On the face of it, the political implosion in Portugal, and the consequent return of the euro crisis, might strike some as surprising.
Since last summer, and Mario Draghi’s commitment to do “whatever it takes”, bond yields in the euro area have been in decline. And although it has had periodic political problems, Portugal has met every single one of the performance criteria and structural benchmarks set by the Troika of lenders who have provided it with money. Moreover, it has funding in place until next spring, so does not need to return to international capital markets anyway.
However, this benign impression relies on a few optical illusions. The first and most deceptive of them is that the debt-reduction plan is, in any way, on track. As the IMF’s own assessment of the country’s progress earlier this year pointed out, the “reduction in the gross debt-to-GDP ratio in 2013 reflects a number of one-off transactions rather than an underlying improvement in the public sector’s net worth.”
The entire purpose of the Troika programmes has been to try to reduce the scale of government spending, to trim over-generous social welfare and pension schemes and, in due course, to make the euro’s Mediterranean economies more efficient. This, in turn, should bring total government debt levels down – or so the theory goes. However, such reforms are hard, and usually take a lot of time and pain, so the Portuguese authorities instead reached for the low-hanging fruit, selling off the foreign assets of the social security fund and transferring its shares in the state-owned bank to a holding company outside of general government. Much of this looks suspiciously like clever accounting rather than actual cuts.
This is not to say that austerity hasn’t been pursued elsewhere in the economy. On the contrary, the situation for most citizens is grim. As you can see from this chart from the IMF, more than one-in-three people working in the construction sector have lost their jobs since 2008. One in ten workers in most other industries have lost their jobs too.
The problem is that this collapse has been largely a consequence of a broad-based economic slump rather than due to any increase in efficiency. Of all the struggling Eurozone nations save, perhaps, for Greece, Portugal is still stuck deepest in the trough. Compared with its level midway through 2008, Portugal’s GDP is currently 8.4% lower, compared with 7.9% in Italy and 7% in Spain (Germany is 1.9% higher).
And yet this hasn’t led to greater levels of efficiency: unit labour costs – which measure how much it costs to get a given unit of economic growth – have fallen less far in Portugal than in Ireland and Spain. In other words, to coin a phrase, what Portugal has undergone is the “wrong type of austerity” – the state remains bloated; some have lost their jobs but those who retained them have had their comparatively generous paychecks safeguarded. In short, the country is not doing more for less – it’s doing less for less.
However, its job is made far more difficult by the fact that its northern euro neighbours aren’t giving it room to rebalance. One of the hopes in the early part of the crisis was that Portugal and its Mediterranean counterparts would be able to reduce their current account deficits (and hence reduce their national indebtedness) by exporting more. However, being a euro member means having to compete with countries like Germany on the price of your exports (being yoked into the same currency means you can’t depreciate your way to cheaper goods). In the early stages of the crisis, Portugal’s exports did indeed increase, but the balance of trade has sunk into negative territory in the past six months, with internal EU trade the biggest drag.
At least part of the explanation is that while Portugal and others have indeed been gradually reducing their costs and trying to compete, Germany has been cutting its own costs too. You can see the phenomenon in the OECD graph below. This is the real reason why the euro crisis is not going away any time soon.
With Germany still competing so hard on cost, there is precious little room for countries like Portugal to attract business, and hence see a windfall for the local deflation they’ve had to endure.
Someone suggested to me recently that the Portugal crisis was more of a political than an economic story. That’s true, but only in the sense that every political story is at heart an economic one. Portugal is suffering from austerity fatigue: five years of pain have delivered diminishing returns, and what we are witnessing is each political party being discredited in turn. The problem is that modern political cycles aren’t well-equipped to cope with economic downturns that outlast them. One political party after another tries and fails to solve the country’s economic problems, and then is deposed. Eventually, people turn to more extreme alternatives.
That is the depressing phenomenon we’ve witnessed in Greece, and it is what we’re now seeing in Portugal. Political, yes, but irretrievably tied up with the economics.