Sunday 21 March 2010

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.
   Let me enumerate some facts (to be disputed eventually):
1. There is little dispute that oil shocks in the 1970s hit hard all economies, including the Portuguese.
2. Portugal depends a lot on imported energy, namely oil.
3. Oil (and related products) have their prices in the international market set in US dollars.
4. There were price increases in oil over several years.
5. During the same years, the exchange rate euro/dollar made imports in US dollars cheaper to the Euro zone.
6. For Portugal, fact #5 compensated #4. If Portugal would be out of the euro, then we would experienced a stronger shock in energy prices (we did to some extent, as reflected in domestic energy prices kept below their production costs, resulting in a deficit that has been securitized and it is to be paid over the next 15 years).
   Thus, the "what if" Portugal was outside the Euro zone seems to require that we consider a mini-oil shock. Perhaps there is something escaping my attention, but most discussions of whether we did well or not by entering the Euro zone seem to neglect this. I wonder whether, or not, someone has actually measured what would have been the evolution of the Portuguese economy under that scenario.
   A different issue is leaving the euro, given that the initial entry decision was taken. Do we have to gain from doing it? The main argument seems to be the advantage of devaluating own currency against the US dollar and the euro. That would cut down imports and increase exports. It also impoverishes the population, and the wealth denominated in local currency. Capital flows would be affected as well. And since the gains to exports were not due to increased productivity (the real and long term gain) but only due to a price effect, the benefits would be probably short lived.
   I put forward my ignorance on international monetary macro issues, but let me apply a simple idea borrowed from revealed preference: if devaluation of a currency can be a solution to increase growth of a country in the long run, why do we not see a race from the countries not belonging to the euro (or US dollar) zone to see which country devaluates more and faster?
   Some will say that devaluation is only good as a response to a shock, but if that is the case, then we are obliged to look for alternative instruments, and battle for them.
   What if we did not enter the euro zone? My guess is that we would be poorer and complaining about not entering the euro zone.
   What if we do leave the euro and go back to own currency? My guess is that we will regret it.
   What if we do keep within the euro and keep the low growth path? My guess is that many will make the euro guilty of our inability to change productivity levels.

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