Improving competition in the non-tradable goods and labour markets: the Portuguese case

Abstract

This study assesses the macroeconomic impacts of increasing competition in the non-tradable goods and labour markets in Portugal. We lean on evidence that the maintenance of low competition in these markets may have contributed to the recent poor performance of the Portuguese economy. The analysis is performed using PESSOA, a dynamic general equilibrium model for a small-open economy integrated in a monetary union, featuring non-Ricardian characteristics, a multi-sectoral production structure and a number of nominal and real rigidities. We conclude that measures aimed at increasing competition in the Portuguese non-tradable goods and labour markets could induce important international competitiveness gains and be valuable instruments in promoting necessary adjustments within the monetary union framework. However, in the short run, real interest rates are likely to increase, driving consumption and output temporarily downwards.

Appendix A: Model calibration

This appendix reports in some detail the calibration of the model parameters reported in Table 2. As reported in the main text, the model matches fairly reasonably the key ratios of the Portuguese economy and delivers a plausible capital-to-output ratio by industry standards, as depicted in Table 3.¹⁵

Table 2 Main parameters

Table 3 Steady-state key ratios

The calibration of households parameters took into consideration the fact that the model features Blanchard–Yaari overlapping generations, instead of the infinitely-lived agents framework. These parameters were therefore largely based on Fagan et al. (2004), Harrison et al. (2005) and Kumhof and Laxton (2007b). $\eta_{\mathcal{A}}$ and $\eta_{\mathcal{B}}$ were calibrated so as to ensure that the elasticity of labour supply to real wage is 0.5, a value commonly found in the literature. Since the Blanchard–Yaari overlapping generations households framework allows for an endogenous determination of the net foreign asset position, the discount rate was calibrated to ensure a net foreign debt position of 60% of GDP in the steady state. The coefficient of relative risk aversion was set to calibrate the inter-temporal elasticity of substitution to 0.2, which might seem a low figure in comparison with the values typically used in infinitely-lived agents models, but is in the range of the values regularly used in models featuring Blanchard–Yaari households. The share of liquidity constrained households was set to 40%, broadly in line with the estimates for Portugal presented in Castro (2006).

Concerning the labour unions parameters, we considered a 25% steady-state wage markup, which is at the upper limit of the values usually found in the literature. Note, however, that since the labour market in Portugal is strongly regulated, one may argue that the markup could be even higher than the figures usually found in the DSGE literature. Nominal wage rigidity was calibrated to ensure that wages adjust to the new equilibrium in six quarters, a value slightly above euro area estimates published in Coenen et al. (2007), but still in the range usually found in the literature.

Turning to manufacturers, the depreciation rate was assumed to be identical across firms and was calibrated to get the investment-to-GDP ratio in line with the National Accounts data. As regards the production function, a standard Cobb-Douglas function between capital and labour was assumed and the distribution parameters were calibrated to match the labour income share in the National Accounts data. The steady-state price markup of tradable and non-tradable goods was calibrated using OECD product market regulation indicators and the correlation between tradable and non-tradable goods markups and product market regulation indicators found in Høj et al. (2007). In particular, the price markup of the non-tradable goods was set to 20%, which is at the upper bound of the range of values commonly found in the literature, but consistent with the evidence pointing to low competition in the Portuguese non-tradable goods market. As for real rigidities, capital adjustment costs were calibrated so as to ensure plausible impulse responses in terms of investment volatility. Regarding nominal rigidities, price growth adjustment costs were calibrated to match average adjustment time spans, in line with what is suggested in the literature. In particular, we impose that the adjustment of prices in the non-tradable goods sector is slightly slower than in the tradable goods sector, reflecting the fact that fiercer competition and lower markups imply lower price stickiness.

We now consider distributors parameters. In the assemblage stage, the elasticity of substitution between domestic tradable goods and imports was taken to be identical across distributors and set above unity, as in most of the literature on open economy DSGE models (see for instance Coenen et al. (2007), Harrison et al. (2005), Erceg et al. (2000) or Kumhof and Laxton (2007b)); on the other hand, in the distribution stage, assembled goods (which are basically a composite tradable good) and non-tradable goods were assumed to feature a low substitutability as in Mendoza (2005) and Kumhof and Laxton (2007b). The distribution parameters of the production function in each stage were calibrated to match the National Accounts import content and non-tradable goods content of each type of final good. The degree of monopolistic competition among distributors was assumed to be lower than among manufacturers, with the steady-state markup being set to 5%, except in the case of exporters, where fiercer competition is likely to determine a lower markup. In terms of price stickiness, it was assumed that prices take 2 quarters to fully adjust for all distributors except exporters, whose prices are assumed to adjust faster. Real rigidities related to the import content adjustment costs were set to ensure a smooth adjustment of import contents to real exchange rate fluctuations.

The steady-state tax rates were calibrated to match the average revenue-to-GDP ratios observed in the data. The same applies to EU transfers and to expenditure components (government consumption and investment and government transfers). The parameters of the fiscal policy rule were calibrated to ensure a smooth tax adjustment. The target debt-to-GDP ratio in the steady state was set to 53%, implying a corresponding fiscal balance-to-GDP ratio of − 2.1%.¹⁶