(The 10 capital sins: #1)
Today we finally knew the “Memorandum of Understanding Of Specific Economic Policy Conditionality” produce by the troika (ECB/EC/IMF). It has some positive contributions, but as I expected it sidestepped some major “capital sins” of public finances. Let us start with Portuguese “federalism”: MAIN PROPOSALS from the troika: to reduce transfers to local and regional governments by at least 175M in 2012 and by 175M in 2012 and limit the reduction of the regional personal and corporation income tax rates to 20%, when compared with mainland tax rates. These measures do not address the structural problem of Portuguese strange “Federalism”.
When Wally Oates developed his seminal work - "Fiscal Federalism" - almost 30 years ago and gave birth to 1st generation theory of fiscal federalism, he was cautious saying that his approach was economic, although he acknowledge that political issues were relevant. Two decades after, a 2nd generation theory has given more importance to political issues.
Well, in the case of Portugal political issues are determinant in shaping and they are responsible for increased public expenditure. What economic theory still suggests is that countries with several tiers of government (federal or unitary states) should have the main taxes (mainly personal and corporate income taxes and VAT) shared by the upper two levels of government (federal/central and regional) or three (also including municipalities) and this should be supplemented by a set of intergovernmental grants designed in a way to somewhat partially equalize revenues (positively discriminating in favour of poor regions) and other to promote efficiency.
The Portuguese model is very peculiar, and almost nonexistent in Europe. One level of government (the Regions of Azores and Madeira) have all tax revenue generated in the territories. Citizens of these regions do not contribute one cent to the national functions of the state. Additionaly, there is a generous regional finance Act that transfers funds to the regions, and also a Local Finance Act which transfers funds to regional (and mainland) Municipalities. Finally, several regional expenditures are funded directly by the State Budget (e.g. Police, Universities, etc.). Obviously all these transfers and expenditures are funded by taxes generated in mainland Portugal. A particular weird situation exists today, since the current Local Finance Act (2007) gives the municipalities the possibility to have up to 5% of the personal income tax (IRS). The government of Portugal wants this revenue to come from the regional IRS, but the governments of the regions want it to come again from the State Budget.
It is clear that this peculiar model of "Portuguese Fiscal Federalism" has no economic rationality, but it has a political explanation. This article of the Constitution was introduced in 1976 after the revolution. At that time a minor threat of independence of the islands must have frightened the politicians in mainland Portugal and the norm was adopted. Over the last 30 years, there were several amendments of the Constitution, which did not change this norm. Also the laws regulating the relationships between the Republic and the Regions (Estatutos Politico Administrativos) have been revised and the tendency has been an ever increasing degree of autonomy. Again the explanation is political. Members of Parliament (MPs) elected from these regions have been pivotal to produce majorities in the national parliament, so that they usually have a big bargaining power.
These issues obviously were not considered by the troika. We just have some cuts in transfers. When the storm of the fiscal unbalance will be over, expenditure will grow again, since here no structural reform is suggested.
Proposal 1 : Preferably to change this norm in the Constitution and the regional finance act, in line with what are the best practices in developed countries (tax sharing arrangements) and the economic theory of fiscal federalism suggests. If this is considered not politically feasible decrease substantially (!) regional transfers. Deduct the value of expenditures that should continue to be financed through the budget (e.g. police), from the value of transfers.
Proposal 2 : Suggest to Eurostat that revenues and expenditures of the regions be classified in S1312 (where state accounts are considered en federal countries). If the regions in Portugal have more taxing powers and a greater share of revenues than states in federations why should they not be considered in S1312? This would increase transparency.
Wednesday, 4 May 2011
One group of people to NOT be congratulated about the package..
The EU/ECB, which after three packages, still does not have a comprehensive approach to deal with the problem. Still no talk of institutional reforms, still no attempt to go to the heart of the debt/bank crisis in Europe. Just continuing to muddle along, waiting for the next crisis to hit.
One group of people to be congratulated about the package..
The officials at the Ministerio das Financas and at the IMF. They worked hard, made sensible proposals, did not exactly have strong political backing, and managed to avoid the kind of crazy/inapplicable grand measures that these packages often contain.
Relative to the original Greek package, there was good progress in terms of doing sound economics.
A very good thing about the package
Lowering payroll taxes and raising VAT in order to effectively do a devaluation of the currency via fiscal instruments (or, more appropriately, levy an implicit import tax).
A big unknown from the package
Privatizing EDP (electricity provider), REN (electricity grid), and TAP (airline) in the next 7 months. Where is the private money going to come for these?
The usual pattern in privatizations in Portugal has been for big economic groups to borrow heavily from banks. But then how can you square these big loan with the increases in capital ratios in the banking sector?
My guess is that the IMF/EU/ECB team, aware of this, was trying to force a sell-off of these companies to foreign owners. But the political resistance to this will be tremendous. So I fear that, in the end, pressured to sell quickly, the government will sell cheap and give *very* good deals to the big Portuguese economic groups.
It will be especially important to see the kind of financial engineering tricks that they will come up with to hide implicit loans form the government to these groups.
Another quick (political) reaction to the package
Conditionality in these circumstances is as powerful a constraint as they get. But what kind of stable political coalition in parliament in support of what kind of government will be able to pass in the next three years the kind of legislation required in the fields of justice, health, education, housing market, local government, scrutiny and elimination of public or semi-public entities, and regulated professions? And what technical capabilities, expertise and - especially - independent agencies are there to adequately perform the kind of analysis and cost-benefit evaluations prescribed in the package? Not sure.
The bad side of the package
After the "big bad wolf" said that they could solve Portugal's problems without firing government employees or even further lowering their wages, the political ability for any party to defend these policies went to zero. One of the many reasons why signing these deals before, rather than after elections, is a bad idea
The wishful thinking part of the package
550 million in cost reductions in health care. They should let the US and other countries fighting with cost control in health care in on the magic secret to do this.
The good side of the package
The economic analysis is quite sound. It tries to fix the problems in public finances by trying to work on multiple margins rather than enforcing any revolution.
On BBC world service
If you want to hear my reaction to the rescue package, you can catch me on the BBC world service.
Tuesday, 3 May 2011
Always surprising !
The Prime-Minister announced today not the measures involved in the bail-out agreement.
Instead, announced the measures that are NOT involved!!
Well, actually the ones that have been reported in the press and are not involved!
Should then we anticipate that ones that circulated, and were absent from the NOT list
will be included? Stay tuned to the next chapter.
What's in the NOT list:
- no pay general pay cuts, not even wages paid with public debt
- no change in pensions below 1500 euros
- no wage cuts to civil servants
- no reduction in minimum wage
- no constitutional revision
- no privatization of the public bank (CGD)
- no change in copayments of the National Health Service
- no change in publicly-funded schools
- no dismissals in civil service
- no dismissals without cause in companies
- no privatization of social security
- no caps in social security
- no increase in retirement age
You can read the portuguese version in the site of the Government here (I find funny the link address has "troika" in it)
Now, let's wait to see the "IN" list !
The length of unemployment benefits
What are the effects of more generous unemployment benefits? This question is addressed in a paper by Mario Centeno and Alvaro Novo delivered last week in a labour economics conference. The paper studies a 1999 reform in Portugal, when the unemployment benefit (UB) entitlement period was increased from 15 to 18 months for people aged 30-34. However, the entitlement was left unchanged at 18 months for people aged 35-39, who are used as a counterfactual.
The figure above displays job finding rates at different unemployment durations and finds very clear spikes exactly at the time when unemployment benefits run out. Consistently with previous evidence, these results indicate that unemployment duration increases very closely with the maximum UB length. Moreover, although one could expect that more generous entitlements would allow the unemployed to look for better jobs, the paper also reports that re-employment wages do not benefit, on average, from longer UB entitlement.
(On the other hand, there is evidence that those that leave unemployment at about 15 months when the maximum entitlement was 18 have higher re-employment wages than those that leave unemployment again at about 15 months but when that was also the maximum entitlement. However, it is not clear if the best comparison would be with workers that leave unemployment at say 12 months when the maximum entitlement was 15 months.)
All in all, the decision to extend unemployment benefits in 1999 (in a period of economic expansion) seems, in my opinion, to have been misguided and wasteful. Let's just hope that, now that the troika-led reforms are about to be unveiled, the findings from the paper prove symmetric in both the business cycle and the direction of change, i.e. that any cuts in UB duration (and generosity?) during a recession will also speed up job finding.
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