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Portugal confronts limits of anti-austerity drive

Thursday, August 9, 2018 - 11:06
Financial Times

Government pioneered measures to exit crisis but critics say investment has suffered

“It’s very simple. We don’t have the money.” The blunt words from António Costa, Portugal’s socialist prime minister, were aimed at teachers’ unions demanding payment of frozen salary increments dating back more than nine years.

Pay talks are set to resume soon against a background of months of protests and work stoppages. Mr Costa’s rebuff in early summer, setting the tone for tense budget talks between the minority Socialist government and its hard left partners, has highlighted the strains within an alliance that has sought to make overturning austerity compatible with fiscal rigour — and the limitations of that approach.

Emerging from the eurozone debt crisis, Mr Costa won popularity at home and admiration abroad as the pioneer of an alternative strategy to the harsh fiscal measures advocated by Germany and other north European governments.

Centre-left parties across Europe have taken heart from Mr Costa’s enviable poll ratings, seeing his policy of promoting growth and budgetary discipline as a way to chart a course between neo-liberalism and traditional leftwing interventionism. Speaking to Portugal’s newspaper Expresso, Peter Mandelson, the British Labour peer, recently praised Mr Costa for “inaugurating a fourth way” for European social democrats.

Others argue that his formula is based on an “illusion” of relieving austerity that is unsustainable and damaging to the long-term health of the economy.

“The idea that austerity has been reversed is a myth,” said Pedro Santa-Clara, professor of finance at Lisbon’s Nova School of Business and Economics. “In fact, increased current spending has been more than offset by drastic cuts in public investment, higher taxation and lower social transfers.”

Federico Santi, an analyst at Eurasia Group, says the fine line the government has tried to follow “is becoming increasingly difficult to maintain as the impact on public services becomes more tangible and growth shows signs of slowing”.

After taking office in late 2015, Mr Costa set about overturning measures enacted by the previous centre-right government during a painful 2011-2014 adjustment programme negotiated with Brussels and the IMF in return for a €78bn bailout.

In the state sector he has reversed wage and pensions cuts and cut the working week from 40 hours to 35. He has increased the minimum wage, cut income tax, especially for the low paid, and restored four bank holidays.

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His alliance of moderate socialists with communists and the anti-capitalist left has also presided over a robust recovery. Growth reached 2.7 per cent last year, the highest in a decade, while unemployment has fallen below 7 per cent, down from 12.5 per cent in 2015.

But economists warn against the notion that Portugal’s turnround is a direct result of Mr Costa’s policy of “turning the page on austerity”.

“The gradual rollback of austerity measures since 2016 may have contributed to some degree, but does not seem to have been a critical factor,” said Mr Santi.

More important drivers, economists say, include the impact of international growth on exports, a tourism boom and a drop in interest rates that has sharply reduced the cost of servicing Portugal’s huge public debt.

Mr Costa’s critics point to failing state services, including overstretched hospitals and a rundown railway network, as evidence that the government has cut back on public investment to offset its largesse towards public sector workers. Income tax cuts have been counterbalanced by higher indirect taxes, they add.


In fiscal policy, the government has proved as strictly disciplined as its centre-right forerunner. Carsten Hesse, an economist at Berenberg, said Mr Costa’s policies have not changed the downward trend in the structural budget deficit, which takes into account the impact of the economic cycle. From 8.5 per cent of national output in 2010, it fell to 1.1 per cent last year. Mário Centeno, finance minister, planned to slow the pace of fiscal consolidation. In fact, he has kept close to the targets set out by his hawkish predecessor and expects to produce a budget surplus by 2020.

“The government focus on keeping a tight leash on the deficit was definitely not what many expected from the unusual alliance that runs the country, but it is a very positive policy,” said Nuno Fernandes, dean of the Católica Lisbon School of Business and Economics.

Ricardo Paes Mamede, an economics professor at the University Institute of Lisbon, said Mr Centeno’s fiscal prudence cannot be equated with previous austerity measures intended as a response to recession. Such policies, he said, have been proven wrong and counterproductive.

Mr Costa’s original plan was based on the supposition that higher public sector wages would fuel domestic demand. In the event, exports have proved the engine of Portugal’s recovery. Yet even his harshest critics accept that his formula has proved remarkably successful in restoring confidence and optimism.

“The problem is that the government’s policy is unsustainable,” said Mr Santa-Clara. “It’s borrowing from the future. In the end, the cut in investment spending will have to be reversed.”


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