Three questions to European leaders

I have been asked to prepare a short question for the european summit in October. I have prepared three. They are broad and purposely rethorical to quench my impatience.

I.

To date the Eurozone is the most highly civilized arrangement between former warring states to provide public goods of primary importance: peace and prosperity. By constructing  the Union, Europeans, want to maintain their status of paragon among other regions of the planet. 

Can you describe what would be the consequences for the international order of a failure of the European project?

II.

Do you think that the current institutional framework is able to provide for consistent macroeconomic policies in periods of calm and rapid and responsible decisions during period of crisis, or is it prone to free-riding behavior and naive "fallacy of composition" analysis by individual members?

III.

The current narrative ascribes the incapacity of European leaders to agree to the war between two world views. It is again the old dispute between the short run and the long run. (Strangely enough we had been taught that the dispute had been settled by the Samuelsonian neoclassical synthesis.) When do you think European leaders will present and offer a shared analytical framework on the economic functioning of the Eurozone?

4th revision update

the new documents from troika on Portugal, are available here, from the site of the Portuguese Government.

An update on wage adjustment

I am still looking for the quarterly time-series but I have managed to find data on General Government employment for 2010 and 2011. This was useful to compute the average compensation inflation (click to enlarge the graph) in the public (blue line) and private sectors (green line). So far the adjustment for the total economy (red line) came in large part from the public sector.

Public and Private compensation query

Query: I am trying to compute a measure of private labour compensation inflation. So far I have been unable to find quarterly data to subtract General Government (GG) compensation from Total Economy (TE) compensation. The annual national accounts by branches (Eurostat/INE) presents the data for the TE and the GG although GG employment ends in 2009. Does anyone knows where to find updated and quarterly data?

Bt the way: the graph above shows: 1) an average compensation premium of 1.95 for GG workers (obviously characteristics are different), 2) similar inflation compensation until 2009 (GG average 4.6, TE average 4.35, correlation 0.75), 3) a declining share of GG employees. 

A brief note on the Euro Symposium

"I would prefer not to"

Bartleby, the Scrivener: A Story of Wall Street", Herman Melville

Tonight representative of the 27 members of the EU will sit together around a dinner table to discuss a report, appropriately titled for the occasion "Towards a Genuine Economic and Monetary Union". The report was prepared by the four presidents of the European council, the Eurogroup, the Commission and the ECB; it identifies four essential building blocks for a "stable and prosperous" EMU to be put in place over the next decade (decade: a period of ten years).

They are, 1) An integrated financial framework, 2)An integrated budgetary framework, 3, An integrated economic policy framework and 4) ensuring the necessary democratic legitimacy and accountability.

 Let me focus on the first and most urgent block to be put in place over the next semester (semester: a period of six months), namely the integrated financial framework (from now IFF). For all practical means it consists in the creation of EZ-banks. The steps to transform euro-members banks into EZ-banks are to institute a single European banking supervision and a common deposit insurance and resolution framework. The motivation found in the report is totally correct: "the financial crisis has revealed structural shortcomings in the institutional framework for financial stability" and the IFF will "ensure financial stability in the euro area and minimize the cost of bank failures". Many commentators agree that the IFF will sever the incestous links between euro members banks and sovereigns, will increase confidence and stop deposits outflows, will help relax the consequent credit tightening. Fundamentally I think adopting a IFF goes beyond checking a list of shortcomings.

A while ago (the analysis is outdated and today would probably be more focused) I came to the conclusion that the architects of the Euro had focused on the necessary conditions to make it work. For example think of the competitiveness problems of the periphery from the financial angle. As long as the euro-members commercial banking system was working as one, the current accounts were intermediated. Then came the crisis and what was necessary turned out to not sufficient to make the Euro work. There are other important parts of the euro institutional infrastructure that can work with euro-member banking and financial sectors, and they worked before the crisis, but are likely to work less well, to say the least, than with a IFF. In normal times, we are entitled to think that the ECB would want to achieve a quasi-uniform transmission of its monetary policy across the EZ and along the EZ yield curve.

I really hope the room is green.

Portuguese Public Finance Council

Created in february 2012, the Portuguese Public Finance Council has published the first review analysis. It can be found in http://www.cfp.pt. There is a version of the report in English. The report is overall positive with the budget policies, but still finds room for recommendation about further improvements.

Guest author: U. Schuetz: Unintended Consequences

Unintended Consequences. Challenges for Portugal’s “Arranged Liberalization”
Ulrich Schuetz, University of Lucerne, Political Sciences (ulrich.schuetz@stud.unilu.ch)

Introduction
   After Ireland and Greece, Portugal was the third eurozone country to receive financial aid within the European Financial Stabilisation Mechanism (EFSM) framework of the so-called “troika”, composed of the European Union (EU), European Central Bank (ECB), and International Monetary Fund (IMF). In May 2011, the Portuguese socialist government, with support of the conservative opposition (which came to power one month later), accepted a reform plan conditional to the disbursement of financial assistance. The plan aims to improve Portugal’s economic competitiveness and performance through structural reforms towards a more liberal system. At the same time, it requires the state to substantially reduce public debt to regain fiscal solvency. Criticism of the reforms mostly reflects different macro-economic standpoints and comes mainly from economic observers. A frequent evaluation states that instead of fiscal austerity, expansionary monetary policy would lead the way out of the crisis (e.g. Krugman 2012). Because of the pro-cyclical nature of their conditions, past IMF programs were blamed for pushing countries into recession (Soros 2002:120). Missing from the debate on the effectiveness of the troika reform plan is the question if the reforms are embedded in an environment favorable for liberalization. A generalized “one size fits all” liberalization program might not produce the expected results, especially if non-economic factors are considered. Analyzing the separate aspects of the reform plan and trying to predict potential shortcomings in their application is necessary to be able to assess the chances of success. This essay is an attempt to do this by starting from the following assumption: If institutional complementarities and non-market relationships such as corruption and clientelism are ignored, the outcome of liberal reforms will be negatively affected.
   The first part of this paper provides a short overview of the troika reform plan. Subsequently, institutional complementarity and the Varieties of Capitalism approach are discussed regarding the Portuguese case. Finally, the impact of corruption and clientelism on a liberal reform process is addressed before summarizing the findings in a conclusion.

Troika Reform in Portugal
Details of the reform program were agreed on by both the old and new Portuguese government and troika. The agreed measures had broad political support as a result of a basic consensus on European issues between the country’s two biggest political parties, conservative Partido Social Democrata and socialist Partido Socialista (Fischer 2011). The two main pillars of the program relevant to this discourse are (1) increasing competitiveness and growth through liberal reforms and (2) regaining fiscal solvency through a substantial reduction of the public deficit (IMF 2012:4)1. Disbursement of financial assistance is subject to troika’s review of the implementation of the reforms. Portuguese authorities also committed to consult with troika on legislative changes that were not part of the agreement (European Commission 2011:1). As a consequence, the Portuguese government sends a quarterly letter of intent to the IMF and ECB with a review of the progress made so far and documenting the next steps, closing with a request to transfer the next installment. This is standard procedure for IMF-supported programs. The Fund itself argues that “conditionality can serve as a valuable commitment device that complements and enhances ownership of structural reforms” (IMF 2003:12).

1 year of troika

17 May 2011 - one year ago - the Memorandum of Understanding was signed and Portugal entered the financial rescue mode.

A year after we have
- new government, and a relatively large political consensus on the complying with the commitments set in the Memorandum, including the main opposition party
- lower wages - both in civil service, as the Government imposed a wage cut, and private sector (either negotiation of lower wages or through unemployment spells, taking lower paid jobs
- unemployment at historically high levels
- emigration rising again to levels unseen in peaceful
- public budget cuts
- price increases (transports, electricity)
- tax increases (both income and VAT) (tourists can still have back VAT, under certain conditions)
- give away 4 holidays (two historic dates + two religious dates)

but we also have
- sun and 30º C in May
- good roads and highways (though, rather empty ones, but hey, they are there to use)
- summer music festivals - Bruce Springsteen, Bryan Adams and Stevie Wonder will be at Rock in Rio
- good food, even if we take smaller portions
- waves
- exports growing, and to non-traditional markets
- GDP fall was smaller than expected this term (though one number is not yet a change in trend).

And if you want to keep tracking some key numbers in main areas of change under the memorandum of understanding, follow what our students are doing here.

What adjusts when a country deleverages

Normal blogging should soon come back. For the moment I continue the advertisement campaign on seminars: Friday we have (at Nova 12am) Pierpaolo Benigno presenting "Deleveraging and the real exchange rate"

A lecture on managing the fragility of the Euro Zone

Next Thursday (19th) here in Lisbon, Paul De Grauwe will give the second of Nova's "Lecture Series in Macro and Finance". link

New empirical evidence on fiscal devaluations

A very neat and insightful paper, here is the summary in a Vox column

a view on the Portuguese NHS

in case you want to have a view on the current situation of the NHS in Portugal through the lens of a North-American newspaper, check here

GNP versus GDP

The Irish case
Ireland has experienced large trade surpluses and current account deficits. The data show that the income paid by Irish residents to non-resident owners of domestic factor of production (such as capital) is often larger than the trade balance surplus. (click to enlarge)



We are told that most of the foreign direct investment to Ireland was in capital intensive industries (such as pharmaceuticals). The implication is that labour compensation (Irish residents) commands a relatively small share of the product of those industries.

GNP and GDP

There are two main concepts of aggregate measure of goods and services produced: GNP and GDP. GDP covers the goods and services produced by labor and capital located in Ireland. As long as the labor and capital are located in Ireland, the suppliers may be either Irish residents or non-residents. GNP covers the goods and services produced by labor and capital supplied by Irish residents.

Portugal is well aware of the difference between GNP and GDP as in the past its trade balance deficit was mostly entirely covered by labour income remitted by emigrants. The advantage with GDP is certainly that it is more precisely measured than GNP. However when the focus is on the availability of a Nation's resources to finance itself, GNP appears to be the relevant aggregate.

It should be now clear that when it comes to the capacity of financing its external debt, the relevant flow concept is the current account. Obviously improving the trade balance is crucial but data have to be analyzed with a grain of salt. Assume a foreign export oriented futuristic motor-vehicle plant that produces and assembles vehicles in minutes and is controlled by 2 workers.Part of the value added produced (net exports) by the plant will stay in the country (the 2 workers wage) and part will flow out (income payments) to the plant owners.

The fiscal devaluation keeps coming back..

Here is a nice piece on it, following the French government announcement that they will do one. In a more modest scale, Ireland has also done it. Portugal, where this measure was first discussed and seriously considered as a response to the crisis, seems less likely every day to ever do it.

Portugal wages and unemployment

This is not a formal analysis and estimation of a wage Phillips curve for Portugal. However the figure (click to enlarge) shows some evidence of a prima facie negative relationship between compensation inflation and the unemployment rate. And the coefficient is not reassuring (although it is probably unstable during recessions such as now). Data are from Eurostat.