The Lost Decade through Pessoa’s bespectacled eyes

   Ever gloomy, ever versatile, Fernando Pessoa, the literary giant of the XXth century, has been summoned back from the dead for some after-life extra hours. The bored-office-clerk-turned-cultural-icon's name now serves as the acronym of the latest model of the Portuguese economy at the Bank of Portugal. As its authors state "PESSOA is a New-Keynesian DSGE model for a small open economy participating in a monetary union... with a rich fiscal policy setup" (more info here and here). Fittingly, as seen through Pessoa's eyes, Portugal's outlook is, well... kind of sad.

The cost of the public debt

   In a week marked by protests and discussions about pay rises in the public sector, many have argued that civil servants are to be held responsible for a disproportionate share of the public debt under proposals of a pay freeze.
   But that is a rather unconvincing claim. The outside option for civil servants is the best between unemployment and employment in the private sector, if available. Its value decreases during periods of slow or negative economic growth with the higher risk of unemployment and downward pressure on private sector earnings.

Educational Outcomes, something to worry?

   Economists seem to agree that human capital is important for growth and development. In light of the urgent cuts that the public sector must undergo, it is worrisome that public education may suffer. According to the data from PISA 2006 (Program for International Student Assessment), 15-year old portuguese students fare quite badly in Sciences and Math. Above is a cross country comparison for the PISA 2006 Math tests that shows Portugal’s average outcome as being below the OECD average.

Non-tradables

   Non-tradables are key to a few interpretations about what is wrong with the Portuguese economy and Miguel argues on such lines below. The argument is roughly that growth is sluggish because there is a policy driven structure of incentives that lead to too much investment in those sectors that produce goods ans services that are not traded internationally. Ok, let's agree with that for the sake of the argument. What we lack then is to know how much? I have never came up to an estimate of the share of non-tradables in GDP and its growth in recent years. And we would have to have some kind of comparison with the rest of the World. I am under the impression that non-tradables are hard to quantify because there are no clear divisions between sectors.

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:

Far west and down under

Concerning the general question of the threat of asymmetric shocks and lack of synchronization of national business cycles within a currency union, Luís made two important points. First, there is no synchronicity between the core and the periphery of the Eurozone. Second, the underlying cause for Portugal being the least synchronous in the Eurozone is probably geographic.

However, one should also consider an important fact about the Portuguese economy: it is relatively closed to international trade. In 2005, its Exports/GDP ratio was 28.5% (the following years were even worse, but we should keep in mind that the Great Recession was showing its ugly teeth depressing imports as well as exports). Not only is it low compared to other European economies similar to ours in demographic terms,

My problem with austerirty

I have a problem with austerity. Not austerity in general (which sometimes is necessary) but the sort of austerity that Greece is now undergoing: the sort of austerity in which you raise VAT rates and cut public salaries by significant amounts with no real solution in sight. By now we are all expecting that the Greek austerity plan is just the opening act of Greece’s rescue by Germany or France or the EU or a combination of these. The austerity plan would then just be a signal that there is no moral hazard in the EU: no country is saved without taking some pain. But even if rescue is on the way, no austerity plan or bailout will change the fundamental problems of Greece’s economy and public spending. Public spending has an inertia that is based mostly on the growth of pensions and health-care. Raising taxes and cutting public salaries are one-off measures. You cannot sustain them forever. Public spending will keep on growing, taxes won’t be enough, deficits will repeat in the future. The question is: will the EU keep on saving Greece in the future? That would transform Greece into a permanently subsidized economy. There are examples of that in Europe, the most famous of them being East Germany. Is that what the Greeks want? Is that what the remaining Europeans want? There is, of course, one healthy way out of this deadlock: high growth in Greece. Unfortunately, at current productivity levels, with no independent exchange rate and monetary policies, one has difficulties in seeing how that will happen. Now fast forward a few months (weeks?), change Greece and Greeks for Portugal and Portuguese, and think about it.

Attracting FDI to Portugal

Let me continue the discussion initiated by Pedro Pita Barros and Susana Peralta: How can we attract FDI flows into Portugal?
I think Pedro is spot on. We can split the factors driving FDI flows into two main categories: (i) factors affecting the productivity of capital, and (ii) factors affecting the return to foreign investors. In (i) we have the factors both Pedro and Susana mentioned, such as human capital, infrastructure, and possibly agglomeration economies. In (ii) we have, in addition to taxes and subsidies, the fundamental issue of investor protection. That is, the laws that protect outside investors' interests against explicit or implicit expropriation of their returns by firm insiders (e.g. managers), and the enforcement of those laws. Even when the productivity of capital is high, and even when the right government incentives are in place to attract FDI, FDI might not come at all if the institutions are weak. This can happen because the actual return to capital, as perceived by foreign investors once the institutional framework is factored in, may be quite low. My thoughts on this are very influenced by a study on the Portuguese economy I conducted recently with my co-author and good friend Gian Luca Clementi ("The economic effects of improving investor rights in Portugal"; free access here; sorry for the publicity!).
Portugal has made a lot of progress since joining the EU regarding corporate governance and investor protection laws. We still have very poor law enforcement though, particularly the judicial system. Reforming the judicial system must be a top priority if Portugal is to further attract foreign capital.

Foreign Direct Investment

Let me bring one element into the discussion initiated by Pedro. Many empirical papers show the importance of "agglomeration economies" for firm location. In other words, belonging to the so-called periphery of Europe and being physically distant from the richer markets is a very strong handicap for the Portuguese economy. Does this make it impossible to attract FDI? No, wise policies can still play a role here, but it is definitely much more expensive to do it for Portugal than for a Core EU region.

What brings foreign direct investment to a country?

   I was asked a couple of days a question to which I have no good answer: what are the major factors to bring more foreign direct investment to Portugal?

   The problem in answering is that education, human capital, infra-structure, incentives (that is, money given by the Government to the foreign investor), all of that is actually offered by most countries anyway, so what is really distinctive is hard to state.
   However, going on the negative side, what could keep investors away, I get two simple answers: Government bureaucracy and rule of law (courts and justice in geral are very slow, and uncertain), but then we are back to "old" problems of the Portuguese society.

   Anyway out?

The Portuguese Dream II

   One of the comments motivates this post.
   The concepts of absolute and relative poverty do differ. The former defines the poverty line by exactly computing the amount one needs to afford a basic consumption basket. The latter defines poverty in relation to a country's living standards. Both have advantages and drawbacks. Absolute poverty relies on a more paternalistic viewpoint, and it is also much more difficult to compute. In particular, one would ideally want geographically differentiated poverty lines, for prices are not the same in all the regions of a country. Relative poverty is the applied concept in most countries, notably in the EU, no doubt due its relatively easy applicability. Lacking any operational way to compute measures of absolute poverty, we must rely on the relative one.

Tying our hands is not enough

"Joining the European Monetary System will result in efficiency and scale gains, which will be propagated over time and will promote and accelerate economic development."
QUANTUM report, Portuguese Ministry of Finance, June 1991

   After more than five centuries of colonial empire, the adhesion to the European Union in 1986 was expected to launch a new era for the Portuguese economy. In the first years, those expectations were fulfilled in many dimensions. After a turbulent decade, the political regime stabilized; in 1989, the path to a socialist economy and society was abandoned and the free market principles were adopted; continental European countries became the main trade partners; convergence to European average per capita income was resumed.

Data on Portugal

   We all need good data and easy access to it. And data may be crucial as it was the case with the Greek crisis. Governments there have played around with national accounts and government statistics for a while, but that became more serious in recent times. Portugal's Prime Minister has been accused of exaggerating this year's government deficit, probably to show better results in the near future. Although that has not been proved yet, I bet that it is true.

UPIGS?

What if we should start thinking in terms of a new acronym: UPIGS? Meaning, the UK, Portugal, Italy (or Ireland, or both, you never know), Greece and Spain. Some people think so. It is more accusatory (as in "you pigs") than simply descriptive. What do U think?

The Portuguese Dream?

   Discussing the growth (or lack thereof) of Portuguese GDP raises an important and complementary question, that of its distributive effects. Let me tell you about the working poor. What is a working poor? Firstly, it’s a poor: an individual (or household) who lives below the poverty line, i.e., the income level which is deemed enough to cater for one’s basic needs (shelter, food, health). In the European Union, the most commonly used definition of the poverty line is 60% of each country’s median income. Secondly, it’s a worker. There are obvious definition issues here, for some people do not work full time nor do they work during the whole year, but let us rely the Eurostat definition, according to which an individual is a worker if she has been working for at least six months in the previous year. Let’s go to the numbers then (unfortunately