Why we shouldn’t bail out Portugal

Allister Heath
HERE’S a heretical thought: let’s not bail out Portugal. The near-bankrupt country has just seen its Prime Minister resign after losing a key vote on his government’s fourth austerity package in a couple of years, while Fitch has just downgraded the country’s credit rating. Yet the talk now is of a bailout – even though Portugal’s parliament has just refused to take the pain. To agree to a rescue would be to send out the wrong message and would force hard-pressed UK taxpayers to underwrite part of the bill.

A rescue package would need to be worth a minimum of €60bn-€70bn to cover the country’s deficit and bond repayments for three years. Part of this would be drawn from the European Financial Stability Mechanism, the €60bn rescue fund which is activated by majority voting and of which the UK is a member. Open Europe, the think-tank, estimates that the UK’s share would range from €810m to €3.7bn under a €60bn bail-out, and €945m-€4.26bn under a €70bn rescue deal. The UK would also have to contribute to any IMF bailout.

Portugal’s main problem is that its unit labour costs are way too high, making its exports uncompetitive. Being a member of the euro, it cannot depreciate its currency (the course of action taken by Britain during the past three years). It cannot inflate its wages down (a strategy that Britain appears to be secretly pursuing, with the Office for Budget Responsibility and others predicting that take-home pay will continue to fall after adjusting for inflation). It certainly cannot print more money to buy back its own bonds (again, unlike the UK). The only way Portugal can readjust, therefore, is to start reducing wages the hard way in nominal, euro terms – an internal devaluation. Yet even if this were politically possible, it would increase the burden of Portugal’s existing private and public debt: if workers earn 10 per cent less, and their mortgages remain the same, interest payments suddenly become more difficult to bear. Taxes would also have to rise as a proportion of lower wages to meet existing spending commitments.

The problem, of course, is that wage cuts are nigh-on impossible in Portugal, which means unemployment will keep on going up. Portugal has one of the most regulated labour markets of the Eurozone countries. Without substantial reform, rigidities will stop any downwards pressure on real wages. The answer must thus be a combination of measures to deregulate the economy – as well as a partial default on the national debt.

The EU’s strategy is to throw good money after bad and to pretend that the only thing an over-leveraged country that has priced itself out of global export markets needs is another loan. This approach stands no chance of success. It is also important to realise that austerity packages alone are a necessary condition for recovery – but not a sufficient one. Radical supply-side policies are also needed to boost growth, not just half-hearted fiscal tightening policies that end up hiking taxes too much rather than taking an axe to privileges and unaffordable spending commitments.

Of course, bond investors and financial institutions will suffer if the EU allows Lisbon to default and forces a proper, well-managed restructuring of its debt. But Portugal is too small to be another Lehman Brothers. The bail-out culture must end – as must the socialisation of risk and the nationalisation of losses. Enough is enough.
allister.heath@cityam.com
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