Monday, 24 May 2010

A balanced budget by 2016

Independently of whether we decide to impose constitutional requirements on the growth of public debt and the budget deficit (a good idea, which I have also defended here), I strongly believe that the next government would greatly benefit if it could achieve a balanced budget as rapidly as possible.
More specifically, I believe that a balanced budget could be achieved by 2016 without unacceptable sacrifices or social tensions and without a major recessionary impact. Why? Because, if all goes according to plan (a big if, I know), the budget deficit will be below 3% of GDP by 2013. Hence, the government would “only” need to reduce the deficit by 1 percentage point per year until a balanced budget is reached by 2016. A 1-percentage point per year reduction in the budget deficit does not strike me as recessionary, especially when compared with the targets of deficit abatement already set for 2010 and 2011.
The question is thus: Why should we aim for a balanced budget? Two words: credibility and reform. Let’s start with the former. One of the sad state of affairs of our economic policy is that most of our governments (not all, but most) have shown a total lack of respect by those who ultimately pay the bills: the taxpayers. By expanding public expenditures virtually without restrain, the Portuguese governments are constantly expecting not only that the subsequent rise in the tax burden will not harm the economy, but also that taxpayers will not mind paying the tab for the rise in expenses (obviously, the last few years have increasingly shown that these two premises are simply wrong).
Therefore, it is not totally surprising that, since democracy was implemented, no government was even close to achieving a balanced budget. Far from it. As we can see in the graph below, the Portuguese governments have always maintained significant budget deficits, even at times of fast economic growth, when revenues are higher. 
The best that our governments have done was to achieve a budget deficit slightly lower 3% of GDP. This at times when they were literally forced to do it, first by the Maastricht criteria and after by the Stability Pact. Suffice to say that this “accomplishment” was also partly done by resorting to some extraordinary measures as well a small dose of creative accounting…. It is also worth mentioning that this was achieved at a time when the Portuguese governments did not have to worry about the growth of public debt, due to the unprecedented windfall from privatizations of enterprises (privatizations earned the Portuguese State 5 billion euros between 1989 and 1994, and more than 17 billion euros between 1995 and 2001, a period when public expenditures rose at record levels).

Portuguese budget deficit as % of GDP, 1976-2009 

In other words, if there is something that Portuguese governments are missing (in the eyes of the markets and the electorate) is credibility. Hence, by setting the target of a balanced budget until 2016, the next government would signal that, from now onwards, things will be different, i.e., governments would be behave responsibly. A big novelty indeed. And a big boost to credibility.
Furthermore, by committing to a balanced budget and fiscal discipline, the government would reclaim some of the sovereignty that was recently lost to Brussels and Berlin. By setting national targets of fiscal discipline instead of being forced to do so by Brussels and Berlin, a new government would be retaking the control of (part) of our economic sovereignty. Foreign direct investment could also benefit from the improvement in the perception regarding our fiscal discipline.

Balanced Budget and a reform agenda
Due to the new austerity measures, I think that the next government will find it difficult to govern, but easy to reform. It will be difficult to govern because, clearly, austerity will bring a rise in social tensions and demands. However, the next government will also find it easier to reform, because, after the lack of control and reckless behavior of the last few years, it is very likely that the Portuguese electorate will be in the mood for reform.
Thus, I sincerely believe that, if it wishes, the next government could implement a sweeping reform agenda that could leave a considerable mark for the foreseeable future. Namely, if the next government decides to implement comprehensive reforms in our inefficient and expensive State (i.e., cut structural expenditures), it will likely find out that the general public will be on the side of the reformists, and against those that want to block reform. By setting a target to balance its books by 2016, the next government would show that true reform of the State can only start when governments consciously and willingly decide to balance their books.
Furthermore, I sincerely think that the next government should not underestimate the political and electoral gains that could obtain if it would be able to reach such a target. In the last 10 years, we have spent so much time and effort discussing the country’s public accounts that it is highly likely that the first government to achieve a balanced budget would surely praised for achieving such a feat. The first government to do so would also influence the agenda of governments that would follow.

Summing up
Portugal needs badly to reform its State and to cut structural public expenditures. What better way to do it than by doing something than no other democratic government has done? What better way to start afresh and anew? What better way to show a reformist spirit than by demonstrating that the State can also (and should also) control its expenditures and balance its books, just like any other economic agent has to do sooner or later. It is time for the Portuguese government to finally show some respect and consideration to Portuguese taxpayers. It is time to bring a balance budget to our agenda.

PS. Here is a similar text in Portuguese.


  1. Professor,

    I completely agree with the idea of a balanced budget, but the problem here is on the details. Government accounting is very different from other economic agents' accounting. For example, selling my house at a firesale price is a bad decision, but the government selling a building at a firesale price is good news because it reduces deficit (even though it increases it in the following years). Therefore, I am afraid that, with current accounting, a balanced budget would ultimately compromise the health of the economy by encouraging this kind of behavior. Shouldn't we reform government accounting first?

  2. Why do you think that no other democratic government has adopted so far the agenda you are now proposing?

  3. I believe that Germany has adopted that goal.

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