Centeno in Wonderland

Centeno was sitting on a riverbank, doing research for Banco de Portugal, when António Costa ran by, seemingly in a hurry, took a brief look at a pocket watch and winked at him. Puzzled, he decided to follow the new Portuguese Prime Minister, even as the latter popped down a hole. Down below, he came upon a great hallway lined with tiny doors, too small for him to fit through. On a table though, there was a bottle marked “Cut direct taxes”and Centeno drank its content. He immediately shrank to the size of the door and walked through.

Meanwhile, three years have gone by and Centeno is still enjoying the pleasures of the beautiful garden, also known as Portugal, that he got to. In fact, as he likes to emphasize whenever asked, it has become better by the day, in contrast to the gloomy years before he arrived. At first glance, most indicators seem to reinforce his thesis. Indeed, after being hardly hit by the global recession in 2009 and falling even further in 2011, 2012 and 2013, amid the financial assistance programme, Portuguese GDP picked up in 2014 and has been accelerating ever since. Centeno took office in 2015 and in 2017 Portugal witnessed its highest rate of economic growth in 17 years, as GDP grew 2,7%. The Finance Minister himself and other Government officials attribute the country’s success to the implemented policy of “returning Portuguese families the income they lost throughout the severe crisis the country went through”.

They are not alone in this analysis. European officials have congratulated the Government on the economic recovery and Mário Centeno has even been dubbed “Ronaldo of Finance”. These compliments eventually translated into Centeno’s nomination as President of the Eurogroup. Nevertheless, before attempting to infer anything on the merits of the current Government in turning economic conditions and leaving the worst behind, we must check whether economic conditions have turned indeed.

Again, GDP growth has accelerated over the past 4 years, standing at 2,7% in 2017, the highest rate since 2000, when GDP rose 3,9%. This pace of growth was above the EU28 rate of 2,4% last yearand therefore standards of living in the country converged towards Europe’s: GDP per capita was 77,59% of the EU28 average in 2017, whereas in 2014 it represented 76,38%.In other words, the average Portuguese citizen is now economically closer to his average European counterpart.

Closely associated with this economic performance was the sharp decline of the unemployment rate, which after falling from its maximum of 16,4% in 2013 to 12,6% in 2015, kept falling during this Government’s mandate, reaching a rate of 6,6% in September of 2018, just below the EU28 rate of 6,7% for the same month. Mostly as a result of this, the percentage of people at risk of poverty or social exclusion fell from 27,5% in 2014 to 23,3% in 2017.

Finally, indebtedness, the main trigger of the Portuguese crisis, has also come down over the last few years, as debt to GDP dropped from 93,87% in 2012 to 73,86% for households; 171,4% in 2013 to 137,66% in 2017 for private enterprises and 130,6% in 2014 to 125,7% in 2017 for the state. The Government expects public debt to further decrease this year to 122,2%, in a particularly important process, given the impact that perceived risk among creditors tends to have on bond yields and thus on state solvency.

However, although the former Prime Minister Pedro Passos Coelho would probably disagree, the devil is in the details, as a closer look at the data suggests. While GDP expanded faster than the EU28 average last year, 17 EU countries grew even faster than Portugal. An overview of economic growth figures for the EU28 shows that lower income countries (for European standards) have been growing more rapidly than higher income countries in the aftermath of the crisis. This phenomenon can be interpreted under the light of neoclassical growth theory, according to which diminishing returns of the factors of production imply slower rates of economic growth as a country becomes richer. Simply put, the race car starts slowing down as it gets further ahead of its competitors.

Therefore, given Portuguese low standards of living when compared to European counterparts’, a stronger pace of growth could be expected. Indeed, 9 out of the 10 countries expanding slower have considerably higher standards of living than Portugal. Greece, for obvious reasons, is the exception. More strikingly though, among the group of 17 faster economies, 9 have higher levels of GDP per capita than Portugal and 2 have about the same, suggesting the country’s pace is not that fast after all. The reason why it is above the EU average is that the latter is biased by the stronger weight of the largest economies.

Why is Portugal not growing as fast as it could be then? The best explanation lies on the behavior of productivity. The country’s GDP per hour worked cumulatively declined 1,23% from 2013 to 2017, whereas the EU28 experienced a cumulative increase of 2,36% over the same period. If, instead, we were to use GDP per person employed, a similar conclusion would be reached: the cumulative rate of growth in this period was -0,26% in Portugal, compared to 3,55% in the EU28. Given the increase of the employment rate from 65,4% in 2013 to 73,4% in 2017, one can easily conclude that economic growth has been solely determined by the increase in the number of workers. Besides, unemployment is approaching its natural rate, making it impossible for the economy to keep expanding through this channel. Getting the population back to work was undoubtedly an important part of the recovery, just as a football team will be better off with all 11 players on the field. Yet, the team will only reach its full potential if each player steps up his game. Similarly, long-term convergence towards European standards of living can only be attained through sustained increases of productivity. Unfortunately, generating the conditions for that is not something we can praise the Government for.

In addition, a more comprehensive analysis of the dynamics of public debt also yields alarming results, as the public debt to GDP ratio increased, on average, 8,89 percentage points per year over the 2007-2014 period, but only decreased a yearly average of 1,63 ever since. The ratio of Government liabilities usually floats over the business cycle, dropping in expansion periods and rising during recessions. The goal of any long-term oriented policy of a state which is highly dependent on external funding must be to make sure that those rising movements of public indebtedness are counterbalanced once the cycle turns. However, that has not been the case.

One of the most famous Portuguese sayings addresses the idea that we can reach big goals by taking many small steps and it could be argued that the public debt reduction and convergence towards European standards of living might behave in a similar fashion. The problem is that economic growth has already started to decelerate this year, with an expected growth rate of 2,3%, implying that the peak of the cycle has been crossed. Portugal turned the page over the last few years and left the crisis behind, but it is far from clear whether the country managed to prepare itself for the next one. Centeno has had a wonderful time in the garden, but once the Queen of Hearts joins him there, his smile is likely to fade away. If only he could then wake up by the riverside again and realize it had all been just a dream.

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