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

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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.

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  1. PESSOA is the acronym for Portuguese Economy Structural Small Open economy Analytical model.

  2. It is worth mentioning that the last stage of the multi-fiber agreement, which opened EU borders to textile imports from low labour cost economies, notably China, determined significant market share losses in European countries with an export pattern heavily dependent on these products, notably Portugal and Italy.

  3. Some interesting examples are: the use of the IMF’s model, GIMF, presented in Kumhof and Laxton (2007b), for the analysis of the effects of fiscal policy in the US economy; the role played by the Sveriges Riksbank model, described in Adolfson et al. (2007b), in the context of policy analysis and forecasting; the extensive use of the AINO model, developed at the Bank of Finland, in the analysis of ageing and demographics in Kilponen et al. (2006a, b); and the use of the New Area Model developed at the ECB and presented in Coenen et al. (2007) for policy analysis.

  4. The information published in these surveys reveals that domestic and industrial electricity and gas pre-tax prices in Portugal are among the highest in OECD countries, despite some improvement in market liberalisation in the context of the Iberian Electricity Market. In the telecommunications sector, telephone charges declined towards OECD average in the mobile-phone sector, but fixed line charges for business remain high.

  5. The available evidence suggests that the sensitivity of real wages to business cycle conditions is higher for newly hired workers than for workers that stay in the firm.

  6. Conway et al. (2005) presents an updated set of product market regulation indicators for the whole economy and compares the 2003 situation of OECD countries with the 1998 situation.

  7. It should be mentioned that technically it is not the event that current generations will die that generates the non-Ricardian effect, but rather the fact that future generations will bear some of the tax burden (Buiter 1988).

  8. It should be pointed out that by definition a SOE does not affect the investment savings balance of the world economy and, therefore, the world real interest rate. Hence, infinitely lived agents will be able to borrow or lend in infinite amounts that can be paid or received in the indefinite future (Barro and Sala-i-Martin 1995).

  9. The probability of an individual dying after t periods of life is equal to (1 − θ)θ t − 1 and the expected life horizon at any point in time is equal to (1 − θ) − 1. Probability 1 − θ can also be interpreted as a probability of “economic death” or a degree of “myopia” (Blanchard 1985; Frenkel and Razin 1996; Harrison et al. 2005; Bayoumi and Sgherri 2006). It represents the inverse of the average planning horizon of the household, which is likely to be far more shorter than its biologic lifetime. Bayoumi and Sgherri (2006) present econometric evidence for the US.

  10. Aggregation across generations is made possible by assuming that habits are multiplicative instead of additive. However, it should be recognised that this generates a low habit persistence.

  11. The fixed cost term is defined as a constant share of nominal output, ensuring that it does not vanish along the inflationary balanced growth path of the economy.

  12. This mimics the national accounts definition of GDP at reference year prices.

  13. The model is simulated in Portable TROLL and is solved using the Newton-based perfect foresight simulation algorithm proposed in Juillard et al. (1998).

  14. It should be mentioned that the decrease in wage markup per se does not affect labour supply since the after-tax households’ real wage income does not include labour union“dividends”.

  15. The Portuguese National Accounts do not include figures for the capital stock.

  16. The values assumed for the debt-to-GDP target and the implied fiscal balance can be questioned in view of the medium term objective that has been set by the European Commission for Portugal (a structural budget balance of − 0.5%, implying a debt-to-GDP ratio close to 12%). However, since in the historical period that was used to calibrate the model the debt-to-GDP ratio averaged 57%, it does not seem reasonable to calibrate it to match a remarkably different figure.


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Correspondence to Vanda Almeida.

Additional information

We would like to thank all the support provided by Douglas Laxton, Michael Kumhof and Antti Rippati. This paper also benefited from the comments and suggestions of the editor in charge, António Antunes, João Amador, Isabel Horta Correia and participants at the 3rd Portuguese Economic Journal Conference, the 4th Dynare Conference and at the seminar held at the Banco de Portugal Research Department. The views expressed in this paper are those of the authors and do not necessarily reflect the views of Banco de Portugal. Any errors and mistakes are ours.

Appendix A: Model calibration

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.Footnote 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%.Footnote 16

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Almeida, V., Castro, G. & Félix, R.M. Improving competition in the non-tradable goods and labour markets: the Portuguese case. Port Econ J 9, 163–193 (2010).

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