José A. F. Machado

English

Research Papers in Economics

PORTUGUESE ECONOMIC DEVELOPMENT IN THE
EUROPEAN AREA: DETERMINANTS AND POLICIES*
José A. Ferreira Machado**
For the fourth time the Bank of Portugal as promoted its bi-annual conference on the topic of “Portu-
guese economic development in the European area: determinants and policies”. The main purpose of
this initiative is to have the Academia reflecting on the long-term or structural problems of the
Portuguese economy.
This article presents a personal (and, necessarily, biased) account of what the author has learnt from
the Conference.
1. Fostering growth in Portugal
The central talk at the conference, “Fostering Growth in Portugal”, was delivered by the Harvard pro-
fessor andgrowththeoryspecialist,PhilippeAghion. The problemsof fosteringPortugal’s growthwere
analyzed from the vantage point of the so called “Schumpeterian theory”, a paradigm originally pro-
posedanddevelopedbyAghionhimself.The centraltenantof thisapproachisthat growthresults from
quality improving innovations; it thus focus on quality improving innovations that render old products
obsolete, and hence involves the force that Schumpeter called “creative destruction.”
Under this framework the growth effects of various policies are highly context dependent, as opposed
to “one-size-fits-all” approaches, policies or institutions. Typically, the Schumpeterian theory gauges
that context by proximity to the technological frontier (representing the stock of global technological
knowledge available to innovators in all sectors of all countries). Far below from the frontier a country
will maximize growth by favoring institutions that facilitate implementation (imitation) activities; here
practices such as long term bank finance, export promotion, incumbent’s protection or subsidies to
production may be beneficial for growth. However as it catches up with the technological frontier, to
sustain a high growth rate the country will have to shift from implementation-enhancing institutions to
innovation-enhancing institutions; now, well functioning capital markets, product market competition,
entry deregulation or labor market flexibility are key for growth.
Acentral idea is thus, that institutions and policies that favor frontier innovation are not necessarily the
same as those that favor imitation. Two further examples highlight this context dependence. Higher
education investment should have a bigger effect on a country’s ability to make frontier innovation,
whereas primary and secondary education are more likely to make a difference in terms of the coun-
try’s abilityto implement or imitate existing(frontier) technologies. Labor market flexibilityis more nec-
essary for frontier innovation than to imitation and, consequently is more growth-enhancingthe closer
a country is to technological frontier.
Economic Bulletin | Banco de Portugal
Articles | Summer 2008
45
* The opinions expressed in the article represent the views of the authors'; they are not necessarily those of Banco de Portugal.
** Universidade Nova de Lisboa.In summary, the basic message from Aghion’s talk is that for Portugal to move up on the skill and pro-
ductivity ladders and thus resist the emerging economies’ competition, the growth-enhancing institu-
tions should evolve. Have they? Will they?
Several institutions or policies always promote growth. Chief among those are property right protec-
tion, the rule of law and product market competition. Two papers (“The impact of firm size and market
size asymmetries on national mergers in a three-country model” by Luís Santos Pinto and “Merger
analysis in the banking industry: the mortgage loans and short term corporate credit markets” by
Duarte Brito, Pedro Pereira and Tiago Ribeiro) provide analytical frames to analyze quantitatively the
impact on welfare of mergers in industries as banking, mobile communications, cement and fuel retail
trade. Within the limits of its assumptions, the papers provide tools that might be used to design more
efficient competition policies.
With the accession to EU more than 20 years ago, Portugal’s economic institutions and policies
changed significantly. Chief among those are, of course, the freedom of movements of capital, goods,
services and people associated with the Single European Market. Also, a vast privatization program
was launched. Additionally, several laws reforming corporate governance were passed: provisions re-
inforcing the protection outside investor’s rights; a new securities law; and a reformed bankruptcy law.
The paper “The Economic impacts of improving investor rights in Portugal” byRui Castro, tries to eval-
uate the relative contribution of those reforms for improved performance of the Portuguese economy
since joining the EU. The main conclusion is that, among the reforms under scrutiny, the improvement
of investor’s protectionis the one most consistent withthe macroeconomicfacts (aggregateproductiv-
ity growth) and micro-evidence of more efficient resource allocation. The rational underlying this con-
clusion has a “Schumpeterian” gist: poor investor’s rights protections takes a disproportionate toll on
the industries where economic activity involves higher risks (“capital goods” sectors in Castro’s paper,
“frontier sectors” in Aghion’s).
2. Social Security
People live longer, living longer is more expensive and people don’t save enough for it. These are
three uncontroversial facts about modern societies that have far reaching implications. The paper by
João Cocco and Francisco Gomes (“Longevity risk, retirement savings and individual welfare”) esti-
mates that a 65 yearsold male in Portugal to needed24% more wealthin 2000 than in 1970 in order to
ensure the same level of consumption after retirement. Only because he’s expected to live longer.
An interesting point addressed in that paper is that longevity is very likely to continue to increase but
these increases are typically underestimated by actuaries and insurers: this uncertainty makes that
private savings only partially accommodate the increases in life expectancy.
The deficits of existingsocialsecuritypensionssystemsareto a largeextentexplainedbytheincrease
in life expectancy. Governments react to these deficits by cutting on pension benefits or by creating in-
centives for additional private saving; Markets also adjust by introducing new types of financial instru-
ments that hedge longevity risk (discussed in the paper “Hedging longevity risk”, by J. Cocco and F.
Gomes).
Several proposals to reform existing pay-as-you-go state pensions systems have been launched.
Ricardo Rodrigues (“Simulation of unemploymentinsurance savings accounts in Portugal”) discusses
oneofthem:The creationofindividualunemploymentinsurancesavingsaccountstoreplacetheexist-
ing unemploymentbenefits system. Asimilar system is in place in Chile since 2002 and has the follow-
ing basic ingredients: (i) Employers and employees contribute to an individual account earning a
Banco de Portugal | Economic Bulletin
Summer 2008 | Articles
46market interest rate; (ii) The individual unemployment benefits are financed by that account; (iii) If bal-
ances not enough the State makes loan at market rate; (iv) Upon retirement or death the balance is
collected or, if negative, debt is forgiven.
The ideaof theproposedsystemis to overcometheincentivesto workproblemsof theexistingsystem
without cutting social protection levels. In spite of several drawbacks of the simulation the system
shows promise of constituting a viable alternative.
3. Climate change
The most widely raised ecological problems are ones involving open-access common-property re-
sources such as the depletion of the ozone layer or the emission of green house gases. Given this na-
tureofglobalpublicgood,marketsfailindeliveringefficientsolutionstodealingwiththeconsequences
of climate changes. The paper by Antonieta Cunha-e-Sá discusses whateconomic science has to say
about appropriate actions to reconcile rapid economic growth and reduced risks of climate change.
In additionto theusualproblemsraisedbypublicgoods’provisionandallocation,globalwarmingpres-
ents some compounding difficulties. The first relates to the very long time horizon since the greatest
costs of today’s emissions will be felt in more than 50 years from now. The second, is that there is a
huge uncertainty on the economic consequences (in spite of the significant progresses the science) of
climate change; some of the consequences may be so large (even with low, and difficult to estimate,
probability) that traditional cost-benefit analysis may be meaningless. Finally, emission control clearly
requires world wide cooperation but impacts are not uniformly distributed among countries.
Two major consequences stem from these difficulties: It is hard to design incentives to foster innova-
tion and R&D investment in low-carbon technologies (a time-inconsistency problem of the optimal
“ramp” (increasingly tighter over time) policy, since it is not credible to announce today the tighter fu-
ture caps); and it is also hard to design incentives for international cooperation.
These constitute major obstacles since anylong term solution willnecessarilyrelyon the development
and adoption of new technologies and the global nature of the climate change externality require
global cooperation. A solution will probably require – more than policies or, better, prior to policies –
new institutions of international cooperation where groups of countries with common interests can
achieve with the global environment what some are achieving with their local environments.
Economic Bulletin | Banco de Portugal
Articles | Summer 2008
47

Portuguese Economic Development in the European Area: Determinants and Policies

http://www.bportugal.pt/en-US/BdP%20Publications%20Research/AB200805_e.pdf

Portuguese Economic Development in the European Area: Determinants and Policies

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