Bailout and the 10 Capital Sins of Portuguese Public Finances

Now that Portugal will have a bailout it is important to understand, what can be labeled as the ten capital sins of Portuguese Public Finances from a politico-economic perspective. This small essay (provided here as times goes by) may be of interest to several groups of people. The technical experts of the institutions that will negotiate with Portugal the bailout (mainly from the European Commission, The European Central Bank and the International Monetary Fund); the European politicians that lead the EU, those who have worked out the revisions to the Stability and Growth Pact (SGP) and those who are now redesigning the European Stabilization Fund ; the Portuguese citizens who will mostly suffer from the mismanagement of public finances, in particular the young generations who will pay the major part of the bill; economic journalists; and last but not least the Portuguese politicians who will run Portugal (and those who will stay in opposition) after the 5th of June general election .
As will become apparent some of the "sins" have developed in close connection with the structure of incentives embodied in European rules. Others are more idiosyncratic. The interest in presenting them is that although they are specifically Portuguese, and should be taken into account by different “stakeholders”, they exist in slightly different forms in several Europeans countries. So what some of them reveal is the urgent need for reforms at an European level.


The order of presentation will not be the sequence of relevance and all comments will be welcome. The timing of writing is uncertain, but I will try (not promise!) one or two contributions per week.

PS Some economists disregard the problem of public finances saying that the problem of Portugal is lack of economic growth and that having the latter the former will be solved. We all know that there is a relationship between the nominal growth rate, and the deficit-to GDP ratio that sustains a constant debt-to-GDP ratio. When the Stability and Growth Pact was designed, politicians assumed European economies will grow nominally on average at 5% so that a deficit ratio of 3% will keep the debt ratio at 60%. Although it is obviously truth that growth really matters, the argument that deficit and debt are just a byproduct of other issues is not only fallacious but also dangerous. As we will show the mismanagement of Public Finances in Portugal is a consequence of several structural problems, the sources of which are independent from economic growth. If these problems are not solved, they will impair economic growth, ie they will have a counter-effect on any measures taken to improve growth. That is why it is dangerous to disregard them.

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.