Mind the gap

   Madeira, the Portuguese island, has some lessons for Portugal. Forty years ago it was the poorest region in the country and now it is above average in terms of income per capita. How did that happen? Part of Madeira’s catching-up was due to net financial transfers from Lisbon and Brussels, and that is reflected in the fact that catching up in terms of income per capita was higher than in terms of factor productivity. And there is also some Irish stuff in Madeira’s success, namely a competitive tax regime. However, the crux of the matter is that Madeira had what was once called a development state – and the dominance of one party, the Social Democratic Party (PSD), led by a charismatic and often controversial leader, Alberto João Jardim.

The Portuguese Brain Drain

   One of the least studied impacts of the sluggish growth of the last decade has been the resumption of large flows of Portuguese emigration. I say large because Portuguese emigration continued during our periods of high growth, such as the 1990s, albeit at a lower pace. However, as the Observatório da Emigração has recently pointed out, emigration has accelerated in the last few years due to the rise in unemployment and low job creation. Unfortunately, we don’t have good data on the emigration flows of the last few years, mostly because most of our emigration is to the European Union, and hence it is a lot more difficult to monitor. I hope to provide news (unfortunately bad news) on this front fairly soon. Meanwhile, while we still don’t have these data, it is worthwhile looking at the evidence already at our disposal.What are, then, the data telling us?

First, it is true that most of our emigration is still constituted by low-skilled workers (i.e. workers with primary or, at most, secondary education). This is not totally surprising, since we also know that, in spite of the improvements of the last decades, the share of these workers in the Portuguese workforce is still dominant. Why do these workers leave? Studies have shown that, similar to what happens with low-skilled migrants from other regions, Portuguese low skilled workers leave in search of better pay and higher living standards, but also due to family ties, as well as to escape from unemployment.

If the story ended here, it could be argued that there was nothing really new in the recent wave of emigration from Portugal, since in the 1960s and in the 1970s low-skilled emigration was also dominant (although the recent wave of emigration is allegedly more “temporary” in nature than in the 1960s and 1970s).

Unfortunately, the story does not end here. Thus, perhaps more surprising, it is interesting to verify that, in all the OECD, Portugal has one of the highest emigration rates of workers with a university education. Simply put, in terms of emigration of the highly skilled, no country in the OECD sends a higher percentage of its university-educated workers to foreign countries as much as we do, with the sole exception of Ireland. 

Very open low-tech economy

   Manufacturing employment has steadily declined in industrialized countries since the 1970s. The Portuguese economy has followed this trend: in 2006, manufacturing employment represented 18% of total employment against 24% in 1988. Jobs lost in low technology industries account for almost 100% of the total jobs net loss (160000).

   Technological change and competition from emerging countries, namely from Eastern Europe and China, have been pointed as the culprit of that job loss. However, economic theory suggests that we explore another explanation: exchange rate movements. Exchange rate changes have an immediate impact on the competitiveness of domestic goods. Between 1988-2006, Portugal abandoned the ‘crawling peg strategy’ (announced devaluations), joined the European Monetary System and was at the launch of the Euro. During that period, the Portuguese real effective exchange rate appreciated more than 20%.

Temporary Protectionism?

Given the delicate situation that some economies face of persistent current account deficits, some may argue that protectionism could be a temporary solution to the problem, as Pedro Lains has warned below. But one has to keep in mind a stubborn fact about temporary protectionism - which has been invoked in the past to support infant industries, to force favourable terms of trade or to alleviate acute macroeconomic imbalances. And the fact is: there is no such thing as temporary protectionism. For the simple reason that protectionism leads not only to disruptions of trade but also to reallocation of resources which, in turn, creates strong constituencies who will do whatever it takes to stop any reversal of policy.

Many years ago, the French economic historian François Crouzet stated, with some exaggeration to be sure, that the resistance to free trade in his own time - the 1960's - was a consequence of the profound reallocation of resources caused by the Continental Blockade during the Napoleonic Wars. Be that as it may, protectionism is never undone without serious political struggle or an external shock of biblical proportions.

Yes

   "Any debate on this?" Yes.
   First, a justification: I have been wanting to blog a little more, namely in reaction to this post by Francesco and this other one by Pedro (Lains), but I have had no time. I will try to find some briefly. So, for the moment, profiting from a quick after-lunch interim, just a quick reaction to this post by Pedro (Pita Barros).

Why the S&GP should go further in fighting tax credits

   One of the announced ways in which the S&GP aims at increasing tax revenue is the introduction of income-related limits to tax credits. This is a most welcome measure, and it will probably fall short of the desirable intervention in this regard.
   Let me give you a few basic facts about personal income tax deductions in Portugal. All the figures below are in thousand million euros. Using data for 2007 (available here), one can check that the total gross income in Portugal was around 80; an approximate amount of 23 is deducted from this. This deduction is equal to a given percentage of the maximum between the annual income equivalent to the minimum wage or the household's social security contributions. (Hence, greater for higher income households with higher SS contributions!) The household may also add itemized deductions related to professional union membership.

and for something completely different, a Finnish joke...

   About the Euro and the cost of not being to devaluate because Portugal is in the Euro zone, a Finnish friend mentioned the following joke (I hope I am able to reproduce it properly): - devaluation would be like being in pants in some street of Finland with -21, it keeps the essential parts warm for a short period, it is problem afterwards.

Eurotalk

   Formally, as we all know, it is not correct to state that Portugal’s slow growth since the early 1990s is due to the euro. The euro comes into the picture only because it impeded the government to devaluate in order to re-establish losses in factor competitiveness. But slow growth was due to those losses. Recognizing that is not arguing that a non-euro counterfactual would be better. As Rui belw recalls, devaluation in small countries leads only – if at all – to short-term gains.
   Nobody is seriously considering that living the euro is a true political option. It is not, I hope, and I hope that it stays a non-option for a long time to come.

Once we were Europeans

Berlin

I am traveling in Germany visiting Frankfurt and Berlin. I felt sad in finding in the local newspapers a common theme with our Blog: leaving the Euro.

The past

Economists and policy makers knew from the beginning that a pan-european euro area would be an imperfect currency area. Still they went ahead. It was coherent with the idea of continuing the European economic integration started after World War II. The economic advantages of increasing trade by reducing transaction costs and exchange rate uncertainty was judged sufficient to offset the loss of instruments to face asymmetric shocks. A large number of economists thought that the implicit adoption of the Bundesbank low inflation and his super-credible monetary policy would also be welfare enhancing. A smaller number thought that the Euro area was not Germany and that the Bundesbank monetary policy might not have been adequate. What was needed was a Euro monetary policy. On the correct level of inflation the IMF has recently published an interesting piece. But I digress.

The euro and the Portuguese slump

   Can we blame the euro for the current economic crisis? Can we really be sure that we will never face the decision of having to leave the euro? Pedro and Rui seem skeptical about these possibilities. I will address these questions in more detail in forthcoming posts. Meanwhile, I would like to reiterate some ideas.
   First, do we have evidence that belonging to the euro played an important role for the current Portuguese slump? Absolutely. If we survey the literature and the existing empirical evidence (including work done by Fernando and his coauthors), it is hard not to attribute at least part of current ailments on the adjustment of the Portuguese economy to the euro.
   Second, is the euro really the main culprit for the “lost decade” in the early 2000s? Well, the jury is out on this matter. There are certainly data that support both positive and negative answers. Personally, I think that the data that suggest that the euro played a crucial role seem pretty compelling (I will survey these data shortly). Still, as I said, we must admit that some doubts remain.

The health of the Portuguese

According to the previous figure published recently in an interesting overview "Health at a Glance 2009" by OECD, Portugal is not doing so bad in terms of life expectancy, a common proxy for health status, considering the little it spends per capita. The problem is that Portugal is not spending that little, it spends 9.9 % of its GDP as the next figure shows.

what if...

   Some of the recent posts created in me a strange feeling. It is natural that in difficult situations all possible routes are examined, it is actually healthy we do such assessments.

   But before taking side with one solution, one should be careful about existing evidence backing up each view.

   In particular, making the euro guilty of all evils of the Portuguese economy seems unwarranted to me, though I could not find what I would like to back up my view (or the contrary view, by the way). Since several analysis and views based on data have been reported, let me say why I am not convinced by the arguments making the euro the problem for Portugal.

Portugal should not abandon the Euro

   Alvaro's post suggests that there is overwhelming evidence that the Euro is responsible for the current situation in Portugal. Alvaro, as well as some of the commentators to his post, suggest Portuguese politicians may envision abandoning the Euro if stagnation persists.
   I am not sure I agree with the statement about the evidence. The evidence that I am aware of shows that common currency unions, such as the euro zone, tend to produce two main positive effects. First, they lower inflation. Second, they promote trade (by reducing transaction costs). The latter effect appears to be large and significant (see Frankel and Rose, QJE, 2002).
   True, common currency areas prevent the use of domestic currency devaluation in adjusting to asymmetric shocks. However, do we really want to go back to the times when Portugal had such flexibility? Let's not forget Portugal had very weak monetary institutions, leading in particular to high inflation. One of the key benefits of the Euro was to allow Portugal to benefit from top quality monetary institutions. This has been invaluable to Portugal, we should not go back.
   Moreover, currency devaluation is like a balloon of fresh air. Sooner rather than later, the fresh air will run out. If there are persistent problems underlying the stagnation, devaluating won't help; which means, I would not assign the blame to the Euro. I believe we do need to look for the deeper reasons of the Portuguese stagnation; I offered a couple of conjectures in a previous post.

Will this time be different? (Part II)

I continue today with the analysis of the Portuguese fiscal consolidation one century ago. In my opinion, Reinhart and Rogoff’s analysis may be biased by concentrating on the debt/ GDP ratio as measure of fiscal sustainability.

PK on the zero lower bound interest rate

This piece by PK might give some relevance to my earlier post.