Piketty, Acemogluand how to break the pattern of economic crises in Portugal

Mariana Abrantes de Sousa

Economist - PPP Lusofonia

PWN Professional Women’s Network Annual Conference

Lisbon 20 - NOV-2014

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Contents

Portugal – A history of economic crises

Portugal – A crisis of history

From deficit to deficitoAcemoglu and Robinson (2012) – Why Nations Fail

oPiketty (2013) - Capital in the XXI Century

This time is different, same causes, different consequences

What needs to be changed

How to become part of the solution

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Declaration of interests

Personal quest

Born in Portugal, studied and worked abroad 25 years, returned 25 years ago

Economics not enough to understand why Portugal is poor

Understand the problem, become part of the solution

Portugal is worth changing for the better

- Exit, Voice, Loyalty, Neglect (Hirschman 1970 ): Choose VOICE

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Portugal – A history of economic crises – 1890

June 1892 Bankruptcy with suspension of payments on external debt, default

Triple crisis - banking , currency crises, and external debt

Heavy dependency on foreign financing for large catch-up investments

Foreign concessionaires

Chronic trade deficit, imports manufactured goods, exports of goods wih low value added ,

X /M = 50% export import coverage ratio

Dependency on emigrants’ remittances

External credit boom in a currency not controlled by the national authorities, £ Pound Sterling, devaluation

External credit retraction due to financial crisis in Argentina and new republic in Brazil 1989

British Ultimatiom 1890 January, Mapa Cor-de-Rosa

Interest on public and foreign debt toook up to 40% of Government budget

Austerity, starting with Rei D. Carlos “Primeiro nos Sacrificios”

External debt restructuring in 1902

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Source: Silveira, http://pt.slideshare.net/BarbaraSilveira9/a-crise-financeira-de-188090

Trade Balance 1896 - 1904

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Portugal – A history of economic crises – 1970-1980s

1974-1984 Debt crisis without suspension of payments on external debt, avoiding default

Colonial war absorbed around 40% of Government budget

Chronic trade deficit, current account deficit reached 9,2% of GDP in 1977 and 13.5% of GDP In 1982

First OPEC oil price shock in 1973

Second oil-shock in 1979

International economic recession reduced emigrants’ remittances and tourism receipts

Revolution and political instability

Abrupt decolonization and need to absorb increase of nearly 8-10% in population in less than one year

IMF first stand-by arrangement in May 1978, with conditionality

Huge increase in public debt, and external debt increased from about one third of GDP between 1979 to 90% of GDP in 1984

IMF second arrangement in September 1983, rearranged in June 1984, with conditionality including sharp currency devaluation, increases in subsidized prices, etc

Severe unemployment, wage arrears, austerity

Strong increase in X / M coverage rate, from less than 50% in 1980-81 to over 80% in 1986-87

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2010-2015 Bankruptcy and debt crisis without suspension of payments on external debt, avoiding default

Current account deficit over 12% of GDP in 2008, balanced in 2013, returning to deficit in 2014

X/M = 62 % in 2010

Energy trade deficit reduced from 6% of GDP in 2012 to from 3,8% in 2013

Large portion of population heavily dependent on the State, pensioners

Within Single Market and Single Currency, unable to: devalue, impose capital

controls, increase import tariffs, or increase interest rates

Severe contraction of commercial and export credit , consumer credit finances imports

Austerity, budget tax increases, wage and pension cuts

Unemployment topped reached 18%,

Distress sales of assets, privatizations, “compra-se ouro” stores

Huge gross external debt EUR 410 Bln Sept 2014, GDP 171 Bln

Vulnerable to increasing real debt burden with internal deflation

Portugal – A history of economic crises – 2010 +

Quem compra o que não pode, vende o que não quer 7

Seven reasons or Portugal’s empoverishment and economic depression, mostly endogenous

1. Competition from China's entry into WTO World Trade Organization2. Diversion of FDI foreign investment to Eastern European countries

1. Poor of human resources, labor market rigidities 2. Costs of context that limit business activity3. Outflow of capital in the 1970s never recovered, low savings rate 4. Excessive growth of the State, public administration and State owned

companies 5. Weak productivity growth, weak commercial

Source: Reis 2013

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Portugal – A crisis of history

Repeated external and debt crises

Small, fragile peripheral economy

Fewer and fewer policy instruments within Single Market and Single Currency

Highly vulnerable to external shocks

No room (but excessive tolerance) for internal policy errors

Government budget deficits, excessive government spending

Poor productivity, poor public services

Uncontrolled credit and poor bank management

Corruption and lack of transparency

Path dependency – Is history destiny ?

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From deficit to deficit- key drivers

Consequences:

Government budget deficit

External tade and CAB current account

Debt, public or external

Causes:

Deterioration in the terms of trade

External shocks (exogenous)

Governance deficit (endogenous)

Planning deficit

Democracy deficit

Literacy deficit, only 35% in 1920

Negotiating skills deficit

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From deficit to deficit – key drivers

Governance Deficit

External Deficit

GovernmentDeficit

If excessive borrowing is at the root of our financial crises, - T why does Portugal accumulate public and external debt repeatedly, - contrary to our traditions of prudent financial management ?

Quem não tem dinheiro não tem vicios ... Quem compra o que não pode vende o que não

quer Ao bom pagador não doi o penhor Quem não deve não teme

Because we count on someone else will pay the bill !

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From deficit to deficit – democratic governance Acemoglu and Robinson (2012) – Why Nations Fail

Poor countries are poor because those in power make choices that create poverty,

often on purpose (pg 68)

Diverging economic institutions are the fundamental cause of differences in economic development among countries

• Extractive political (and economic) institutions, top-down, hierarchical, non-democratic, State captured

• Inclusive institutions, bottom-up, democratic, difficult to capture, low tolerance for abuse

Economic growth under extractive institutions is not sustainable

Characteristics of concern in the case of Portugal

• Late investments in human capital, only recently

• Ineffective justice system

• Archaic labor system, among the worse in Europe

• Inefficient public services

• Ineffective taxation

• Poor leadership, elites

Dangers in divergence: EU was created to avoid disparities and conflicts among member countries 12

From deficit to deficit – trade Piketty (2013) - Capital in the XXI Century

• Income inequality within countries tends to increase because return on capital is consistently higher than growth

Inequality mechanism: r > g except in short exceptional periods such as wars and recovery periods

• Income from capital (rents dividends, interest, profits) grows more than total national income, increases inequality between those who receive capital verus labor income

• Initial inequality of wealth increases progressively

• But rise in global inequality over last 200 years comes mostly from “between-country inequality”, a wider gap between rich and poor nations

• Income inequality among countries increases when countries diverge, with net creditors/investors and net debtors

• Net creditors countries – national income is greater than national output

• Net debtor countries - national income is less than national output

• Net creditor countries receive a positive flow of income from the net borrowing countries (as high as 10% of GDP)

• Countries that have achieved sustained growth financed investments in physical and human capital domestically

• Conversely, “countries “owned by other countries” have been less successful, ...specializing in areas with less development potential, suffering from political instatbility when pressed to pay external creditors and investors

• Asian countries ... have benefitted more from open market for goods and sevices than from free capital flows or borrowing

• Gains from free trade come mostly from diffusion of knowledge, not from trade specialization (error of Ricardo) 13

Piketty Q & A

Q: Which is more likely ?• « Oligarchic divergence », rise of global billionaire wealth: billionaires own a rising

share of global wealth, or

• « International divergence, rise of foreign wealth: countries own other countries

A: Both can happen.

• But international divergence is relatively easier to deal with through capital controls*.

• Oligarchic divergence is harder to deal with, because it requires detailed information on individual wealth levels and strong international coordination, as wealth moves to off-shores distorting the NFA - net foreign assets positions of many countries.

(* Single Market Single Currency like the Eurozone do not allow capital controls)

Zucman 2013, « The missing wealth of nations: are Europe and the US net debtors or net creditors? »

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Devil in the divergence – income

Forces of convergence exist

• Diffusion of knowledge (education, scholarships)

• Investment in education

• Legitimate and efficient government

• Foreign lending and foreign direct investment (in theory)

Forces of divergence are stronger

• r>g, return on capital exceeds growth

• Top earners have the power to set their own remuneration (pg 25)

• Accumulation and concentration of wealth higher when growth is weak, r>g widens

• Debt (negative wealth)

Source: https://www.youtube.com/watch?v=ULfosfhWZ7c

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From deficit to deficit – Governance Governance systems function at various levels, in sequence, with checks and balances, redundancies, back-ups

Portugal’s first bankruptcy of the XXI Century due to a tragedy of errors In Portugal

• Excessive and illegal government spending, hidden Government liabilities • Eexcessive lending and borrowing, "Folia dos Fiados“ • Poor bank regulation and supervision, failures of prudent financial intermediation • Poor public administration • Unproductive public and private investments, empty roads, empty houses • Poor management of PPPs, swaps and other innovations • Corruption, lack of transparency, tolerance of abuses

Outside of Portugal• Excessive (subprime) lending, incorrect policy and price signals • Unwillingness to take losses on subprime lending within the Eurozone • Growing divergence and extenal imbalances, lack of adjustment instruments

A quem do seu foi mau despenseiro, não confies o teu dinheiro

Quando a esmola (subsídio) é grande, o pobre (contribuinte) desconfia

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Good governance needed at every level Good governance

Effective, efficient, and ethical management

Overcome power distance, fear, indifference

In hierarchical countries, top down,

all it takes to capture the State is

to capture the top, “cupolas do poder”

Corruption often masquerades as incompetence

Use diversity to avoid capture

Need vaccination against bad governance

Maitain memory of the crisis alive to avoid repetition

Zero tolerance for abuses, imprudent actions

Portugal to Norway: Hold the cod, send governance

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This time is different- in the Eurozone

Same problems

External deficits

External debt

Excessive spending

Different consequences

No FX devaluation

Wage and pension cuts

Higher unemployment

Much more debt

Much more taxes

Adjustment costs now supported almost entirely by the borrower, for the next several generations

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Alerts: When solutions turn into problems

Abuses

Interest rate subsidies for first time home buyers (bonificações ao crédito à habitação)

PPP – public private partnerships

Golden visas

Interest rate swaps

Regulatory failures

“BdP did all it could (?) within the strict letter of the law”, which proved insufficient in the changing circumstances

New circumstances require solutions unforeseen in the law

EU and Eurozone are new experiements, unprepared to avoid and deal with unexpected severe divergence of fortunes

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What needs to be changed

Ourselves

Buy local - monitor your family’s “foreign trade balance”, cut imports

Increase savings, reduce debt

Increase productive investment, education, marketable skills

Reduce waste Denounce abuses, intolerance for

corruption

Join together and speak up, VOICE

Lead by example

Our country

Increase bottom-up democracy Organize sector associations to gain

critical mass

Export, together

Gain bargaining capacity Negotiate better external debt

repayment terms

Tax consumer credit

Increase quality and productivity

Set high standards, high objectives

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Actions: How to become part of the solution Watch for warning signs of economic

mismanagement o Excessive credit and debt accumulationo Hidden expenditures o Abusive implementation of potential

solutions o Lack of transparency o Collusion (uma mão lava a outra)o ...

Set objectives high o Match productivity of strongest of the

smaller countries

Zero tolerance for corruption

Demand good management

Organize and join together

Build consensus Share sacrifices, especially with

creditors

Demand accountability

Correct Portugal’s negative image abroard with real stories

Speak up, overcome fear and indifference

Maintain memory of the crisis alive, as a vaccine against abuses in the future

Povo que Aguenta Povo que Supera

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We cannot continue doing business-as-usual, the same old way. Albert Einstein : "Insanity is doing the same thing over and over again and expecting different results "

In summary:

• Struggling to overcome a legacy of underdevelopment, Portugal has suffered repeated financial crises, from 1892 to the 1970’s and 1980s, to today.

• First, we must look for the truth and look to authors like Piketty on “Capital” and to Acemoglu on “Why Nations Fail”

- To understand the origins of the current and past financial crises, and

- To create solutions that may prevent similar problems in the future

• Then, we must have the courage and the political will to take action by implementing the necessary changes in economic governance at all levels

Those who ignore the lessons of history are condemned to repeat it

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PPP Lusofonia

Obrigada!Mariana ABRANTES

de Sousa

PORTUGAL

ppplusofonia@gmail.com

Blog PPP Lusofonia http://ppplusofonia.blogspot.com

All rights reserved

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Presenter background

Mariana ABRANTES de Sousa • Independent Financial Consultant and PPP Specialist in advisory,

training and evaluation of PPP projects and programs, and in credit and banking

• WPO Women Presidents’ Organization Portugal Chapter Chair

• Professor of Project Finance, Nova School of Business and Economics

• Member of the Board and credit committee of Infrastructure Crisis Facility (PIDG/KfW)

• Member of the Supervisory Board of FLO CERT GmbH

• Former Financial Controller in the Ministries of Transport and Health reporting to the Minister of Finance, Portugal

• Former international banker with ABN AMRO Bank (Portugal), European Investment Bank and The Chase Manhattan Bank, in Lisbon, Luxembourg, New York and Mexico City

• Economist with BA -UC Berkeley and MPA - Princeton University 1975

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How is the current financial collapse of Portugal within the Eurozone different from the financial crises of the 1890s and 1970s?

Who’s fault is it anyway, who is responsible for the current debt crisis?

How many bottles of wine did Portugal export to pay for your imported smartphone?

If you were a Member of the Board of a bank under stress, would you “see nothing and say nothing”, until the final collapse?

Are you dependent on the State budget ?

Are you satisfied with the quality of public services ?

Do you work for a company which is a net exporter or a net importer ?

Is Portugal condemned to suffer repeated financial collapses?

Can we incresase productivity just by producing more?

If we can’t export more and generate a current account surplus, will our foreign creditors accepta interest payments in kind, bottles of the real Port wine and hotel vouchers ?

What can we do together so that Portugal can avert the next three financial crises over the remainder of the XXI century?

For further reflection

25Lisboa, 20-Nov-2014