It was in 13th October of 1987 that Portuguese people listened from their Prime Minister, Aníbal Cavaco Silva, that investors would be buying “gato por lebre” (“Pig in a poke”).
Emerging from a revolution, Portugal was a new player in the European team and had recently received foreign aid throughout two adjustment programs to solve the problem of external imbalance.
The crisis passed, the stock reacted and Portuguese economic situation steadied during a decade of growth. Being able to recognize the mistakes made since then we find ourselves today in a situation that is no less serious, hovering over the whole economy a question: will we be “gato ou lebre”?
Between Portugal’s entry in EU and the euro membership it was witnessed a period of economic growth, with a strong inflow of EU capital, launching major public investments in infrastructures and a national effort to catch up with other member states. With the euro started a period of stagnation that came to result in the crisis recently faced.
Without its own currency and no autonomy in monetary or exchange rate policy, since 2000 Portugal went through a period called “the lost decade” marked by an artificial enrichment resulting from a large inflow of foreign capital with desirable interest rates.
Excess liquidity and easy credit access resulted in a strong expansion of aggregate demand and also in a progressive external debt due to a permanent trade balance deficit. At the same time, the real exchange rate appreciated, resulting in a huge loss of competitiveness of Portuguese exports and an allocation of resources in favour of the non-tradable sector.
The country, itself not athletic, then settled down in its basket as a big fat cat, sedentary, domesticated and oblivious of the difficulties that would follow.
As Guillermo Calvo and coauthors document for the Latin American economies in the 1990s, large capital inflows typically come with increases in the real exchange rate, that is, increases in the domestic prices relatively to prices abroad. Therefore, this Portuguese crisis can be analyzed through the Salter & Swan approach, observing the tradable and non-tradable sector dynamics.
According to Ricardo Reis, an explanation for the Portuguese slump is the large capital inflows that were misallocated across sectors, causing a strong fall in the domestic productivity growth. This misallocation caused a strong increase in the non-tradable prices and the country ran successive current account deficits until we reached this situation. Additionally, the government amounted to an excessive annual deficit which caused an unsustainable level of public debt, i.e. becoming more and more dependent from abroad.
After the sudden stop, the Portuguese government was forced to sign the Memorandum of Understanding which established, beyond other goals, the commitment of supporting “the reallocation of resources towards the tradable sector.” Figuratively speaking, the country committed on ceasing to be “the gato” and start being “the lebre”, capable of becoming positive the animal spirit in order to achieve economic stability, growth and development.
Have we been successful?
Despite the difficulties associated with nominal rigidities in prices and wages and a huge lack of ability to attract international investment, prices of non-tradables have decreased in contrast to the perceived inflation in tradables.
Although, the pricing system is not promoting an efficient allocation in the labor market, and consequently we can see that until the first quarter of 2013 the employment reduction felt more in the non-tradable sector (more subject to international competition). This is not a good indicator of success.
Even though, Portugal has managed to generate trade balance surpluses because of a massive contraction in domestic demand. Considering the graph, Portugal was producing at A and it’s now at C, which is clearly ineficient.
However, according to Eurostat, it is estimated that in the 2nd and 3rd quarters of the year Portugal was the EU country where employment grew most, a factor which is due to the recovery of markets and investors confidence and a clear support in the export sector.
Fortunatelly, the signs of this adjustment process are starting to be noticed and soon our production level will be able to return to the Production Possibilities Frontier (at B) with a strong, competitive and sustainable economy.
The effort has been tremendous but the optimists say that if, even after the end of the adjustment program, these reforms continue to be undertaken with the same determination, the “gato” will become “lebre”.
Dino Alves #607
Sara Simões #643
[Graphs on Tradables and Non-Tradables – Prices and Employment – from Equilibria nº 1 and 2]