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.

Public Debt 1850-2011

It's now official. We have the largest public debt as a percentage of GDP since, at least, 1850. A sad, sad legacy.

Public Debt as % of GDP, 1850-2011

 Source: Mata and Valerio (1992), Neves (1994), INE, Santos Pereira (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 http://jornal.publico.pt/noticia/22-01-2011/execucao-do-oe-2011-bussiness-as-usual-21079652.htm and for earlier writings http://www.iseg.utl.pt/~ppereira/finpub)