Sunday, May 12, 2013

Does Portugal Have Its Own “Shortage Of Japanese" Problem?

In a number of posts recently I have highlighted the impact of declining workforces on economic growth (here, for example, or here, or here) and the way the policies persued to address the Euro debt crisis are having the impact of  accelerating the movement of young people away from the periphery and towards the core (here, or here) thus accelerating the decline in their working populations and exacerbating their growth problem. This issue has been already highlighted strongly in Japan's ongoing crisis, and has to some extent come to be known as the "shortage of Japanese" problem following Paul Krugman's memorable use of this expression to explain  why Japan's economic performance seemed so poor to so many.

Recently I came across a post by Portuguese blogger Valter Martins, where he looks in some depth at what is happening in Portugal. Really, despite the use of some technical details his argument is extraordinarily straightforward, in fact it is as elegant as it is simple. What he points out is that population growth rates serve as some kind of "quick and dirty" proxy for GDP growth rates, and growth in working age population serves equally well as a quick proxy for growth in GDP per capita. Any simple growth accounting process breaks growth down into a labour input component and a productivity component, so if your labour component turns negative, even to get the same growth your productivity component has to be greater. For societies that have considerable difficulty raising productivity in the first place this process of working population decline is going to make an already Herculean task even more difficult.

In addition Valter picks up a point few researchers seem to have noticed up to now, that working age population in Portugal just surprisingly peaked. Natural population dynamics have long been stationary in Portugal, and emigration has long-standing and deep roots. During the first eight years of this century the population loss caused by emigration (nearly all young educated Portuguese) was masked by the steady influx of immigrants looking for work. But now the country is in deep recession the immigrants aren't coming. Indeed  some are even leaving, while the rate of emigration by Portuguese nationals has accelerated and continues to accelerate, sending working age population (and just as importantly its age distribution) on an increasingly negative path.

During the years of austerity we have become familiar with the phenomenon that as fiscal spending is cut growth falls making the achievement of fiscal targets even more difficult. Well something similar seems to be happening with migration movements, as part of the benefit to long term growth that accrues from making structural reforms disappears on the other side of the ledger as the workforce shrinks.   Again we are in danger of running round and round in ever diminishing circles.

Reading Valter's post I became impressed with the power of his argument and was struck by the importance of what he had discovered. I therefore took the unusual step of asking him to translate the piece and offering to publish it on my blog. So, without more ado, here is:

Is Portugal Facing A “Shortage Of Japanese"?

Guest Post by Valter Martins

So, about the slow growth/debt connection: I’ve done a quick and dirty mini-RR for the period 1950-2007 ……focusing only on the G7……and if you look at it, you see that most of the apparent relationship is coming from Italy and Japan……And it’s quite clear from the history that both Italy and (especially) Japan ran up high debts as a consequence of their growth slowdowns, not the other way around.” – Paul Krugman, Reinhart-Rogoff, Continued

Despite so much intense debate about the ailment from which Portugal suffers, and the mountain of sacrifices currently being borne by the Portuguese people one fact has gone virtually unnoticed in amongst all the noise - for the first time, at least in the modern era, Portugal’s working age population has started to shrink. Demography and its possible impact on economic growth is a topic which has been largely ignored by practitioners of economic science in recent decades as population growth has by-and-large been on an upward trend. However, as we enter a new period in human history, one in which the upward trend has shifted towards stagnation or even in some cases towards long run decline, the economic and financial implications of this transformation can no longer be ignored. As Nobel economist Paul Krugman indicates in the above quote, some countries have large debt simply because they have low growth.

So what is the common thread that runs through these low-growth high-debt countries? Could it be decelerating labour force growth and eventual labour force contraction? The cases of Italy and Japan are well known. In the case of Portugal, it will be argued here, demographic trends can not only explain a significant part of the slow economic growth the country experienced during the first decade of this century, they can also help us understand the depth of the current recession. More important still, we need to think about the consequences of this continuing lose-lose dynamic for the country’s future in both the short and much longer term.

Economists didn’t always take the view that population dynamics were irrelevant to economic performance. The 1930s gave birth to a serious debate about the possible problem that would arise if many decades of strong population growth were followed by population stagnation and then decline, a debate which was provoked by the fact that birthrates in a number of countries fell below replacement level for the first time in human history during the economic depression. And among the names of those economists who took the problem seriously enough to think and write about it was none other than John Maynard Keynes.

There are, indeed, several important social consequences already predictable as a result of a rise in population being changed into a decline. But my object this evening is to deal, in particular, with one outstanding economic consequence of this impending change; if, that is to say, I can, for a moment, persuade you sufficiently to depart from the established conventions of your mind as to accept the idea that the future will differ from the past.” J.M. Keynes, Eugen Rev. 1937 April; 29(1): 13–17.

While the phenomenon has arrived largely unnoticed Portugal’s total population has long been near to stationary.

As can be seen in the above chart, Portugal’s population has been struggling to find growth momentum since the mid 1980’s (the first time numbers actually dipped downwards) but the years 2010/2011 seem to mark a more fundamental turning point, since it was in that time interval that Portugal’s population started on a long, and possibly irreversible, path of decline. Having long had a total fertility rate of below 1.5 this was a more than predictable outcome, and one that should have been expected ever since the total fertility rate fell (and stayed) below the 2.1 replacement level in 1982.

As is well known, population change is comprised of two major components: natural growth and net migration. Natural growth, births minus deaths, became negative in 2007 and thereafter population growth has become exclusively dependent on having sufficient positive net migration. Up to 2010 this condition was satisfied given the continuing influx of immigrants into the country as can be seen in the chart below.


However, since the onset of the 2008 recession, not only have the immigration flows reversed completely, but emigration has started to increase again, thus reanimating a trend that has been constantly present in Portuguese history over decades, even centuries. This is perhaps the most critical factor driving the recent population decline. In fact the decline would have occurred much earlier had it not been for the return of thousands of refugees from the Portuguese colonies in the 1974-1981 period.

According to the European Commission's 2012 Ageing Report, projections for the Portuguese population during the period 2010 - 2060 anticipated that population would peak in 2034, but as we have seen, the latest data show the population unexpectedly reached its peak in 2010 (total population, previous chart), the year in which the population began to decrease (a similar phenomenon seems to have occurred in Spain in 2012, with again a reversal in migrant flows in an otherwise stagnant population being the trigger). This fact that this turnaround comes as a surprise is clearly the result over optimistic assumptions on the net migration front since the numbers for natural growth are well known and change little (although birth numbers are now dropping in many EU countries under the impact of the long recession). Clearly the unexpected factor here is the severity of the recession from which the country is suffering and the size of the exodus of young people who are leaving.

Just to highlight even more the speed with which all this is happening, in Japan, the interval between the beginning of the decline of the working age population and the beginning of total population decline was a full decade. In Portugal this interval was only two years.

Even more relevant than the decline in total population for the purpose of the present discussion is the decline in the working-age population. While the former gives us a good proxy for domestic consumption, it is the later which is important in terms of potential national output. All other things being equal a reduction in the working-age population means a reduction in output. Therefore, the most important detail to catch from the chart above is that the working-age population, defined as the population with ages ranging from 15-64, declined for the first time in Portugal between 2008 and 2009. As highlighted by both Daniel Gros and Paul Krugman if you want to compare economic growth performance as between countries with growing populations and those with declining ones the best indicator to use is undoubtedly GDP per Working Age Person (GDP/WAP).

In the Portuguese case if we take this ratio and compare it with both Real GDP growth and Working Age Population change (my calculations VM), we can get an impression of how variations in the Working Age Population affect the economic growth of a country. Surprisingly or otherwise, the data for Portugal viewed graphically not only confirms the existence of the “workforce effect” – the relationship seen between Real GDP and GDP/WAP - but also suggests that Portugal has already passed the point where this effect is beginning to have a negative impact on GDP growth.

As can be seen in the above chart, until 2008 the growth rate of Real GDP was always higher than the rate for GDP/WAP offering a strong suggestion that labour force growth was having a positive impact on GDP growth. It is noteworthy, however, that both in the period 1986 - 1991 and in the period 2003 - 2008, the growth rates of Real GDP and GDP/WAP almost overlapped. This phenomenon coincided with very low or zero rates of working age population growth and as such the “workforce effect” was mostly neutral. The first of these periods, 1986 - 1991, the stagnation in the workforce was the direct result of the increase in emigration that followed the entry of Portugal in the European Union. The second one coincides with the arrival of the turning point in long term WAP growth, as the size of the working age population irrevocably turns negative.

Indeed, during this early period of emigration towards the EU Portugal’s total population decreased, as shown in the chart Population by age group (above, blue line), but at the time, since the population in general was much younger, and many more new labour force entrants were arriving at working age, the growth rate of the workforce remained slightly positive. In other words, there were still enough Portuguese entering the labour market to replace those who were leaving it (either to retire or to seek a future abroad). In the second period, 2003 - 2008, the large exit of Portuguese nationals, about 700,000 between 1998 and 2008 according to research by the now Economy and Employment Minister Álvaro Santos Pereira, was to some extent offset by an inflow of immigrants, but these were only sufficient in number to maintain the workforce at a stationary level.

All this calm and stability disappeared, however, after 2008 when the growth rate of Working Age Population turned negative, i.e. the labour force began to decline (see graph below). Where the growth rates of Real GDP and GDP/WAP overlap we can surmise that working age population change is having no effect on real GDP growth. Subsequently, however, the growth rate of GDP/WAP becomes higher than the growth rate of Real GDP and thus the "workforce effect” starts to act as a drag on the economy steadily bringing the potential overall growth rate down. In other words, Portugal is now suffering from a "Shortage of Japanese" as Edward Hugh has called the phenomenon, after Paul Krugman originally coined the term to describe the underlying problem which has been afflicting the Japanese economy since the mid-1990s.

The fact that the three lines in the above chart happen to intersect at zero is perhaps just an unfortunate coincidence but is consequences are disastrous, since the downward trend that was already evident accelerated greatly after the onset of the recession. The resulting rise in unemployment not only caused a collapse in the immigration flow, it also led to a sharp increase in emigration. As a result workforce shrinkage intensified even further, as can be seen in the above chart by looking at the growing distance between the Real GDP and the GDP/WAP lines. That is, if the workforce had remained stationary the economy would be growing at similar rates to the GDP/WAP, i.e. above the current level as indeed happened in the period 2003 – 2008.

Naturally, the argument can be advanced here that the recession is a cyclical phenomenon, and this is surely true, there is an ongoing cycle, but the argument being used refers to long term trends – a reversal in direction (or change of sign) for inputs from the labour force component brings down the overall trend growth rate making booms weaker and recessions deeper, all other things being equal. This would seem to be a simple conclusion which stems from elementary growth accounting theory. Naturally, there are other factors which contribute to growth, like multi factor productivity, but again other things being equal you would need more of this to achieve the same growth rate as before under conditions of weakening in the labour force growth component.

Thus the argument is not that economic growth becomes impossible with a stagnant or slowly declining workforce, but simply that it becomes harder to achieve because it relies more on other factors, such as productivity and raising participation rates, but these change slowly over time, and more so in already developed countries. As such trend growth will surely steadily fall. This can be clearly seen in the following chart: while workforce growth was an important source of growth when Portugal was a developing country, its importance fell back as the workforce started to stagnate even as Portugal was approaching converge with other developed countries in terms of productivity. Other factors took over and increased their importance steadily as the economy started to converge with more advanced ones. Now that this catch up process seems to have come to a standstill as well the economy simply can’t growth, at least at rates considered normal. With a stagnant workforce, low growth or no growth is the new normal.

Following standard growth accounting procedures, during the 1970s workforce growth accounted for more than half of Portuguese economic growth (see chart above, my calculations VM), and this contribution had fallen to only 16% in the first decade of this century. However, since 2008 not only has this contribution reversed sign but also the magnitude of the negative effect has begun to increase rapidly. Such that, by 2011 the “workforce effect” could be considered to explain more than 29% of the GDP decline. This “negative drag” will continue, and the effect possibly become greater, as the working age population shrinks further. Had the workforce remained stationary we could surmise the 2010 recovery would have been more pronounced and the 2011 recession wouldn’t have been so deep. This is the principal reason why official growth forecasts have been being constantly revised to the downside, and this will continue to happen until the models the forecasters use adequately incorporate the effects of population decline on economic growth. Adding insult to injury, ignorance of the existence of such effects recently led Portugal’s Prime Minister Pedro Passos Coelho to suggested young unemployed Portuguese resort to emigration as an escape route from the crisis, advice thousands have now followed thus making a bad situation even worse.


Economic growth in Portugal appears to be on a long downward trend, a trend which will only be made worse by the onset of the decline in its working age population. Economic output is now at 2001 levels and thus we can now conclude that the last decade has been completely lost. More worryingly though, is that after such a bad start to this decade, it might not be unreasonable to conclude that this one is also in the process of being lost too.

At best the economy will stagnate in the years to come but the possibility is there that it will continue to regress – especially if nothing is done to stem the outflow of young educated people - and by 2019 it might even be back somewhere in the 1990’s. This is scenario simply cannot be excluded since, in addition to all the other problems the country faces, a situation that would be in any circumstance challenging is now being aggravated by one more variable whose contribution cannot be easily reversed in the short term – the decrease in the working age population. More than the fact in itself, it is the speed at which this is happening which is alarming, and the fact that policymakers appear unaware of the problem. In analyzing the low Portuguese economic growth issue the decrease in the country’s working age population can no longer be ignored! Or at least it is hoped that this will be one of the outcomes of this short report.

To return to where we started, Keynes concluded in his pioneering presentation that a stationary or slowly declining population could increase its standard of life while preserving the institutions society values most if, and only if, the process was managed with the necessary strength and wisdom. On the contrary, he argued, a rapid decline in population, of the kind that we are seeing in Portugal today, would almost inevitably result in a serious decline in living standards and a breakdown in highly valued social security mechanisms. The distinction Keynes drew some 80 years ago between rapid and managed rates of decline seems plausible, reasonable and highly relevant today. What we now need to see are urgent measures taken – initiated by the EU and the IMF - to counter the exodus which lies behind this dramatic decline which is occurring before our eyes, measures which at least try to decrease its speed, because once a process like this gains full velocity it will be very difficult to stop, and we have already seen it gather considerable traction. Ireland is a pointer and a great example to learn from, since it took that country more than a century to recover the population decline precipitated by the natural disaster which hit the country in the middle of the nineteenth century. Postscript From Edward

I have established a dedicated Facebook page to campaign for the EU to take the issue of  emigration from countries on Europe's periphery more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.

Sunday, April 28, 2013

Beyond Their Ken?

Spain's economic problems now form part of such a complex web of cause and effect, action and reaction, that it is getting increasingly difficult for laymen, journalists and politicians alike to get to the core of what is actually happening.

To a herd of rams, the ram the herdsman drives each evening into a special enclosure to feed and that becomes twice as fat as the others must seem to be a genius. And it must appear an astonishing conjunction of genius with a whole series of extraordinary chances that this ram, who instead of getting into the general fold every evening goes into a special enclosure where there are oats- that this very ram, swelling with fat, is killed for meat”. – Tolstoy, ‘War and Peace’.

After so many false dawns, the recent announcement by Spain’s Prime Minister Mariano Rajoy that the government was revising down its 2013 economic forecast hardly caused a blink among a citizenry that is now completely inured to deception and ready to believe the worst about the intentions of any politician willing to come forward with either good or bad news. The long announced recovery has once more been delayed, and will now be noted not in the last three months of this year, but during the first six of 2014. Naturally, a public which is now totally accustomed to such postponements will not be surprised if this one is far from being the last.

In fact, the latest institution to throw a bucket of cold water over the Spanish government’s rose-tinted promises is the IMF. In their latest five-year forecast for Spain they paint a pretty bleak picture of low growth and high unemployment lasting at least all through what is left of the present decade. Mariano Rajoy has already jumped into the fray to take issue with their outlook for 2013, but it is their longer-term forecast which is most interesting and preoccupying. Growth between 2015 and 2018 is now only expected to average around 1.5 percent annually. This would seem to be what the IMF now consider longer-term trend growth to be for Spain, and the most notable thing about the number is that it represents a significant downward revision from their earlier optimism. Even this comparatively low number may still be overly optimistic and may yet come down again – I personally expect NO noticeable recovery as cumulative negative developments more or less cancel out positive ones – but it is certainly much more realistic than anything we have seen from the Fund before. There is no question here of any “V” shaped bounce. That is just a fiction of Finance Minister Cristóbal Montoro’s imagination.

Naturally, the other side of the coin on this is the consequence for unemployment. With growth so low there will be little in the way of job creation (watch out, pension system sustainability) and unemployment will linger over 20 percent for many years to come – indeed the IMF have 2018 unemployment at 22.9 percent, meaning they don’t expect it to fall below 20 percent come 2020.

And there’s another highly interesting detail from the IMF Spain forecast. Even to get that rather low level growth of 1.5 percent a year, the Fund pencil in Spain’s running a fiscal deficit of 5 percent a year all the way through to 2018, with the natural consequence that the debt-to-GDP ratio is expected to reach 110 percent by that point, and that isn’t making allowance for any further bank recapitalisation that will be needed. As I have been arguing since 2008 now, Spain’s sovereign debt simply is not on a sustainable path, and what 1.5-percent growth supported by a 5-percent fiscal deficit means is that there is no structurally adjusted growth going on in the economy at all. As a country you are getting more into debt than any increase in output you generate with the borrowing.

A well-oiled crisis

As I have argued in an earlier post, it may well be that the Spanish contraction machine is now so well-greased that it simply continues winding the economy down and down in such a way that things may never recover, in the classic sense of that term. The only argument which stands in the way of reaching this conclusion is the near religious belief now so often heard in policy circles that, well, “economies always recover, don’t they?”

As it happens, they don’t, as a quick look at what happened in Argentina in the 20th century would confirm. But Argentina is arguably an isolated case, and the current economic malaise (I hesitate to use the word “crisis” due to the duration of what is so evidently an ongoing process) seems to be far more general. What people seem to find hard is asking themselves one simple question, “but what if this time really is different?” Which is strange, since reasons for thinking that things may well not return to what was previously considered “normal” are not in short supply.

Populations in developed economies are all now ageing rapidly, generating a phenomenon never before seen in the entire history of known human societies – systematically falling numbers of under-15s coupled with an ever growing population in the over-80s group. The sheer novelty of this phenomenon, coupled with the manifest feeling of unsustainability it generates about our current welfare arrangements should at least give policy makers food for thought, yet evidence that it actually is doing so is in very short supply. Plough on regardless seems to be the watchword.

The current round of cuts to health and education spending are described as “painful but necessary” in order to facilitate a return to growth which will make further adjustments in the future unnecessary. Unfortunately nothing could be farther from the truth. The credit ratings agency Standard & Poor’s, which has been one of the global leaders in highlighting the likely impact of “first world” demographic changes, argues in its latest report on the subject that despite some recent progress, without ongoing and continuous changes in provision entitlement, deficits and debt in developed economies will spiral out of control as the century advances.

I think everyone who stops and thinks for five minutes about the situation will recognize the obviousness of this point, yet scarcely a single politician is willing to come out from behind the curtain and explain to voters the longer-term implications of having shrinking and ageing workforces at the same time as the size of retirement age populations explodes.

Ignoring the obvious

By the middle of this century, and without policy changes, average deficits for developed countries will rise to 15.1 percent of GDP as the interest cost of the increasing debt burden exacerbates the budgetary impact of demographic spending. Median general government NET (not gross) debt (as a percentage of GDP) is expected to increase to 71 percent by the mid-2020s (from around 40 percent today) – and would then accelerate to 216 percent of GDP by 2050. Government spending would rise to about 57 percent of GDP in 2050, from some 49 percent today.

Naturally, these numbers are just very rough and ready estimates, and such levels are unlikely to be reached since markets will surely not fund them, and policy changes will happen. The problem is that many policy makers are still stuck in denial about the need to make them, and where they are willing to do so it is largely linen washing conducted in private and not in the public space provided by election manifestos. Spain’s leaders, for example, continue to insist that no major changes in either pension contributions or entitlement are in the offing even though the need for one or the other is evident, as the structural deficit in the system continues to grow.

Worse, the more frequently they say in public that there is nothing to worry about and all is well, the lower their credibility falls, since few people continue to believe them. At the same time they insist and insist that the current level of health provision will be maintained no matter what, when obviously this is something the country simply cannot afford to do.

But more than the simple impact on government spending possibilities, it is the impact of these demographic changes on growth which seems to be the least widely appreciated part of the story. This is not an oversight of which Standard and Poor’s is guilty. According to the agency:
For several sovereigns in the Eurozone (European Economic and Monetary Union), the financial strains caused by shifting demographics are being compounded by the current economic and financial troubles, which are both strangling growth and increasing the need for social safety net spending. This environment can result in tighter financing conditions amid private-sector deleveraging, plus cuts in public investment leading to a reduction in total investment and consequently the stock of capital. At the same time, the decline in investment activity will likely hurt total factor productivity (a measure of an economy’s technological innovation). Adding to these adverse trends, low employment and net emigration from several sovereigns implies a smaller contribution of labor to future economic growth, a continuing threat if unemployment becomes structurally high.
As can be seen, Standard and Poor’s mention a number of other factors which contribute to what they call the current “strangling” of economic growth in countries like Spain (tighter financial conditions, private sector deleveraging, cutbacks in public sector infrastructure spending, net emigration).

They could also have cited the mere existence of the euro. It is evident that participation in the common currency has had the perfectly foreseeable effect on Spain of making it simple to get into trouble and a lot harder to get out of it. Borrowing was cheap and easy of access during the boom years, now lending to Spain’s banks has all but dried up, and what there is available remains burdensomely expensive.

Divergences in interest rates paid by businesses on bank loans across the Eurozone have recently reached record highs, despite ECB attempts to achieve the opposite result. While the spread between yields on Spanish 10-year bonds and their German equivalent has narrowed significantly the Goldman Sachs interest rate divergence indicator – a measure of cross-border variations in rates charged by Eurozone banks on a selection of business loans – has once more risen and reached 3.7 percentage points in January. This means that companies in southern Europe continue to pay significantly higher interest rates than their northern rivals, leading to the conclusion that while ECB measures may well have been effective in avoiding short term Eurozone break-up, they have still failed to address the problem posed by such inhibitive credit conditions along the southern periphery.

The lessons learned from inaction

So not only does Spain have uncompetitive productivity levels, and a damaged brand image, it also has a high cost of new capital making investment in the country’s economy both unattractive and prohibitively expensive. With unemployment at over 26 percent, non-performing bank loans remain on their upward path, meaning that more companies are facing potential insolvency. The recent bankruptcy of food multi-national Pescanova has renewed rumours in financial circles that the Bank of Spain is preparing another round of provisioning increases – this time for loans to large corporates and small and medium companies – is an indication of how severely the crisis is now hitting the entire business sector. The Spanish problem is now no longer simply one of a construction collapse, since the ensuing impact on overall economic activity has now spread right across the board. A stitch in time saves nine, as the saying goes, but in the Spanish case there was no stitch (since according to policymakers there was no deep-seated issue to address) and the garment simply unravelled. Lesson – it is a lot easier to make things worse by inaction than it is to make them better using the same approach.

But backtracking a bit, the euro makes correcting Spain’s present situation difficult due to the absence of a national central bank able to conduct a full range of monetary policy operations, a limited access to fiscal policy and the fact the country has no currency of its own to devalue. But that does not mean, as Wolfgang Munchau recently suggested, that it is becoming more and more rational to think about euro exit as the cost-of-leaving threshold gets lower and lower. Countries may well one day leave the euro, but if they do it will be because the cost of trying to hold it together has driven them all but mad, not because they have made some back-of-the-envelope calculation showing that the benefits outweigh the costs. Leaving the euro would be a huge leap into the unknown, leaving one side of the calculation sheet simply beyond our ken. As I argued in a post for the CNN blog, the currency bares an uncanny resemblance to Dr Strangelove’s doomsday machine, designed so that one day it would almost inevitably blow up the global financial system, but constructed so that any attempt to dismantle it would also produce the same outcome.

Yet, despite the risks, as Gideon Rachman puts it in the Financial Times, in today’s Spain people are slowly but surely losing their faith in both national and EU institutions, and are slowly being driven towards ever more radical “solutions” which far from being rational bear a pretty strong resemblance to the exact opposite:

The “European dream” that Spaniards embraced promised a middle-class lifestyle for most people. But with little prospect of secure jobs for the young and a threat to the future of the welfare state, the fear now is that the Spain of the future will look more like Argentina than Germany. An Argentine future would involve the constant fear of financial crises – and a widening gap between the social classes, as many continue to enjoy a first-world lifestyle, while a growing underclass becomes detached from prosperity. Above all, Argentine public life is characterised by deep cynicism about national institutions and leaders.
Leaving the euro would be an incredibly costly decision for Spain, and becoming yet another Argentina would surely be no panacea, but that doesn’’t mean it won’t happen.

Following in the Footsteps of Japan?

Meanwhile Mariano Rajoy struggles on. Since it is quite obvious that the current policy mix isn’t working, and with one eye on the growing number of “platforms” out there desperately seeking his scalp (those affected by the mortgage crisis, those affected by the preference share haircut) he is desperately thrashing around for a fig leaf policy to stop the nightmare. Last week he found one – in Japan. “I think in Europe we must all ask ourselves whether the ECB should have the same powers as other central banks around the world,” he told a press conference. In particular he seemed to be thinking about what he described as the “very important” shift in monetary stance that had just been undertaken by the Bank of Japan. Now here is not the place to go into the background to the Japan crisis (see my arguments here if you are really interested), but one thing I am sure about is that neither Rajoy nor his main policy advisers have any real idea about what lies behind Japan’s long lingering deflation problem. What he does know is that Japan is able to run a 10-percent fiscal deficit and a 235-percent government debt-to-GDP level with what Nobel economist Paul Krugman calls “no evident ill-effects”. Sounds good to Rajoy. Will it work in the long run? “No idea”, could be his response. In the long run, as is well known, we are all dead, and “anyway I won’t be in the Moncloa” might easily be his reply.

In fact, as billionaire investor George Soros recently warned, systematically debasing a currency (ie not just conducting a one-off devaluation) is an extraordinarily dangerous move. The Bank of Japan has, in Krugman’s words, committed itself “to credibly promise to be irresponsible”. What this “irresponsibility” means is devaluing the currency sufficiently every year to generate sufficient price rises to comply with the central bank’s recently announced 2 percent annual inflation target. This is one promise it will be hard for the bank to keep since Japan’s deflation is being caused not by a poor adjustment in the economic system by structural demand deficiencies produced by the country’s ageing and shrinking population.

The best case scenario would be that the country’s policy makers realize in time that the experiment won’t work, and come to recognize that they have to learn to live with deflation – in which case the only big headache they will have will be what to do with all that debt (you know, the debt that many thought presented no evident problem). Far worse would be success, since if the Bank of Japan succeed in changing expectations (not in the why, but in the how) and lead people to believe that the currency will be debased every year ad infinitum (even assuming the rest of the G20 could ever agree to this), just to guarantee that 2-percent inflation, then they may well end up forgetting their supposedly innate “home bias” and start converting as many yen as they can get their hands on into dollars or some other convenient monetary unit, in the process creating a run on the currency which will make what happened in Argentina look like child’s play.

Such details are doubtless lost on Mr Rajoy and his advisers, which is just my point. The current crisis – which is arguably no longer a crisis but rather a way of life – has all now gotten so complex that the issues involved are almost certainly, and in principle, “beyond their ken.” Spain’s economy will continue to march boldly forward towards what now seems almost guaranteed to be long term decline, while from within the captain’s tower, far from an acceptance that what is happening really is happening, we will continue to hear yet one more crazy and implausible story after another telling us “if only this”, or “if only that” even as representatives of the Plataforma de afectados por las hipotecas (or equivalents) start to assemble outside the local version of the winter palace looking for their hides.


I have recently established a dedicated Facebook page to campaign for the EU to take the issue of the Euro Area accelerating population imbalances more seriously, in particular by insisting member states measure movements of their own national populations more adequately and also by having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometimes great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.

Tuesday, March 26, 2013

Does Emigration Put Spain’s Health and Pensions System At Risk?

According to the Economist’s Buttonwood, “desperate times require desperate measures”. I am sure this is right, times in Spain are certainly getting desperate and many of the measures being implemented in Brussels, far from representing radical and innovative solutions look much more like continually closing the barn door after the horse has bolted.

The issue Buttonwood draws our attention to in the blog post which accompanies this statement is that of migration trends within the Euro Area and the impact these have on trend GDP growth and structural budget deficits in the various member countries. This is an important issue indeed, since such movements seem to be an unforeseen and largely unmeasured by-product of the current monetary and fiscal policy mix being pursued by the EU and the ECB, yet the consequences they have shape the long term future of the whole Eurozone, and with it the sustainability or otherwise of the component states.

As I said in my last Spain post
One of the less commented features of Spain’s boom during the early years of this century is the way the arrival of economic migrants fuelled a significant part of GDP growth. The country’s population grew by more than six million (from 40 to 46 million) in the first eight years of the century, raising employment levels in both the formal and the informal economies. Migrants are still arriving, but the balance has now turned negative. According to data from the National Statistics Office, as of last June the net outflow was 20,000 a month and accelerating. That is to say a quarter of a million a year, or a million every four years. And the final numbers will almost certainly be much larger.

So a country which already doesn’t have enough people working to pay for its pension system now faces having less and less as time goes by, while the number of pensioners looking to claim will only grow and grow. In part that is the end result of sitting back and watching a 1.3-child-per-woman fertility rate for over 30 years. But to this grave underlying problem is now being added a new and potentially more deadly one. Those leaving are not only migrants who came earlier. Increasingly, young, educated, Spanish people are upping and leaving, and unlike in earlier periods many who go now will never return. Not only is there a massive human capital loss involved here, trend GDP growth is evidently being reduced as the workforce steadily shrinks, while all those unsellable surplus-to-requirement houses become even less sellable.

The motivation for the Buttonwood post was a research report published at the end of last week by the European Financial Economist at Jefferies International, Marchel Alexandrovich. Ostensibly his concern is about optimal currency area theory as applied to the Eurozone, but underlying this concern is a further one: that Mario Draghi and his governing council at the ECB may not be living up to their promise. That is to say they may not be doing enough to hold the Euro together. The Outright Market Transactions (OMT) policy was intended to try to remove break-up risk in the capital markets. Despite the fact that the programme has not been made operational, it has worked reasonably well in that capital flight has been brought to a halt and even reversed, the bank deposit base in most countries on the periphery is now rising, and the break-up risk component in national bond spreads has been virtually removed.

But as often happens in economic matters, solutions to one problem may inadvertently lead to the creation of another. Avoiding radical debt restructuring on the periphery, and going for a "slowly slowly" correction doesn’t necessarily mean that all other things remain equal. Take the labour market, for example (I have already touched on this whole topic in my recent post on Bulgaria). As Alexandrovich points out one of the pre-conditions for the existence of an optimal currency area is the existence of cross frontier labour mobility, and the workings of the  Eurozone have often been criticized on precisely these grounds. Buttonwood puts it like this:
“A SINGLE market works best when its workers are mobile; Americans have shifted to the south and west over the years, for example, as jobs in the rust belt have disappeared. Europeans have the right to work anywhere in the EU and have been doing so for decades; a British series about Geordie builders in Germany (Auf Wiedersehen, Pet) appeared all the way back in 1983. But language barriers mean it is more difficult in practice for Europeans to move than for their American counterparts”.
But now, suddenly, in the wake of the current crisis things are changing. While “the political process to evolve the euro area toward an optimal currency area is slow,” says Alexandrovich, “the migration data suggest that there are rapid changes made in terms of the labour mobility dimension”.

The question is, is this good news? Obviously in one sense it is, if this is needed to make the Euro work it has to happen. But there is a downside, one which Alexandrovich points to: changes in the political process are lagging well behind developments in other areas, and especially in the migration one. It has been clear since the Euro debt crisis that a common treasury was a necessity for the good functioning of the currency union, yet progress in this direction has been painfully slow, and full of bitter recrimination. The migration problem might be just about to bring this simmering issue right to a head.

As Alexandrovich points out, migration trends have recently reversed in some key Euro states. While Spain had rapidly growing population due to large scale immigration during the first decade of the century, migration into Germany was falling steadily, and at one point even went negative. Now all that has changed, people, on aggregate, are moving into Germany and moving out of Spain.

In fact a similar situation exists in Portugal, Ireland and Greece (see my last piece on Portugal), while the UK, for example, has steadily been receiving economic migrants.

These migration patterns affect working age population growth, and with this the rate of underlying potential GDP growth, the number of people paying taxes and social security contributions, the rate of new family formation and demand for new housing, etc etc. As Alexandrovich notes, movements in population momentum are an important economic indicator, and the degree of uncertainty about what individual national population dynamics  are is rising.

One of the interesting details within the latest European Commission Winter economic forecasts for instance is the downward revision to Spanish population estimates, with the country’s population now expected to shrink in size by 0.2% in both 2013 and 2014 – the previous forecast from only a few months previously was a 0.1% annual fall (see table below). This may not seem particularly significant, but these are obviously just first estimates and as the economy goes through another tough year this years outcome could be much worse than expected with the drop potentially extending for years into the future.

In fact the negative movement in Spain’s population is accelerating and no one really knows how far this acceleration will go, or how long it will continue. What we do know is that the likelihood of Spain’s unemployment rate falling below 20% by 2020 is small (it is currently over 26%), and with such high unemployment the pressure to move will continue to be strong.

Now, if we look back over Spain’s “good” economic years, it is clear that even though growth between 1999 and 2006 was normally in the 3% to 4% range, most of this growth came from population increase, which was extraordinarily rapid, while productivity growth was miniscule, and even in the best of cases less than 1%.

Spain’s population had been virtually stationary in the second half of the 1990s, and the subsequent rise was almost entirely due to immigration, the overwhelming majority of which was of working age population, as can be seen in the chart below from the Spanish national statistics office.

Now why, if this was the case you might ask, did Spaniards feel so much better off during these years, since GDP growth per capita, and especially per working age person was not exactly stellar. Well, the next chart tells us why.

Basically Spain as a country was getting into debt, by borrowing abroad through the European interbank market, and consuming a lot of products which were produced elsewhere. Naturally, with house prices going up each year, homeowners felt increasingly well off. Now, of course, house prices are going down each year, and exports are being increased to help pay down all the accumulated debt. So we getting the “continually feeling worse” effect.

Not unsurprisingly, IMF growth forecasts for Spain are being steadily revised downwards to reflect the new reality. And naturally if the current working age population dynamics continue they will be revised down further and further. This is what makes listening to that continuing string of speeches from Spanish politicians just so tiresome. They continually talk about recovery being just around the corner, but in reality they have no idea what recovery will mean in Spain, or even of what they are talking about.

And there’s yet another nasty twist here. Spain’s employment legislation effectively protects older workers at the expense of younger ones. That is why while the overall unemployment rate is 26% the rate for 15 to 24 year olds is 55%. This “older worker bias” also has implications for productivity, as a recent report by Deutsche Bank’s Gilles Moec indicates:

"The dualism of the labour market in many European countries means that, on average, workers under the age of 25, since the beginning of the crisis, have contributed 4 times as much to the contraction in employment as their actual share in total employment (see Focus Europe 9 November 2012). Young workers often are the vehicle of innovation in companies and any labour market adjustment which is skewed towards young workers will ultimately reduce aggregate productivity.

Using data collected at the firm level in Belgium (which in our view is a good proxy for the Euro area in general), Lallemand and Rycx estimated the impact of a change in the age structure of staff on productivity, by adding to a canonical model of productivity based on firms’ characteristics (such as sectoral specialization and educational attainment of workforce) the share of three age groups (below 30, 30 to 49, above 50) in firms’ workforce, as explanatory variables. To provide an illustrative order of magnitude of the negative impact of the recent change in the age structure of companies on aggregate labour productivity in the peripherals, we applied the coefficients estimated by Lallemand and Rycx on the actual changes observed in Spain and Italy between 2007 and 2012 (see Figure 1). This effect is actually quite sizeable, with an adverse shock on the level of aggregate productivity of around 2% in both countries".

So really the whole current situation is most lamentable, since Spain’s ongoing loss of young talent means that the country may well be losing growth potential just as fast as the implementation of structural reforms is recovering it.

But, to go back to the start, and Buttonwood’s point that “desperate times require desperate measures,” these are just what Marchel Alexandrovich at Jefferies is calling for, serious and substantial political measures to shore up the Euro fiscal system, to enable people to move without making the instability in health and pensions systems, and the difficulty of carrying through national level fiscal adjustments, even worse. Spain’s pension system shortfall added at least 1% to the 2012 deficit, and the situation is only deteriorating as fewer people contribute to the social security system with each passing month  while ever more people retire and claim benefits.

Alexandrovich is not, however, as Buttonwood appears to suggest, advocating “a fiscal union where tax revenues is distributed to the smaller countries to allow people to stay put”. This is what happened to the Spanish system of inter-regional solidarity following the 1970s transition  and has now become part of the problem in Spain’s labour market. No, he is arguing for automatic health and pension fund stabilisers to be put in place, so that workers can move freely around without worrying about the implications for their parents or grandparents back home. Otherwise we really will have winners and losers coming out of this crisis, with some countries shoring themselves up, while others are (unknowingly) melting themselves down.

But first, we need to take more determined steps to really measure what is happening. At the moment our knowledge about these flows and their implications is woefully limited. As the European President of the Migration Policy Institute Demetrios Papademetriou put it recently: “The current knowledge base on the economic and social impacts of free movement is slim — in part because its evolving, flexible nature is difficult to capture in official data sources — but it must be improved, to afford a greater understanding of the effects on communities, local workers, and the public purse.”

In conclusion, I leave the last word to Mr Alexandrovich:

"And so we have gone full circle back to the idea of an optimal currency area. The way that a banking union tries to mitigate the effects of a potential bank run, similarly one could help mitigate the effect of Spanish or Greek workers going to work in Germany by having a union where tax revenues get redistributed between the various countries. Otherwise, debt needs to be serviced by fewer taxpayers which then need to be squeezed even harder to keep the whole thing ticking over. So on various levels arguably the euro project remains incomplete and migration data simply help shine a light on some of its further shortcomings, where some countries get isolated and left even further behind".


I have established a dedicated Facebook page to campaign for the EU to take this issue more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.

Tuesday, March 12, 2013

When Is A Promise Not A Promise?

Mario Draghi is proving to be a man of his word. He said he would do whatever he needed to do to hold the Euro together, and - so far so good - he has. Up to now of course some would say his will has not been truly tested, since all he has had to is sit there and twiddle his thumbs, and that has worked. It seems to have been the subliminal symbol the markets were waiting for.

But now he has added to his repertoire, and gone one stage further. This time he really did do something. Last Thursday he openly and publicly turned a blind eye to a blatant example of  monetary financing being carried through out there adjacent to  the flagship's starboard bow. Like Nelson peering along the length of his telescope at Trafalgar, he saw no monetary financing activity in Ireland. The reason he didn't see it was because he simply didn't look. Naturally he did tell curious journalists last Thursday that someone one day would do so, but such was his control of the situation  he even feigned  he couldn't remember the date when they would take that look. Nice one Mario.

Thus he kept to his promise, while allowing the Irish government to sharply revise down the net present value of one of  theirs. 

The really impressive part in the performance was the extraordinarily skillful way in which the ECB's very own Lord High Admiral managed to navigate his flagship through the tiny skiffs of the assembled press corps. At one point he almost taunted them with their own impotence, appealing to some seemingly innate masochistic tendency they share  by giving them a dressing down for the way in which they constantly get things out of proportion while jocularly  drawing their attention to how they were prone to a sort of  “angst of the week” syndrome. It always helps when you want to insult someones intelligence if you start off by saying, "let me tell you a joke."

What he had in mind were things like, well you know, the size of the ECB balance sheet (what a thing to fret about), the value of the Euro, the threat of currency break up, deposit flight from the periphery, the hawkish Bundesbank etc etc. The list of causes for such childlike angst could be very, very long. When all is for the best in the best of all possible worlds, what on earth could reasonable men and women be doing worrying their silly little heads about so many and such varied topics? These things are better left in the capable hands of the big boys over on the ECB governing council who, self evidently, know exactly what they are doing. Another nice one Mario.

Curiously though one "angst of the week" the journalist didn't seem to be suffering from at last Thursday's press conference was whether or not "monetary financing by stealth" might be going on in Ireland. After all, why should they have been, it's such a trivial item.

However, surely even those with the shortest of short memories must somehow or another be able to  recall  that notorious Irish Promissory Notes issue. This certainly was fret of the week in February, but had somehow - apart from one isolated question - conveniently slipped off the radar by the time we got to March. But just as a reminder, here's the story so far.
February Press Conference

Question: Unfortunately, I have one more question about Ireland. You said that it is a decision of the Irish government and probably the Central Bank of Ireland, and not your problem. But, at some point, I guess it could still be a Eurosystem problem because, as I understand it, the Central Bank of Ireland is now the owner of a promissory note, or something else, maybe government bonds with longer durations, which should be part of the so-called ANFA assets. I know that there are certain rules which cap these assets so, at some point this year, you have to look at that. Do you have any proposals for the Central Bank of Ireland to reduce that?

Draghi: You are running too fast, you are running ahead. We will certainly review the situation in due course. I am not saying that this is the last word on this. I am only saying that, today, the Governing Council unanimously took note of the Irish operation. So I have to say that this is certainly not the last word. We will come back to this.
Fine, we don't want to precipitate things. We need to consult so for the moment we are only taking note with no further comment. But what a difference a day makes, come March  they were not even taking notes. Poor Mario couldn't even remember the date when the Governing Council was planning to come back to the matter. Curious..................
March Press Conference

Question: Last month you said that we have not heard the last word on the Irish promissory notes. So, I wonder, when will we hear the last word?

Draghi: We periodically review compliance with Article 123 by all countries. If I am not mistaken, the review should happen at the end of the year, but the Governing Council will decide in complete independence when to have this review, or a review of similar situations. I do not have a date to give you now. I think there is a date when this is going to be done, and I believe it is at the end of the year, but I cannot let you know for sure .
Now for those who need reminding  Article 123 of the EU Treaty is the one which explicitly prohibits monetary financing by either the ECB or national central banks. The agreement reached between the Irish central bank and the Irish government would certainly appear to breach the letter of that article, and given the way the Bundesbank has voiced such concerns over the months about anything that even vaguely smack of it, you'd have thought it would have been a hot topic.

Under the agreement, the Irish Central Bank agreed to assume full ownership of the 25 billion Euros in in promissory notes issued by the Irish government when it bailed out Anglo Irish bank. Subsequently these notes were exchanged for Irish sovereign bonds with maturities of up to 40 years. The first principal payment is not due till 2038 and the last payment will be made in 2053.

In addition the average interest rate was massively reduced. Interest on the new bonds will begin at just over 3%, compared with  well over 8% on the promissory notes. Evidently the Irish government has just been relieved of a short term burden on its finances to the tune of over 2  billion Euros a year. This money can now be put to use stimulating the Irish economy, avoiding damaging cuts as the fiscal deficit is steadily reduced. If this isn’t monetary financing, then it isn’t exactly clear what would be.

Growing Weariness At Both Ends Of The Curve

 So what happened between the two press conferences? The Italian elections happened, that's what happened. What the Italian election outcome suggests is not just that Italy won't find it easy forming a government, that part is obvious. More importantly there is a growing recognition that even after a government is formed, twisting its arm to push through a hefty reform programme is going to be difficult, and in the meantime Italy's debt to GDP ratio is simply going to keep going onwards and upwards (it was near 130% by the end of 2012, and rising), no matter how much soothsaying goes on about how the country now has a primary balance.

So at some point this surge in the debt level will need to be capped, and I think there is a growing resignation about this fact in Brussels, Berlin and Washington. It is this resignation that the markets are sniffing, when they aren't taking the appropriate advisers out to lunch to get them to spill the beans, and this is why the periphery bond spreads are reacting so calmly to almost anything.

Italian debt will need to be restructured, or at least "re-profiled" (that basically means extending the term of the debt  say to 30 or 50 year bonds in a way the the Net Present Value is significantly reduced), just like that of its Greek peer. But hey, isn't that just what the Irish government got the Irish central bank to sign up to and, as John Dizard points out, didn't Maria Cannata, director-general of public debt in Italy, recently go so suggest that the country might soon be issuing bonds in the 30 to 50-year range? "We intend to restart with the lengthening of the duration in the average life of our debt," she told an investor conference in London recently. "We are ready to launch also a new 30-year (bond) as soon as possible."

So while Europe's central-bank-watching journalists may momentarily have lost sight of the problem, hedge fund research teams surely  haven't, indeed I think it would be pretty difficult to understand why markets are responding so calmly to the absence of even the first signs of a stable government in Italy. Somehow or another one gets the feeling that none of this now matters, risk premia will come down regardless.

Something similar seems to be happening in the case of Spain. At the end of last week Spanish 5 and 10 year bonds reached their lowest yield level since November 2010. And this in a week when credit rating agency Moody's announced they had identified 200 billion euros worth of badly classified property assets in Spain's bank balance sheets, assets which had not been specially provisioned for. Isn't financial sector risk supposed to be one of the main risks to Spanish debt and solvency? How come the stock market continues to go up even as almost every real economy indicator deteriorates. A combination of reform weariness on the periphery and bailout weariness in the core is producing what many perceive as being the perfect storm. A world where almost nothing can go wrong, unless that is you are in Spain or Greece and searching for a job. In fact it is now starting to look increasingly unlikely that Mariano Rajoy will ever ask for those famous Outright Monetary Transactions bond purchases ever to be implemented. Landon Thomas - like many of us - had it wrong, the world wasn't waiting for Mariano, it was waiting for Mario to see if he would just keep twiddling his thumbs.

Will The National Central Banks Support The Bond Markets No Matter What?

Naturally this is a win win solution - for the ECB, the Bundesbank and for Angela Merkel who won't have to keep going to the German parliament to get authorisation for yet more bailout money. So maybe this is an important moment in the crisis. The moment when you can say that one stage is over, and another, the one Citi Chief Economist Willem Buiter once called the Rubelisation of the Euro Area , about to begin. Now it could be that national central banks rather than  the ECB will become the focus of attention, at least in terms of assuming the risk of growing debts in countries that are going to have trouble ever paying it all back.

As I said in this post back in October last year:
The heart of the issue is that Mario Draghi has vowed to do enough, and enough seems to have no limits. So what could the ECB do if we really put our imagination to work on the issue? Well like Ray [Dalio] argues, they could print money, lots of it, even to the point of doing it helicopter style. Those people who think the ECB is already printing money (which they aren’t necessarily doing when they increase their balance sheet) ain’t seen nothing yet. That’s what the “it will be enough” promise means. None of this is in the mandate yet, naturally it isn’t, but it could be, and it would be much easier to put more in the mandate than it would be to keep going to the German Parliament to ask for more money. So it could, and most probably will, happen.When you’re crossing that rope bridge and it starts to creak and sway then you just have no alternative but to continue moving towards the other side. We have all seen far too many movies about what happens to the people who try to turn back.

FT Alphaville's Izabella Kaminska also senses it, "Something very important has changed, which makes this a very different type of bubble.The government will continue to support the market no matter what....The crisis happened precisely because there weren’t preset expectations of government support."

Izabella is of course talking about the United States government, but the point is generalizable. The Euro crisis broke out precisely because there weren't expectations of collective support for the struggling countries. As I pointed out at the time, the Greek crisis broke out in the wake of what happened in Dubai, where markets started to doubt that big brother Abu Dhabi would bail the country out. The same thing happened to Greece, expectations of German government support dwindled largely because the government itself was denying it would. But now, four years later a formula has been found: march together but strike separately, or something like that.

So it is to Mario Draghi's credit that he has shifted that perception, he vowed he would save the Euro no matter what, and now inadvertently the Irish government have offered investors a blue print of how it might all work. The national central banks will support their sovereign bond markets, no matter what. After all, isn't that just what the new Japanese Prime Minister Shinzo Abe has said he is going to do, and aren't the global financial markets whirring resplendently with joy just hearing him saying it.

Why in the end should Europe be so different? Maybe it will all end in tears, but it will be fun while it lasts.

So we are off on a splendid monetary experiment, with Japan leading the pack. As Paul Krugman so aptly puts it it in the title of a recent article -  "Is Japan The Country of the Future Again." And the moral - "It will be a bitter irony if a pretty bad guy, with all the wrong motives, ends up doing the right thing economically, while all the good guys fail because they’re too determined to be, well, good guys."

He wasn't by any chance talking about Silvio Berlusconi, was he?

This post first appeared on my Roubini Global Economonitor Blog "Don't Shoot The Messenger".

Saturday, March 09, 2013

The Great Portuguese Hollowing Out

With every passing day Portugal has less and less economy left, while fewer and fewer people remain to try to pay down the debt.

As Portuguese President Aníbal Cavaco Silva once put it, "A country without children is a nation without a future." He was, of course, referring to his country’s ultra-low birth rate, which is just over 1.3 (Tfr) and has been below replacement level (2.1Tfr) since the early 1980s. In 2012 only just over 90,000 children were born in the country, the lowest number in more than a century – you need to go back to the nineteenth century to find numbers like the ones we have been seeing since the crisis really took hold.

But added to this longstanding, yet unaddressed, problem there is now another, just as dangerous, one. High unemployment levels and the lack of job opportunities are leading an ever increasing number of young Portuguese to emigrate. The numbers are large, possibly a million over the last decade, victims of the country’s ridiculously low growth rate – under 1% a year. And the departures are accelerating. Jose Cesario, secretary of state for emigrant communities, estimated recently that up to 240,000 people may have left since the start of 2011.

Naturally this is one of the reasons why Portuguese unemployment numbers haven’t hit the Spanish or Greek heights. According to data from the Portuguese Institute of Employment and Professional Training, during the first nine months of last year 24,689 people cancelled their unemployment registration due to a decision to emigrate. This compares with 16,977 in the first nine months of 2011. In September alone, 2,766 people signed off for the same reason, a 49% increase on September of 2011. Yet between January and September Portugal’s EU harmonized unemployment rate rose from 14.7% to 16.3%, suggesting that without so many people packing their bags and leaving the figure would have been significantly higher, and offering some explanation as to why government officials don’t do more to try and stop the flow.

Nobel economist Paul Krugman recently suggested that among the ailments Japan was suffering from was a shortage of Japanese. Or put another way Japan’s slow growth is partly a by-product of the country's ageing and shrinking workforce. Looking at the country’s population dynamics Portugal certainly looks a likely candidate to catch this most modern of modern diseases. Not only does Portugal have the key ingredient behind the Japanese workforce shrinkage – long term ultra-low fertility – it has some added issues to boot. Japan may be immigration averse, but its inhabitants aren’t fleeing in droves.

Of course, a shortage is always relative to something. Many hold that the planet is overpopulated, and that energy constraints mean fewer people would be better. So shouldn’t we be celebrating all these children who aren’t getting born? Well, no, at least not if you want sustainable pension and health system, and that is what the developed world sovereign debt crisis is all about, how to meet implicit liabilities for an ever older population. One thing Portugal won’t have a shortage of is old people, since the over 65 age group is projected to grow and grow, even as the working population shrinks and shrinks. No wonder the young are leaving, even if the youth unemployment rate wasn’t 38.3%, just think of all the taxes and social security contributions the remaining young people are going to have to pay just to keep the welfare ship afloat. Patriotism at the end of the day has its limits.

Unfortunately population flight and steadily rising unemployment aren’t the only problems the country is facing. The economy is also tanking, and getting smaller by the day.

Far from the recession getting milder as last year progressed it actually accelerated, and there was a 3.8% output drop in the three months to December in comparison with a year earlier. Naturally, it isn’t all bad news. Exports are doing extremely well. They were up by 5.8% during the course of 2012, and the really good news was an increase of almost 20% in shipments outside Europe - exports to countries outside the EU jumped 19.8% to13.1 billion euros. These now constitute nearly 30% of total exports, up from just over 25% in 2011. In contrast exports to other EU countries – where domestic demand is contracting rather than expanding - were up a mere 1%. In contrast retail sales were down nearly 10% on the year, construction output 15%, and industrial output 5%.

This is a familiar picture across Europe's southern periphery, where positive export performance does not compensate for shrinking domestic demand due to the smallish size of the export sector, generating a negative environment which ongoing reductions in government spending do nothing to assuage.

And next year it looks set to get worse. The Bank of Portugal is now forecasting a GDP drop of 1.9% in 2013, compared with earlier expectations for a much softer fall. As recently as last October the IMF was expecting only a 1% drop. In any event it will be the third consecutive year of decline, making for five out of the last six years where the Portuguese economy has gone backwards following the best part of a decade where it scarcely moved forwards.

But if there is a shortage of both growth and young people, there is no shortage of debt. Gross government debt as a percentage of GDP hit the 120% of GDP level last year. And it isn’t only public sector debt, the Portuguese private sector owed some 250% of GDP at the end of last year, according to Eurostat records, one of the highest levels in the EU.

Worse still the country’s net international investment position had a negative balance of nearly 110% of GDP, the worst in the EU.

This last detail is important, since according to conventional economic theory it is by drawing down on overseas assets (which have been acquired by pensions and other saving) that elderly societies can help meet their pension and health liabilities (the Japan case). But in Portugal far from reaping returns on this account, paying down these debts, or interest on them, will be a drain on public resources for many years to come.

So with less people working and paying into the welfare system, less GDP, and huge debts the numbers simply don’t add up. This year we will see GDP levels last seen in 2000. Yet in their latest Article IV consultation report the IMF Executive Directors actually “welcomed the [Portuguese] authorities’ impressive policy effort to gradually reverse the accumulated imbalances and prevent future crises”. How they can say this and keep a straight face when talking about a country which is actually travelling backwards in time is hard to understand. It looks increasingly like the Fund is suffering from “integrity flight” and relegating itself to the role of a public relations body for a group of fumbling European politicians.

The depth of ignorance which exists on the challenges the country faces was revealed last year when Prime Minister Pedro Passos Coelho actually said that the best solution to youth unemployment problem was for young people to emigrate. We are increasingly handling the new and complex problems presented by the 21st century with the aid of simplistic formulas derived from 20thcentury textbook economics. It’s time for someone somewhere to wake up to the fact that the old models don’t work, because there are growing number of key factors they simply don’t capture. The poor performance of economists using these models is increasingly getting the profession a bad name among the public at large. Mr Draghi’s outright monetary transactions programme may well be doing a marvelous job of addressing the issue of financial capital flight but it offers few solutions to the human capital one. In the absence of policies which acknowledge these issues exist and then address them none of the sustainability analyses – debt, financial sector, whatever – are worth the paper they have been written on.


I have established a dedicated Facebook page to campaign for the EU to take this issue more seriously, in particular by insisting member states measure the problem more adequately and having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometime great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.