Tuesday 5 July 2011

Should a struggling country predict too much?

So we have a new centre-right government and, despite previous promises, a new extraordinary income tax, on the 14th monthly pay check (I guess a southern oddity but already factored in by international wage comparisons). The tax is biased against the lower strata of the population, as it is almost flat above 3,000 euro monthly wage or so, and dividends and profits are exempt. Not a very well designed tax, one should say.

The EU/IMF/ECB troika didn't ask for it, at least until now. So, the key question is: should the government of a distressed country, such as Portugal, going through an already massive restructuring program, compress further the economy before it is necessary? Or should it have waited and see whether it would be necessary? The more I think about it, the more I get close to the conclusion that the move was in the wrong direction.

I think I still prefer to be ruled by policies set in Brussels then by too imaginative local officials. At least in Brussels they do not follow so closely the electoral cycle, which may be one of the reasons why the Portuguese government acted as it did on this matter. In fact, it looks as if they were following the same old rule of doing the hard stuff at the beginning of the electoral cycle to ease up later one. Unfortunately, in this juncture, that may have considerable negative macroeconomic effects.


  1. Should they really wait and see? What if this is one of those situations that it's better to prevent then to mend? I just don't understand why some forms of revenue such as dividends and profits are out of the equation.

  2. Pedro,
    I am not sure that this policy action has been driven essentially -- not even mostly -- by electoral reasons.
    The schedule set by the Adjustment Programme is indeed very tight and the pressure on Greece calls for an energetic policy in Portugal, to (try to) avoid that markets speculate us out of the Euro is Greece goes.
    I guess that the previous Ministry of Finance had considered measures such as this one.
    There are many Portuguese -- persons and institutions -- still not aware of our current status; it is crucial to bring them rapidly back to the real-reality of a broken state and an uncompetitive country.

  3. If you're going to have to cut wages of those who most need them, might as well do it while you are riding the high poll ratings, because later on it accelerates your unpopularity and at this stage of the game, the probability of civil unrest.

    Further, it is typical (although I don't know if this applies to Portugal) that when a new government takes over, they learn that the official numbers published by the previous administration didn't exactly account for all the nasty stuff hidden under the off-book rugs - and some times, that learning takes some time as "surprise!" financial data isn't all available on the first day, nor can they perform all the analytical number crunching that fast.

    The trouble with spending cuts to the poor is that while it may help debt roll over repayments in the short term, it really does steal from consumer consumption rates, because the most poor typically live pay cheque to pay cheque and have little or no savings - so that would have been money spent into the economy. The only question is, what % of GDP will that impact down the road.

    One thing is certain though, if Portugal can pull the miracle of meeting its debt roll over loans without needing to take on even more debt at even higher interest rates, it may just have a chance, and if it is going to have any chance of doing that it is immediately after a new government is formed, because once that new government starts failing to meet deadlines and payments, it doesn't matter how honest the new prime minister or his cabinet is versus the last one, it will plunge Portugal deeper down into the abyss.

    In the end, the only answer to structural debt problems (aside from defaulting) is to cut the debt, the very tricky part is how exactly to accomplish that.