Portuguese Economy Behavior from 1997 to 2017

Portuguese Economy Report

1997-2017

Portuguese Economy behavior from 1997 to 2017

Introduction

During the 1997-2017 period, the Portuguese Economy went through two external relevant events: the euro adoption in January 1999 and the subprime financial crisis of 2008.

But before explaining what happened between 1997 and 2017, we think it is useful to briefly describe the path that led Portugal to adopt the euro in 1999.

From 1986 to 1991, the Portuguese economy was considerable successful. It grew at an average real annual rate of 5.4%, benefiting from the stabilization achieved in 1985, the favourable external climate, transfer of Community funds and expansionary fiscal policy (the deficits were not less than 7% of GDP in three of the six years of the period and were never below 3%.). The high growth rates in that period resulted in convergence to the EU average: between 1986 and 1991, the annual growth differential of per capita GDP to the EU15 was always positive (Figure 1) and this differential reached 5 and 5.7 percentage points in 1987 and 1990, respectively.

[pic 1]

In April 1992, Portugal joined the European Exchange Rate Mechanism (ERM) and, in August 1992, announced the conclusion, by the end of that year, of the liberalization of international capital movements. Membership of the ERM meant the transfer of autonomy from monetary policy to the Deutsche Mark domain, which has ensured the recognition by the markets of the credibility of the price stability. However, the escudo (PTE) still had to suffer impact of the currency crises in which the European economies plunged between mid-1992 and mid-1993.

During the years 1992-1998, the period corresponding to the years of preparation for EMU and reflecting the nominal convergence effort developed under this process, the real conditions of the Portuguese economy deteriorated. At that time average GDP growth fell to 2.8%, with substantial fluctuations in the GDP growth annual rate. The fall in the average annual growth of the domestic product had a significant decrease in 1993, when the growth rate was negative (which since 1983 did not had happened and did not occur again until 2003), reflecting, in large part, the deterioration of the international environment (Banco of Portugal, 1993). Between 1994 and 1998, economic activity expanded with annual rates of real product growth rising from 1.8% in 1994, to 5.1% in 1998. However, the years prior to EMU membership were marked by a decline in the persistence of real convergence with the EU15, when compared with the convergence observed in the period 1986-1991, with the annual growth differential of GDP per capita in volume being negative from 1993 to 1995 - see Figure 1.

BBNN framework applied to the Portuguese economy between 1997 and 2017

To apply the BBNN framework to the Portuguese economy, we collected data for wages growth, inflation and current account balances, using as sources Trading Economics and the Bank of Portugal.

The chart bellow represents the evolution of the real wages growth for the 1997 to 2017 period.

[pic 2]

As one can observe, real wages growth in Portugal was above 0% between 1997 and 2010 (with the exception of a natural unemployment situation in 2006), which means that during these years Portuguese economy was in a situation of overheating. Then, the 2008 financial crisis had a huge impact in an open economy such as the Portuguese, leading to an austerity program and a decrease in wages that provoked an unemployment situation from 2011 to 2013. Finally, IMF measures and the improvement of the global economy climate shifted the Portuguese economy to a situation of natural employment from 2013 onwards.

Regarding the current account balance, one can observe in the below chart that the Portuguese economy was in deficit during the 1997-2012, turning this situation around in 2013 to a surplus in the current account, balancing its balance to around 0 in 2014 and 2015, and registering a slight surplus in 2016.

[pic 3]

Translating this into the BBNN framework, we can outline the following chart:

[pic 4]

The grey concentric spiral represents the automatic adjustment process. The four quadrants are represented by the combination of the following categories: surplus and deficit, overheating and unemployment. An economy that is located to the right of the NN line will experience an increase in wages. This can be explained by the bazaar reference in which a bazaar has a lot of stalls, but few people shopping. Similarly, there are few people looking for jobs and the amount of jobs available is high. This results in a situation where the economy is slightly overheating. In this situation, if everything remains constant, the economy will move downwards until it reaches the NN line and the overheating ends. Here, there is an equal amount of jobs as there are people looking for work.

In Portugal in 2016, there was minimal overheating and a slight surplus. This means that wages will increase and the demand will increase as well. The labor market gets more attractive as a result of the increase in wages. Therefore, more people will enter the bazaar (search for a job) because they want a job with a higher salary. This means that the dot of Portugal will pass the BB line and move to the next quadrant. When the dot is exactly on the BB line, the current account will be zero.

When the dot of Portugal passes the BB line, the country is in a deficit, but the labor market stays overheated. Here, the competitiveness goes down because there are more jobs available than people and the dot will move down and slightly left. As the labor forces continue to move the economy down, the demand goes left, continuing the spiral towards equilibrium. Once the dot reaches the NN, unemployment is at its natural rate and wages remain constant. Here, the amount of jobs available is equal to the number of people looking.

As the dot continues in the spiral and passes the NN, it moves towards unemployment and the current account is in a deficit. In this environment, with many people in the bazaar, wages, productivity and demand go down. Wages keep going down and the competitiveness goes up because people are fighting for a limited amount of available jobs.

The dot will then pass the BB line. While it is located on the BB line, imports equal exports, because demand has reduced, and productivity has gone down. As the dot moves to the next quadrant, the dot is in the surplus and unemployment situation. At that moment it is above the BB line, which means that the country is earning more than it is spending. Here, savings can accumulate, but at some point, they will have to start spending, which will increase demand and eventually reach the equilibrium point.