Saturday 22 January 2011

An Economic or a Political Problem?

Source: P. Pereira et al. (2009) Economia e Finanças Públicas, Escolar Editora, Lisboa

Several posts below have wondered whether Portugal has an economic or political problem. I believe it has both. I shall illustrate with the topic of public finances.

When we look at the history of public finances after the revolution (1974) four main facts emerge. Firts, Portugal never had a superavit in 36 years of democracy. Second, the only time it reduced the weight of public expenditure in GDP (without off-budget measures) was after the second IMF intervention (1983-84).

Third, the growth of public debt has been curved down only through privatization of a huge amount of public assets nationalized after the revolution (a pattern followed with and without the IMF). Fourth, there is a strong evidence of political business cycles over the last 20 years in all legislative elections (1991, 1995, 2002, 2005, 2009) except one (1999).

Now, do we have an economic or a political problem? As we all know a deficit of 3% would not be a problem with a nominal growth rate of 5%, because it woul stabilize the debt to GDP ratio at 60%. The problem is that we did not have that growth rate in the last decade and will not have it in the next decade. So, we have an economic problem.

However, we also have a political problem. As I see it Portugal (and peripheral mediterranean countries) has the instituional disease Mancur Olson identified almost 3 decades ago in The Rise and Decline of Nations: institutional sclerosis. And only a strong government with wisdom, and a majority support in parliament can tackle it. It is a necessary (but not sufficient) condition...

We also have political problems!

(for my articles in Portuguese see Publico and for earlier writings


  1. Sorry, but I refuse the idea that reduces all economy to the government budget.

    First we have to establish the relevance of the budget deficit, to know it deficits are a real problem or some kind of "bogeyman" used to scare children into eating theire soup.

    We all know (well some of us) when a budget deficit is a problem, and it requires a mechanism of transferal to the economy, being it the monetary supply the and exchange rate. So usually the simptoms of a budgetary problem are high inflation and interest rates.

    Can a goverment deficit be a problem on a integrated economy? How?

    In theory in an integrated economy such as the portuguese, interest rate and exchange rate should be the same, and although inflationary differences can occur, those should be permanent nor biase the trade terms.

    If the Portuguese government defaults on the debt, what would be the consequences, and please don't refer to the apocalypse, and assume backrupcy has a "normal" business decision.

    All and all, we know that goverment deficits have a high correlations to GDP growth, and we all know that GDP growth is the real problem in Portugal and in the European periphery, not the budget, nor public spending.

    Just imagine a scenario where this countries stop spending and reduce the budget to 3%. Imagine the consequences of a 4% direct cut on GDP via public spending, add to that the multiplier effect, which society can take a 8% cut on GDP?

    The problem isn't government spending, the problem is the anemy of private demand.
    Problem isn't the overspending and lack of criteria (remember Keynes)the problem is that governments are killing private demand by raising taxes and imposing an high euro exchange rate.

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