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From Crisis to Convergence: Charting a Course for Portugal

Author(s):
Dmitry Gershenson, Albert Jaeger, and Subir Lall
Published Date:
March 2016
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6. Generating Sustainable Growth: Institutional Change1

Minimizing rent-seeking and improving education will channel the country’s resources to productive uses and enhance growth prospects.

Starting in the early 2000s, Portugal’s growth stagnated while unemployment grew. The debt crisis had accentuated the problem, but did not create it, and the postcrisis recovery has been modest, at least in terms of GDP growth. This underscores the fact that while the flow adjustment has been large, the recovery has done little to eliminate Portugal’s significant stock imbalances.

Looking forward, unfavorable demographic trends and dearth of investment render Portugal’s growth challenge even more acute. The earlier boom episodes have largely been due to factor accumulation, not productivity growth (Amador and Coimbra 2007). In fact, productivity growth has been declining over the past half-century. Portugal’s working-age population is projected to fall by 3.9 percent between 2014 and 2020 due to both aging and emigration,2 and the country’s capital stock is depleting because of underinvestment. In such an environment, encouraging investment in the productive sectors is essential for moving to a higher growth path.

Portugal: Real GDP and Unemployment Rate

Sources: Haver Analytics; and IMF staff calculations.

Portugal: Productivity and Capital Stock

Misallocation of resources has been stifling growth. Dias, Marques, and Richmond (2014) explain the sluggish growth by the inefficient allocation of resources, especially in the nontradables sector, and Amador and Soares (2012) make a case for improving competitive environment in that sector. Pina and Abreu (2012) and Reis (2013) caution that earlier inflows into Portugal were misallocated to the relatively unproductive nontradables sector.

What allows a less productive sector to attract investment and even thrive? The nontradables sector is less productive than the tradables sector, but it offers opportunities for rent-seeking—activities wherein private return exceeds social return—due to the prevailing noncompetitive environment, such as barriers to entry, heavy regulation, and so forth.3 This results in higher markups, which makes the nontradables sector an attractive investment destination and leads to misallocation of resources, with companies devoting scarce resources to socially unproductive activities.4

Breaking the nontradables sector’s stranglehold over the economy requires institutional change. Institutions are constraints imposed on human interactions to create order and reduce uncertainty (North 1991), and good institutions are those that ensure a relatively equal access to economic opportunity and guarantee that private returns are commensurate with social returns (IMF 2005). While institutions are naturally persistent, real change is possible (Acemoglu and Robinson 2008).

Tradable and Nontradable Sectors

Portugal is in an advantageous starting position. A cross-country study finds that institutional transitions are associated with trade openness, press freedom, “good” neighbors, and higher levels of education (IMF 2005). In the Portuguese context—with abundant press freedom and “good” EU neighbors—the focus should be on developing the tradables sector to encourage trade openness5 and on further investment in education.

The literature suggests that reforms have to be introduced at the height of the crisis or in its wake, when the need for reforms is widely appreciated and the opposition to reforms is weak (Drazen and Easterly 2001). Rajan (2004) points to the postcrisis recovery as the perfect time to proceed, since the available resources may be used to address concerns of those left behind by reforms. In other words, the time for reform is now.

Critically, the reforms need to enjoy domestic political support. The early 1990s India is a case in point, where the technocratic conviction of key public officials and the strong pro-openness and pro-liberalization industrial lobby paved the way for successful economic reforms (Mukherji 2008). Ideally, the country would benefit from the creation of a self-perpetuating pro-reform coalition, which would make reforms irreversible.

To summarize, government policies must strengthen Portugal’s tradables sector by minimizing rent-seeking and improving education. Steps to minimize rent-seeking ensure that the country’s scarce resources are channeled to productive activities and strengthen the clout of the pro-reform tradables sector companies. Better education, with particular emphasis on vocational training, allows the tradables sector companies to compete more successfully in the global economy and to exert more pro-reform pressure domestically.

References

    AcemogluD. and J.Robinson. 2008. “Persistence of power, elites, and institutions.” American Economic Review98 (1): 267293.

    AmadorJ. and C.Coimbra. 2007. “Characteristics of the Portuguese Economic Growth: What Has Been Missing?Working Paper 8/2007Banco de Portugal. Lisbon.

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    AmadorJ. and A.Soares. 2012. “Competition in the Portuguese Economy: An Overview of Classical Indicators.” Working Paper 8/2012Banco de Portugal. Libon.

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    DiasD.C.Marques and C.Richmond. 2014. “Resource Allocation, Productivity and Growth in Portugal.” Banco de Portugal Economic Bulletin (October): 6172.

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    DrazenA. and W.Easterly. 2001. “Do Crises Induce Reform? Simple Empirical Tests of Conventional Wisdom.” Economics and Politics13 (2): 12957.

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    International Monetary Fund. 2005. “Building institutions.” World Economic Outlook.WashingtonSeptember12560.

    National Institute of Statistics (INE). 2014. “Resident Population Projections 2012–2060.” Press releaseMarch28. Lisbon.

    KruegerA.1974. “The Political Economy of the Rent-Seeking Society.” American Economic Review64 (3): 291303.

    LevchenkoA.2013. “International Trade and Institutional Change.” Journal of Law Economics and Organization29 (5): 114581.

    MukherjiR.2008. “The Political Economy of India’s Economic Reforms”. Asian Economic Policy Review3: 31531.

    NorthD.1991. “Institutions.” Journal of Economic Perspectives5 (1): 97112.

    PinaA. and I.Abreu. 2012. “Portugal: Rebalancing the Economy and Returning to Growth Through Job Creation and Better Capital Allocation.” Economic Department Working Paper 994Organisation for Economic Co-operation and Development. Paris.

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    RajanR.2004. “Why Are Structural Reforms So Difficult?Finance and Development.June: 567.

    ReisR.2013. “The Portuguese Slump and Crash and the Euro Crisis.” Brookings Papers on Economic Activity.Spring: 143193.

1

Prepared by Dmitry Gershenson and Li Zeng.

2

That is the central scenario prepared by the National Institute of Statistics. There are also the optimistic and the pessimistic scenarios, which envisage working-age population declines of 3.7 and 5.9 percent, respectively (INE 2014).

3

There is extensive literature devoted to the social costs of rent-seeking, starting with the seminal work by Krueger (1974).

4

The charts are based on the analysis by A. Jaeger and A. Gomes.

5

The importance of trade in improving institutions is also noted by Levchenko (2013).

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