School of Economics and Management TECHNICAL UNIVERSITY OF LISBON Department of Economics Carlos PestanaAntónio Barros Afonso & Nicolas Peypoch Anatomy of a fiscal débacle: the case of A Comparative Analysis ofPortugal* Productivity Change in Italian and Portuguese Airports WP 01 /2013/DE/UECE _________________________________________________________ WP 006/2007/DE _________________________________________________________ WORKING PAPERS ISSN Nº 0874-4548 Anatomy of a fiscal débacle: the case of Portugal* António Afonso# January 2013 Abstract After entering the EU in 1986, Portugal benefited from low interest rates and some growth momentum. However, the difficulty in taming fiscal imbalances, the pro-cyclicality of fiscal policy, the use of extraordinary fiscal measures, coupled with the 2008-2009 economic and financial crisis led to a fiscal débacle and to an international financial rescue in 2011. We briefly review here those developments. JEL: E62, E65, H6 Keywords: Portugal, public finances, fiscal imbalances 1. Introduction After 1985 Portugal faced several important economic and institutional transformations regarding notably a deeper economic and financial integration in the European Union (EU) level: joined the EU in 1986, joined the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) in 1992, and adhered to the Economic and Monetary Union (EMU) on January 1999, adopting the euro in 2002. In terms of public finances developments, the fiscal consolidations that occurred in the 1980s were short-termed and mostly not successful. Indeed, Portugal was the first country in the EU to breach the Stability and Growth Pact (SGP) in 2002, becoming therefore subject to the Excessive Deficit Procedure (EDP), a situation that occurred again in 2005 and in 2009. * I am grateful to useful comments, on previous versions, from Cláudia Braz, Vítor Gaspar, Patrícia Martins, and Clara Raposo. # Univ Tecn Lisboa, ISEG, School of Economics and Management, Department of Economics; UECE, Research Unit on Complexity and Economics, R. Miguel Lupi 20, 1249-078 Lisbon, Portugal, email: [email protected]. UECE is supported by FCT (Fundação para a Ciência e a Tecnologia, Portugal). Then, on April 2011, notably in the context of the global economic and financial crisis, and in the midst of the European sovereign debt crisis, with prohibitively rising long term yields, Portugal asked for the financial support of the EU and of the International Monetary Fund (IMF), signing a Memorandum of Economic and Financial Policies (MEFP), adopting a programme set to last until mid-2014. This note offers some stylised facts and assessment of the main developments in fiscal policy in Portugal in the last 30 years, in particular to what extent fiscal behaviour has been on an unsustainable path. Mostly, the upward path in primary spending, the lack of relevant cyclically adjusted primary balances, coupled with pro-cyclical fiscal policies, and the wide use of extraordinary and one-off fiscal measures (for example, sales of non-financial assets and revenues resulting from the transfers of pensions to the general government), and the weak growth after the 200s, compounded with the capital markets turmoil, paved the way to the inability of autonomous sovereign long-term financing. This not eis organised as follows. Section two reviews developments in public finances. Section three offers comments on the fiscal débacle. Section four concludes. 2. Stylised developments After the adoption of the euro, Portugal’s business cycle became more synchronized with the euro area business cycle, as one would expect. Indeed, business cycle synchronization increased from 0.265 in the period 1993-1998 to 0.793 in the period 1999- 2009. 1 On the other hand, and contrarily to several other more exported oriented economies in the euro area (for instance, Austria, Belgium, Finland, Germany, and Ireland) in Portugal the share of private consumption in GDP increased from 63.6% in the period 1993-1998 to 65.2% in the period 1999-2009. In addition, and regarding some changing composition in the components of GDP, per sector, one observed also the diminishing relevance of the share of the primary sector activities in GDP, following notably some EU incentives in that direction after the entrance in the EU. 1 Synchronization is measured on the basis of correlation coefficients between the cyclical component of real GDP in Portugal and the cyclical component of real GDP in the euro area (HP filter), see Afonso and Sequeira (2010). 2 2.1. Public finances’ developments Portugal was one of the countries that gained the most from the decrease in interest rates, given the high interest rate levels that it incurred in the past. For instance, between 1986 and 2004, the implicit interest rate in the stock of government debt decreased around 9 percentage points (see Figure 1), after have peaked in 1992, and that could have been used to implement sustained fiscal consolidations, but basically that was never fully pursued. Figure 1 – General government debt implicit interest rate 16,0 15,0 14,0 13,0 12,0 11,0 10,0 9,0 8,0 % 7,0 6,0 5,0 4,0 3,0 2,0 1,0 0,0 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 1 1 1 1 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 Source: European Commission, AMECO, October 2012. Own calculations for the implicit interest rate, which is Interest payments/Government debt *100. Indeed, public primary expenditure in Portugal has been trending upwards since the late 1980s, after the adhesion to the EU (see Figure 2). Indeed, primary expenditure averaged 23.5%, 31.6%, 35.7%, and 42% of GDP respectively in the 1970s, 1980s, 1990s, and 2000s. This contrasts with the developments observed on average in the EU, where the government spending-to-GDP ratio remained more stable. Another worrisome conclusion (see Figure 3) is the existence of high budget balance deficits and rather inexistent primary surpluses in the last decades.2 Indeed, the budget deficit in the period 1974-2012 was below 3% of GDP only in two years, 1989 and 1999, 2 See Guichard and Leibfritz (2006), Pina (2004), and Cunha and Braz (2009) for assessments of the pitfalls in past fiscal policy developments in Portugal. See also OECD (2012) for a recent analysis. 3 with average budget balances of -6.9%, -5.0%, -4.8%t of GDP respectively in the 1980s, 1990s, and 2000s. In such context, it was not surprising that two distinct stylized events, but naturally connected, occurred. First, the fact that the few fiscal consolidations that took place in the period 1970-2012 were mostly short lived. Second, the recurrent Excessive Deficit Procedures opened for Portugal after 2001 (three in total). Figure 2 – General government spending-to-GDP ratios, Portugal and EU15 (1970-2013) 55 50 45 40 P D G 35 f o % 30 25 Total expenditure Primary expenditure 20 Tot. exp. EU15 15 0 3 6 9 2 5 8 1 4 7 0 3 6 9 2 7 7 7 7 8 8 8 9 9 9 0 0 0 0 1 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 Source: European Commission, AMECO, October 2012. Another worrisome conclusion (see Figure 3) is the existence of high budget balance deficits and rather inexistent primary surpluses in the last decades.3 Indeed, the budget deficit in the period 1974-2012 was below 3% of GDP only in two years, 1989 and 1999, with average budget balances of -6.9%, -5.0%, -4.8%t of GDP respectively in the 1980s, 1990s, and 2000s. In such context, it was not surprising that two distinct stylized events, but naturally connected, occurred. First, the fact that the few fiscal consolidations that took place in the period 1970-2012 were mostly short lived. Second, the recurrent Excessive Deficit Procedures opened for Portugal after 2001 (three in total). More specifically, we can observe in the 1990s and in the 2000s a higher spending-to- GDP ratio in terms of the compensation of public employees, vis-à-vis the EU15 average. 3 See Guichard and Leibfritz (2006), Pina (2004), and Cunha and Braz (2009) for assessments of the pitfalls in past fiscal policy developments in Portugal. See also OECD (2012) for a recent analysis. 4 That ratio in Portugal trended upwards after 1986, and stayed above the EU15 average all through the 1990s, being only reversed after 2005 (see Figure 4). However, part of the reversion in 2003 is due to the fact that several hospitals were given the status of enterprises, and exited the general government sector, implying the reduction in the number of employees and in the overall wage bill. Figure 3 – Budget balance and debt-to-GDP ratios in Portugal (1973-2013) 118 10.0 114 Budget balance Total revenue 9.0 110 8.0 106 Total spending Debt 102 7.0 98 6.0 94 5.0 ) t 90 4.0 b e 86 3.0 ) D 82 , 2.0 e c d 78 n n 1.0 a e 74 l p 70 0.0 a S B , ( 66 -1.0 v P e 62 -2.0 D R ( 58 -3.0 G P 54 -4.0 % D 50 G 46 -5.0 % 42 -6.0 38 -7.0 34 -8.0 30 -9.0 26 22 -10.0 18 -11.0 14 -12.0 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 1 1 1 1 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 Source: European Commission, AMECO October 2012.