) and the state of goods and labor markets functioning. Finally it contains the IMF staff recommendations.
A synthetic summary of the conclusions is:
1. the economy performance has improved in the last four quarters,
2. the plans to continue the external rebalancing, to anchor on a sustainable trajectory both private and public debt and to effectively implement the structural reforms, must be embedded in a medium term political economy strategy. 

My purpose in this post is to provide the reader with information that he can process to form an opinion on the current state and expectations on the future of the Portuguese Economy. (In wonkish jargon I want to feed the reader with an information set). The twist is that I provide information on the same variables over three different time spans (three different samples).
I choose to show the evolution of four variables: gross domestic output, total employment, total unemployment and the trade balance. 

First time span: the last four quarters

(click to enlarge) The second quarter of 2013 marks a turning point: GDP, employment and unemployment have improved for three consecutive quarters (and are projected to continue for a fourth). Even more promising the trade balance turned positive for the first time since … statistical records exist. News are good. (Process this information: form an opinion and expectations on the Portuguese Economy)

Second time span: the "troika" period 

(click to enlarge) The second figure starts in the 2011q2, when Portugal asked financial assistance to the EU and the IMF. The fall in GDP and employment and the increase in unemployment have been large, very large indeed. The bright spot is the persistent improvement in the trade balance. The economy is finally rebounding, but the adjustment period under the troika appears to have been costly and painful. (Process this information: form an opinion and expectations on the Portuguese Economy)

Third time span: the last decade

(click to enlarge) The third figure starts in 2003q4 and shows the last decade. GDP stalled around 2007. Employment was flat for 5 years and started to decrease rapidly at the end of 2008. The number of unemployed was also flat for 5 years until the end of 2008 when it also rapidly increased. The trade balance was persistently negative and the its improvement coincided with the beginning of the assistance program. When the "troika" came in, the economy had been worsening for at least three years; rapidly worsening. After all you do not call for external assistance if you are not in need for help. (Process this information: form an opinion and expectations on the Portuguese Economy.)

This pedantic exercise does not have the ambition to be a proper experiment but the more modest objective to be a suggestion: you need to maintain a sufficiently broad perspective to form your opinion and your expectations.
Let me now turn to the comprehensive sample (the information I process) and present the evolution of the interest rate on bonds, the real GDP growth rate, the current account ratio to GDP and the real exchange rate.   

The broader perspective

A comprehensive story for the macroeconomic performance of Portugal starts in 1995, a year in which the net international investment position of Portugal as well as the current account were close to zero. Blanchard (here) gives the first coherent narrative of the 1995-2006 period. For an updated version you can read the second section of a recent paper I wrote (here). The Figure shows the boom (real GDP growth) fuelled by the interest rate convergence towards German rates. A boom financed through a very large increase in the current account deficit and the simultaneous real appreciation against euro partners first and later (with the euro appreciation) the non-euro trading partners. Then came the crisis and the sudden recognition by the markets of the imbalances, their questioning of the sustainability of these imbalances and the difficulties to address them in an incomplete currency union. Finally the ECB Peelian assumption of responsibility and now a rebound.  The reader will forgive me to unduly compress the argument. He can find in the links a more detailed analysis that also addresses the fiscal and debt challenges for Portugal and the euro-area architecture and performance issues.      

The rationale of the IMF prescriptions

To conclude I propose to first process the complete sample information and then go back and read the eleventh review. Then, and only then, the reader can form an educated opinion and expectations on the Portuguese economy. The IMF prescriptions do not only aim at rebalancing the economy and permit Portugal to create the resources to repay their loan. They clearly aim at strengthening the structure of the economy in order to avoid future build-up of excessive imbalances and permit less costly and painful adjustment periods in face of new adverse shocks. In jargon these prescriptions are an international public good.     


  1. Yes, but could it be possible that this excessive imbalances of Portugal will stock up naturally if the imbalances of countries such us Germany are not corrected too. Should not this public good be administrated to countries running a CA surplus.

  2. And it is. Although very asymmetrically.

  3. The bottom line is that CA surplus countries have not done any adjustment to revert it at all, quite the opposite, some have taken measures that will expand their trade balance. Aren't we walking into a current account surplus european union that will destabilize its trade partners.
    Germany is saying it won't intervene, as it want to build up its balance sheets to help stabilize the eurozone. If a new adverse shock is to happen in the near future are we really prepared, or are we as depend of the help of other as in the past.

  4. Consider that it is historically rare to observe surplus countries adopting policies to rebalance. It might well never happened.
    During the high Gold Standard, Great Britain would use the accumulated surplus to maintain the role of guardian and lender of last resort of the international monetary system. Something similar to the role you are suggesting the German are envisaging for themselves.
    Today, maybe China with the new quinquennial plan. But it will be slow, it took a long time to recognise and the deficit country is somewhat special. Nevertheless…China.
    The eurozone has indeed reached external balance (and overshoot it) before internal balance. The fact is that the eurozone was externally balanced to start with. Now EZ has the largest current account surplus of the world…and yet many complain about the euro strength. It has always been an internal rebalancing problem. I will try to post some numbers during the week end.