Abstract
Over the past 20 years, Portugal has gone through a boom, a slump, a sudden stop, and now a recovery. Unemployment has decreased, but remains high, and output is still far below potential. Competitiveness has improved, but more is needed to keep the current account in check as the economy recovers. Private and public debt are high, both legacies of the boom, the slump and the sudden stop. Productivity growth remains low. Because of high debt and low growth, the recovery remains fragile. We review the history and the main mechanisms at work. We then review a number of policy options, from fiscal consolidation to fiscal expansion, cleaning up of non-performing loans, labor market reforms, product market reforms, and euro exit. We argue that at this point, the main focus of macroeconomic policy should be twofold. The first is the treatment of non-performing loans, the second is product market reforms and reforms aimed at increasing micro-flexibility in the labor market. Symmetrically, we also argue that at this point, some policies would be undesirable, among them faster fiscal consolidation, measures aimed at decreasing nominal wages and prices, and euro exit.
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Notes
He already had substantial help from the coauthor of this paper.
Two other reviews, which overlap in part with this paper are by Reis (2013, 2015). Throughout, we also rely on the information in the annual OECD surveys of Portugal and various IMF documents, from article IVs to reviews and post-program monitoring reports of the 2011-2014 Portugal program (International Monetary Fund 1995, 2011, 2014, 1999).
Part of the revisions come from a change in definition, from number of workers to number of full-time equivalents as a measure of employment, and the reclassification of public employment. Most of the revisions reflect retrospective changes in the underlying series. In the course of writing this paper, and thus checking on the numbers in the 2007 paper, we have been struck by the size of the revisions of some of these numbers. In some cases, an explanation that appeared plausible then appears less plausible today, with the reverse also being true.
The analysis of the two crises, the exact nature of the financial shocks, the relative roles of the credit crunch and of fiscal policy, deserve a much longer treatment than we can give here.
An alternative hypothesis is that firms, which were facing much lower domestic demand, had no alternative but to explore foreign markets (see Esteves and Rua 2015). We have explored this hypothesis using firm level data and have not found significant quantitative support for the hypothesis.
The fall in unemployment is surprisingly large in view of the low growth rate of output. Part of the earlier increase and part of this decrease is due to measurement issues coming from a change from a master sample based on the 2001 census to one based on the 2011 census. The transition occured gradually from the 3rd quarter of 2013 until the 4th quarter of 2014.
This article was written in June 2017. As it goes to press, new IMF forecasts are now available (World Economic Outlook data base 2017). Given the stronger than expected growth so far in 2017, they have been revised upwards somewhat. Growth is now forecast to be 2.5% in 2017, and average 1.5% over 2018-2022. The unemployment rate is now forecast to decrease to 7.2% by 2022. This more optimistic outlook is obviously good news, but does not fundamentally change the policy recommendations below.
As discussed at length in the literature, this does not mean that reforms of employment protection are useless. Shorter duration of unemployment makes individual unemployment experiences less painful. And higher flows reflect a better reallocation of resources and are likely to increase productivity growth.
This increase in markups is also present in Spain, Italy, and Greece. We have looked at the evolution of wages, productivity, unit labor costs, and markups at the sectoral level in Portugal and have not been able to detect a clear pattern. One fact, which argues against the explanation in the text, is that there is no clear difference between the evolution of markups in tradable versus non-tradable sectors. One would expect firms to be more price makers in the non-tradable sector, and thus to pass on lower unit labor costs through prices; this does not appear to be the case.
Estimates from another data source, the KLEMS data base, for 2006 (the latest available year) were roughly similar except for trade, in which relative labor productivity was estimated to be much lower, 44%. The difference comes from different definitions of the trade sector in the two data sets. Trade includes transportation and storage, accomodation and food services in the OECD data set, not in the KLEMS data set.
Productivity growth was surprisingly high during the crisis. Large decreases in output are typically associated with large decreases in productivity, as firms cut employment less than output. This was not the case, and measured productivity growth was actually high in 2010. In thinking about the future, it is important to understand why this was. One hypothesis is that many firms were financially constrained, and thus were forced to shed labor to survive. In ongoing work, we have found some evidence that this was indeed the case. A firm-level regression based on balance sheet and credit registry data from 2005 to 2015 shows that more financially constrained firms, i.e. firms having either a probability of default in the upper quartile, or firms having a negative EBIT (negative earnings before interest and taxes), decreased employment more than other firms. This increase in productivity must be seen as a “one off”, unlikely to be repeated in the future.
This was the topic and the theme of the 2003 McKinsey study in which one of the authors participated. It identified specific sectors and reforms and sectors with a scope for large productivity improvements. Among them were construction and tourism. Yet, there appears to have been no convergence in those sectors relative to, say, Germany, since 2003.
In each case, a more formal treatment, and a tentative quantitative assessment, are needed. We have been working with José Maria, Paulo Júlio, and the modelling team at the Banco de Portugal to generate simulations of the PESSOA model. These simulations will be presented as a separate contribution later.
Somebody’s debt is somebody else’s claim. This raises the issue of why the positive effect of the reduced value of the debt is not offset by the negative effect of the reduced value of the claim. The answer is twofold. Even if debt is held domestically, the net effect comes from the asymmetry between the behavior of borrowers and of lenders. Borrowers are more likely to be constrained and thus react more strongly to the decrease in debt than the lenders do to the decrease in their claim. And, to the extent that debt is largely held by foreign creditors, the increase in their spending falls largely on their domestic goods rather than on Portuguese goods.
This builds on Blanchard et al. (2013).
See for example Eggertsson et al. (2014).
We shall not re-litigate here whether the fiscal consolidation was excessive or not. Given the nearly total loss of market access, the speed of fiscal consolidation was largely determined by the size of the Troika program.
This is an example of a more general proposition, that reallocating debt among debtors, in this case from the banks to the government, is not neutral, as the effects of public debt on government spending may well be less than the effects of private debt on private spending.
Such recapitalization and deficit spending run into the various constraints on financial rules and on fiscal policy imposed by the European Union. As we indicated earlier, we are discussing policy options based on their economic merits, whether or not they are consistent with current Portuguese or European Union rules.
Thus, we disagree with the statement by Joseph Stiglitz that “It costs more to Portugal to stay in the Euro than to leave.” (Stiglitz 2016).
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Acknowledgments
Presented at the Gulbenkian Foundation, May 2017. Special thanks to Abebe Selassie for many discussions, to Bill Cline, Jorge Correia da Cunha, António Domingos, Christopher Erceg, Francesco Franco, Vitor Gaspar, Subir Lall, Jesper Linde, Maximiano Pinheiro, Ricardo Reis, and Nicolas Veron for comments and discussions, and to Portuguese authorities for very useful discussions. We have also benefitted from interactions with, and simulations by José Maria, Paulo Júlio, and the modeling team at the Banco de Portugal. Finally, we thank Julien Acalin and Colombe Ladreit for excellent research assistance.
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Blanchard, O., Portugal, P. Boom, slump, sudden stops, recovery, and policy options. Portugal and the Euro. Port Econ J 16, 149–168 (2017). https://doi.org/10.1007/s10258-017-0139-8
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DOI: https://doi.org/10.1007/s10258-017-0139-8