Thursday 31 March 2011

Elections and revision of the public deficit

Today, two pieces of news: elections set for June 5 and revision of the public deficit.

At the same time, interest rates on public debt are still rising. The question is why. It is tempting to link it to one or both pieces of news. Somehow, this is sounds unconvincing.

That elections would have to take place has been relatively obvious since past week, so no surprise there.

On the revision of the public deficit, if it was the case that new information on previously unknown spending was surfacing, I would understand it. But the revision does not bring new facts, just rearranges expenditure. It is counting as part of public deficit the debts from public transport companies (railways, subway) and the rescue of two private banks (BPN and BPP). (you can read the press release with the explanation here: Press release by INE)
None of it is new.
The deficits in transport companies are usual, and sooner or later will have to be covered by the Government.

And none of the rearrangement of how public accounts are reported brought new expenditure to the open. So, it is hard to understand any "financial market" reactions, unless we want to consider that operators in international financial markets still have shallow knowledge of the Portuguese economy.

An alternative explanation, is that I am neglecting something, of course...

Still on privatizing Caixa

The comments box on my previous post, together with the two cited articles, have several good arguments for why, or why not, Caixa should be privatized in the long run. However, my concern in the last post was with the next 6-12 months. And, frankly, I don't see how that is possible. My concerns are:

1. In the next 6-12 months, Portuguese private banks are going to have to recapitalize. Judging from the noise they have made about this, they are very worried that they will not find the needed capital in Portugal. So, if there isn't private money out there to raise capital ratios in private banks by a few percentage points, how can there be enough money to buy 100% of the capital in one of the largest banks?

2. An answer is foreign capital. But then, let's be clear. Privatizing Caixa right now is not just putting it in private hands; it is putting it in private foreign hands. Is that what the people proposing it really want?

3. But even if that is so, I am skeptical that you could find a foreign group that would want to buy Caixa right now, and pay a decent price for it. The natural candidate, Spanish banks, have their hands full with their own problems. And with the amount of uncertainty about Portugal's economic prospects over the next two years, would anyone really be willing to invest this much money in the country?

So, I just don't see it.

I do see the opposite direction, where the government has to inject public capital into the private banks. And I don't have to think too hard to come up with several scenarios where this happens, some desirable, many not so.

Public Debt 1850-2011

It's now official. We have the largest public debt as a percentage of GDP since, at least, 1850. A sad, sad legacy.

Public Debt as % of GDP, 1850-2011
 Source: Mata and Valerio (1992), Neves (1994), INE, Santos Pereira (2011)

Wednesday 30 March 2011

Privatizing Caixa

Caixa Geral de Depositos is one of the largest Portuguese banks, and it is owned by the State. It is a profitable bank with significant market value, and the Social-Democratic Party suggested privatizing it a few days ago. The immediate goal is to raise revenue to reduce the public debt. Pedro Lains and Alvaro Santos Pereira, contributors to this blog, have written about it elsewhere, against and in favor of privatization, respectively.

This debate puzzles me. When I think of the big policy challenges in the Portuguese financial markets in the next 6-12 months, it is not privatizing the State bank that comes to my mind. Rather, it is whether or not to (partially) nationalize the private banks.

Same topic, opposite sign.

Income Account vs Trade Account: a dramatic milestone for Portugal

This is a figure from the latest Banco de Portugal's Economic Bulletin - Spring 2011: Projections for the Portuguese economy: 2011-2012, published yesterday.

A dramatic consequence of the increasingly negative Portuguese net international investment position as well as of the rise of our external credit interest rates: Banco de Portugal predicts that in 2011 the income account deficit will surpass the trade deficit (which never happened in the past, to the best of my recollections); and that in 2012 the income account deficit will amount to 7 percent of GDP.

In other words, a substancial part of our domestic income will be subtracted from national income, and therefore the nation's disposable income, in the foreseable future.
Even though we may get the (irrealistic, from my point of view) forecasted growth in net external demand that would avoid an even higher drop in GDP, a lot of that GDP will not be ours to consume or save.

A dramatic milestone for this country.

Friday 25 March 2011

Minimising future problems

Some evidence that I obtained earlier indicates that state-owned firms in Portugal tend to increase their hirings considerably (by as much as 50%) in the months just before general elections. Now that an election will probably take place very soon - and when some of those firms have so many financial problems -, it would be really important to try to minimise that very peculiar pattern of hirings this time.

I wonder if the government and/or the parliament could impose a ban on hirings during the next few months (including the months just after the general election too)? Or at least demand greater transparency on those appointments? One idea could be to require state-owned firms to disclose on the web the names and CVs of the new appointees and their job and pay levels.

"A Nation of Dropouts Shakes Europe"

The Wall Street Journal writes about the Portuguese education system - in a not very flattering light.

Wednesday 23 March 2011

Prime-minister resigns, next steps?

And the announced path has been walked down half-way - the portuguese prime-minister resigned today, after the new austerity measures have been rejected in Parliament.

Does it mean they will not be applied? hardly the case, most likely the measures
will adopted, and since several, if not most, would take effect only next year, there is still time for this or another government to apply them.

Does the political crisis bring a bailout closer? it is difficult to say, but again it is hard to believe it should, as there are not many policy options; in particular, it is not predictable the government entering a spending frenzy to gain elections - people are aware and concerned about the budget prospects and the costs it will entail.

Solution to the political crisis? several options are available, including finding another government solution within the current parliament, with some sort of majority in parliament. We have to wait for the meetings the President will hold with the main political parties, though the first reactions of parties point to elections. If another solution is attempted, then it means a very active role of the President backstage.

Will elections solve political instability? I give a 50% chance it may keep everything the same.

Are elections needed? probably yes, people in the street feel the need to express their views, and probably want some hope and common purpose, let's see how much of it politicians are able to deliver if elections becomes the way forward

Tuesday 22 March 2011

Healthy crisis

In a smart move, the main opposition party released a statement in English yesterday, hinting that a political crisis now may very well be a good thing in terms of the sustainability of the Portuguese economy. In any case, a general election is surely the only way to restore trust in the government, given yesterday's clarification on PEC 4b by the Eurogroup president.

Friday 18 March 2011

Δεν είστε μόνοι

Interesting post (Can Greece pull it off?) in VOX by the European Economic Advisory Group.

Here is the abstract:

Will the Greek rescue package be enough or is restructuring inevitable? In this column, members of the European Economic Advisory Group argue that even if the sovereign debt crisis is resolved, Greece must deal with its unsustainable current-account deficit. This requires an unenviable choice between internal and external depreciation and a government strong enough to take on the country’s rife tax evasion.

Does this remind you (hint:current account) of anything?

Wednesday 16 March 2011

The horror scenario

Credibility deficit

Everybody knows that politicians will have, almost inevitably, a difficult relationship with the truth. But the latest developments in Portugal's political life increasingly remind me of Orwell's "1984" and the sudden shift in alliances there between Oceania, Eurasia and Eastasia - while, at the same time, the ruling class got to persuade the people that the ally had always been the same.

The "problem", of course, is that we aren't in the totalitarian world of "1984". Whoever is willing to spend a few minutes on the internet can easily expose many recent, glaring reversals in policy goals over a period of only a few months (for instance, here, here and here).

Even if one can leave aside issues about the strength of political convictions (which are irrelevant from the point of view of the hard-nosed international markets), questions about credibility become increasingly more pertinent: Can the European Commission (and/or Germany) really pretend to believe a program of reforms such as a 17-slide PEC IV which, at least in some areas, is in complete contradiction with what were regarded as fundamental principles for many years up to just a few months ago?

Monday 14 March 2011

Policy options...

... to deal with “precarious” jobs and segmentation:

1. Increase public sector employment
2. Rule out temporary jobs, “recibos verdes” and traineeships
3. Cut dismissal costs for all permanent jobs
4. Cut dismissal costs for new permanent jobs
5. Merge temporary and permanent jobs into a new, single contract type

Sunday 13 March 2011

Some evidence on the segmentation of the labour market

The table below presents mean characteristics of workers under permanent and temporary contracts, according to the 2009 personnel records ("Quadros de pessoal"). "Recibos verdes" are excluded, as well as those working for temporary agencies, on traineeships (and the unemployed).

Only workers aged 25 to 35 and with a university degree are considered, a total of about 220,000 people. 35% of these workers are found to be on temporary contracts.

Gender, age and schooling means appear to be similar across the two contract types. The big differences emerge in terms of tenure (years with the same employer): 4.5 in the case of permanent workers and only 1.6 in the case of temporary workers; and monthly gross salaries, 1,600 euros in the case of permanent workers and less than 1,200 in the case of temporary workers.

Saturday 12 March 2011

Peaceful demonstration

We have seen in the news a crescendo of interest on today's demonstration,
and how it could go.

In the end, despite the announcement of more hard and harsh measures to
bring the budget deficit under control, despite interest rates in Government debt reaching
historical maximum in financial markets, all of it went peacefully in Lisbon, Oporto
and the other cities.

If the international press (and perhaps some national press as well) was hoping
for tears, blood and smashed windows of stores, nothing of that sort resulted.

Not sure what it means... but much better than having violence around, for sure.

Friday 11 March 2011

The New Austerity

In the last year or so the Portuguese government has been announcing successive measures to control public expenditure and deficit. This is in line with what is asked for by Berlin, Brussels and Frankfurt. Clearly, austerity measures in Portugal are the reflexion of the new Europe. Germany may be blamed for that but we all know that finding the culprit, be it Germany or Socrates, or the ECB (or Greenspan…), generally means that one has reached the wrong answer. Austerity is not about Merkel or Germany, although domestic pressure there and in the other “northern” countries should be accounted for. But the bottom line has to lie elsewhere, namely, on the gradual redefinition of how the European Union is going to work in the next decade or so. And what will it be? It will be a Union where “fiscal responsibility” will prevail over “cohesion”. I am not worried about that, frankly. Portugal can live with the new Europe on the making, and the changes may even have positive effects on the structure of the economy and on the overall institutional framework. It is a shame, however, that changes had to be imposed on such a short notice and in such a drastic way, mostly because their effects on the less protected parts of the population will be felt more severely. But Portugal will cope with what the new Europe implies: lower wages, lower pensions, higher retirement age, smaller welfare state, lower infrastructure investments, etc. All counterfactual scenarios are most probably worse. And in the end we may have higher savings rates, higher export growth, and lower dependence on foreign capital.

Thursday 10 March 2011

Portugal needs peace but no Carthaginian peace

Portugal needs to secure stable access to funding at 4% for the next five to seven years and the rest of Europe must offer such funding to Portugal. The conditions that Europe granted to Ireland, namely funding at 5.8%, are a non starter. Consider that from 1999 to 2007 nominal GDP growth in Portugal averaged 4.8% per year. Any cost of funding that is above the nominal GDP growth rate requires a switch from deficit to surplus just to stabilize the debt to GDP ratio. In short, “Irish conditions” imply that, in a scenario where Portugal follows the right set of policies (defined below), debt will start stop increasing in a decade or so. I assume Europe will grant funding to Portugal at 4%. (Assumption1 cost of funding is 4%)

Assessing if Portugal needs a bailout is hard and somewhat subjective as it requires a consistent and uniform analytical model. I sidestep this difficulty by assessing Portugal solvency only using an intertemporal budget constraint (IBC). In words Portugal becomes bankrupt if unable to pay off foreign obligations at their face values, and if this happen the Portuguese IBC would not hold with foreign debts valued at par. I focus on national solvency as opposed to government solvency as I stronlgy believe the priority is on stabilizing the external debt. As a reminder Figures 1 and 2 show the government and the external debt as a share of GDP. On one hand the government debt dynamics are worrysome but hardly justify the risk premium markets are requiring to finance Portugal. On the other hand the external debt dynamics are just explosive and might well scare any international investor.

Eurostat forecasts Portugal nominal GDP growth to be 0% in 2011 and 1.8% in 2012. To extrapolate further into the future I assume that from 2013 on, nominal GDP growth will stand at 4.8% per year. (Assumption 2: nominal GDP growth is 0 in 2011, 1.8% in 2012 and 4.8% from 2013.)

All other things equal, securing access to reasonable rates will not be sufficient to make Portugal solvent. The trade balance has averaged -8.8% per year from 1999 to 2007 and stands at -6.25% in the first three quarters of 2010. If Portugal does not improve the trade balance any attempt to assess its solvency is futile.

Let me illustrate a favourable scenario. Assume that Portugal does initiate a process that transforms the country in a net exporter. I do not discuss specific proposals to achieve such a target and interpret the process as a reduced form of many policies. The process improves the trade deficit (now at -6.25%) by 1% every year starting in 2012 and stabilizes at 6.75% in 2024. This scenario correponds to the blue line in Figure 3. By that year Portugal’s trade balance would resemble the Netherlands’ trade balance (6.7% is the average 1999-2007 Netherlands trade balance). If such a policy is implemented, the Portuguese international investment position stabilizes around 2015 at 136% of GDP and starts to decline the year after. Notice that the external net debt is stabilized before the trade balance turns positive and the subsequent trade surpluses will repay the debt. Things could go worse (yellow line) because of bad shocks or better (green line) maybe if the structural change is complemented with other policies such as a fiscal devaluation that would affect positively the trade balance in the short run. In any case Portugal would remain solvent and the European fixed rate coupled with the Portuguese transformation would have been successful.

Difficult scenario? Challenging. Obviously the “real” policies behind the transformation must be enumerated and discussed but as a target they are necessary to live in the currency union. Realistically the undertaking of such reforms during a period of severe fiscal consolidation might require further help from Europe. One possibility could be to use the EU Structural Funds intertemporal budget constraint and front load all expenditure allocated to Portugal to the next five years period. On paper it would not be an additional transfer from other European partners, call it a timely transfer. In any case square one is to secure funding at a reasonable rate.

Does Portugal need a bail-out?

Here are the views on this key question as contributed by some of the economists writing in this blog:

Alvaro Santos Pereira:
Absolutely. There is no doubt in my mind that Portugal will be bailed out, whether that is done through the “conventional” means that have been used by Greece and Ireland, or whether Europe gets its act together and agrees on a permanent framework to deal with these situations (a big if, indeed). Still, in both instances, Portugal needs to solve rapidly the acute liquidity shortage that threatens to dampen even more the country’s economic activity.

Why is a bailout almost inevitable? Because the credit constraints and the lack of financing of the economy are untenable, the debt dynamics are unsustainable, and because, frankly, there is a self-sustaining belief that Portugal is the next country to fall in the European sovereign debt domino.

Independently of what will happen in the next few days, the fact is that Portugal has a very serious debt problem in its hands, which will likely not go away with a mere bailout. Just to put things into perspective, in 2011, Portugal will have its highest public debt (as % of GDP) of the last 160 years, and the largest external debt in the last 120 years. Our public debt will be higher than 91% of GDP, and that does not even include the debt of public enterprises or the future debt already committed with the private-public partnerships that substituted for public investment in the last decade. In addition, the country’s gross external debt amounts to more than 240% of GDP, and net external debt is around 110% of GDP. The economy has not grown significantly in the last decade, and there is no major indication (with the possible exception of exports) to make us believe that we are on a prelude for an unforeseen economic miracle. To make things worse, government policies have been close to disastrous, and have only aggravated Portugal’s economic ailments. In short, the situation is dire, and it is difficult to envision any scenario in which a bailout will not take place, even though the latter might not be enough to help resolve Portugal’s debt problems in the medium and long term.

The fact is that the only reason that has prevented Portugal to ask for a bailout are the political costs that will be associated with such a decision. Everyone in Portugal knows that as soon as the country is rescued, the government will (deservedly) fall and new elections will be scheduled. That is the sole reason that has made the Portuguese government so reluctant to activate the bailout mechanisms. It’s not national pride, it’s really high political costs. The prime-minister and the government don’t want to be judged by History for being responsible for the most serious financial crisis that Portugal has experienced since it was forced to declare bankruptcy in 1892. Alas, they are and they will. And, unfortunately for us, even their stubbornness will likely not be enough to prevent an more-than-probable bailout.

Pedro Lains:
Yes it does. But no, thanks.
Where should we look at to find the answer?
The Government is not interested because it would have large political costs. So let’s look elsewhere.
The IMF is probably interested in the bailout, as they are part of its business. So, most analysts linked to the Fund say that it should be asked for. Merkel’s government follows this line of thought.
Would medium term average sovereign debt interest rates be reduced with a bailout? Apparently that was not the case with Greece and Ireland. Saying the sooner the better does not help either.
Portuguese bankers and those voices in Europe that favour the deepening of European integration are against. Bankers in Portugal fear the bailout because, they say, it would reduce (domestic and foreign) deposits. The pro-deepening people argue that a European response would be enough to curb interest rates on peripheral sovereign debt. Interestingly the head of the European rescue fund also says no, that it is not needed for now.
So, I guess that my reading of these different positions leads to the conclusion that at this stage the costs of a bailout would be higher than its benefits.

Pedro Pita Barros:
Portugal can benefit from a bail out. Is it essential? Not necessarily, depends on what price is to be paid for it. An Irish-like intervention will not help much. If that's what is on the table, then I would say no to the bail out. The bail out is worthwhile only if the discipline mechanism does not include to a considerable extent high interest rates.

Pedro S. Martins:
Yes. Things need to change as the current combination of high debt and high interest rates is clearly unsustainable. It's not equitable to burden young people and the future generations with so much debt and all the taxes that follow. The bail-out would mark a clear threshold in the management of the Portuguese economy and prompt much-delayed reforms that can restore productivity growth and ensure this decade will not be completely lost.

Paulo Trigo Pereira:
With 6% yields in 2 year sovereign bonds issued this Wednesday, Portugal has reached interest rate levels on sovereign debt that are unbearable. Although there are good signs that fiscal consolidation will reduce the primary balance in 2011 (mainly through the increase of tax revenues), part of this reduction will be offset by increase in debt interests so that public deficit will not decrease as much as it could.

GDP growth in 2011 is unpredictable, basically given the uncertainty on exports, but it is reasonable to assume a recession this year around 1%, and since fiscal consolidation will have to continue in 2012, a close to zero growth in 2012. Under this scenario, unemployment rate will keep its actual two digits, and long term yields, with or without bail out (see the cases of Greece and Ireland), will remain above 7% in the next two years starting to decline in the second half of 2012, when (and if) there are good signs that reduction of public deficit is sustainable and will continue in 2013. Available data suggests that we are in a consolidation path, but some time is needed to gain credibility.

Under this framework it seems wise to have immediate access to the European Financial Stability Facility (EFSF) covering most of our gross borrowing requirements for the next two years, while yields would remain high. The exact amount will depend on the expected privatization revenues over these two years.

The access to the EFSF should be carefully worked out with a reasonable agreement not only with respect to the yields (around 5% is acceptable), but also all the “package” of measures that will be included in the memorandum of understanding.

Finally, a bail out has to be demanded by the prime minister, and domestic political debate has mixed this demand with a political crisis and general elections. The two issues should be disentangled. And in order to do so a political agreement should be set between the government and the main political party.

A development of this argument will be set out in my “Público” article this Friday 11th March (in Portuguese). Simulations of savings in interests having access to EFSF, with two scenarios, done by myself and João Duque will be presented at Instituto Superior de Economia e Gestão, Friday 11th at 6pm in Auditório 2 (Rua do Quelhas).

Thursday 3 March 2011

Deolinda's sad song

Youth unemployment in Portugal is 23%. Firms tend to reduce their hirings considerably during slumps. Germany demands more reforms including, presumably, some labour market deregulation. But the Portuguese government now decides to impose a minimum wage and several other contractual constraints on traineeships (e.g., a minimum duration of 12 months).

Traineeships are a form of investment in one's human capital - even if trainees are not paid, they may be better off given the gains in experience, networks, signaling/screening, etc. Why make it more costly for employers to take on trainees? Why risk pricing out many more youngsters from the labour market?

Tuesday 1 March 2011

The Portuguese Economists

The 2011 issue of "Economics Research in Portugal: People and Institutions", which lists and ranks academic research in economics, is now available.

This is a notable effort (by Paulo Guimaraes and Miguel Portela) in compiling and disseminating information about the work done by Portuguese economists (and non-Portuguese economists based in Portugal) in pushing the frontiers of knowledge in the "dismal science".

According to the website, there's somewhat surprising evidence that 2010 was a not very good year in terms of academic results, given the upward trend starting in the mid-1980s. But perhaps this is only a one-off blip (or, alternatively, 2008 and 2009 were one-off spikes):

Here's the list of top 10 economists, according to one of the many criteria (summing all research contributions since 1970 and weighting each article using a combination of metrics):

1: Sergio Rebelo, Northwestern U
2: Luis Cabral, New York U
3: Pedro Pita Barros, U Nova
4: Miguel Villas-Boas, U CA, Berkeley
5: Nuno Garoupa, U Illinois
6: Alfredo Marvão Pereira, Col William & Mary
7: João Santos Silva, U Essex
8: Guilherme Carmona, U Nova
9: Nuno Limão, U Maryland
10: Pedro Portugal, U Nova

It's interesting to note that only three out of those ten economists are based in Portugal (and all of those are in the same university, Nova).