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A work project, presented as part of the requirements for the award of a
masters degree in Economics from the Faculdade de Economia da
Universidade Nova de Lisboa
Effects of a monetary union on a small
peripheral country: Stabilization and
competitiveness in Portugal
Henrique Moreira da Silva de Oliveira Castro
student number 242
A Project carried out on the internationalization and development area
with the supervision of: Maria Cristina Corado
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Effects of a monetary union on a small peripheral country:
Stabilization and competitiveness in Portugal
Abstract
The fi rst decade of the 21s t cent ur y introduced the euro i n Portugal. This st ep towards European int egration implied that Portuguese economic aut horiti es lose m onetar y i ndependence. We i nvesti gate t he impact of that loss in P ort uguese com pet itiveness t hrough the construction of compe ti tiveness indi cators, and on current account d ynami cs t rough a decom posit ion of the current account . Despit e the
continuous loss of competitiveness after 1999, empirically we don’t find
evi dence that t he euro is contribut ing t o it. We do find evidence tha t current account adjustment patt ern changed aft er 1999.
Ke ywords: Monet ar y Union, Competitiveness, Current account, adj ustm ent
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Introduction
E u r o p e a n H i s t o r y i s o n e o f c o n f l i c t . F o r c e n t u r i e s , r e l i g i o u s w a r s , p o w e r s t r u g g l e s a n d i r o n c u r t a i n s h a v e b e e n a c o n s t a n t i n E u r o p e a n s l i v e s . H o w e v e r , i n t h e a f t e r m a t h o f W o r l d W a r T w o , a i m i n g a t c o n t i n e n t a l p e a c e s o m e E u r o p e a n c o u n t r i e s s t a r t e d a n a m b i t i o u s p r o j e c t o f e c o n o m i c i n t e g r a t i o n , c u l m i n a t i n g i n t h e f o r m a t i o n o f a m o n e t a r y u n i o n . T h e s i n g l e c u r r e n c y , t h e e u r o , h a s b e e n i n c i r c u l a t i o n s i n c e t h e 1s t o f J a n u a r y o f 2 0 0 2 , i n i t i a l l y i n a g r o u p o f t w e l v e c o u n t r i e s t h a t w a s l a t e r e n l a r g e d b y o t h e r f o u r .
T h e l e v e l o f e c o n o m i c i n t e g r a t i o n E u r o p e e n j o y s p r e s e n t l y w a s f r u i t o f a l o n g a n d g r a d u a l p r o c e s s . T h e r e s u l t i s t h a t E u r o p e a n c i t i z e n s e n j o y a l e v e l o f e c o n o m i c w e l f a r e , p o l i t i c a l u n i o n a n d i n t e r n a l p e a c e o n l y c o m p a r a b l e t o t h e o n e f e l t d u r i n g t h e e x i s t e n c e o f t h e R o m a n E m p i r e . S t i l l t h e r e i s s o m e t h i n g u n i q u e a b o u t t h e a c t u a l u n i o n : i t w a s a c h i e v e d p e a c e f u l l y a n d v o l u n t a r i l y b y i t s m e m b e r s .
O n t h i s w o r k w e w i l l s t u d y t h e l a s t s t e p o f e c o n o m i c i n t e g r a t i o n , m o n e tar y union. It’s usual to pose the question: why s h o u l d a c o u n t r y r e l i n q u i s h i t s o w n c u r r e n c y , a n d s h a r e a n o t h e r c u r r e n c y w i t h a g r o u p o f c o u n t r i e s . T h e a n s w e r i s o b v i o u s : t h e r e a r e b e n e f i t s i n t a k i n g s u c h a s t e p . N o t s o o b v i o u s i s w h a t t h e s e b e n e f i t s a r e . S k i m m i n g t h e m o n e t a r y u n i o n l i t e r a t u r e w e c a n g e t a r o u g h i d e a o f t h e s e b e n e f i t s .
T h e m o s t o b v i o u s g a i n i n j o i n i n g a m o n e t a r y u n i o n i s t h e e l i m i n a t i o n o f t r a n s a c t i o n c o s t s a m o n g i t s m e m b e r s . T h e E u r o p e a n c o m m i s s i o n e s t i m a t e s t h e s e g a i n s t o b e b e t w e e n 0 , 2 5 % a n d 0 , 5 % o f t h e E u r o z o n e G D P . T h i s m a y s e e m i r r e l e v a n t , b u t i t s h o u l d b e n o t e d t h a t t r a n s a c t i o n c o s t s a r e a d i s t o r t i o n , a n d e l i m i n a t i n g t h e m h a s o t h e r i n d i r e c t b e n e f i t s .
O n e o f t h e m i s p r i c e t r a n s p a r e n c y . I n a m o n e t a r y u n i o n c o n s u m e r s c a n o b s e r v e p r i c e s e x p r e s s e d i n t h e s a m e c u r r e n c y a c r o s s b o r d e r s , i f w e a d d t h i s t o t h e a b s e n c e o f t r a n s a c t i o n c o s t s w e e x p e c t a n i n c r e a s e i n c o m p e t i t i o n . T h i s s h o u l d r e s u l t i n l o w e r p r i c e s f o r t h e c o n s u m e r .
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A l s o , t h e r e i s a p o i n t t o b e m a d e c o n c e r n i n g e c o n o m i c g r o w t h . A s s u m i n g t h a t b y e l i m i n a t i n g e x c h a n g e r a t e r i s k w e r e d u c e s y s t e m i c r i s k , w e k n o w t h a t i n v e s t o r s w i l l d e m a n d a l o w e r r i s k p r e m i u m f o r t h e s a m e i n v e s t m e n t . T h i s w i l l l e a d t o l o w e r r e a l i n t e r e s t r a t e s , t o h i g h e r i n v e s t m e n t a n d t o a n e x p a n s i o n o f t h e c a p i t a l s t o c k l e a d i n g t o e c o n o m i c g r o w t h .
T h e r e a r e o t h e r l e s s r e l e v a n t b e n e f i t s f r o m e n t e r i n g a m o n e t a r y u n i o n . F i r s t t h e n e w c u r r e n c y i s l i k e l y t o f i n d b i g g e r u s e o u t o f t h e u n i o n , b e c o m i n g a m o r e i n t e r n a t i o n a l c u r r e n c y . T h i s b r i n g s a d v a n t a g e s f o r t h e i s s u e r , s u c h a s a d d i t i o n a l r e v e n u e s a n d e x p a n s i o n o f t h e c e n t r a l b a n k b a l a n c e s h e e t . A s a n e x a m p l e , t h e c e n t r a l b a n k c a n i s s u e m o r e c u r r e n c y t o f i n a n c e f o r t h e b u d g e t d e f i c i t , a n d f o r e i g n e r s w i l l b e w i l l i n g t o p a y f o r i t . A l s o a n i n t e r n a t i o n a l c u r r e n c y i s l i k e l y t o b o o s t a c t i v i t y f o r t h e d o m e s t i c f i n a n c i a l m a r k e t s .
T h e s e a r e t h e m o s t i m p o r t a n t b e n e f i t s o f a m o n e t a r y u n i o n . W e c a n s u m m a r i z e t h e m i n t w o p o i n t s : F i r s t , t h e y h a p p e n m a i n l y a t t h e m i c r o e c o n o m i c l e v e l , b y i m p r o v i n g e f f i c i e n c y ; S e c o n d , t h e y a r e b i g g e r t h e m o r e o p e n t o t r a d e a n d t h e m o r e i n t e g r a t e d a r e t h e m e m b e r e c o n o m i e s . A n i m p o r t a n t q u e s t i o n t h a t I w i l l n o t a p p r o a c h i s w h e t h e r a m o n e t a r y u n i o n f o s t e r s f u r t h e r i n t e g r a t i o n b e t w e e n m e m b e r e c o n o m i e s , o r n o t . T h e a n s w e r h o l d s t h e k e y t o k n o w i f
it’s worth “investing” in forming a monetar y union when benefits aren’t bigger than costs.
C o n c e r n i n g t h e c o s t s o f a m o n e t a r y u n i o n , t h e s e d e r i v e f r o m t h e l o s s o f s e v e r a l i n s t r u m e n t s o f e c o n o m i c p o l i c y . B y a b a n d o n i n g i t s c u r r e n c y a n d j o i n i n g a m o n e t a r y u n i o n , a c o u n t r y i s n o l o n g e r a b l e t o c h a n g e i t s e x c h a n g e r a t e , n e i t h e r t o d e t e r m i n e t h e s t o c k o f m o n e y c i r c u l a t i n g o r s e t t i n g t h e i n t e r e s t r a t e . T h e s e i n s t r u m e n t s a r e n o t a s o u r c e o f l o n g r u n g r o w t h , b u t t h e y a r e a n i m p o r t a n t i n s t r u m e n t o f s t a b i l i z a t i o n a n d a d j u s t m e n t . T h e s e a d j u s t m e n t i n s t r u m e n t s w i l l b e i n t h e h a n d s o f t h e u n i o n c e n t r a l b a n k , w h i c h
has to use them for the monetary u nion as a whole. It won’t be
p o s s i b l e t o d i s c r i m i n a t e d i f f e r e n t m o n e t a r y p o l i c i e s f o r u n i o n m e m b e r s .
T h i s l o s s o f p o l i c y a u t o n o m y i s i n t h e c o r e o f t h e c o s t s a s s o c i a t e d w i t h b e l o n g i n g t o a m o n e t a r y u n i o n . I f c o u n t r i e s f a c e a s y m m e t r i c s h o c k s , a n d n e e d d i f f e r e n t t y p e s o f a d j u s t m e n t , t h e
union’s central bank can´t perform the desired adjustment through
m o n e t a r y p o l i c y .
5
t o p e r f o r m a n a d j u s t m e n t o n t h e w h o l e e c o n o m y t h r o u g h m o n e t a r y p o l i c y .
M u n d e l l n o t e d t h a t i f t h e a f f e c t e d c o u n t r i e s h a v e p e r f e c t l a b o r m o b i l i t y b e t w e e n e a c h o t h e r , s h o c k s w i l l b e f o l l o w e d b y m i g r a t i o n , w e a k e n i n g o r s t r e n g t h e n i n g d e m a n d , l e a d i n g t o a d j u s t m e n t . A n o t h e r m e c h a n i s m o f a d j u s t m e n t i s w a g e f l e x i b i l i t y . I f w a g e s a r e c o m p l e t e l y f l e x i b l e , t h e y w i l l e i t h e r g o d o w n i f t h e
shock is negative, or up if it’s positive, bringing back the econom y
t o e q u i l i b r i u m .
K e n e n ( 1 9 6 9 ) n o t i c e d t h a t t h e c o s t s o f e n t e r i n g a m o n e t a r y u n i o n a r e g r e a t e r t h e m o r e s p e c i a l i z e d i s t h e p r o d u c t i o n o f a n e c o n o m y . T h e m o r e s p e c i a l i z e d i s a n e c o n o m y , t h e m o r e l i k e l y i t i s t o s u f f e r l a r g e a n d a s y m m e t r i c s h o c k s .
A c c o r d i n g t o M c K i n n o n ( 1 9 6 3 ) , t h e e x c h a n g e r a t e i s l e s s u s e f u l t h e m o r e o p e n i s a n e c o n o m y . T h i s l o g i c r e l i e s o n t h e o b s e r v a t i o n t h a t v e r y o p e n e c o n o m i e s c a n n o t c h a n g e c o m p e t i t i v e n e s s b y d e v a l u i n g i t s c u r r e n c y . I n v e r y o p e n c o u n t r i e s t r a d e c o m p e t i t i o n e q u a l i z e s r e l a t i v e p r i c e s i n i n t e r n a t i o n a l
markets, and a country can’t affect its goo d s r e l a t i v e p r i c e s
an ymore. This means that very open and small economies don’t
l o s e m u c h s t a b i l i z a t i o n p o w e r w h e n t h e y l o s e t h e i r e x c h a n g e r a t e . A n i m p o r t a n t m e c h a n i s m t h a t m i g h t m i t i g a t e t h e n e g a t i v e e f f e c t s o f m o n e t a r y u n i o n i s t h e e x i s t e n c e o f c r o s s c o u n t r y r e d i s t r i b u t i o n s c h e m e s i n t h e p r e s e n c e o f a s y m m e t r i c s h o c k s . T h i s r e d i s t r i b u t i o n s h o u l d p r o m o t e t h e a d j u s t m e n t t o s h o c k s i n s i d e t h e u n i o n , m i n i m i z i n g t h e n e g a t i v e e f f e c t s o f a s y m m e t r i c s h o c k s .
T h e r e a r e m a n y o t h e r i s s u e s r e l a t e d t o t h e c o s t s o f a m o n e t a r y u n i o n . H o w e v e r , a c c o r d i n g t o t h e l i t e r a t u r e t h e m e n t i o n e d c o s t s a r e t h e m o s t i m p o r t a n t . W e c a n s u m m a r i z e t h e m a s w e d i d w i t h b e n e f i t s : M o n e t a r y u n i o n c o s t s h a p p e n m a i n l y a t t h e m a c r o e c o n o m i c l e v e l a n d c o r r e s p o n d t o i n c r e a s e d d i f f i c u l t i e s i n s t a b i l i z i n g t h e e c o n o m y i n t h e p r e s e n c e o f a s y m m e t r i c s h o c k s .
Those difficulties are bigger the more rigid is the union’s labor
m a r k e t , t h e m o r e s p e c i a l i z e d a r e t h e e c o n o m i e s t h a t b e l o n g t o t h e u n i o n , t h e m o r e c l o s e d a r e t h e e c o n o m i e s a n d t h e l e s s r e d i s t r i b u t i o n s c h e m e s e x i s t s a c r o s s e c o n o m i e s . J u s t l i k e w i t h b e n e f i t s , i t w o u l d b e o f e x t r e m e i m p o r t a n c e t o k n o w t h e e f f e c t s t h a t b e l o n g i n g t o a m o n e t a r y u n i o n h a s o n m a t t e r s s u c h a s t h e l e v e l o f s p e c i a l i z a t i o n , l a b o r m a r k e t r i g i d i t y a n d b u s i n e s s c y c l e s y n c h r o n i z a t i o n .
6
t h a t a n a l y s i s , w e u s e d a t e c h n i q u e t o d e c o m p o s e a n d i d e n t i f y t h e d y n a m i c s o f t h e c u r r e n t a c c o u n t . T h i s t e c h n i q u e a l l o w s o b s e r v i n g t h e c o m p o s i t i o n o f s h o c k s a n d t h e i r i m p a c t o n t h e c u r r e n t a c c o u n t , a n d a l s o t h e a d j u s t m e n t p a t h a n d i t s c o m p o s i t i o n . W e c a r r y o u t a c o m p a r i s o n f o r t h e p e r i o d a f t e r a n d b e f o r e j o i n i n g t h e m o n e t a r y u n i o n , t o l o o k f o r d i f f e r e n c e s i n a d j u s t m e n t .
I n a d d i t i o n , w e a l s o e s t i m a t e s e v e r a l c o m p e t i t i v e n e s s i n d i c a t o r s , a n d s k e t c h t h e i r e v o l u t i o n i n t h e p e r i o d b e f o r e a n d a f t e r a d o p t i n g t h e e u r o . T h e p u r p o s e i s t o o b s e r v e i f t h e l o s s o f t h e e x c h a n g e r a t e i n s t r u m e n t w a s r e f l e c t e d i n t h e e v o l u t i o n o f c o m p e t i t i v e n e s s f o r b o t h c o u n t r i e s . A l s o , w e m a k e a n a t t e m p t t o e m p i r i c a l l y e s t i m a t e t h e d e t e r m i n a n t s o f c o m p e t i t i v e n e s s .
Competitiveness indicators
O n e o f o u r a i m s w a s t o e s t i m a t e a n d q u a n t i f y t h e e v o l u t i o n o f c o m p e t i t i v e n e s s i n P o r t u g a l . T h i s i s c r u c i a l t o u n d e r s t a n d t h e e f f e c t s o f t h e s i n g l e c u r r e n c y o n t h e P o r t u g u e s e e c o n o m y . T h e r e i s a w i d e s p r e a d a r g u m e n t f a v o r i n g t h e i d e a t h a t t h e e u r o i s c a u s i n g a l o s s o f c o m p e t i t i v e n e s s o n t h e P o r t u g u e s e e c o n o m y . I t i s a f a c t t h a t P o r t u g a l l o s t c o n t r o l o v e r i t s e x c h a n g e r a t e , b u t i n t h e l o n g r u n w e d o u b t o f t h e e f f e c t i v e n e s s o f t h a t i n s t r u m e n t a s a m e a n s o f b e c o m i n g m o r e c o m p e t i t i v e . T h u s , w e a l s o d o u b t o f t h e f o r m e r a r g u m e n t . T h e p u r p o s e o f c o m p u t i n g d i f f e r e n t i n d i c a t o r s o f c o m p e t i t i v e n e s s w a s t o c o m p a r e t h e e v o l u t i o n o f c o m p e t i t i v e n e s s i n d i f f e r e n t m e a s u r e s . T h e s a m e i n d e x e s w e r e b u i l t f o r I r e l a n d , f o r c o m p a r i s o n p u r p o s e s .
7
W e c a l c u l a t e d 4 a g g r e g a t e i n d i c a t o r s o f c o m p e t i t i v e n e s s f o r b o t h c o u n t r i e s : r e l a t i v e c o n s u m e r p r i c e s (E C P I) , r e l a t i v e p r i c e o f t r a d e d a n d n o n - t r a d e d g o o d s (E) , r e l a t i v e u n i t l a b o r c o s t s (R U L C) a n d r e l a t i v e u n i t c o s t s (R U C) . W e a l s o c a l c u l a t e d a w e i g h t e d a v e r a g e o f b i l a t e r a l n o m i n a l e x c h a n g e r a t e s (E n) , u s e d i n 2 o f t h e 4 m e a s u r e s . W e n o w b r i e f l y d e s c r i b e t h e c o n s t r u c t i o n o f t h e i n d i c a t o r s , a n d a s w e w i l l s e e , t h e y a l l t e l l u s d i f f e r e n t t h i n g s .
E C P I w a s c a l c u l a t e d a c c o r d i n g t o t h e f o l l o w i n g f o r m u l a :
( 1 ) ECPI En CPI * CPI
W h e r e E n i s t h e w e i g h t e d n o m i n a l e x c h a n g e r a t e , C P I * i s t h e w e i g h t e d f o r e i g n p r i c e l e v e l , a n d C P I i s t h e d o m e s t i c p r i c e l e v e l , a l l i n p e r c e n t a g e c h a n g e s . I n t h e P o r t u g u e s e c a s e w h e r e t h e m a j o r i t y o f t r a d i n g p a r t n e r s s h a r e t h e s a m e c u r r e n c y , E n l o s e s i t s i m p o r t a n c e . T h u s , E C P I w i l l m o s t l y r e f l e c t d i f f e r e n c e s i n i n f l a t i o n r a t e s . T h i s r e i n f o r c e s t h e i m p o r t a n c e o f i n f l a t i o n c o n t r o l i n s i d e a m o n e t a r y u n i o n i n o r d e r t o m a n a g e c o m p e t i t i v e n e s s .
T h e r e l a t i v e p r i c e o f t r a d a b l e a n d n o n t r a d a b l e g o o d s , E, w a s c a l c u l a t e d a c c o r d i n g t o :
( 2 ) E En Pt * Pn
W h e r e E n i s a g a i n t h e w e i g h t e d n o m i n a l e x c h a n g e r a t e , P t * i s t h e p r i c e o f t r a d e d g o o d s , a n d P n i s t h e p r i c e o f n o n t r a d e d g o o d s , a l l i n p e r c e n t c h a n g e s . P t * w a s c a l c u l a t e d b y a g g r e g a t i n g t r a d e d g o o d s i n t o a c o m p o s i t e g o o d . P n w a s a s s u m e d t o b e t h e s a m e a s n o m i n a l u n i t l a b o r c o s t s , s i n c e n o n t r a d e d g o o d s a r e u s u a l l y s e r v i c e s , w h o s e i n p u t s a r e m a i n l y l a b o r . T h i s c o n c e p t m e a s u r e s d i f f e r e n c e s b e t w e e n e x t e r n a l a n d i n t e r n a l m a r k e t p r i c e s , a d j u s t e d b y t h e n o m i n a l e x c h a n g e r a t e .
C o n c e r n i n g R U L C, t h e c o n s t r u c t i o n o f t h e i n d e x w a s e a s i e r , s i n c e t h e n e e d e d i n d e x e s w e r e a l r e a d y c o m p u t e d i n t h e E u r o p e a n c o m m i s s i o n d a t a b a s e . W e u s e d t h e r e a l u n i t l a b o r c o s t i n d e x . I t w a s j u s t n e e d e d t o w e i g h t t h e i n d e x e s o f p a r t n e r c o u n t r i e s , a n d
C o u n t r y S p a i n G e r m a n y F r a n c e U . K . I t a l y N e t h e r l a n d s U S A B e l g i u m T o t a l
P o r t u g a l 40.1% 18.08% 13.66% 7.15% 6.96% 5.35% 4.67% 4% 1 0 0 %
8
b u i l d a c o m p o s i t e R U L C, s u i t e d f o r d i r e c t c o m p a r i s o n w i t h t h e P o r t u g u e s e a n d I r i s h o n e t h a t c a n b e s e e n i n t h e a n n e x .
R e l a t i v e u n i t c o s t , R U C, w a s t h e m o s t d i f f i c u l t i n d e x t o c o m p u t e . I t s c o n s t r u c t i o n i s e x p l a i n e d i n t h e a n n e x . I n t u i t i v e l y , t h e i n d e x m e a s u r e s l a b o r c o s t s a n d c a p i t a l c o s t s t o g e t h e r . H o w e v e r ,
it’s conceptuall y different from R U L C, i n t h e s e n s e t h a t i t m e a s u r e s t h e e v o l u t i o n o f u n i t c o s t s , b u t d o e s n o t a d j u s t t h e m f o r p r o d u c t i v i t y . A s a r e s u l t t h e i n d e x i s , i n n o r m a l c o n d i t i o n s , a l w a y s g r o w i n g . T h e i n d e x i s e x p e c t e d t o d e c r e a s e o r d e c e l e r a t e , w h e n P o r t u g a l s t a r t e d t o b e n e f i t f r o m l o w e r i n t e r e s t r a t e s , d u e t o t h e e n t r a n c e i n t h e e u r o z o n e , i n t h e p r e v i o u s y e a r s t o 2 0 0 0 . G i v e n t h a t l o w e r i n t e r e s t r a t e s m e a n l o w e r c a p i t a l c o s t s .
W e s h o w i n t a b l e 2 a n d 3 t h e e v o l u t i o n o f t h e m e n t i o n e d i n d i c a t o r s f o r P o r t u g a l a n d I r e l a n d .
Table 2 –Portuguese indicators of competitiveness (period averages at annual rates)
E n E E C P I R U L C R U C 1 9 7 7
-1 9 8 5 17.81% 19.22% 4% -4.27% --- 1 9 8 6
-1 9 9 0 4.25% -0.93% -3.04% -0.95% 11.79% 1 9 9 1
-1 9 9 5 1.9% 0.21% -1.27% 1.26% 12.7% 1 9 9 6
-2 0 0 1 2.14% 1.61% 1.41% 0.45% 5.69% 2 0 0 2
-2 0 0 5 -2.03% -3.42% -2.48% -0.14% 6.57% 2 0 0 6
-2 0 1 0 -1.75% -2.44% -1.60% 0.75% 6.45%
Table 3 – Irish indicators of competitiveness (period averages at annual rates) E n E E C P I R U L C R U C 1 9 7 7
-1 9 8 5 2.63% 2.95% 7.69% -0.83% --- 1 9 8 6
-1 9 9 0 -3.58% -6.76% 3.5% -1.07% 4.55% 1 9 9 1
-1 9 9 5 -0.03% -1.26% 3.31% -1.16% 1.67% 1 9 9 6
-2 0 0 1 3.7% 1.72% 1.86% -2.48% 4.32% 2 0 0 2
-2 0 0 5 -3.4% -4.11% 1.9% 0.17% 9.24% 2 0 0 6
9
W h e n a n a l y z i n g t h e t a b l e s w e m u s t t a k e i n t o a c c o u n t t h a t 2 0 1 0 i s a p r e d i c t i o n . A l s o , w h e n c o m p u t i n g R U C s e v e r a l y e a r s
weren’t available (from 1977 to 1985 and 2009 to 2010). As a rule
o f t h u m b , a c o u n t r y g a i n s c o m p e t i t i v e n e s s w h e n e v e r E n, E o r E C P I
g o e s u p , o r R U L C a n d R U C g o d o w n .
S u m m a r i z i n g t h e P o r t u g u e s e i n d i c a t o r s e v o l u t i o n , t h e b e s t p e r i o d s w e r e 1 9 7 7 - 1 9 8 5 i n a l l i n d i c a t o r s ( e x c e p t f o r R U C w h e r e
it’s not available and where the best period is 1996- 2 0 0 1 ) . T h e r e a s o n l i e s i n t h e f a c t t h a t d u r i n g t h i s p e r i o d , t h e r e w e r e t w o l i b e r a l i z a t i o n a n d s t a b i l i z a t i o n p a c k a g e s c o n d u c t e d b y t h e I M F . T h i s p a c k a g e s i n c l u d e d , a m o n g o t h e r s , n o m i n a l d e p r e c i a t i o n s , w a g e r e s t r a i n t a n d i n f l a t i o n r e d u c t i o n . T h e s e m e a s u r e s a r e s u s c e p t i b l e t o g r e a t l y i n f l u e n c e a l l i n d i c a t o r s .
F o r E a n d E C P I, t h e s e c o n d b e s t p e r i o d , w a s 1 9 9 6 - 2 0 0 1 . I n t h i s p e r i o d , P o r t u g a l w a s p r e p a r i n g t o a d o p t t h e E u r o a n d m e a s u r e s s u c h a s e x c h a n g e r a t e s t a b i l i t y a n d i n f l a t i o n r e d u c t i o n w e r e r e q u i r e d . E a n d E C P I a r e v e r y i n f l u e n c e d b y e x c h a n g e r a t e m o v e m e n t s a n d i n f l a t i o n d i f f e r e n t i a l s . F r o m 2 0 0 2 o n w a r d s , w h e n t h e e u r o c a m e i n t o c i r c u l a t i o n , b o t h m e a s u r e s a t t a i n 2 o f t h e w o r s t s c o r e s . T h i s s u g g e s t s t h a t t h e e u r o m i g h t h a v e b r o u g h t s o m e d i f f i c u l t i e s i n m a n a g i n g p r i c e c o m p e t i t i v e n e s s . N e v e r t h e l e s s , I r e l a n d p e r f o r m s w o r s e t h a n P o r t u g a l i n E a f t e r a d o p t i n g t h e e u r o .
H o w e v e r , i f w e l o o k a t R U L C a n d R U C t h e s t o r y i s d i f f e r e n t . C o n c e r n i n g R U L C, P o r t u g a l a c t u a l l y p e r f o r m e d w e l l i n t h e f i r s t 3 y e a r s t h e e u r o c a m e i n t o c i r c u l a t i o n . S t i l l , a f t e r 2 0 0 6 t h e p e r f o r m a n c e w a s s l i g h t l y n e g a t i v e , w h i c h c a n b e a s y m p t o m o f i n t e r n a l r e c e s s i o n f i r s t , a n d w o r l d r e c e s s i o n l a t e r . A g a i n , a f t e r 2 0 0 1 I r e l a n d p e r f o r m s w o r s e t h a n P o r t u g a l i n t h i s i n d i c a t o r .
F i n a l l y , P o r t u g u e s e R U C s e e m s t o s t a b i l i z e a r o u n d 6 . 5 % a f t e r
2001. It’s an almost identical performance to the weighted basket
o f P o r t u g u e s e s e l e c t e d t r a d i n g p a r t n e r s . A f t e r 2 0 0 1 I r e l a n d p e r f o r m s w o r s e a g a i n . T h e n u m b e r s a n d g r a p h s f o r b o t h c o u n t r i e s a n d t h e i r t r a d i n g p a r t n e r s c a n b e f o u n d i n t h e a p p e n d i x .
A n o t h e r i n t e r e s t i n g t o p i c c o n c e r n i n g i n d e x e s i s t h e r e l a t i o n b e t w e e n s o m e o f t h e m , e s p e c i a l l y r e l a t i v e c o n s u m e r p r i c e s a n d r e a l e x c h a n g e r a t e s . F o l l o w i n g M a c e d o a n d C o r a d o ( 1 9 8 9 ) , w e d e f i n e :
( 1 ) CPI a Pn (1 a)(En Pt*)
( 2 ) CPI * a*Pn * (1 a*)Pt *
10
( 4 ) E En Pt * Pn
W h e r e a a n d a * a r e t h e d o m e s t i c a n d f o r e i g n w e i g h t o f n o n t r a d a b l e s r e s p e c t i v e l y . P n a n d P n * a r e t h e p r i c e o f n o n - t r a d a b l e s a t h o m e a n d a b r o a d r e s p e c t i v e l y . E n i s t h e n o m i n a l e x c h a n g e r a t e . P t *
i s t h e p r i c e i n f o r e i g n c u r r e n c y o f a g o o d t h a t r e s u l t s f r o m a g g r e g a t i n g a l l t r a d e d g o o d s i n t o a c o m p o s i t e g o o d . A l l i n p e r c e n t c h a n g e s .
S u b s t i t u t i n g C P I a n d C P I * i n t o E C P I a n d d e v e l o p i n g w e c a n r e a c h t h e f o l l o w i n g e x p r e s s i o n :
( 5 ) 1 * (Pt* Pn*)
a a ECPI a
E
T h i s i s o f g r e a t i n t e r e s t , s i n c e i t c a n g i v e u s t h e p e r c e n t a g e o f t r a d e d a n d n o n - t r a d e d g o o d s i n a n e c o n o m y a n d i n i t s p a r t n e r s . S o w e a t t e m p t t o e s t i m a t e i t , f i r s t u s i n g O L S . T h e r e s u l t s w e r e v e r y u n s a t i s f y i n g , d u e t o t h e p r e s e n c e o f u n i t r o o t s a n d c o i n t e g r a t i n g r e l a t i o n s h i p s b e t w e e n t h e v a r i a b l e s . T h e f i r s t a t t e m p t e d s o l u t i o n w a s t o e s t i m a t e t h e e q u a t i o n u s i n g f i r s t d i f f e r e n c e s , w h i c h g i v e s o n l y t h e s h o r t r u n d y n a m i c s . T h e i n c o n v e n i e n c e i s t h a t s h o r t r u n r e l a t i o n s h i p s t e l l u s n o t h i n g a b o u t t h e w e i g h t s o f t r a d a b l e s a t h o m e a n d a b r o a d .
T a k i n g t h i s i n t o a c c o u n t , w e c h o s e t o e s t i m a t e a V e c t o r E r r o r C o r r e c t i o n M o d e l , w h i c h g i v e s u s b o t h t h e l o n g r u n r e l a t i o n s h i p b e t w e e n v a r i a b l e s a n d t h e s h o r t r u n d y n a m i c s . W e p r e s e n t t h e l o n g r u n r e l a t i o n s h i p f o r P o r t u g a l :
( 6 ) E 5.7 2.35 ECPI 1.23 (Pt *-Pn*)
T h i s m e a n s t h a t t h e a v e r a g e p r o p o r t i o n o f n o n t r a d a b l e s i n t h e P o r t u g u e s e e c o n o m y f o r t h e y e a r s 1 9 8 3 - 2 0 1 0 h a s b e e n o f a = 4 2 % w h i l e f o r o u r p a r t n e r s h a s b e e n o f a * = 5 1 % . T h i s m a k e s s e n s e , s i n c e o u r m a i n p a r t n e r s a r e m o r e d e v e l o p e d e c o n o m i e s , a n d s h o u l d h a v e g r e a t e r p r o p o r t i o n o f s e r v i c e s i n t h e i r e c o n o m y .
11
h a v e b i g g e r p r o p o r t i o n o f s e r v i c e s i n t h e i r e c o n o m y t h a n f o r e x a m p l e S p a i n , w h i c h i s t h e b i g g e s t P o r t u g u e s e p a r t n e r .
F o r a n e s t i m a t i o n o f t h e d e t e r m i n a n t s o f c o m p e t i t i v e n e s s , a n d e f f e c t o f m o n e t a r y u n i o n o n c o m p e t i t i v e n e s s , c h e c k t h e a p p e n d i x .
Current account dynamics
T h i s s e c t i o n i n v e s t i g a t e s t h e e f f e c t s o f s h o c k s o n t h e P o r t u g u e s e a n d I r i s h c u r r e n t a c c o u n t s , a n d t h e c o r r e s p o n d i n g a d j u s t m e n t . W e u s e a c u r r e n t a c c o u n t d e c o m p o s i t i o n , u s e d b y M a c e d o a n d C o r a d o ( 1 9 8 9 ) a d a p t e d f r o m B a l a s s a ( 1 9 8 1 ) .
T h e t e c h n i q u e w o r k s i n a s i m p l e w a y : w e d e c o m p o s e t h e c u r r e n t a c c o u n t i n t o e x t e r n a l s h o c k s a n d p o l i c y r e s p o n s e s t o i s o l a t e d i f f e r e n t t y p e s o f s h o c k s , a n d t o s e e h o w t h e e c o n o m y a d j u s t s t h r o u g h p o l i c y r e s p o n s e s . S p e c i f i c a l l y , w e a s s u m e a b a s e y e a r f o r t h e c u r r e n t a c c o u n t , f r o m t h a t p e r i o d o n w a r d s w e c o m p u t e t r e n d v a r i a b l e s a n d h y p o t h e t i c a l v a r i a b l e s t h a t w e c o m p a r e w i t h t h e a c t u a l v a l u e s , a l l o w i n g t o a c c o u n t f o r s h o c k s , t h e i r n a t u r e a n d t h e i r m a g n i t u d e . I w i l l b r i e f l y i l l u s t r a t e t h e d e c o m p o s i t i o n o f t h e c u r r e n t a c c o u n t u s e d . W e d e p a r t f r o m t h e c u r r e n t a c c o u n t d e f i c i t i n t h e b a s e p e r i o d , g i v e n b y :
( 8 ) R0 M 0 X0 S0 J0
W h e r e R i s t h e c u r r e n t a c c o u n t d e f i c i t , M i s i m p o r t s , X s t a n d s f o r e x p o r t s , S i s s e r v i c e s a n d t r a n s f e r s , J i s i n t e r e s t p a i d o n f o r e i g n d e b t a n d t h e s u b s c r i p t i n d i c a t e s t h e p e r i o d . T h u s , w e c a n r e p r e s e n t t h e c u r r e n t a c c o u n t d e f i c i t i n a n y p e r i o d t b y :
( 9 ) Rt Mt(1 Pm) Xt(1 Px) St Jt
W h e r e P m a n d P x a r e t h e i m p o r t a n d e x p o r t p r i c e c h a n g e s i n p e r c e n t a g e , i n r e l a t i o n t o t h e b a s e p e r i o d . T h e n e x t s t e p i s t o t a k e t h e d i f f e r e n c e b e t w e e n e q u a t i o n ( 1 ) a n d ( 2 ) . T h i s r e s u l t s i n :
( 1 0 )
) (
) (
) (
) (
) (
0 0
0 0
0
J J S
S
X X M
M Px
X Pm M R
R
t t
t t
t t
12
I f w e i n t r o d u c e h y p o t h e t i c a l e x p o r t s ( X H ) a n d t r e n d e x p o r t s
( X T ):
( 1 1 )
) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( 0 0 0 0 0 t t t t t t t t t X XT XH XT J J S S X X M M Px X Pm M XH X R R
T h e m e a n i n g a n d h o w t r e n d a n d h y p o t h e t i c a l v a r i a b l e s w e r e c a l c u l a t e d i s e x p l a i n e d b e l o w . W e c a n i n t r o d u c e i n t h e e q u a t i o n h y p o t h e t i c a l i m p o r t s ( M H ), t r e n d i m p o r t s ( M T ), t r e n d i n t e r e s t p a y m e n t s ( J T ) a n d s k i p s o m e s t e p s , y i e l d i n g :
( 1 2 )
) ( ) ( ) ( ) ( ) ( ) ( ) ( XH XT JT J Px X Pm M MH MT M MH XH X RT R t t t t t t
It’s worth y of notice that we removed the services component
f r o m t h e e q u a t i o n , a n d a l s o a l l v a r i a b l e s e x p r e s s e d i n t h e b a s e p e r i o d . W e h a v e i n t r o d u c e d a n e w v a r i a b l e , R T, w h i c h i s t h e t r e n d
current account deficit. It’s given by the values of trend imports,
t r e n d e x p o r t s a n d t r e n d i n t e r e s t p a y m e n t s
W e n o w g i v e o u r i n t e r p r e t a t i o n o f e q u a t i o n ( 1 2 ) . W e a s s u m e
that countries are price takers, so they can’t influence thei r i m p o r t a n d e x p o r t p r i c e s .
O n t h e r i g h t s i d e w e h a v e t h e t e r m s t h a t r e p r e s e n t t h e e f f e c t s o f e x t e r n a l s h o c k s . T h e f i r s t t e r m r e p r e s e n t s t h e t e r m s o f t r a d e e f f e c t , t h e s e c o n d t h e i n t e r e s t r a t e e f f e c t s , a n d t h e t h i r d t h e e x p o r t v o l u m e e f f e c t .
O n t h e l e f t s i d e , w e h a v e w h a t w e c a l l p o l i c y r e s p o n s e s . T h e f i r s t t e r m r e p r e s e n t s a d d i t i o n a l n e t e x t e r n a l f i n a n c i n g , t h e s e c o n d r e p r e s e n t s t h e p r i c e e f f e c t o f e x p o r t p r o m o t i o n , t h e t h i r d r e p r e s e n t s p r i c e e f f e c t o n i m p o r t s u b s t i t u t i o n , a n d t h e f o u r t h r e p r e s e n t s i n t e r n a l p r o d u c t e f f e c t o n i m p o r t v o l u m e .
F o l l o w i n g M a c e d o a n d C o r a d o ( 1 9 8 9 ) , w e c a n o r g a n i z e v a r i a b l e s i n t h e f o l l o w i n g w a y :
E x t e r n a l s h o c k s a r e c o m p o s e d b y t e r m s o f t r a d e e f f e c t ( 1 3 ) a n d e x p o r t v o l u m e e f f e c t ( 1 4 ) :
( 1 3 ) TOT MtPm XtPx Jt JT
( 1 4 ) EXV XT XH
13
( 1 5 ) DEM Rt RT MT MH
( 1 6 ) EXP Xt XH
( 1 7 ) IMS MH Mt
W e n o w e x p l a i n h o w t r e n d a n d h y p o t h e t i c a l v a r i a b l e s w e r e o b t a i n e d . W e n e e d e d t o e s t i m a t e i n c o m e a n d p r i c e e l a s t i c i t i e s f o r i m p o r t a n d e x p o r t s . S i n c e m o s t u s e d v a r i a b l e s h a d u n i t r o o t s a n d i n a l l e q u a t i o n s w e d e t e c t e d c o i n t e g r a t i n g r e l a t i o n s h i p s , w e o p t e d t o e s t i m a t e t h e m u s i n g a v e c t o r e r r o r s c o r r e c t i o n m o d e l i n o r d e r t o d i s c o v e r t h e l o n g r u n r e l a t i o n s h i p s . W e e s t i m a t e d P o r t u g u e s e e x p o r t s t o b e g i v e n b y t h e f o l l o w i n g r e g r e s s i o n :
( 1 8 ) Xt 11.46 0.55PXt 1.746 X *t
W h e r e X t i s e x p o r t s i n c o n s t a n t p r i c e s , P X t i s e x p o r t p r i c e s , a n d X * t i s t r a d i n g p a r t n e r s i m p o r t s i n c o n s t a n t p r i c e s . B o t h e l a s t i c i t i e s a r e s i g n i f i c a n t a t t h e 1 % l e v e l . T h e r e s u l t s f o r I r e l a n d c a n b e f o u n d i n t h e a p p e n d i x .
E x p o r t t r e n d s ( X T ) w e r e o b t a i n e d a s s u m i n g t h a t t h e a v e r a g e o f t h e l a s t t h r e e y e a r s f o r b o t h r e g r e s s o r s ( e x p o r t p r i c e s a n d f o r e i g n i m p o r t s ) h a s b e e n m a i n t a i n e d i n t h e c u r r e n t p e r i o d . H y p o t h e t i c a l e x p o r t s ( X H ) w e r e o b t a i n e d u s i n g t h e s a m e p r o c e s s a s f o r e x p o r t t r e n d s , b u t u s e s c u r r e n t f o r e i g n i m p o r t s i n s t e a d o f l a g g e d f o r e i g n i m p o r t s . S o t h e t e r m E X V ( = X T - X H ) c a p t u r e s t h e e f f e c t o f s h o c k s f r o m f o r e i g n d e m a n d , w h i l e t h e t e r m E X P ( = X t -X H ) c a p t u r e s s h o c k s f r o m e x p o r t p r i c e s .
R e s e m b l i n g e x p o r t e s t i m a t i o n , w e e s t i m a t e a r e g r e s s i o n t h a t e x p l a i n s P o r t u g u e s e i m p o r t s i n t h e f o l l o w i n g w a y :
( 1 8 ) Mt -4.75 1.78Yt 0.536 EMt
W h e r e M t i s c u r r e n t i m p o r t s a t c o n s t a n t p r i c e s , Y t i s G D P a t c o n s t a n t p r i c e s a n d E M t i s a n i m p o r t e x c h a n g e r a t e d e f i n e d a s i m p o r t p r i c e s o v e r n o m i n a l u n i t l a b o r c o s t . B o t h e l a s t i c i t i e s a r e s i g n i f i c a n t a t t h e 1 % l e v e l . W e s h o w i n t h e a p p e n d i x t h e r e s u l t s f o r I r e l a n d .
14
s h o c k s i n i m p o r t s c a u s e d b y c h a n g e s i n G D P . T h e v a r i a b l e I M S ( = M t - M H ) c a p t u r e s t h e e f f e c t o f e x c h a n g e r a t e s h o c k s .
F i n a l l y , i n t e r e s t p a y m e n t t r e n d s w e r e c a l c u l a t e d a s s u m i n g a c o n s t a n t i n t e r e s t r a t e . T h e b e n c h m a r k i n t e r e s t r a t e i s t h e 3 m o n t h E u r i b o r f o r t h e y e a r 1 9 9 0 . T h e i n t e r e s t t r e n d ( J T ) t e l l s u s w h a t w o u l d b e t h e t o t a l i n t e r e s t p a i d , i f i n t e r e s t r a t e s r e m a i n e d t h e s a m e a s i n 1 9 9 0 . W e n o w p r e s e n t i n t h e f o l l o w i n g t a b l e s , t h e d e c o m p o s i t i o n o f t h e c u r r e n t a c c o u n t , a c c o r d i n g t o t h e m e t h o d d e s c r i b e d a b o v e :
Table 4 – Decomposition of Portuguese current account. Numbers are period averages at annual rates.
1 9 7 7 - 1 9 9 1 1 9 9 2 -1 9 9 8
1 9 9 9 -2 0 0 4
2 0 0 5 -2 0 1 1 E x t e r n a l s h o c k s a s % o f
G D P - 1 . 4 9 % - 1 0 . 9 1 % - 2 3 . 3 2 % - 3 8 . 7 7 % T e r m s o f t r a d e e f f e c t
( T O T )
1.09% -6.78% -17.941% -36.78%
E x p o r t v o l u m e e f f e c t ( E X V )
-2.59% -4.13% -5.38% -1.99%
P o l i c y r e s p o n s e s a s %
o f G D P - 1 . 4 9 % - 1 0 . 9 1 % - 2 3 . 3 2 % - 3 8 . 7 7 % P r i c e e f f e c t o f e x p o r t
p r o m o t i o n ( E X P )
-0.76% 4.49% 0.42% 1.19%
P r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n ( I M S )
-0.49% -2.88% -1.42% -1.62%
D e m a n d m a n a g e m e n t ( D E M )
-0.23% -12.57% -22.32% -38.33%
W e c h o s e t o d i v i d e t h e a n a l y z e d p e r i o d i n f o u r s u b s e t s , a n d p r e s e n t f o r e a c h s u b s e t t h e y e a r l y a v e r a g e s . T h e p e r i o d 1 9 9 2 - 1 9 9 8
E x t e r n a l s h o c k s a s % o f
p o l i c y r e s p o n s e s 100% 1 0 0 % 1 0 0 % 1 0 0 %
T e r m s o f t r a d e e f f e c t
( T O T ) 59.86% 60.16% 76.19% 87.3%
E x p o r t v o l u m e e f f e c t ( E X V )
40.13% 39.83% 23.80% 12.69%
P o l i c y r e s p o n s e s a s %
o f e x t e r n a l s h o c k s 1 0 0 % 1 0 0 % 1 0 0 % 1 0 0 % P r i c e e f f e c t o f e x p o r t
p r o m o t i o n ( E X P )
188.69% -50.93% -1.86% -1.87%
P r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n ( I M S )
-191.8% 36.35% 6.26% 8.86%
D e m a n d m a n a g e m e n t ( D E M )
15
c o r r e s p o n d s t o t h e f i r s t s t e p t a k e n t o w a r d s E u r o p e a n m o n e t a r y i n t e g r a t i o n . I n 1 9 9 2 P o r t u g a l b e c a m e m e m b e r o f t h e E u r o p e a n m o n e t a r y s y s t e m , w h i c h w a s b a s i c a l l y a f i x e d e x c h a n g e r a t e r e g i m e , w i t h s o m e m a r g i n f o r f l u c t u a t i o n s . T h e i n i t i a l e s c u d o m a r g i n o f f l u c t u a t i o n w a s o f 6 % ( u p a n d d o w n ) i n r e l a t i o n t o a l l o t h e r m e m b e r c u r r e n c i e s o f t h e E M S .
W e s h o u l d n o t e t h a t m o s t c o u n t r i e s b e l o n g i n g t o t h e E M S h a d a m a r g i n o f f l u c t u a t i o n o f o n l y 2 . 2 5 % ( u p a n d d o w n ) . I n 1 9 9 2 - 1 9 9 3 t h e r e w e r e s y s t e m a t i c a l d i f f i c u l t i e s i n k e e p i n g c u r r e n c i e s i n s i d e t h e 2 . 2 5 % b a n d s , l e a d i n g t o r e f o r m o f t h e E M S i n 1 9 9 4 w h i c h c o n s i s t e d i n e n l a r g i n g t h e f l u c t u a t i o n b a n d s t o 1 5 % ( u p a n d d o w n ) .
I n 1 9 9 9 , E M S m e m b e r s f i x e d d e f i n i t e l y t h e i r p a r i t i e s a g a i n s t a w e i g h t e d b a s k e t c o m p o s e d o f t h e i r o w n c u r r e n c i e s , w h i c h w a s w o r t h o n e e u r o f r o m t h e n o n . A l t h o u g h t h e e u r o o n l y c a m e i n t o
circulation in 2002, it’s reasonable to assume the beginning of the
m o n e t a r y u n i o n i n 1 9 9 9 .
P o r t u g a l h a s b e e n e m e r g e d i n c r i s i s a l m o s t s i n c e t h e b e g i n n i n g o f t h e m o n e t a r y u n i o n , f i r s t i n t e r n a l t h e n e x t e r n a l . T h e P o r t u g u e s e s i t u a t i o n h a s t u r n e d o u t t o w o r s e n a s t i m e g o e s b y , e s p e c i a l l y a f t e r t h e w o r l d b u s t . S o w e d e c i d e d t o s p l i t t h e p e r i o d b e l o n g i n g t o t h e E M U i n t w o , t h e f i r s t ( 1 9 9 9 - 2 0 0 4 ) i n c o r p o r a t e s a n o r m a l s i t u a t i o n a n d a s m a l l r e c e s s i o n , t h e s e c o n d ( 2 0 0 5 - 2 0 1 1 ) i s a p e r i o d o f b i g g e r i n t e r n a l c r i s i s f o l l o w e d b y a w o r l d b u s t .
O b s e r v i n g e x t e r n a l s h o c k s i n p e r c e n t a g e o f G D P w e c a n s e e a c o n t i n u o u s a n d g r o w i n g d e t e r i o r a t i o n o f o u r t e r m s o f t r a d e , e s p e c i a l l y a f t e r e n t e r i n g t h e E M U . I n t h e c o r e o f T O T c h a n g e s t h e r e a r e t w o e f f e c t s . T h e f i r s t i s t h a t t h e v a l u e o f i m p o r t s g r e w m u c h m o r e t h a n t h e v a l u e o f e x p o r t s . H o w e v e r , t h i s g r o w t h i s a d j u s t e d f o r i n t e r e s t p a y m e n t s a n d t r e n d i n t e r e s t p a y m e n t s w h i c h i s t h e s e c o n d e f f e c t . F o r t h e l a s t t h r e e p e r i o d s t h i s d i f f e r e n c e i n d e b t a n d t r e n d d e b t i n t e r e s t p a y m e n t s i s b i g g e r a n d g r e w f a s t e r t h a n o u r t r a d e d e f i c i t e s p e c i a l l y a f t e r 1 9 9 9 . T h e s e t w o e f f e c t s g o i n d i f f e r e n t d i r e c t i o n s i n s i d e t h e t e r m s o f t r a d e ( v a l u e o f i m p o r t s i s b i g g e r t h a n t h a t o f e x p o r t s , b u t s o i s t h e t r e n d d e b t b i g g e r t h a n a c t u a l d e b t p a y m e n t ) , a n d t h e d e b t e f f e c t d o m i n a t e s c a u s i n g t h e p r i c e e f f e c t o f t e r m s o f t r a d e t o b e n e g a t i v e . I f P o r t u g a l w o u l d p a y t h e s a m e i n t e r e s t r a t e s o n d e b t a s t h e r a t e s i n 1 9 9 0 , i n t e r e s t p a y m e n t s w o u l d e x p l o d e . T h i s i s a n a d v a n t a g e o f b e l o n g i n g t o t h e E M U , a n d i s t h e m a i n c a u s e w h y t h e p r i c e e f f e c t o f t e r m s o f t r a d e i s s o n e g a t i v e .
16
t r e n d s (E X V i s n e g a t i v e ) . T h e e x c e p t i o n i s 2 0 0 9 a n d 2 0 1 0 w h e r e P o r t u g u e s e p a r t n e r s i m p o r t s c o n t r a c t e d , a n d w h e r e P o r t u g u e s e h y p o t h e t i c a l e x p o r t s w e r e l o w e r t h a n e x p o r t t r e n d s . T h a t c a u s e d t h e p e r i o d a v e r a g e t o b e l e s s n e g a t i v e t h a n i n t h e f i r s t h a l f o f E M U m e m b e r s h i p .
C o n c e r n i n g p o l i c y r e s p o n s e s i n p e r c e n t a g e o f G D P , w e s t a r t w i t h d e m a n d m a n a g e m e n t . T h e m a i n r e a s o n w h y i t i s b e c o m i n g m o r e n e g a t i v e , e s p e c i a l l y a f t e r e n t r y i n t h e E M U i s a g a i n r e l a t e d t o i n t e r e s t p a y m e n t s . T h e c u r r e n t a c c o u n t t r e n d d e f i c i t s t a r t s d i v e r g i n g s i g n i f i c a n t l y f r o m t h e r e a l c u r r e n t a c c o u n t d e f i c i t a r o u n d 1 9 9 5 , d u e t o t h e l o w e r i n g o f t h e i n t e r e s t r a t e s i n c o m p a r i s o n t o 1 9 9 0 . I t “ex plodes” after the year 2000, especially in 2009 and 2 0 1 0 . T h i s a g a i n r e f l e c t s t h e c a p a c i t y o f P o r t u g a l t o a c c u m u l a t e l a r g e q u a n t i t i e s o f d e b t g i v e n i t s a c c e s s t o l o w i n t e r e s t r a t e s .
However this has two sides. On one hand, it’s good just p e r s e. O n t h e o t h e r h a n d , i t m i g h t c a u s e a s o r t o f m o r a l h a z a r d p r o b l e m , i n t h e s e n s e t h a t c o u n t r i e s h a v e l o w e r i n c e n t i v e s t o l i m i t d e b t e x p a n s i o n . I f P o r t u g a l l e f t t h e E u r o z o n e , d e b t s e r v i c e w o u l d b e c o m e m u c h m o r e p a i n f u l , m a y b e u n s u s t a i n a b l e .
T h e p r i c e e f f e c t o f e x p o r t p r o m o t i o n a s a p e r c e n t a g e o f G D P s h o u l d b e t e n d e n t i a l l y p o s i t i v e . T h e r e a s o n i s t h a t , f o r a g r o w i n g a n d s t a b l e w o r l d e c o n o m y a n d g r o w i n g e x p o r t p r i c e s , c u r r e n t e x p o r t s a r e b i g g e r t h a n h y p o t h e t i c a l e x p o r t s . T h i s g r o w t h o f p r i c e s s h o u l d b e f a c e d i n t h e c o n t e x t o f P o r t u g a l a s a p r i c e t a k e r . E x p o r t p r i c e g r o w t h m e a n s t h a t P o r t u g u e s e g o o d s a r e m o r e v a l u a b l e , n o t t h a t P o r t u g u e s e p r o d u c t i o n i s g e t t i n g m o r e e x p e n s i v e . A s i t i s r e p o r t e d i n m o s t p e r i o d s , t h e E X P i s p o s i t i v e . I t c a n b e n e g a t i v e i f t h e r e a r e s o m e u n e x p e c t e d e x p o r t p r i c e s h o c k s , l i k e o i l s h o c k s w h i c h h a p p e n e d i n t h e p e r i o d 1 9 7 7 - 1 9 9 1 . A f t e r b e i n g p a r t o f t h e E M U , o u r e x p o r t p r i c e s s h o w a m u c h m o r e s t a b l e b e h a v i o r , a c t u a l l y p r e s e n t i n g s o m e d e c r e a s e s , w h i c h c o n t r i b u t e d t o l o w l e v e l s o f E X P a f t e r 1 9 9 9 .
O p p o s e d t o e x p o r t p r o m o t i o n , t h e p r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n s h o u l d b e t e n d e n t i a l l y n e g a t i v e . S i m i l a r l y t o h y p o t h e t i c a l e x p o r t s , h y p o t h e t i c a l i m p o r t s o n l y t a k e i n t o a c c o u n t l a g g e d i m p o r t e x c h a n g e r a t e s , w h i c h i s a m e a s u r e c a l c u l a t e d a s i m p o r t p r i c e s d i v i d e d b y n o m i n a l e x c h a n g e r a t e s . W e e s t i m a t e d t h a t t h e i m p o r t e x c h a n g e r a t e a f f e c t s n e g a t i v e l y i m p o r t s a n d h y p o t h e t i c a l i m p o r t s , a n d a l s o t h a t i t h a s a n e g a t i v e t r e n d o v e r t i m e . A s a n e x a m p l e , a f t e r e n t e r i n g t h e E M U i m p o r t e x c h a n g e r a t e d e c r e a s e d a l m o s t 1 5 % b e t w e e n 1 9 9 9 a n d 2 0 1 0 . F o r t h i s r e a s o n h y p o t h e t i c a l i m p o r t s a r e u s u a l l y l o w e r t h a n c u r r e n t i m p o r t s ( s o I M S
17
i n s i d e . S o t h e i m p o r t e x c h a n g e r a t e i s c o n t r i b u t i n g t o i m p o r t s u b s t i t u t i o n o f n a t i o n a l p r o d u c t i o n . I n s i m p l e t e r m s , i t i s g e t t i n g c h e a p e r t o i m p o r t r a t h e r t h a n p r o d u c e . N e v e r t h e l e s s , t h i s t e n d e n c y i s s m a l l e r a f t e r t h e e u r o e n t r y i n c i r c u l a t i o n t h a n b e f o r e ( 1 9 9 2 -1 9 9 8 ) w h i c h i s g o o d n e w s
N o w t h a t t h e b a s i c m e c h a n i c s o f t h e v a r i a b l e s b e h a v i o r a r e e x p l a i n e d w e w i l l f o c u s o n t h e m o r e i m p o r t a n t p o i n t , t h e d y n a m i c s o f c u r r e n t a c c o u n t a d j u s t m e n t . T o s e e h o w c u r r e n t a c c o u n t a d j u s t s , w e e x p r e s s e x t e r n a l s h o c k s a s p e r c e n t a g e o f p o l i c y r e s p o n s e s a n d v i c e v e r s a .
E x t e r n a l s h o c k s c a p t u r e e f f e c t s o f e x o g e n o u s v a r i a b l e s , s u c h a s p r i c e s a n d i n t e r e s t r a t e s d e f i n e d i n e x t e r n a l m a r k e t s . T h e i n t e r p r e t a t i o n o f t h e c a l c u l a t e d s h o c k s i s t r i c k y . E x t e r n a l s h o c k s t h a t h a v e a n e g a t i v e s i g n a s p e r c e n t a g e o f G D P a r e i n f a c t a p o s i t i v e s h o c k . I n f a c t t h e w a y w e m e a s u r e t e r m s o f t r a d e s h o c k s a n d e x p o r t v o l u m e s h o c k s , d e l i v e r s t h e r e s u l t t h a t P o r t u g a l h a s s u f f e r e d p o s i t i v e s h o c k s m o s t o f t h e t i m e . F i r s t P o r t u g u e s e b i g g e r p a r t n e r s i m p o r t s h a v e g r o w n s y s t e m a t i c a l l y , w h i c h i s a p o s i t i v e s h o c k o n P o r t u g u e s e e x p o r t v o l u m e ( E X V ). T h i s s h o c k i s b i g g e s t i n t h e p e r i o d o f 1 9 9 9 - 2 0 0 4 . T h e o t h e r s h o c k h a s t o d o w i t h t h e w a y w e m e a s u r e t e r m s o f t r a d e . I f w e m e a s u r e d t h e m w i t h o u t t a k i n g i n t o a c c o u n t i n t e r e s t t r e n d s , t e r m s o f t r a d e w o u l d s u f f e r a n e g a t i v e s h o c k . H o w e v e r , b y i n c l u d i n g a h y p o t h e t i c a l s i t u a t i o n w h e r e
P ortuguese debt would be more “expensive”, we see that European
i n t e g r a t i o n c o n s t i t u t e s a p o s i t i v e s h o c k . T h e r e d u c e d d e b t s e r v i c e c o m p e n s a t e s t h e i n c r e a s e d t r a d e d e f i c i t t h a t c o i n c i d e s w i t h E u r o p e a n i n t e g r a t i o n . H o w e v e r , s i n c e t r a d e d e f i c i t i s r e l a t e d t o d e b t a c c u m u l a t i o n , w e c a n n o t s a y P o r t u g a l i s b e t t e r p r o t e c t e d a g a i n s t n e g a t i v e e x t e r n a l s h o c k s i n s i d e t h e E u r o z o n e .
T h e s e t w o t y p e s o f s h o c k s s e e m t o d i f f e r i n n a t u r e b e f o r e a n d a f t e r P o r t u g a l e n t e r e d t h e E M U . I n t h e f i r s t t w o p e r i o d s t h a t r a n g e f r o m 1 9 7 7 t o 1 9 9 9 , t e r m s o f t r a d e s h o c k s r e p r e s e n t e d a r o u n d 6 0 % o f p o l i c y r e s p o n s e s . H o w e v e r , a f t e r 1 9 9 9 t e r m s o f t r a d e s h o c k s k e p t r i s i n g i n p e r c e n t a g e o f e x t e r n a l s h o c k s . O n c e a g a i n t h e
Euroz one is to “blame” for the lowering of interest rates, and
l o w e r i n t e r e s t p a y m e n t s o n d e b t , a l l o w i n g P o r t u g a l t o l i v e w i t h b i g g e r a m o u n t s o f d e b t a n d a t r a d e d e f i c i t b i g g e r t h a n o t h e r w i s e w o u l d b e p o s s i b l e .
18
I n t e r m s o f p o l i c y r e s p o n s e s , w e c a n s e e t h a t a d j u s t m e n t s t h r o u g h e x p o r t p r o m o t i o n a n d i m p o r t s u b s t i t u t i o n h a v e l o s t m a g n i t u d e a s t i m e w e n t b y . T h e s e t w o v a r i a b l e s a l w a y s h a v e d i f f e r e n t s i g n s , b u t b o t h t e n d t o v e r y l o w l e v e l s . O n t h e o t h e r h a n d , d e m a n d m a n a g e m e n t m a i n t a i n e d a w e i g h t o n c u r r e n t a c c o u n t a d j u s t m e n t a l o n g a l l p e r i o d s o f a r o u n d 1 0 0 % , m e a n i n g t h a t i n t h e l a s t p e r i o d s a l m o s t a l l a d j u s t m e n t h a s b e e n d o n e t h r o u g h t h i s v a r i a b l e .
I n t h e c a s e o f t h e p r i c e e f f e c t o f e x p o r t p r o m o t i o n , w e c a n i n t e r p r e t i t a s t h e p r i c e c o m p e t i t i v e n e s s e f f e c t o n e x p o r t p r o m o t i o n . E X P g r o w s i f e x p o r t p r i c e s g o u p , a n d t h e o p p o s i t e i s a l s o t r u e . E x p o r t i n g m o r e i s o n e w a y o f c o m p e n s a t i n g f o r a d v e r s e e x t e r n a l s h o c k s , w h i c h h a s l o s t i m p o r t a n c e o v e r t i m e . I n f a c t e x p o r t p r i c e s h a v e r i s e n , b u t a d j u s t m e n t t h r o u g h e x p o r t s h a s c o n t r a c t e d a s a p e r c e n t a g e o f e x t e r n a l s h o c k s . T h e n e g a t i v e s i g n m e a n s t h a t e x p o r t p r o m o t i o n i s c o n t r i b u t i n g n e g a t i v e l y t o t h e e x t e r n a l s h o c k s , o r t h a t t h e p o s i t i v e s h o c k s w e s u f f e r e d i n m o s t p e r i o d s d o n ´ t c o m e f r o m e x p o r t p r o m o t i o n .
T h e p r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n b e h a v e s i n a s i m i l a r w a y . I t s w e i g h t a s p e r c e n t a g e o f e x t e r n a l s h o c k s h a s d i m i n i s h e d o v e r t i m e a n d b e c a m e p o s i t i v e i n t h e l a s t t h r e e p e r i o d s . I t i s i m p o r t a n t t o n o t e t h a t a f t e r 1 9 9 9 t h e p r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n i s b i g g e r i n a b s o l u t e v a l u e t h a n t h e p r i c e e f f e c t o f e x p o r t p r o m o t i o n . T h i s d i f f e r e n t i a l m e a n s t h a t t h e g r o w t h o f t r a d e d g o o d s p r i c e s i s a g g r a v a t i n g P o r t u g u e s e t r a d e d e f i c i t .
F i n a l l y d e m a n d m a n a g e m e n t b e c a m e t h e m a i n i n s t r u m e n t o f s t a b i l i z a t i o n o f t h e c u r r e n t a c c o u n t a f t e r 1 9 9 2 . I t s m a g n i t u d e d i d d e c r e a s e a f t e r 1 9 9 9 , b u t s t i l l i t r e p r e s e n t s a l m o s t 1 0 0 % o f e x t e r n a l s h o c k s . I n t h e p e r i o d s t a r t i n g o n 2 0 0 5 t h e r e i s a s l i g h t d e c r e a s e o f d e m a n d m a n a g e m e n t a s p e r c e n t a g e o f e x t e r n a l s h o c k s c o m p a r e d t o t h e 1 9 9 9 - 2 0 0 4 p e r i o d . T h e r e a s o n i s t h a t t h e s l o w d o w n a n d r e c e s s i o n o f P o r t u g u e s e G D P i n t h e s e c o n d h a l f o f E u r o z o n e m e m b e r s h i p c o n t r i b u t e d n e g a t i v e l y t o i m p o r t s . T h i s d e c r e a s e
helped to compensate the “explosion” of trend interest pa yments in
t h e s e c o n d h a l f o f E u r o z o n e m e m b e r s h i p . S t i l l w e c a n c o n c l u d e t h a t a f t e r t h e e u r o c a m e i n t o c i r c u l a t i o n , P o r t u g a l r e l i e s m o r e o n d e m a n d m a n a g e m e n t t h a n o n e x p o r t p r o m o t i o n o r i m p o r t s u b s t i t u t i o n t o a d j u s t f o r e x t e r n a l s h o c k s .
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Table 5 – Decomposition of Irish current account. Numbers are period averages at annual rates.
1 9 8 5 -1 9 9 -1
1 9 9 2 -1 9 9 8
1 9 9 9 -2 0 0 4
2 0 0 5 -2 0 1 1 E x t e r n a l s h o c k s a s % o f
G D P 2 . 8 6 4 % 6 . 3 5 % 4 . 1 1 % - 8 . 6 9 % T e r m s o f t r a d e e f f e c t -1.406% -0.51% -2.38% -9.62%
E x p o r t v o l u m e e f f e c t 4.27% 6.86% 6.49% 0.93%
P o l i c y r e s p o n s e s a s % o f G D P
2 . 8 6 4 % 6 . 3 5 % 4 . 1 1 % - 8 . 6 9 %
P r i c e e f f e c t o f e x p o r t p r o m o t i o n
6.003% 9.02% 36.16% -7.15%
P r i c e e f f e c t o f i m p o r t s u b s t i t u t i o n
-16.49% -21.46% -26.2% -15.35%
D e m a n d m a n a g e m e n t 13.35% 18.79% -5.84% 13.82%
E x t e r n a l s h o c k s a s % o f
p o l i c y r e s p o n s e s 1 0 0 % 1 0 0 % 1 0 0 % 1 0 0 %
T e r m s o f t r a d e e f f e c t -148.35% -13.37% 526.51% 42.07%
E x p o r t v o l u m e e f f e c t 248.35% 113.37% -426.5% 57.92%
P o l i c y r e s p o n s e s a s % o f
e x t e r n a l s h o c k s 1 0 0 % 1 0 0 % 1 0 0 % 1 0 0 % P r i c e e f f e c t o f e x p o r t
p r o m o t i o n 363.88% 104.21% -5766.39% 132.82% P r i c e e f f e c t o f i m p o r t
s u b s t i t u t i o n -952.25% -411.09% 3918.73% -82.33% D e m a n d m a n a g e m e n t 688.36% 406.88% 1947.66% 49.5%
It is int eresting t o note that , as percent age of GDP, export volum e effect is posit ive al ong all periods, m eani ng Ireland is losing export volum e. However, t he price effect of export prom otion is al so positive in the fi rst three periods and bi gger than the volum e effect . This means t hat Irel and is increasing the price of its exports, at a hi gher rate than i t l oses volum e, resulti ng in an increase in export value. The exception is t he last peri od.
Also, we can check t hat the evoluti on of Irish import exchange rat e contri but es t o increasing imports (negati ve pri ce effect of im port substi tution as a percent age of GDP). This value takes the less negati ve val ue i n the l ast peri od, caused b y t he l owering of unit l abor cost s in t he period l ast years.
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The poli c y responses as a percent age of external shocks had a huge boom in t he first hal f of Eurozone m embership. The cause i s that in som e years of this period, the Irish econom y suffered ver y sm al l ext er nal shocks. Its volum e of exports di d decrease but not much. Its trend debt did not diverge much from act ual debt and i ts export val ue grew at a similar rate t o its i mport value. C ont rasting t o thi s, the price of Irish export s did grow at hi gh rat es and th e i mport exchange rat e also hi ghl y decreased, leading to extrem el y hi gh val ues of poli c y responses as percentage of external shocks.
Conclusion
In t his work proj ect we proposed t o anal yz e t he evoluti on of Portuguese competit iveness along the period 1977 -2010 and the pat tern of st abiliz ation of the current account in the sam e peri od. Bi gger emphasis was put on the comparison of periods aft er and before Portuguese adoption of the Euro in a t ent ative to uncover effects t hat monetar y union mi ght have had on the P ortuguese econom y. Ultim at el y, a com parison wit h Irel and was done. Its purpose was to anal yz e how a
“successful” country behaved in the same conditions than Portugal, how
different was the evolution of its competitiveness and adjustm ent d ynami cs.
Acco rdi ng to general monet ar y union theor y, joining a monet ar y union changes the fram ework in which a count r y m anages its com peti tiveness and perform s current account adjustments. The obj ective of t he work was to check i f abdi cating of m onetar y and exchange ra te poli c y had an y effect s on the st udi ed vari abl es.
21
Concerni ng the current account anal ysi s, we conclude t hat the dimension of Portuguese debt would most probabl y be unsust ainable outsi de of the Eurozone. Adoption of the euro was refl ect ed in m ore positi ve shocks for Portug al, gi ven the access to lower i nterest rates and the i nt egrat ion of Eurozone m arkets t hat allowed an expansion of export volum e. The further integrati on of European m arkets, coincided with an increase of the price of Port uguese exports, and wit h a surge in internal dem and, whi ch also accel erat ed import value growt h. Nevert hel ess, these two effects are of ver y sm all magnit ude i n adjusti ng for external shocks when compared to periods prior to the euro. Great er rol e in adj ustm ent to external shocks has been as sumed b y dem and management aft er 1999, whi ch mi ght be associ ated with the growth of i nternal dem and, and wi th the impossibilit y of affecting the nominal value of i mports and exports.
In t he end we cannot sa y surel y whether adopting the euro was a good decision or not, although we bel ieve t hat we are bett er off inside
the Eurozone. It’s unquestionable that adopting the single currency
brought innumerous benefits for the Portuguese econom y. It ´s also unquest ionabl e that it int roduced several const raints in te rms of macroeconomi c poli c y. That loss of monetar y poli c y enforced the importance of fiscal polic y, price st abilit y and wage rest rai nt, three topi cs in whi ch P ort ugal did not perform so well com pared to its part ners aft er adopti ng t he euro. With economi c i ntegrati on comes increased com peti tion across borders, promoting an increase of t rade deficits for a countr y t hat needs t o reform several sectors of soci et y in order t o gain com peti tiveness. In our opi nion, t he Euro is not to blame for the problems that ca m e along with i t and abandoni ng it now woul d be dangerous. The lack of com pet itiveness, current account defi cit and internal recession (before the worl d bust) are the result of wrong poli cies, t he euro just exposed our weaknesses. The fi rst best soluti on i s to seize all opport unities offered b y the single currenc y, t o reform our soci et y and adapt our poli c y m aking to the m onetar y union landscape.
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Appendix
A. Competitiveness indicators :
Table A.1 – Portugues e and Portugu es e trading p artn ers i ndicators of comp eti ti ven ess (period averages at annual rates)
Portugu es e RUL C
Portugu es e trading partners RULC
Portugu es e RUC
Portugu es e trading partners
RUC 1977-1985 -4.27% -0.79% --- ---
1986-1990 -0.95% -0.38% 11.79% ---
1991-1995 1.26% -0.31% 12.7% 4.36%
1996-2001 0.45% -0.35% 5.69% 2.85%
2002-2005 -0.14% -0.77% 6.57% 4.84%
2006-2010 0.75% 0.057% 6.45% 7.56%
Table A.2 – I rish an d Iri sh trading p artners indi cators of competi tiven ess (p eriod averages at an nual rates )
Irish RUL C
Irish tradin g partners RULC
Irish RUC
Irish tradin g partners RUC
1977-1985 -0.83% -0.56% --- ---
1986-1990 -1.07% -0.07% 4.55% ---
1991-1995 -1.16% -0.49% 1.67% 3.16%
1996-2001 -2.48% 0.06% 4.32% 3.83%
2002-2005 0.17% -0.64% 9.24% 0.49%
2006-2010 1.73% -0.22% 13.31% 4.94%
B. det er minants of competiti veness
