IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Because the music stopped.
As Thatcher said, “They [socialists] always run out of other people’s money”. Portugal is now a perfect study case for this golden rule, with its quadruple-crisis.
First and foremost, Portugal faces a Financial Crisis. According to Visão, a major magazine in Portugal, Portugal needs 80 000 Million Euros during 2011. From that total, 13 500 will go to the State deficit and interest, 30 000 Million to debt rollover, 20 000 Million to the private sector, 15 000 Million to the financial system and 1 500 Million to big companies rollovers. To a total that equals 50% of Portuguese GDP. Just to keeps the country going.
Portuguese State Debt issues are finding lesser and lesser speculators interested in buying it, even when it is paying higher and higher rates. The rates in most maturities are now over 7%, the magic number Fernando Teixeira dos Santos – the ex-finance minister – told in a major interview in the public channel that would trigger an IMF intervention. Refer – the public railroad company – failed to issue 500 Million in debt in February, for the first time ever. In March, it asked that the “public service compensations” would be paid earlier or it could not met payrolls obligations in some months.
The banking sector is also facing a liquidity problem. As the Republic rating keeps falling (A-, by S&P), banks see their ratings downgraded (to BBB, by Fitch, in the case of BES), and the ECB is now the main international buyer of Portuguese banks debt – in fact providing liquidity and profits, as that money is then lent at 7% to the Portuguese State.
The second crisis is a profound Economic Crisis. Lending without guarantees has almost halted, the costs of financing are growing and the tax burden is getting heavier. As a consequence, investments diminish, production is already diminishing as well (measured by GDP, as assumed by the government in SGP4) and demand is tepid.
On its 2011 budget, the government forecasted a 0.2% GDP growth for the year. With the austerity package, it now predicts a 0.9% drop, in line with the European Commission report. Inflation is in line with European – i.e., at 2.4% and rising, despite the surge in unemployment, defying the much debated Philips Curve.
Traditionally, Portugal was a low-unemployment country, as it has one of the lowest minimum-wages across Europe: 475 Euros per month. Not anymore: Portugal has now 11% unemployment and it is now the eighth country regarding unemployment. The international crisis is responsible for part of the problem, but the ranking escalation cannot be fully explained by such factor.
This leads to the third crisis: the Social. On March 12th, 200 000 in Lisbon and 80 000 in Porto (and more in other major cities) demonstrated against the generational inequality between the academically prepared but low-paid youth and the acquired-rights generation that came out of the Carnation Revolution in 1974. In March 19th, CGTP – a workers union – demonstrated with tens of thousand in Lisbon. In May 1st, left-wing activists promise a “grand journey of fight”. The 4 Stability and Growth Packages have eroded some social groups more than others. SGP1 (March 25th, 2010) targeted the middle class: it limited income tax deductions and benefits, introduced pay tolls in several highways, taxed financial gains at 20%, tightened unemployment subsidy requirements and reduced social expenses by 20%. SGP2 (June 9th, 2010) targeted the poorest: VAT was raised 1 percentage point in all brackets, income tax was raised 1 or 1.5 percentage point in all brackets, and the lower brackets lost the 25% extra family subsidy. SGP3 (November 26th, included in the 2011 budget) targeted civil servants: VAT top bracket was raised 2 percentage points, civil servants above 1500 Euros were cut 5% in average, new limits to income tax deductions and benefits, banks were taxed 0.01% to 0.05% of its liabilities and pensions were frozen. SGP4 (failed March 24th, 2011) would have attacked the retired, cutting medicine support, raising taxes on pensions, reducing social benefits and raising several excise taxes.
This finally led to a Political crisis. In 27 European countries, only 1 had a minority government: Portugal. Each SGP was passed by the government and the main opposition party, with the small parties voting against. During Budget/SGP3 negotiations, tension was raised to the limit, with negotiations over weekends and major names clashing on television. For SGP4, the main opposition party and the president were not consulted, several measures so hard fought against during budget negotiations were included and the prime minister assured the press the package was first presented in Portugal (which a letter found in Brussels proved false) and that it was negotiable (which a statement by the Luxembourg Prime minister Jean-Claude Junker negated), leading many to propose that the crisis was provoked.
From the point of view of the Prime Minister Mr. Sócrates, the timing is the best possible: with party elections scheduled to March 25th and 26th, there is no time for a major candidate to appear. Re-elected by his party, he promises to try to get his job again, with a new mandate from the people to manage the country against all enemies, foreign (speculators) and domestic (IMF defenders).
From the point of view of Passos Coelho, the opposition leader, the timing is perfect: with a now comfortable lead in the polls (10% above the main opponent) unrest from within the party was starting to threaten due to the time it was taking to overthrow such a weak and unpopular government, but this momentum can now be used in a general campaign, while he just finished his political program. This includes: lowering corporate tax while raising VAT, several privatizations, increased privatization of hospitals, school vouchers, Danish “flexicurity” and an extensive cut in public companies, institutes, parishes, counties, and members of parliament.
The reason given by PSD to side with the small opposition parties and voting against SGP4 was not the package itself, deemed as “needed” given the current state deficit, but the lack of credibility a fourth austerity package in less than a year implicitly carried. Passos Coelho is known in Portugal as a liberal politician and, despite some socialist proposals (like co-paying salaries to endangered companies to avoid paying unemployment benefits in the future) and his party election obligations (he was elected as the choice of the party structure, a favour he must now pay), he will probably be the best choice in the last decades.
The future is unclear. An IMF or EFSF (European Financial Stability Facility) intervention is almost certain but, on the political front, the president can even reject the resignation (he postponed the decision due to the European Council) or form a “presidential-initiative” government. However, the most likely scenario is that Passos Coelho and PSD are going to win the June elections and form a majority government, with or without its companion in the European People’s Party (PP, the small right-wing party), depending on concrete results.
The country is going to turn right, but the left is certainly going to take it to the streets. The music is going to be different this time.
You will have the opportunity to hear a piece of it in May, during the next Eurovision. “The struggle is joy”.