A post by Luis Cabral
As Portugal exits its 2011 stabilization program, it’s a good time to ask: Was the program too severe? The “troika” — the European Union, the European Central Bank, and the International Monetary Fund – demanded significant cuts in government spending in return for temporary external financing. Many in Portugal and elsewhere argued against this policy of “austerity.” Were they wrong?
The short answer: Yes, they were wrong. The policy worked and the Portuguese economy is now growing.
A more complete answer starts with some facts. During the years of Portuguese “austerity,” the economy was in a deep recession. The decline in GDP and the increase in unemployment were greater than the IMF and its troika partners predicted. And to some extent they were a consequence of the troika’s policies.
Nevertheless, some good things happened. Debtors are now able to access financial markets on reasonable terms. This includes banks, firms, and even the government. Public debt was restructured on favorable terms, with relatively low interest rates (lower than during the euro era “golden years” of the past decade) and long maturities (an average increase from eight to twenty years). And the “death spiral” that was predicted for the Portuguese economy failed to materialize.
On the whole, do we see more good or bad? It’s not possible to give a definitive answer. The question is not whether we’re doing better in 2014 than we were in 2010, but whether 2014 would look better if we’d followed a different path. We’ll never know for sure. But my estimate is that we are considerably better off than we would have been had the program not been implemented.
Specifically, consider the debate surrounding the supposed tradeoff between austerity and growth. One of the main obstacles to growth is the difficulty in obtaining credit. Portuguese banks and large corporations experienced enormous difficulties in obtaining credit, especially after 2011. This difficulty was a significant drag on the economy. Since then, things have improved considerably, largely due to the Portuguese state’s greater credibility as a borrower. Here, I would say, austerity has made a positive contribution to growth. I don’t mean to deny that there are demand effects as well, but even Keynes would agree that long term growth requires a functioning financial system.
In my view, the opposition to austerity has been hypocritical. First, for political forces in the opposition, fighting austerity is an easy shot at a government facing a choice among bad alternatives. Witness, for example, François Hollande’s overnight change of tune once he was elected France’s president: he was against austerity before he was for it. Second, austerity was not so much a choice as a reality. You might ask: What part of “we have no money” don’t you understand? And third, much of the opposition to austerity was simple self interest. It’s fine to cut spending, but not my spending. Sometimes it’s education, other times pensions, and yet other times health and wages or support for the arts: everyone wants to protect their favorite program. It’s interest group politics pure and simple.
At the risk of oversimplifyin, Greece and Ireland represent two drastically different strategies for dealing with the problem of sovereign debt. Greece followed the principle that “the squeaky wheel gets the grease.” They did get the grease of a “special program” for Greece, with more generous concessions in terms of debt forgiveness and a fiscal program that was tough on paper but mostly ignored in practice. Ireland adopted a less confrontational strategy and followed the policies handed to it. You might ask yourself now: Which country is in better shape?
Portugal chose a path closer to Ireland than Greece. I’m glad we did.