Cronyism and the next government

One of the most interesting papers that I have recently read on the Portuguese economy was the paper (already referenced here) by Pedro Martins on cronyism with regards to public sector jobs. Martins uses the "Quadros do Pessoal" data in order to undergo an extensive empirical investigation of job hirings in public sector enterprises before and after general elections. The paper is important because it confirms fairly convincingly something that many suspected and from which we only had, up to now, anecdotal evidence: that hirings in public enterprises are strongly associated with general elections. Namely, Martins finds that hirings in public sector enterprises goes up immediately before and in the 3-6 months after a general election (see graph below, where period 0 represents the date of the election). Interestingly, but probably not suprisingly, the effect on hirings is stronger when the party in power changes (i.e. if there is a change in the "color" of the party in power), that is, when the jobs-for-the-boys effect comes clearly into play. The results hold even after Martins controls for experience, education, private sector hirings, among others.
   What this points out very clearly is that, in the last 30 years (i.e. at least since 1980, the year the data begin), public sector enterprises have been blatantly used for political gains and to reward whoever helps you get into power. Yes, there are jobs for the boys alright and  they are not only in the public administration or the State. Public companies also do.
   This is certainly not completely surprising, but it is surely very nice to have substantial and unequivocal evidence on the extent of cronyism in Portugal. One of the obvious implications of this study is that we now understand better why public expenditures have been so difficult to control in our country, or why the debt of public enterprises keeps on growing at, on average, about 3 billion euros a year.

Cronyism _ Job hirings in public enterprises before and after general elections

 Source: Martins (2010), and taken, with permission, from here.

   I would like to end with a word of caution about the future. It is widely expected that we will have general elections sometime in 2011 (hopefully sooner rather than later), after the presidential election is over and after the constitutional limits allow. It is also widely expected that there will be a government of a new "color"(to use Martins's terminology),  probably in coalition with a smaller party. Thus, the temptation to emulate the past will be there, with interest groups associated with the new parties in power pushing for new jobs for the boys.  Let's hope this does not happen. If it does, it would be simply unexcusable in times like these. The fact is that it is not worth changing the boys from pink to orange or even to blue just for the sake of doing it. Boys will be boys will be boys. And this "boy" culture and tradition is partly responsible for the sad state of our public  finances. Therefore, if the new government truly wishes to reform the State and get away from the sorry state of affairs that is taking place in Portugal right now, it must avoid, at all costs, the temptation to distribute new jobs for the boys in the State and in public companies. If it does so, the new government will fail and won't be able to implement a truly reformist agenda, something that Portugal desperately needs. Let's hope not. I am sincerely hopeful that next time will indeed be different (even if it is because we really can't afford to do otherwise).

The usual, please

My friend André Azevedo Alves gives his perspective on the Portuguese situation in the Institute of Economic Affairs blog. Check it out.

André insists rightly on the need for a "haircut" on private creditors if a bailout materializes.

I would like to hear him on other serious issues such as private sector debt, the unbalanced relationship between the prices of tradable and untradable goods, or unit labor costs in Portugal. And ultimately membership in the eurozone.

Cronyism -- no jobs for the boy

Asbtract

Politicians can use the public sector to give jobs to cronies, at the expense of the efficiency of those organisations and general welfare. Motivated by a simple model of cronyism that predicts spikes in appointments to state-owned firms near elections, we regress 1980-2008 monthly hirings across all state-owned Portuguese firms on the country’s political cycle. In most specifications, we also consider private-sector firms as a control group. Consistent with the model, we find that public-sector appointments increase significantly over the months just before a new government takes office. Hirings also increase considerably just after elections but only if the new government is of a different political colour than its predecessor. These results also hold when conducting the analysis separately at different industries and most job levels, including less skilled positions. We find our evidence to be consistent with cronyism and politically-induced misallocation of public resources.

By Pedro Martins (read the working-paper)

Time (in)consistency once again?

   One of the more recurring features of Portuguese politics is the time inconsistency of decision makers. Probably the same happens everywhere.

   I would like to know the contribution of time inconsistency of policies to the slowdown in economic growth. Basically, if you cannot believe in agreements signed with the Government, this should have a cost in terms of economic activity.

   This was brought again to my mind by the agreement on minimum wage - It was signed 4 years ago an agreement involving the Government, the unions and the industry associations (I think the industry associations signed it, not sure, but it is not essential). It stated that minimum wage should go to 500€/month in phased way.

   Now, industry associations want the Government to refrain from it, based on the bad economic conditions. Unions (and left wing parties) argue the Government should stick to the agreement.

   For once, I agree with the later on the grounds of consistency of policies (they use other arguments, of course). Actually, it is in the interest of the industry associations that

the Government does it. Otherwise, any agreement with the Government becomes only valid until the next convenient moment to change it? and if instead of minimum wage would be a VAT tax? or an exceptional tax on sales with "frozen" prices? A bit demagogic, I know, but once you enter the uncertainty that agreements do not bind the parties, everything goes.

   Moreover, I was puzzled by a news report stating that some computations made by the Government showed little impact associated with the minimum wage increase.

   Overall, without entering the discussion of whether a minimum wage has negative effects upon employment and growth of economic activity, I feel that not respecting agreements must also be damaging, in a hardly visible way.

Making sense of external debt (?)

A few weeks ago, a piece on the FT mentioned that the Irish gross external debt was close to 1000% of GDP (not a typo!). Based on this observation, the FT commentator explained that the EFSF could provide liquidity to Irish banks but certainly not make them solvent. His conclusion might be true, but I believe that inferring solvency from gross (or even net) external debt is not correct. Today most developed countries have very large gross external positions (external gross liabilities and assets of 300% of GDP are quite common). These positions are the outcome of the massive increase in the size of capital inflows and outflows across countries experienced in the last 20 years or so. Most available data on bilateral external positions are based on the concept of residence. This accounting principle implies that a debt by, say a German bank located in Dublin on a French. resident is an external debt of Ireland vis-à-vis France, instead of a German debt. The BIS constructs a different measure (only for banks and for 24 developed countries), called “ultimate risk” basis, that identifies exposures on the basis of the nationality of the ultimate creditor and debtor. In short the “ultimate risk” basis is constructed to identify the bank that is ultimately responsible for the liability and is a better measure to assess solvency and liquidity. According to this measure, at the end of June 2010, European banks had 423 billion dollars claims on Irish banks, while Irish banks had 375.8 billion claims on European banks. Within Europe the net debt of Irish banks was therefore 47 billion or approximately 20% of GDP. The overall net figure is not available but we know that Ireland bank claims vis-a-vis “all countries” amount to 548 billion dollars and the 24 countries claims vis-a-vis Ireland amount to 518 billion. The graph below shows the creditors of Ireland (millions of dollars, June 2010, BIS.) The creditors breakup is useful to assess the transmission channels of a default and the incentives of each nation to bail out their debtor. (click to enlarge)

Portuguese banks have 80 billion dollars claims against other European banks while European claims against Portugal amount to 205 billion. Within Europe Portuguese banks have a net debt of 125 billion or 54% of GDP. Portugal bank claims vis-a-vis “all countries” amount to 140 billion dollars and the 24 countries claims vis-a-vis Portugal amount to 212 billion dollars.

Saved by the Irish?

A few days ago I wrote in another blog a post stating that Ireland was lucky to be saved by the EU/IMF fund. But now I am confused. Was the Irish rescue the rescue of the Irish economy? Or was it imposed on Ireland - and on its government that will suffer in next year's polls - to rescue the banks in Europe that hold a large share of the country's sovereign debt, as today's FT argues? In the meantime, Portugal's yields have stabilized. Were we just lucky not to have been "saved" by a similar loan? What's next?

What do they know?

Strangely enough, in the last month or so it seemed that Portugal's politics was going to be run to the beat of the interest paid on sovereign bonds. At some point, 95% of analysts, politicians, and the media, were arguing that there could be no discussion about the 2011 budget, because otherwise the "markets" would ask for higher yields. The correlation however proved to be much lower than expected. Surprise? No, I don't think so. Markets are looking at models and computer screens, not at the Portuguese parliament or newspapers. And I have a hint that that is in fact so: the other day I got this email from a "lead analyst for Portugal in the Sovereign Risk Group" at one of the World top three rating agencies, asking for papers on a certain topic, but they had to be in English because he/she spoke (or read) "absolutely no Portuguese". How do you rate countries like that? And how do you decide about the price of the bonds? By looking at what Pedro Passos Coelho (btw, the leader of the main opposition party) says? Maybe not so. It was of course relavant that the budget passed. But also that there was genuine political dispute, and negotiations between the parties.

Courtesy of Portugal, the Daily Show within the New York Times

A lesson from thinking about economics is that the evident truths are, on closer inspection, just plain false or even silly. This piece in the New York Times looks like a sketch out of the Daily Show where a somber "analyst" makes grave statements without realizing how hilariously ridiculous it all is. According to the reporters, the problems of Spain, Portugal, and Greece are that:

i) "You can’t build an economy on real estate, finance and tourism."
ii) "...it’s an absurd idea to have the same currency in a country like Greece or Portugal as in Germany, which has totally different habits and culture."
iii) "They lived on a bubble of credit and real estate development that sent wages and debt soaring."
iv) Deficits and debt are high.

These reporters were looking outside their window to face Manhattan just as I am right now. Funny that they didn't notice that the city in front of them has:

i) An economy built on real estate, finance and tourism.
ii) The same currency as Alabama, Alaska, and California.
iii) Very large increases in credit, real estate development, wages and debt in the last decade.
iv) A huge amount of debt and current deficits in the state government.

Jon Stewart couldn't have done it any better.

The decline of the West

I just came back from Korea. Being away for a few days from the problems facing the Fed in the U.S. and the government in Portugal that have been occupying my mind had the virtue of giving me some perspective.
I already knew that the IMF had estimated a 4.5% growth in world output for next year: the highest in a couple of decades. But I just ran across the following graph from the IMF October economic outlook and it really stunned me. If a good image is worth a thousand words, this one is worth a thousand articles and books on the decline of the West (U.S., Europe and Japan) and the rise of the developing world.

I am writing a little more about this (in Portuguese) tomorrow in my column in jornal i.

Portuguese Higher Education in a British Mirror

Figure 1

The UK received this week, not without some trepidation, the conclusions from the so-called Browne report on higher education and student finance in England. As was long expected, the review committee recommended an end to the cap on university fees, currently £3,290 per year (€3,800). The report suggests that different universities should charge different fees and, in particular, that world-class institutions should be allowed to charge much higher fees from their students, possibly above £12,000 (€13,800) per year. The report justifies this proposal for increased private contributions as a necessary means “to support high quality provision and allow the sector to grow to meet qualified demand.” The current budget crunch added to the urgency of these conclusions, as the country braces itself for the comprehensive spending review due next week. Today’s newspapers rumoured that the government is set to cut up to 80% of the public funding of university teaching, which would leave UK universities in serious financial strictures.

Earlier in the year, the results of the university admission exercise revealed that more than 150,000 applicants would not get a place, out of a total of 660,000. In the face of such excess demand for university places, elementary economics would suggest that some price rationing was in order. Some politicians, parents’ and students’ representatives have contended that a fee hike would unfairly saddle students with a heavy debt burden at the beginning of their working lives. Furthermore, fees of £12,000 or more would surely dissuade bright or otherwise aspiring pupils with an underprivileged background from applying at all.

The authors of the report disagree and take particular pains at arguing how this dissuasion effect can be avoided. One of the reasons is that graduates can pay more for their education. How much more? The authors rightly leave that to the market, while noting that “compared to other countries, high numbers of students in England complete their degrees and go on to employment with an earnings premium that is high by international standards.” This “earnings premium” is measured as the net benefit (in lifetime earnings) from completing a degree over the expected life-long remuneration of an individual who enters the job market with a high-school diploma. According to the data in Figure 1, this premium in the UK stands at slightly above 200,000 US dollars (€150,000) for a male with higher education. This is a third higher than the OECD average.

We all know the debate, as it has been rehearsed several times in Portugal since 1992. What I found interesting in the report was the oblique reference to Portugal as an outlier in the context of OECD countries. Portuguese university graduates have a staggering relative advantage over their non-degree holding competitors in the labour market. We currently lead the OECD in both net and in gross benefits from higher education. A university education is worth today €265,000 in Portugal, fully 2.5 times the OECD average.

This is clearly not a matter to be proud of. As a university lecturer myself, I refrain from commenting on what a fee hike from the current €920 could represent for the quality and growth of Portuguese universities. But I cannot but see the connection between a very high “earnings premium” and the low fraction of the population that has attained a university degree (Figure 2). Contrary to a contemporary current of opinion, there may not be “too many graduates” looking for inexistent jobs, but too few.

Figure 2

And here is another connection. A very interesting book recently singled out Portugal as an outlier, again for the wrong reasons. The authors of The Spirit Level notice that by level of income inequality, Portugal comes second among OECD economies, just after the USA... Most economists will agree that access to education is a powerful equalizer of opportunities, and that, vice-versa, a restrictive university system is a certain way of perpetuating income (and social) inequalities, particularly in our current skills-intensive model of economic growth. How one may go about increasing access to tertiary education is another question (namely in terms of how to split the cost between the state and the students), but the weight of evidence about the consequences of not doing so cannot be ignored.

Civil servants' wage cut

The Price of Irresponsability

A quick assessment of the new austerity measures (in Portuguese... sorry!).

What to think

1) The negotiations between Passos Coelho, the leader of the main opposition party, PSD, and José Sócrates, the Prime Minister, did not really break down. They were simply interrupted. I hope. The two men are clashing in many issues and one of them is certainly their character - I don't need to have lunch with Sócrates to know that I wouldn’t buy a second hand car from him.
2) The Prime Minister wants Coelho to sign a blank cheque before the Budget goes to Parliament, in a fortnight’s time, and of course the latter does not want to do that: we may guess that he wants his MPs (unfortunately he is not one of them because the former PSD leader blocked his election) to discuss the budget, loud and clear, so that he does not loose his electorate.
3) Passos Coelho should not follow the same people in his party that proposed the "revisão constitucional" which was an ideological, badly designed and unnecessary move. He does not need ideology but pragmatism instead.
4) Cavaco Silva, the President, will ultimately help Passos to get out well from this episode.
5) Passos needs to get the Budget passed and to be able to say that he did what was best for the country.
6)It may be necessary to raise taxes in order to fulfil the deficit target for 2011 agreed with Brussels.
7) Contrarily to common sense widely spread in Portugal and abroad, this country has a good record in keeping its international financial obligations and that tradition is well embedded in both the Socialist and the Social Democratic parties.
8) People are not protesting on the streets, contrarily to Greece, France or even Spain, which somehow prouves the point above.
9) Since Cavaco Silva´s reforms, back in the 1990s, Portuguese governments have at their disposal enough tools to cut expenditure and/or raise taxes, as they wish (tools that Mário Soares, for instance, did not have in the early 1980s).
10) Let's see what happens next.

SCUTs or how to make life messy...

   Last week, the major decision from Government was to introduce tolls in highways that were built under the concept of "no cost to the user" - Government would pay private contractors that built and operate the highway according to traffic (with some "demand insurance" though).

   Now, faced with severe budget constraints and having to cut down public spending, the Government introduced payment in highways where people were already used not to pay.

   But given the protest of local populations, that were using arguments put forward some years ago by the same Government, exemptions and discounts were created, based on household distance to the highway.

   From a pure economics viewpoint, price discrimination, as this is the case here, can be welfare increasing - translating from our jargon, it may be good for society that different prices apply to different people.

   The problem is when pure economics meets political economy - by having differential treatment as a rule, everyone will claim and press the Government to have particular exceptions - thus transforming tolls in highways into a bargaining game.

   I wonder what will be the end result, especially if in highways where no price discrimination exists populations start demanding application of the same rules.

The monster fights back

In Greece, until July, public expenditure had fallen by 14%; in Ireland 2.9%; in Spain 2.5%. What about Portugal? It raised by 4%.

-- Ricardo Reis