Should the IMF try a new approach in Portugal?

The IMF has a long experience of adjustment programs which have been exhaustively audited. Some of those programs were executed in situations of dollarization, which are the closest one gets to a full monetary union like the Euro area. The success rate of the IMF programs is over 50%, which is a major achievement when compared with company restructurings whose success rates are generally lower. Failures, often occur in countries who waited too long to ask for the IMF intervention, negotiated softer terms and applied reluctantly the adjustment policies.

On theses counts alone Portugal is already a likely candidate for failure. This fear is compounded by the failure so far of the Greek and Irish programs. This raises the issue of whether the IMF programs for dollarization situations can be applied to full monetary unions. One fundamental difference is the absence of an autonomous monetary policy and the option of a one-off devaluation of the local currency.

The policy of using cuts in nominal wages as a form of devaluation does not work for reasons explained long ago by Keynes. Although it might improve export growth it will only discourage imports by causing a recession via a reduced aggregate demand. The cost of such policy is disproportionate to its benefits because it reduces aggregate demand for both tradable and non-tradable sectors.

I teach my students why other alternatives such as exchange controls and open or disguised forms of subsidies paid to exporters have also a limited impact and cause costly distortions. However, I also list a number of alternatives that might work in the short run. Here are a few: a) the sale of state-owned assets; b) temporary price-controls on oligopolies with a major impact in the cost structure of exporters (mostly energy, transports and telecommunications); c) extended working hours; and d) competitive tax rates.

There is certainly a case to include all these alternatives in the Portuguese adjustment program. Let me just illustrate with the potential impact of on extra hour of work per day. Theoretically, that would be equivalent to a real wage cut of about 11%, but it would not change the nominal wage and would not depress aggregate demand. Even assuming that this real wage cut was halved through shirking and other avoidance strategies the impact on the competitiveness of Portuguese economy would still be significant. Moreover, this “patriotic extra hour” could be rewarded later on with tax credits.

Now that Portugal seems to be ready to get rid of Prime Minister José Socrates who bankrupted the country, it is also the time for the IMF to try new approaches to adjustment in countries within a monetary union.