This is the opening speech of Prof. Pedro Passos Coelho, former Prime Minister of Portugal, guest Professor at the University of Lisbon (Institute of Social and Political Scienes) and at the Lusíada Universidade of Lisbon. The speech was held on Thursday, 17th October, 2019, at United Europe`s Young Professionals Seminar “How to strengthen the Eurozone” at Lusíada Universidade in Lisbon.
Good morning. I would like to thank to United Europe and to Lusíada University for invited me to address this first words in your Seminar here in Lisbon. I had a great honour for being leader of the leading opposition party at the beginning of the crisis and later for being Portuguese Prime Minister in a so demanding time as it was the time of the sovereign debt crisis and the euro crisis that followed the financial crisis of 2008. And I’m sincerely pleased to share with you some of my experience of dealing with the crisis, involving both political and economic dimensions.
Portugal was badly shaken by the financial crisis of 2008. But the request for foreign aid presented in 2011 was merely triggered by external events, it was not caused by them. So, before any consideration about the crisis in itself, comprising the most significant events between the eve of the Portuguese bailout around 2010 and the overcoming of the adjustment programme that it followed until 2014, allow me to give you a brief outline of what led to the arrival of the Troika in 2011. My country, like other European countries with a history of currency devaluations and high inflation, benefitted, from 1995 onwards, from a low interest rates context during the process of nominal convergence towards the Euro. That, in turn, promoted investment and consumption growth, both in private-sector terms and in budgetary terms. In the early years it also helped to sustain low levels of unemployment which drove a rise in nominal salaries, unfortunately well above productivity gains.
The consequence was clear. Like other Southern countries, unit labour costs grew in Portugal more than in its main trading partners inside European Union [slide 2]. This situation undermined our economy’s competitiveness and brought with its enormous current account deficits [slide 3]. In 1995 we had a virtually non-existent external deficit. But by 2000 current account had reached almost 10 per cent of GDP.
After 1999, when Portugal joined the Euro, thus removing the exchange rate risk, this process intensified. However, relative productivity continued to fall, and the growth recorded in the early years started to slow and then stagnate, bringing a drop-in consumption and investment. Meanwhile, the so-called tradable sector, linked to exports, also became less profitable with the relative rise in unit labour costs and with the deterioration of the terms of trade [slide 4]. This led to a less efficient allocation of resources, rewarding mainly the most protected sectors of the economy, which had become relatively more attractive.
The following years, therefore, were blighted with growing unemployment [slide 5], and a stagnant GDP per capita [slide 6], that grew in average 3.9% between 1985 and 2000, while between 2000 and 2010 it grew only 0.3%, performing worse than the USA during the great recession of the 1930s and worse than Japan in almost two decades lost in the liquidity trap. And, of course, during this period a process of enormous indebtedness began. It began with the persistent increase in public spending, which was not accompanied by the same evolution of state revenues (despite the growth of the tax burden) led to the increasing indebtedness of the State. In fact, the Portuguese public debt was placed on an explosive path, fuelled by high primary deficits and by weak growth of nominal GDP [slide 7].
For some years, indeed, Governments have followed off budgeting practices (Public-Private Partnerships and creation of financial liabilities in public companies outside the perimeter of consolidation of public accounts) that have helped to disguise, for some time, higher responsibilities only later reflected in the deficit and indebtedness time series, particularly after 2010. Also, the private sector (companies and families) generated a strong indebtedness in the first decade of the euro. Non-financial corporations (companies) were indebted, although part of that debt was contracted to carry out public works, particularly in concession or Public-Private Partnerships.
Between 1997 and 2009, the indebtedness of companies to monetary financial institutions increased from about 31% of GDP to almost 70% of GDP, implying that the liabilities associated with these loans grew from 74% of GDP to 108% of GDP in the same period. And indebted were also individuals (families), for whom easy access to abundant and inexpensive credit channelled many resources for consumption or the acquisition of own house – which constitutes the first factor associated with the indebtedness of households. Families followed a similar pattern to companies in the same period: their indebtedness rose from 33.5% of GDP to 81.9% of GDP, meaning that loans liabilities evolved from about 41% of GDP to 95% of GDP.
By the way, it is very interesting to note that this strong public and private spending, supported by the indebtedness process, didn’t avoid an anaemic per capita growth, as mentioned. This experience illustrates a point which is most relevant for current policy discussions: stimulating demand does not guarantee economic growth! All this situation, structurally very unbalanced and difficult, was recognized by the economist Olivier Blanchard still in 2007, before the financial crisis, in his paper ’Adjustment within the euro. The difficult case of Portugal’. Let me quote him: According to Blanchard, without policy changes, the most probable scenario for the Portuguese economy was that of the so-called ‘competitive disinflation’, that is, to face a long path marked by a sustained high level of unemployment until the correction of the current account imbalance. It was a path with great economic and political risks, which could easily derail.
The alternatives were: The more attractive one, increasing productivity (and hoping that this growth would not be greatly absorbed by wage increases); Another, less friendly and faster, implied a cut in nominal wages (given the low inflation environment) of about 20%. However, the Portuguese authorities didn’t react at all and any action was postponed.
In 2011, after the collapse of Greece and Ireland, Portugal simply could not resist to current account deficits close to 10% each year for over more than a decade. Portugal could not cope anymore with an accumulation of private debt among households and non-financial companies reaching almost 250 per cent of GDP. On top of that, public debt had practically doubled between 2005 and 2011, going from close to 67% to almost 111% of GDP, or, in nominal terms, going from 106.9 billion to 196.2 billion Euros [slides 8-9]. In particular, in 2009 and 2010 public deficits were around 10% and 11% of GDP, respectively. The unemployment rate rose above 12%, which is abnormally high. In the wake of the crisis it reached 17.7%, in early 2013.
In this context, the least one can say is that the Portuguese economy failed to adjust to the Euro and was on a totally unsustainable course. As other economies in the euro zone already knew, when market access was closed and the financial markets were perceiving a risk of bankruptcy, there was no other way out other than a bailout. Still in 2009, in response to the global financial crisis, the Portuguese Socialist Government responded with expansionary policies, increasing public servants’ wages and lowering taxes. But one year later, and with the emergence of the sovereign debt crisis that had begun with Greece, the Government changed its opinion. And, still in 2010, seeing the effects of the lack of productivity and competitiveness of the economy, together with the major macroeconomic imbalances that this prolonged situation generated, the Socialist Government then tried to respond with… austerity, of course. It presented quite a tough package, which included nominal cuts in wages in the public sector of around 5% on average for everyone earning more than 1500 Euros, as well as cuts in social services, a freeze on pensions and the minimum wage, and a steep hike in taxes, namely, and for the second time since 2005, increases of 2 percentage points in VAT and a cut in income tax benefits for families in the areas of housing, health and education, among many others.
That Government also presented a broad package of structural measures, geared towards the restructuring of state-owned enterprises, including privatizations and concessions, but also aimed at reforming the labour and products markets, trying to improve competitiveness and competition, thus trying to address the structural bottlenecks. None of this, however, was in time to persuade the markets. And the main reason for that was the lack of credibility of the Portuguese Government dealing with the implementation of the measures.
Despite the announcements, the Government was incapable of controlling public spending during the year of 2010 and seemed not convincible with the structural agenda. The pressure of the markets began in a more severe way after the negative surprise of the fiscal deficit of 2009, revealed in January 2010. It is very illustrative to see the sequence of the events that led to the bailout. The budget for 2009, approved by the parliament at the end of 2008, pointed to a deficit target of 2.2% and estimated the public debt around 64% of GDP. But, few months later, in January 2009 with the presentation of the Stability Programme, the Government revised the deficit target for 3.9% and presented an estimate for the public debt for 2010 above 70%.
Meanwhile, the European Commission also revised significantly the estimates for the public deficit and debt: at the end of 2008, in the autumn forecast, the deficit target was 2.8% and the public debt estimate was 65.2%, but a couple of months later, in the spring forecast in 2009, the Commission pointed for 6.5% deficit and 75.4% debt. At the end of the year, in the autumn forecast, new revision fulled concerns: 8% deficit and 77.4% debt. Because of the 2009 elections, the Government postponed the budget proposal for 2010, which eventually submitted to the Parliament in January 2010. In the occasion, it presented a 9 new estimation for the targets of 2009: 9.3% deficit and 76.6% of public debt.
For 2010 the targets were 8.3% and 85.4% respectively. These figures represented a significant upward revision with respect to the Government’s previous estimates in early 2009. They also depicted a worse scenario than the European Commission’s autumn 2009 forecast. Most importantly, they confirmed that the expansionary policy followed in 2009-2010 had dramatic consequences for national public finances. Debt sustainability was clearly threatened. The repercussions of this announcement in financial markets were immediate and severe [slide 10].
Since the inception of the financial crisis, Portugal’s 10-year Government Bond yields had closely followed Spain and Italy’s. In January 2010, they jumped up significantly, moving closer to the values observed for Ireland. Portugal was hence in a vulnerable situation just before the euro area sovereign debt crisis broke in May. When Greece and Ireland agreed Economic Adjustment Programmes in 2010, Portugal was seen as the next in line. It is worth to mention that while financial pressure was building up, the country benefited from significant support: the ECB increased the amount of short run liquidity provided to Portuguese banks by approximately 24 billion euro and acquired almost 23 billion euro worth of Portuguese bonds 10 through the Securities Market Programme. In total, support from the Euro system amounted to almost 50 billion euro.
Let me underline the meaning of that support. Only in one year, since the first quarter of 2010 and until the eve of the request for financial aid, in April 2011, the ECB supported 50 billion euros in Portuguese public debt, an amount of identical dimension of the European financial envelope that we have received from the Troika during the three years of the adjustment programme (representing 2/3 of the 78 billion of the Troika financial rescue). In other words, even before the financial rescue, we received from the ECB for one year as much as we have received from the Troika for three years! This fact is for itself very clear about the inevitability of the bailout package.
Accordingly, in early 2011, as international investors refused to roll over Portuguese debt and interest rates in Government Bonds jumped up, the request for international financial assistance became inevitable. But the important thing that must be highlighted is this: when markets close and financing stops, the only form of response is ask for financial help and to apply an austerity programme which can give you some time financing the overspending bill while you address the excess of expenditure. That is why I had insist saying that austerity is not something that is left or right, nor is it conservative or liberal. It’s just what you are left with when you no longer have access to financing your bills. Particularly so, when you are in a common currency zone, where you cannot unilaterally devalue your currency.
The process is, therefore, quite tough from the social point of view. This is what we call internal devaluation. And, while its intensity depends on how big imbalances are, and on the level of financing guaranteed by creditors, the process in itself becomes inevitable, with or without one’s own currency, in order to rebalance the economy and regain competitiveness, something that no-one else can do for us in our own country. To be sure, in the medium and long term, policies that improve productivity also help to restore balance. However, when political decisions fail and solutions are late in coming, and given the productivity of an economy, it is only possible to avoid bankruptcy and regain competitiveness by resorting to foreign aid, adjusting needs to available resources and performing internal devaluation. And this is what is called austerity. That it was the Troika full package. [insert the general presentation of the PAEF, mentioning the three dimensions of the Programme and the summary of the most significant measures adopted: slides 11-15].
What were the political conditions:
- The Government was a coalition of two parties with absolute majority in the Parliament;
2. The empowerment of the Finance Minister (he was the number 2 of the Government, despite what the coalition would impose in normal conditions, that is the leader of the 2nd party as number 2);
3. Adoption of a special body – ESAME – in the orbit of the PM and close to the Finance Minister, which had the work of been the operational coordinator and the interface between Ministers and Ministries, on one hand, and the teams of the Troika on the other hand;
4. True determination, whatever it takes, to deliver.
The unexpected economic problems we faced:
a. A bigger gap on the estimates of the initial MoU related with deficit targets for 2011 and a huge (impossible?) consolidation effort (frontloaded approach and the need of a very sharp decrease in deficit targets, contrary to the Irish case, for example) [slides 16-20];
b. The synchronisation of the crisis among EA represented a weaker external demand, affecting negatively the potential growth (headwinds);
c. Demanding risks of a credit-crunch with the crowding out of the private sector financing on banking system (the Troika’s envelope didn’t cover the significative financial needs of the biggest public enterprises, which were oblige to ‘compete’ against private sector for the credit provided by a banking system plunged in a severe deleverage process…);
d. Portugal as a particular case of two-broken growth engines (public and private).
The major difficulties we faced:
1. The main constitutional interpretation on the limits of Constitution regarding acquired rights and against spending cuts (which forced very frequently to renegotiate the fiscal measures with the Troika every year and to resort to taxes increases more than the initial MoU defended – the initial composition of fiscal consolidation, between spending cuts and taxes increases, was 2/3 and 1/3 respectively, and turned out to be almost 50% each) [slide 21];
2. The management of information with the pressure of Troika negotiations and public information of the pipeline of measures;
3. The political crisis inside the Government associated with 5th and 7th reviews.
The decisive aids:
1. The extension of loan maturities of EFSF (which was critical for regaining market access because of the concentration of the redemption calendar; and which was supposed to happen jointly with the Irish loans, favouring our objective to be seeing by the markets associated with the ‘well succeed’ Irish case – but initially the German Government didn’t want to support this joint-operation because Ireland had already lower interest rates than Spain or Italy and only changed his opinion because of Portugal) permitted us to develop a process of successful return to the markets, issuing public debt at 5 and 10-years one year before the ending of the Programme [slide 22];
2. The new and non-conventional monetary policy conducted by the ECB (mostly with the announcement of the OMT in 2012, which favoured the yield curves among the euro area participants who provided sound financial policies and exhibited compliance with the rules, as it was the Portuguese case with positive Troika’s assessment) [slide 23];
3. The ‘clean exit’ without any precautionary programme that 12 positive Troika’s reviews had permitted.
Returning now to the Adjustment Programme. In the Portuguese case, this process was a painful one, but with results that speak for themselves. In 2010 the value of the public deficit was 20 billion, in 2015 it was under 5 billion. The primary balance, which was minus 8 per cent of GDP in 2010, has been positive since 2013. The current account became positive, after almost 15 years of racking up a foreign debt at a rate of 10 per cent per year [slides 24-25].
The economy reversed its downwards trend in the first quarter of 2013 and has been growing moderately since 2014, when it grew 0.9% and by 1.8% in 2015. Unemployment has been falling since 2013 and was around 12 per cent at the end of 2015 and reached 6% this year. Fortunately, we have preserved social cohesion despite the crisis, because we answered to the social impact of the crisis with an emergency programme. And inequality did not worsen during the toughest years because of the design of the consolidation measures.
The structural change performed during the Programme was very significative and its evaluation was assessed as extremely positive by different international institutions like OECD. The European Commission highlighted the results of the Portuguese structural reform against other countries in a report where estimated the total accumulated impact in terms of GDP growth around 4.3% up to 2035 [slides 26-28].
Allow me a final word. Today, when the worst of the crisis is behind us, and when we are benefiting of the past efforts to correct imbalances and to regain confidence that permitted the recovery and the return to the markets, relaunching both growth and employment, it is common to hear people say that austerity came within the maxim of “TINA” – “there is no alternative”, when, in fact, there is an alternative and it is possible to govern with different public policies, more geared towards growth and social aid. But in fact, this is a political fallacy, both in what regards the interpretation of the past as well as the lessons that are drawn for the future. Today, it is possible to alleviate austerity (and in Portugal we are still living with austerity measures in public spending and in tax revenues) because it produced the expected results and the rebalancing was accomplished.
The idea that it would have been possible, in 2010 and the following years, to avoid austerity in countries like Portugal is illusory, as I explained. A balance of payments crisis, which was thought to be impossible within the Euro zone, where the stability and growth pact would require the national responsibility of each participant to keep its house in order and not generate significant spill-overs for its neighbours, indeed happened (still did, by the way). And the response to such a financing crisis requires, among other things, the adoption of policies of austerity to endorse the fiscal problems and restoring the confidence of the markets and of creditors, which demands more than austerity measures. It implies structural reforms that address the causes of the imbalances and the lack of competitiveness.
On the other hand, I do not forget that some people argued that the best thing was to leave the Euro and recover the instruments of monetary policy in order to regain competitiveness, as in the past. I must say that this kind of people who defended the exit of the euro area, is now very calm and quiet about this topic. And for the past four years they seemed to forget this kind of approach. However, it is important to remember that this kind of alternative, which I do not endorse, would never be a genuine one, in as much as the path to follow would be that of devaluation, and, therefore, that of inflation reducing income in real terms, leading to internal recession and a reduction in imports. Therefore, it would lead in any case to a policy of austerity possibly a lot harsher than the one we implemented. To conclude, I would say that the best alternative is to avoid postpone the structural reforms when they are needed and to manage fiscal policy with responsiveness, as prescribed in the stability and growth pact. Unfortunately, the facts show that most part of the countries and their politicians prefer not to do it and, when the crisis come, to blame anyone who seems to be a good candidate to assume responsibilities.
Alexandre, Fernando et al. ‘A Economia Portuguesa na União Europeia (1986-2010)’
Blanchard, Olivier, ‘Adjustment Within The Euro: The Difficult case of Portugal’
European Commission, ‘The Economic Impact of Selected Structural Reform Measures in Italy, France, Spain and Portugal’; ‘Autumn 2008’ and ‘Autumn 2009’ and ‘Spring 2009’
Forecast Gaspar, Vitor, Preface to the Portuguese edition of ‘This Time is Different’ from Reinhard & Rogoff Mateus, Augusto, ‘25 anos de Portugal Europeu’ and ‘Três Décadas de Portugal Europeu’ (several charts)
Portuguese Government: several ESAME’s internal documents; Budget Proposals for 2009 and 2010; Stability Programme 2008-2011, actualização 2009; Fiscal Stand Report (Relatório de Orientação da Política Orçamental) of 2009 and 2010 Reis, Ricardo, ‘The Portuguese Slump and Crash and the Euro Crisis’