Productivity growth main economic risk in long term

Productivity growth in Portugal is the main macroeconomic risk in the long term, according to the report ‘Fiscal Risks and Public Finance Sustainability’, released by the country’s Public Finance Council (CFP) on Thursday.

“Productivity growth is the main macroeconomic risk in the long term, similarly to what was identified in the 2018 Fiscal Risks and Public Finance Sustainability report,” reads the latest document, while warning that “projections for the evolution of labour productivity are shrouded in much uncertainty.

“In the CFP scenario, recovery in 2021-2025 from the pandemic shock and convergence to 1.1% growth in the long term are dependent on a contribution from the capital intensity that was not observed in the most recent past of economic expansion, but is expected to partly stem from the implementation of the RRP,” the document states, referring to Portugal’s Recovery and Resilience Plan for spending post-pandemic European Union recovery funds.

The CFP notes that the contribution of capital accumulation “presupposes the maintenance of favourable financing conditions and the stabilisation of the investment to output ratio around the values projected for the end of the RRP implementation period (2021-2026).”

It assumes “an upward trajectory” of the ratio in question, based on “an efficient implementation of the RRP and absorption of funds in the economy.

“Thus, a lower-than-expected execution of the plan could lead to lower investment ratios, jeopardising capital intensity and thus labour productivity and the long-term growth of the economy,” the text stresses.

The other risks signalled relate to the output gap – the difference between potential and real gross domestic product – as well as the impact of the pandemic, the labour market, investment and the relationship of the pandemic with productivity.

On the output gap, the outlook “must be analysed with additional caution” due to the “magnitude of the shock caused by Covid-19 and the high uncertainty in the nature of its effects (cyclical or structural) on potential output.

“This uncertainty is in addition to the other sources of uncertainty that typically frame estimates of potential output and output gap”, which are usually associated with uncertainties about samples, incorporation of new information and methodologies for calculating potential output,” the report notes.

As for the pandemic, its impacts “on the productive structure of the Portuguese economy will be felt both in the short and long term,” the report warns. “These may materialise in the labour market, as well as in investment, or in productivity dynamics, thus constituting a relevant risk to the growth of the national economy.”

As for the labour market, “even if, in the short term, no significant reduction in employment has been observed, a possible reorientation of productive resources from the less productive to the more productive sectors, or a permanent change in the economy’s demand patterns, may lead to an increase in unemployment via the mismatch between skills and job supply and demand.”

This mismatch may eventually give rise to “the phenomenon of hysteresis in the labour market (maintenance of the unemployment rate at higher levels)” – which will “gradually dilute as workers with inadequate qualifications leave the labour market or are retrained.”

On investment, “in the long term, the pandemic shock is not expected to have significant direct impacts,” with the consequences on the degree of use of installed productive capacity in the economy being more evident; this fell by 3.1 percentage points “to 75.7% in 2020, the lowest value since 2009,” the report notes.

As for productivity, “there is some uncertainty regarding the impacts of the pandemic, with some factors encouraging an increase … while others penalise it.”

“On the one hand, the various support programmes for companies were an important instrument in containing the short-term effects of the pandemic” by avoiding “the insolvency of numerous productive companies, and the losses of human and physical capital that could result from this,” the CFP recalls.

On the other hand, support programmes “may also have a perverse effect in that they may allow stagnant companies, with low productivity and high indebtedness, and which manage to survive due to reduced financing costs (usually called zombie companies in the literature) to remain in the market”.

In more negative impacts, the CFP lists the expenditure of resources to improve the internal organisation of companies, the creation of redundancies in production processes, the effects on young people, both in entering the labour market and in their training, and also the increase in protectionism.