Wednesday 31 March 2010

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. 

Tuesday 30 March 2010

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%.

Friday 26 March 2010

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.

Wednesday 24 March 2010


   "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.

Monday 22 March 2010


   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


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.

Sunday 21 March 2010

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.

Saturday 20 March 2010

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.

Friday 19 March 2010

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.

Wednesday 17 March 2010

Will this time be different? (Part I)

   Two economists, Carmen Reinhart and Kenneth Rogoff, published last year an important book entitled “This Time is Different. Eight Centuries of Financial Folly.” The title is a tongue-in-cheek reference to the recurrent lack of memory evidenced by politicians and experts alike in the build up to all past financial disasters. The main conclusion of this book is that times have never really changed, and that financial markets have been hit by crises remarkable in their frequency, duration, and severity. The amount of empirical evidence uncovered by the authors is just too much to ignore and continue to claim that markets are immune to ‘irrational exuberance’. Among the several pathologies of financial influenza, sovereign debt problems figure prominently in this book. Contrary to many authors, Reinhart and Rogoff are skeptical about the ability of emerging nations to ‘graduate’ from sub-investment grade to the club of investment-grade nations. Portugal even if not usually classified as “emerging” falls among the candidates for graduation.

Historical vitality, not hope

   Nowadays many people argue that "hope" is the miraculous word. It should be repeated over and over. These people say that the appeal to "hope" is part and parcel of any meaningful economic recovery. I guess we can call it the "Obama effect".
   As far as I am concerned I reject this appeal. For reasons that I can explain in some other occasion, I don't think "hope" is the appropriate psychological resource in democratic politics, even in depressed and dangerous times such as ours.
   Be that as it may, Portugal does not need "hope". Portugal needs to show "historical vitality", that is, it needs to show the moral and psychological energy to fight concrete threats. To put it in contrast, "historical vitality" is very different from "hope". It is not a light and a force from above which somehow allows us to jump over our difficulties; it is not a promise to make dangerous threats disappear. It is rather the moral strength which sustains us when we look those same difficulties and dangerous threats in the eye. With confidence, but without illusions.

The way out (2)

   An alternative to Pedro's provocative idea: dumping the euro. I know that economists are notorious in making predictions. Still, I think that it is pretty safe to assume that if the Portuguese economy does indeed have another "lost decade" (that is, if it remains stagnated for a prolonged period of time), it is very likely that in 10 years time we will be discussing how and when we will leave the euro. The country will not take another 10 years of low growth, high unemployment and high emigration (which, yes, is back big time) without politicians (and economists) starting to consider this heretic possibility. I know that leaving the euro is risky and costly, but I would not be surprised if this possibility becomes increasingly attractive if stagnation persists. (If it is not us, this is certainly a possibility for Italy or Greece).

Tuesday 16 March 2010

The way out

Yesterday a gloomy Portuguese philosopher stated on TV that this crisis was different because this time there was no way out. But there is in fact the same way out as always: protectionisn. What is really different this time is that very few people seem to be in favour of such type of solution. But politicians across the EU should beware, because that may change very quickly.

Monday 15 March 2010

The arranged marriage of schools and teachers

   A school teacher committed suicide last week, which, like bullying, is not a new phenomenon. I recall that a high school teacher of mine also committed suicide. And I remember we, the students, making fun of him (something I am not proud of), despite his sweetness and educational effort. I was in a school where the student population was diverse, with a high rate of students from disadvantageous neighborhoods with family-related violence problems. Since that time, I have wondered why public schools in Portugal are not involved in the hiring of teachers.
   Schools are assigned teachers according to the schools’ needs in their fields of studies. But the uniqueness of a school comes not only from its infrastructure and curriculum but from the uniqueness of the communities and neighborhoods they serve, and consequently the background and ability of their students. Therefore, a “good teacher” is in part school-specific. Apart from formal qualifications, on-the-job future training and personality traits are extremely important and left out of the centralized school-teacher matching.

Sunday 14 March 2010

A day at the Portuguese Parliament

A few thoughts after having spent last Friday at the Portuguese Parliament with some students, to watch the final debate on this year's budget. The most striking thing of the discussion is the accounting perspective that dominates the debate. The proposals are discussed in terms of their budgetary impact but little or no reference is made to a cost-benefit type of assessment, apart from some vague qualitative statements about, e.g., the role of not-for-profit organizations in the provision of local public services. Not a single figure about the effectiveness or efficiency of the service delivery. This same perspective dominates to a large extent the debate surrounding the Stability and Growth Programme. While it is obvious that the S&GP should begin by a careful quantification of the impact of each measure in terms of revenue and expenditure, this should be a first step into assessing the impact of these measures in the economy and whether they are able to put the country in a sustainable growth path in the medium to long term. Solving the deficit issue is a means and not an end in itself, and it doesn't seem like decision makers have that clearly in mind. A new culture of political decision making is needed in Portugal, one where the impact assessment of each decision becomes the rule rather than the exception.

Saturday 13 March 2010

Lessons from the Portuguese Stability and Growth Programme

After a long wait, we are finally getting to know some of the measures proposed by the Portuguese government to reduce the fiscal deficits. The strategy of the government is simple: tax, privatize, cut spending the least as they can, and expect the economy to recover. Will this strategy solve the structural imbalances of Portugal’s public sector? Likely not. Does that mean that Portugal will not be able to meet its target of reducing the budget deficit to 3% of GDP by 2013? It might, or not. It  depends, mostly on how the economy will behave. Still, it also might not matter, especially if the deficit is close enough to that limit (and if other European countries also struggle to meet the 3% limit). What the government seems be doing is trying to do is buying time. There are difficult decisions to be made, but the government is clearly opting not to take them. At least for now. Having said that, there are several lessons that we can draw from reading the latest Portuguese Stability and Growth Programme (SGP).  What are, then, these lessons?
 Lesson #1 _ Stay positive, stay the course
Right or wrong, the Portuguese government genuinely believes that the strategy of the last few years is bearing fruits, and that public spending and investment (both in the form of traditional public investment and public-private partnerships) will, sooner or later, stimulate the economy. More specifically, the government estimates that 36% of deficit reduction (about 2% of GDP) will come from the recovery of the economy. Is this reasonable? Probably yes. Between 2008 and 2009, tax revenues declined around 1,7% of GDP, while public expenditures increased around  2000 million due to the temporary rise in fiscal transfers related to the crisis. The government is thus assuming that by 2010, or 2011, tax revenues will be back to its pre-international crisis levels and that the temporary expenditures will cease to exist (a big assumption, mainly if stagnation persists).
Lesson #2 _ Increase taxes (but don’t tell the public)

Friday 12 March 2010

Thursday 11 March 2010

Fiscal consolidation at the zero interest lower bound

Here I scratch the surface of a more general question: the effects of Fiscal consolidation at the zero interest lower bound which is not far from where the EMU and US short term interest rates are right now. This suggests that what we should debate is Fiscal consolidation at the zero interest lower bound and not Fiscal consolidation tout-court. In the last two years Macroeconomists have (re)-learned that in a liquidity trap the fiscal multiplier is at maximum and larger than in normal times. Therefore elasticities estimated in samples that do not contain periods of near zero interest rates might not be reliable for near-liquidity trap periods. This observation has another implication: if fiscal multipliers are larger when interest rates are close to the zero lower bound, fiscal consolidation should be performed during times when the economy is far from the lower bound. Wait, it becomes worse: at the zero interest rate lower bound, the larger contractionary effect of fiscal policy increases the probability of maintaining the interest rates at zero, making it more difficult to escape from the trap. There are many caveats, the most obvious regard interest rates payments on national debt (the longer we wait the larger are the payments) and credibility. Let me conclude by suggesting that the escape from near-zero interest rate lower bound in a monetary union necessarily involves an increase in aggregate demand in the monetary union. This would suggest to have fiscal consolidation plans contingent with the EMU recovery and monetary policy normalization.

Automatic Stabilizers and the Deficit

   In the previous post Pedro Pita Barros asks how much of the current deficit is due to “automatic stabilizers” and therefore how much of the recovery will be automatic as well. For a quick answer one has to look at measures of the cyclically-adjusted deficit and this what I do here.    The cyclically-adjusted deficit is computed (in this case by the OECD) to show the underlying fiscal position when cyclical or automatic movements are removed. The cyclically adjusted components are calculated from actual tax revenues and expenditures adjusted using the ratio of potential output to actual output, the ratio between structural unemployment and actual unemployment and the assumed elasticities. OECD use several indicators to capture the degree of resource utilization and compute measures of potential output and unemployment. These calculations constitute an approximation and are of course subject to errors. The overall cyclical sensitivity of the budget to the economic cycle can be calculated by the semi-elasticity of the budget balance with respect to the output gap. This semi-elasticity is 0.46 for Portugal, meaning that for each percentage point change in GDP the budget balance change, as a per cent of GDP by 0.46. Estimates of real GDP growth are around -3%. That would imply that circa 1.5% of the primary deficit GDP ratio is due to the GDP contraction.This number looks small and I suspect that a larger fraction of the deficit-gdp ratio is due to the crisis. Why should I not trust the semi-elasticity estimate? This leads me to the more general question in the next post.

The Stability & Growth Programme, Portugal, 2010-13

For the executive summary in English see here.

Wednesday 10 March 2010

The road to nowhere

   The last few days were characterized by a huge expectation about the new program for stability and growth of the Portuguese Government. The images of civil unrest in Greece, the fear of credit rating agencies and the current political situation created an interest for that program that it had not seen in past releases. Finally, we get a glimpse of it in an official document here (sorry, only Portuguese version for the moment).
   The first reading meets my (low) expectations and will leave unsatisfied all those waiting for a "silver bullet" to solve the budget deficit issue.
   There are several unsettled issues in the document, and a simple question that I am interested on was not answered: how much of the current deficit is due to "automatic stabilizers" at work on a downturn, and therefore how much of the recovery will be automatic as well? Can the PESSOA model mentioned in another post provider an answer to this?
   Without a precise knowledge (or at least as precise as we can get) about the role of economic growth in reduction of "social payments" and increase of fiscal revenues, it will be hard to judge the impact of the currently proposed measures.
   Additionally, although the economic press has made extensive reviews of some of the measures, there is no precise account on the impact of each of them in the economy, or of alternatives that have been, eventually, considered and discarded. That would be useful to know as well.
   Overall, I do not expect any civil unrest translating into street fighting, due to the calm nature of people and not to the particular measures adopted.

Tuesday 9 March 2010

The Marshall Plan and Germany (and vice versa)

   European post-war security, the Cold War and the rhetoric surrounding its announcement provided the necessary political framework, but the economics of the Marshall Plan was fundamentally about a country with a huge current account surplus providing funds to countries with high growth potential and limited access to international capital markets. The funds were provided conditioned on the recipient countries agreeing on democratic institutional reconstruction, free trade and international co-operation which, incidentally, led to the creation of the Common Market and to economic prosperity.

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.

Sunday 7 March 2010

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.

Saturday 6 March 2010

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 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.

Friday 5 March 2010

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.

Thursday 4 March 2010

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?

Tuesday 2 March 2010

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.

Monday 1 March 2010


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