Saturday, 13 March 2010

Lessons from the Portuguese Stability and Growth Programme

After a long wait, we are finally getting to know some of the measures proposed by the Portuguese government to reduce the fiscal deficits. The strategy of the government is simple: tax, privatize, cut spending the least as they can, and expect the economy to recover. Will this strategy solve the structural imbalances of Portugal’s public sector? Likely not. Does that mean that Portugal will not be able to meet its target of reducing the budget deficit to 3% of GDP by 2013? It might, or not. It  depends, mostly on how the economy will behave. Still, it also might not matter, especially if the deficit is close enough to that limit (and if other European countries also struggle to meet the 3% limit). What the government seems be doing is trying to do is buying time. There are difficult decisions to be made, but the government is clearly opting not to take them. At least for now. Having said that, there are several lessons that we can draw from reading the latest Portuguese Stability and Growth Programme (SGP).  What are, then, these lessons?
 Lesson #1 _ Stay positive, stay the course
Right or wrong, the Portuguese government genuinely believes that the strategy of the last few years is bearing fruits, and that public spending and investment (both in the form of traditional public investment and public-private partnerships) will, sooner or later, stimulate the economy. More specifically, the government estimates that 36% of deficit reduction (about 2% of GDP) will come from the recovery of the economy. Is this reasonable? Probably yes. Between 2008 and 2009, tax revenues declined around 1,7% of GDP, while public expenditures increased around  2000 million due to the temporary rise in fiscal transfers related to the crisis. The government is thus assuming that by 2010, or 2011, tax revenues will be back to its pre-international crisis levels and that the temporary expenditures will cease to exist (a big assumption, mainly if stagnation persists).
Lesson #2 _ Increase taxes (but don’t tell the public)
Although the Prime Minister said something akin to “read my lips: no more taxes”, it is clear that the Portuguese SGP entails an increase in the country’s tax burden. How? By lowering tax credits for taxpayers and by increasing the tax brackets for the highest income earners. New tax increases might not be discarded in the future. Can we achieve fiscal consolidation with these measures? Clearly not. However, they might help (a bit, at least). Can Portugal increase even further its tax burden in order to improve its fiscal imbalances? It can. However, the real question should be: is this wise? Probably not, especially when a recent study of the OECD clearly shows that Portugal is already in the European top 2 in terms of the brain drain of university-educated workers, and the country seems to be struggling in the attraction substantial new projects of FDI (something that the AICEP will likely dispute…).

Lesson # 3 _ Cut spending, but only if you really have to
The latest Portuguese SGP argues that there will be a reduction of 49% in government expenditures (corresponding to 2.8% of GDP), by implementing wage freezes for public sector workers, decreasing social transfers, and by continuing the reforms of the public sector. We don’t have any specifics on how the government is planning to do this, at least for now. Nevertheless, there are some vague intentions to continue the policy of hiring only one civil servants for each two that retire (a good idea), there are some promises to reduce social transfers (which increased recently due to the rise of unemployment), as well as renewed promises for more efficiency in the Public Sector.
However, the current document still does not answer two important questions. First, how will the government manage to reduce social transfers if the economy remains stagnated and unemployment stays high? Second, how confident can we really be that we will be able to obtain the considerable efficiency gains in the public sector that the SGP seems to imply?

Lesson #4 _ Privatize, privatize, privatize
The government predicts it will be able to get 6000 million euro from the privatization of public enterprises. Does this sound reasonable? Probably yes, especially because some of the enterprises involved will likely be attractive to investors. Moreover, as we all know, in the last 2 decades Portugal has been fairly successful in privatizing public enterprises (see table below)

Revenues from privatizations (millions of euros)

And while Greece might not want to sell its islands to foreign investors, the revenues from the sale of public enterprises means that the Portuguese don’t need to forego any of its most precious assets (i.e. land, Caixa Geral de Depósitos, etc), at least for now. The reason is that Portugal still has several state enterprises that account for a good chunk (about 5-6%) of the country’s GDP. In other words, Portuguese governments are big fans of privatizations, because it gives them greater room for maneuver with regards to fiscal policy. They don’t have to be as disciplined as they could be, and they don’t have to be too careful in managing the public debt, because there is always the option of selling a few state enterprises. Obviously, this strategy will only work while the State has assets to sell. If the Portuguese governments persist in an unsustainable fiscal path, sooner or later we will not have enough public enterprises to help pay off the public debt. And then, the really difficult choices will begin (especially if stagnation continues).

Lesson #5 _ Be creative
Like many other European countries have done, in the last few years the Portuguese governments have undergone substantial creative accounting in order to hide and postpone the public deficit. From postponing payments to suppliers, to extraordinary revenues, to sophisticated financial engineering, the Portuguese governments (of several political persuasions) have been fairly creative in the last few years in order to lower the budget deficit. The latest SGP is, once again, no exception.
The document is correct in pointing out that the salaries and wages from civil servants decreased from 14.4% of GDP in 2004 to 12,9% in 2009. This was perceived as crucial, because the Portuguese State spent more with its civil servants than anyone else outside Scandinavia. However, the document “forgets” to mention that this decrease in wages was mostly due to the transformation of hospitals and health centers from the public sector into public enterprises. According to a recent study by the Bank of Portugal, this transfer enabled the reduction in the public sector wage bill by around 1,3 percentage points of GDP (i.e. virtually all the reduction in the public sector wage bill from 2004 to 2009). Therefore, if things don’t go well in the next few years (that is, if stagnation continues) we shouldn’t be surprised if our accounting creativity flourishes once again in order to slash the (official) deficit.

Lesson #6 _ Forget (and hide) future debt
Another European trend in the last few years has been the utilization of public-private partnerships to substitute for public investment. PPPs are a great way to avoid the fiscal rules of EU’s Stability Pact, since they don’t enter into the calculations of a country’s public accounts. Portugal was no exception to this trend. In fact, Portuguese governments like PPPs so much that Portugal has now one of the highest rates of adoption of PPPs in Europe. Thus, in the last few years PPPs were introduced to build hospitals, roads and even high-speed trains. The only small problem is that, while governments like PPPs, they don’t include them in their calculations of fiscal sustainability of public accounts. At least in the short run. Still, as we can see in the graph below, the implications of PPPs for future budgets are fairly substantial. More specifically, from 2013 onwards, governments will have to pay around 2000 million years every year for PPPs.
Surprise, surprise, the latest SGP barely mentions this fact. Obviously, PPPs will have to be paid, but mostly after 2013. By then, paying the bill will be the responsibility of future governments, not this one. Thus, the government has all the incentives in the world to continue to feed its voracious appetite for PPPs. Yes, it is true that so many PPPs will cause more fiscal imbalances for future governments. But, why should this government really care about this?

Final lesson _ Postponing the problems
Pedro says that this document is the road to nowhere. It probably is. However, another way of characterizing the strategy of the Portuguese government is to call it the “strategy of dragging along”. That is, while this SGP does nothing to solve Portugal’s structural fiscal imbalances, it also does not cause major harm. The truth is that if it weren’t for Greece, Portugal would be barely on the radar screens of the markets. The government knows this and, hence, it must be secretly wishing that all the dust settles so that it can continue its agenda of spending its way out of recession (a big mistake, of course, especially knowing that this isn't working and it only aggravates the country's fiscal woes).
And thus the big lesson of this SGP seems to be that, once again, we will happily postpone the solution to Portugal’s fiscal woes. Yes, Portugal is in a fiscal mess. However, for this government, this is still not the time to deal with this mess. Someone else will have to clean it up.

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