Wednesday, December 16, 2015

On Paul Krugman, Portugal and debt and demographic debt spirals

Paul Krugman's recent blog post, "Debt at Demographic Spirals", briefly considered if too much emigration could be a bad thing for Portugal, and countries like Portugal.

We used to think that high labor mobility was a good thing for currency unions, because it would allow the union’s economy to adjust to asymmetric shocks — booms in some places, busts in others — by moving workers rather than having to cut wages in the lagging regions. But what about the tax base? If bad times cause one country’s workers to leave in large numbers, who will service its debt and care for its retirees?

Indeed, it’s easy conceptually to see how a country could enter a demographic death spiral. Start with a high level of debt, explicit and implicit. If the work force falls through emigration, servicing this debt will require higher taxes on those who remain, which could lead to more emigration, and so on.

How realistic is this possibility? It obviously depends on having a sufficiently large burden of debt and other mandatory expenditure. It also depends on the elasticity of the working-age population to the tax burden, which in turn will depend both on the underlying economics — is there a strongly downward-sloping demand for labor, or is it highly elastic? — and on things like the willingness of workers to move, which may depend on culture and language.

We've looked at the specific example of Portugal before. I made a brief post in October 2009 about the resumption of mass emigration in Portugal and a longer post. Edward Hugh has written in greater detail, in March 2013 speculating that Portugal was being hollowed out by the shrinkage of its working-age population and in August of that year suggesting that Portugal's demographic issues had been hindering economic growth since at least 2000. Let's not forget a May 2015 guest post speculating that Portugal had been turning Japanese for some time.

My personal sense is that there is some risk of this, especially in countries with contemporary traditions of emigration. From the perspective of European Union policymaking, some sort of fiscal union uniting pension and other social welfare system might well be necessary, producing rather less problematic results than wholesale fiscal collapse in the worst-effected labor-exporting areas.

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