A More Detailed Look at the Economy of Portugal

In a prior post (here), I reviewed an journalistic article from the Atlantic (here) that tried to understand the puzzle of Portugal's economy using a sampling of conventional wisdom from macroeconomic analysis. One of the articles mentioned in the piece was published by the prestigious Brookings Institution and written by Prof. Ricardo Reis of Columbia University (here). It provides a more in depth, academic, macro-economic analysis that is worth some careful reading. The graph above is taken from earlier post and annotated with various historical fictions about the economy of Portugal from A-E. I will refer to each fiction in the discussion below.

Notes

• Power Outage in Spain and Portugal

World-System (1975-2150) Breaking Cycles of Austerity in France

 

The background graphic above was from a protest in Aug 2012 (you can see the small peak in AUST1--see the Operational Definitions in the Notes below--in the overlay time series plot). Emmanuel Macron took office in 2017, right after AUST1 hit bottom. His government has been riding the AUST1 Recovery wave since then. From my Business-As-Usual (BAU) model of French Austerity (here), AUST1 can be expected to peak in the next few years and decline after that. However, the decreasing Cycles of AUST1 will continue well past 2150. 

The BAU model, however, is not the best model for French Austerity. In the long-run, AUST is better seen as being driven by the EUL20 model (which is also steady state). In future posts, I will look at Austerity in the European Union (EU). In the short run, the best model is a Random Walk (RW)--validated by the Macron Administration's inability to form a government and retain a Prime Minister. The attractor path for the RW model is presented above (dashed red line). The RW attractor path suggests that AUST1 should be kept at a low level aside from random movements.

Austerity is a difficult component of Neoliberal Theory (see below). Especially, the dominant controller, AUST1, depends on external forces such as US Military support and the Russian-Ukrainian War which is forcing military expenditure up and creating the budgetary crisis with Health, Education and Welfare.

For an understanding of why Austerity has become such an issue in France, keep in mind that the Economy of France is becoming a Steady State Economy (see the FRL20 Model). One interesting hypothesis is that cyclical processes such as Austerity become more important as the system reaches a steady state and the dream of unending exponential growth (Techno-Optimism) is over. Promises can no longer be made that growth will solve Social Inequality problems. The New Axis of Evil can be used to motivate increased military expenditure but, to avoid reducing Social Expenditure, Debt will have to be used to drive the economy, creating another focus for Protest and wide-spread civil unrest.

You can experiment with the FR_AUST model here. For more information about how the models are constructed see the Boiler Plate.

Notes

More reading:

• Six Futures for France
• French Debt, Collapse of the Government, and COVID-19
• Shefner, 2015 here and here.
• Macron has No Good Options
• How Does the Economy of France Work?

Theoretical Considerations (it's bigger than just Austerity):

Austerity, as a theoretical concept, is part of Neoliberalism (see the graphic above and Shefner, 2015 here and here). I will explore the other aspects of French Neoliberalism in future posts.

The data for the AUST index is taken from the World Development Indicators (WDI). The indicators and definitions are listed in the table above. NOTE: AUST is entirely measured by budgetary categories as percentages; the cyclical nature of the index is a result of percentages hitting up against limits [0%,100%].

The AUST index contains three components that explain 94% of the variation in the indicators. 

AUST1 = (0.433 GED + 0.4571 MIL - 0.4477 G - 0.393 GE - 0.4701 GH)  

AUST2 = (0.822 GHE - 0.357 GED - 0.377 GE) 

AUST3 = (Overall Growth) 

AUST1 and AUST2 are historical feedback controllers for the budgetary categories defining Austerity. AUST1 focuses on controlling Education, Military expenditure, Overall Government Expenditure and Health Expenditure. AUST2 focuses on controlling Health and Education Expenditure.

In the Economy of France, Austerity, Debt and Globalization (KOF) are closely related. The relationship can be seen from the Measurement Matrix above when DEBT and WorldGlobal (KOF) are added to the model. In future posts, I will investigate all the indicators of Neoliberalism in France.

The state space of the French Economy is dominated by three components explaining 98% of the variation in the underlying indicators: 

FR1=(Overall Growth)

FR2= (CO2+EF-KOF)

FR3=(LU-L-N) 

FR2 and FR3 are Historical Feedback Controllers regulating Environmental Impacts of Globalization and Unemployment, respectively. EF is the Ecological Footprint and KOF is the Index of Globalization.

You can run the FRL20 Model with code available in Google Sites.

World-System (1990-2060) Globalization and Trump II Tariffs

 

The Trump II Administration announced today (here) that it is imposing stiff tariffs on goods from Mexico, Canada and China because "...they haven't treated us fairly on trade...". The Wall Street Journal (here) is calling the move "...the dumbest trade war in history...". Other than the Trump II administration breaking decisively with Neoliberalism (free trade and Globalization were key elements of Neoliberal orthodoxy), what is going on here?

Let's first look at the state of Globalization among the trading partners (US, CN, CA, and MX) using the KOF Index of Globalization. The dominant state variable attractor path for the trading system is displayed above as being driven by the USL20 model. From 1990 to 2000, the system had its ups and downs but did stay pretty much within the 98% prediction intervals for the attractor path. In 2010, the system was right on the attractor path. After that, the US-dominated system is predicted to peak somewhere around 2040. Trump is throwing a tariff-wrench in the system and, as with prior swings in Globalization, the policy may have little impact and we can expect a return to the attractor path after Trump II is gone.

But, does Trump understand that the Globalization system is reaching a peak and might well collapse in the future? Is Trump attempting to pull globalized US industries back on-shore before system collapse? Trump claims to act intuitively and his ample gut might tell him that the global World-System is collapsing. At this point, my goal is to get a stake in the ground to understand what has happened after the Trump II Administration is over.

Notes

The Measurement Matrix for this KOF Index of Globalization system is presented above. KOF1=overall growth, KOF2 is dominated by the US and KOF3 is dominated by Canada. All look at KOF2 and KOF3 in future posts.

The Mystery of Why Portugal's Economy Has Performed So Poorly.

Matthew O'Brien recently wrote a piece for the Atlantic titled "The Mystery of Why Portugal Is Doomed". The reasons given in the piece are all essentially recitals of the conventional wisdom on economic development and, although each point might make sense in and of itself, the actual causes are simpler to understand and less complicated. From the graph above (real GDP in US$ from the World Data Bank) the economy in Portugal experienced an economic bubble after it joined the EU in 1999 and the bubble popped in 2007 as a result of the Subprime Mortgage Crisis. The bubble can be clearly seen in the dynamic attractor plot above (the dashed red line is the dynamic attractor path and the other dashed lines are the 98% bootstrap prediction intervals). Before going into more detail, let's review the conventional wisdom.

Matthew O'Brien lists the following problems with the economy of Portugal:

• Between 2000 and 2012, Portugal's economy wasn't growing fast enough. To prove this case, GDP per capita in Portugal from 2000-12 is compared to the USA 1929-41 (the Great Depression) and Japan 1992-2004 (the Lost Decade). The comparison supposedly supports the conclusion that "this wasn't the case of the bust erasing the boom, because there was no boom". But this is certainly a logical non-sequitur since these economies and time periods really have nothing to do with each other (more about the supposed "non-boom" and a-historical comparisons later).
• Portugal's Immature Financial Sector. After Portugal's entry into the EU, the financial sector "...misallocated the foreign capital that poured in to low productivity, non-tradeable sectors like wholesale and retail trade. In other words, it wasted money on things that never had a chance of paying off." This argument is rejected because German Banks in Portugal also made "bad bets". Bankers making bad bets sounds consistent with bubble behavior which seems inconsistent with the "non-boom".
• Portugal's Small Business Culture, Too Much Corruption and Regulation. Portugal and all of Southern Europe supposedly have too many small "mom-and-pop" businesses that stay small to fly under the radar of a corrupt government. The conventional wisdom: if small-and-medium-sized-enterprises (SMEs) play too big a role in the economy, the economy can't grow and take advantage of economies of scale. The article correctly rejects this explanation because it has been true for most of the late 20th century and hasn't changed much recently.
• Portugal Has To Fix All The Structural Problems.  Here the article trots out the laundry list of conventional criticism of Southern European countries: labor market inflexibility (they need to fire more workers), difficulty starting a business (too much red tape), and legal problems (inability to enforce contracts). "After all, Portugal's stagnation between 2000 and 2008 shows that adequate demand isn't sufficient in the face of these deep problems--but it is necessary. That's why Europe needs to stop insisting on punishment as the path the prosperity." What seems more interesting about the period after 2000 when looking at the graph above is why the bubble was able to stay inflated for so long?

In the end, the article concludes that Portugal's economic performance is a "puzzle". What creates the puzzle, I would argue, is illogical comparisons and arbitrary lines (explicitly or implicitly) drawn on graphs.

The starting point for all the consternation about Portugal is the counterfactual assertion that Portugal should have grown more rapidly. The counterfactual assertions can be conveniently summarized by drawing lines on graphs (the solid red lines with arrows in the graph above) projecting rapid future growth based on strong periods of (bubble driven?) economic performance.  Portugal should have taken-off after the mid-1990s (Dot-com bubble), or after 1999 (EU bubble, "I contend that the European Union itself is like a bubble." George Soros, June 2, 2012) or after 2007 (Subprime Mortgage Housing bubble). Something must have been preventing the take-off into sustained growth implied by the red-line counterfactuals and the usual culprits are trotted out to affirm the conclusion.

None of the red-line "take-off" extrapolations have anything to do with the capabilities of Portugal's economy but rather with the implications of neoclassical economic growth models. Unfortunately, Portugal's economy is not correctly described by the unrestrained exponential growth embedded in such models. Portugal's growth is slowing because the economy is moving toward a steady state. To understand these issues, which are very different from the conventional wisdom, will require a comparison of the neoclassical growth model to the PT20 state-space model of Portugal's economy (the model used to generate the dynamic attractor path in the plot above) and a more detailed discussion of macroeconomic analysis underlying the conventional wisdom, to be covered in future posts.

Iceland's Experiment With Neoliberalism

Paul Krugman recently wrote a NY Times Op Ed piece (here) as a follow up to his earlier "Icelandic Post-crisis Miracle" Op Ed (here). He thinks that Iceland is yet another example of an economy that "produced a decent standard of living for its people" but "was in effect hijacked by a combination of free-market ideology and crony capitalism." Of course, his analysis has been disputed (here and here).

Krugman compared Iceland's percentage changes in GDP since the start of the financial crisis (2007Q4) to Estonia, Ireland and Latvia. He argued that Iceland's approach (let the banks fail and continue deficit spending) allowed it to better weather the crisis than other countries. The critics argue that he was cherry picking starting points for comparisons and if you look back to 2000Q1 or even 2007Q3, Iceland's performance doesn't really look that good.

In some future post I'll look at Estonia, Ireland and Latvia, but for now I would argue that all such comparisons are questionable. Without having an attractor value for GDP growth in each country, it's not really possible to distinguish "bubble" growth from "normal" growth. The graph at the start of this post displays a simple business-as-usual (BAU) attractor path and 98% bootstrap confidence intervals for Iceland's GDP (in real $2000 USD). That graphic tells a better story about Iceland's late 20th century economic history than do the comparisons to other bubble economies provided by the Council on Foreign Relations.

For much of the mid-20th century, the Icelandic economy was underperforming. However, from the late 1980's until the mid-1990's, the economy went through a period of almost stagnant GDP growth. In response, Iceland undertook extensive neoliberal reforms (here). And, in the late 1990's the economy certainly seemed to take off into sustained growth.

Around 2001, however, the economy had reached is BAU attractor and, indeed, there was a period of slow growth. My guess is that growth in the 2% range around the attractor was simply not acceptable and Iceland's answer was financialization which seemed to be producing high growth rates for the foreseeable future (dark red arrow in the graphic) until the Icelandic financial crisis of 2008-2011 brought the economy back to the BAU attractor in 2010.

Compare Iceland to Germany (here). What Iceland has going for itself right now is that (1) it didn't overshoot its BAU attractor by that much (by 2020 the economy will be back to peak bubble GDP values) and (2) it is currently at or near its BAU attractor value (unlike Germany on both counts). The question for Iceland is whether modest growth rates stabilizing around 1% will be acceptable to right-wing, neoliberal policy makers.