The IMF/EU/ECB bailout for Portugal: Structural Reforms

The IMF diagnostic of the Portuguese situation is broadly correct: “deep-rooted structural problems—including low productivity, weak competitiveness, and high debt—severely undermine potential growth”. To re-launch growth the adjustment program includes a set of structural reforms focused on “increasing competition, reducing labor costs, and boosting employment and productivity”.

Yet the end of the dismal growth of the Portuguese economy over the last decade (only 0.7% of annual growth) is not on sight. The cyclical rebound expected for 2013–14 will reach only 2.5% and will decline subsequently to 2%. Unemployment is projected to peak at 13 percent in 2012 and the current account deficit is projected to narrow gradually to 3.4% in 2014. The unemployment and the current account projections seem to be on the optimistic side. In particular the expected strong decline in imports is at odds with the expected growth of exports given the high import content of Portuguese exports.

The five key measures include: a) a fiscal devaluation through the payroll taxes; b) a reform of the housing market; c) a reduction in the backlog of judicial cases; d) increased labor market flexibility by reducing severance pay by 1/3 (10 days) and restricting unemployment benefits; e) reducing the implicit subsidies in the electricity sector and improve the competition framework to rebalance growth towards the tradable sector and reduce rent-seeking behavior; and f) a privatization program aimed at raising €5 billion in revenue.

These measures point in the right direction but are modest and miss some of the major cancers that we identified in the Portuguese economy. For instance, they completely fail to address the widespread system of subsidies that are an important source of corruption, make companies subsidy-dependent and kill true entrepreneurship. Moreover the efficacy of the measures listed above is questionable in some cases.

Namely, the privatization program is too slow and too modest. And, in cases like water supply, it might add to the problems already caused by other privatized utilities. Indeed, the program would need to be supplemented by a nationalization program covering PPPs, the health sector and some utilities.

Likewise improvements in the competitive framework are not enough to solve the rent-seeking problems mining the Portuguese competitiveness. As has been observed in the oil sector collusion among oligopolistic firms is clearly seen but not easily proved. For example, an efficient and competitive solution could be achieved by introducing a leveling field fee to ensure cross border competition.

Most importantly the fiscal devaluation may turn out to be fiscally non-neutral and insufficient. Its broad base makes it a costly solution and the offsetting tax rises will dampen growth. Assuming a likely cut of about 4% this means a one-off reduction in unit costs of less than 2.5%. Thus its impact on growth might not even be enough to offset the reduction in growth caused by the tax rise. In any case this compares poorly with a potential 7% devaluation achieved with our proposal to increase the number of working hours.

In conclusion, although the IMF program points in the right direction it will not reverse the slow growth of the Portuguese economy and may not fulfill the countries ambition to resume the normal access to international markets and to take care of its own destiny. Unless the new government is able to improve and extend the IMF program, I am afraid that we will need soon another bailout.