IMF ambulance too late for Portugese suicide

stated yesterday that I thought the IMF jumping ship on the current fiscal plan could be a bellwether of change in direction for the Eurozone’s crisis response. Last week we saw Italy’s Mario Monti announce a surprise change to low income earners tax rates while cutting the planned VAT increase and even Angela Merkel has stated that tax cuts are on the way in order to spur growth across the zone. I note, however , that both Schauble and Merkel are defending their current position on Greece, but Ms Merkel’s recent visit to Athens demonstrates there is probably further compromise coming once the final Troika report is delivered.
That good news has been somewhat offset by Sweden’s Finance Minister reportedly claiming that it is “most probable” that Greece would leave the monetary union within six months. Obviously I am also still very concerned about the implementation of counter-productive policy in the Eurozone, but at least there appears a hint of change on the horizon. Unfortunately however that good news doesn’t appear to extend to Portugal who now appear to be making the same policy mistakes we’ve seen since the crisis began.
As I explained again back in September, the current IMF/EU response framework is for nations to internally devalue with the aim of making countries more internationally competitive which will eventually mean current account surpluses can be used to pay down the existing debts. But this plan has some serious problems:

The basic premise of European policy is to tighten government budgets in an effort to drive down deficits. In the absence of a current account surplus in order to maintain a level of national income  this requires an expansion of private sector balance sheets. If this does not occur then the most likely outcome is a slowing of internal demand and therefore a slowing of imports. This in turn should drive the balance of trade towards positive territory, but at the same time lower overall GDP.

Falling GDP leads to falling national income, which in the absence of real across the board wage deflation means more unemployment and therefore slowing government revenues which, as I’ve said previously, leads to a self-defeating process of re-newed cuts to government budgets.

So in essence this whole process becomes a struggle between the balance of the external sector, real wages  and unemployment and this is the dynamic we have been witnessing in much of the periphery over the last 18 months. What I have noticed recently is that the adjustments in periphery nations balance of trade has been seen by some as a sign of recovery, which in part it is, but ultimately what is required is a sustained current account surplus.

This issue, as I also explained in that post, is that the initial side-effect of this policy implementation is rising unemployment and falling industrial production which obviously have upper limits, in a democracy more so.
Overall the basics of this plan is to restructure the economy to get the external account in surplus within a time-frame that the entire thing doesn’t blow up due to social and political unrest. Obviously writing off foreign debts would be a very quick way of helping this adjustment take place ( as with Iceland ) but for reasons of their own the Northern creditors of Europe think this is a bad idea and have been slowly jawboning the southern debtors into legally binding programs.
The problem is that Greece, Spain and Portugal certainly appear to be reaching the upper limits of what their citizens will endure but these countries are yet to reach external surpluses because there existing debt burdens are still too large.  In other words the EZ has spent the last 2-3 years dismantling their existing economic structures but so far they have little to show for it. In fact by most macro-economic metrics these nations are far worse off, and therefore by definition so are their creditors.
As I have explained before what we tend to see when a nation reaches these limits is an attempt to implement even stricter fiscal tightening in the misguided belief that the problem has been that they’re just not trying hard enough:
If a country’s current account deficit is structural then these efforts are very dangerous because this can easily develop into a damaging feedback loop. The loss of income through the external sector leads to a loss of income in the private sector, this then drives the stronger desire to save, meaning government revenues fall further. This inevitably leads to calls for higher taxes, which once again drain income from the private sector … and around we go. The result of this dynamic is a rise in unemployment, therefore national production and income, meaning once again the government sectors revenue decline while private sector spending and investment fall further.
And so the most likely outcome of further tax rises is that the government’s revenue will actually fall, not grow, meaning government sector debt actually grows, not shrinks, all the while the nation’s wealth ( social and economic ) deteriorates via continuing external sector deficits, a growing idle labour force and, increasingly, emigration.
Once a country reaches this point, the options are relatively limited and in the case of Europe we have seen these nations given greater amounts of credit in order to stave off default. It is obviously self explanatory that this is simply adding to the problem because by doing so the external account of the nation goes deeper into deficit. In the absence of some new external stimulus, the inevitable outcome is eventually outright default which is exactly what we have seen, and will likely see again, in Greece. But Spain and Portugal, and possibly Italy, are on Greece’s path.
Each of these economically troubled nations has different economic, political and social circumstances, differing levels and compositions of debt, and are all at different stages in the crisis. But at a high level the problems are basically the same and we have witnessed their issues steadily grow over time . Last month I noted that Spain had reached the point where it had begun to once again increase taxes which signaled to me it was about to take another leg down based on the dynamic I explained above.
Unfortunately overnight I read that we are about to see the same from Portugal:

The Portuguese government was all set to push ahead on Monday withmassive tax rises in a draft 2013 budget just two days after mass street protests against further austerity. The new measures, a condition of debt-rescue funding, are known to target income tax, pensions, and unemployment and sickness benefits.

….
The list of the new measures to satisfy EU-IMF debt rescue conditions will go from a cabinet meeting to parliament later on Monday.
Finance Minister Vitor Gaspar has already revealed the main thrust of the budget and what he termed an “enormous” increase in taxes, notably by means of reducing from eight to five the number of bands for income tax.
A surtax is to be introduced, and payments for pensions, unemployment and sickness benefit will be reduced. The changes to the tax banks will have the effect of raising income tax on the lowest incomes from 11.5 percent to 14.0 percent.

Tax on the middle income band ranging from 20,000 to 40,000 euros ($25,870-$51,740) per year will rise from 35.5 percent to 37.0 percent.

The rate on incomes above 80,000 euros will rise from 46.5 percent to 48.0 percent. This nearly halves the level at which the top rate applied previously, from 153,000 euros.

The increases could worsen a recession in Portugal. Official data suggests that the economy could shrink by 3.0 percent this year with the unemployment rate being close to 16.0 percent.

This is a preliminary announcement so there is a possibility of backtracking on some components but the message is clear. The Portuguese government is going “all-in” in order to meet it’s obligations under the emergency program even if the end result is a worsening economic outlook.
I would have hoped that a change in policy response would have come in time to save Portugal from this sort of economic suicide, but it appears now that this may not be the case.
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Comments

  1. We all know academically that turning off the credit flow and further squeeze the existing pool of credit in the middle of a depression, e.g., 1931-1932, would be a bad idea.

    But politically, this is an absolutely necessary step (“In fact by most macro-economic metrics these nations are far worse off, and therefore by definition so are their creditors.”; exactly). Both the debtors and creditors must show to the world that they had suffered enough (to the satisfaction of whoever is going to bail them out), before asking for mercy so that the rules can be bent and they can restart with clean balance sheets again.

  2. Ask yourself. If you and your mates all owe a heap of money to a menacing lender, who of you do you get to pay off their debts first from whatever resources you all have; the stronger ones, who have a job, or the weaker unemployed ones? The answer, of course is the weakest ones first, if the objective is for you all to survive. (Unless the strong are shielded from insolvency they can’t help the weaker members later on). So it is with the global recovery. It was suggested years back, that global debt reduction had to take place – but not by all at the same time. That’s what’s happening. The weakest go first via fiscal contraction, giving the stronger time to prepare via monetary expansion. Monetary policy won’t work if it’s applied everywhere, at once; just as neither will fiscal restraint. It’s a balancing act that is being done as best as can be at the moment. Someone had to do the debt reduction bit first, and the fabled PIIGS appear to be the right place to start.

  3. Thanks DE for the post….I’d quit in disgust but your posts are always worth reading and I can’t help commenting on this austerity business.
    ” these countries are yet to reach external surpluses because there existing debt burdens are still too large. In other words the EZ has spent the last 2-3 years dismantling their existing economic structures but so far they have little to show for it. In fact by most macro-economic metrics these nations are far worse off, and therefore by definition so are their creditors.”

    If you forgave all the debts immediately you would have achieved near nothing. The problem is not that they have debts. The problem is that the structure of their economy, their social system, their education system, that brought these debts into existence in the first place.
    If you forgive all the debts today they will need to start borrowing again tomorrow.
    Why do we expect that an social, educational, and economic system that has taken 40 years to generate can be reversed and repaired within two years?
    It’s easy to criticise austerity. We all want more…and more…and more no matter what the cost. We need the earth to give up more and more every day.
    Austerity is simply saying we cannot keep doing this.
    Why do we ridicule the economic policies of anyone who says this cannot go on forever? Yes cutting back means our GDP does shrink.
    Everyone just talks about how stupid and bad austerity is. Yet the ‘austerity’ proposed is simply trying to stop the growth of over-consumption. What is always proposed is the restoration of that consumption.
    It just simply can’t go on.

    P.S. All the above applies to Aus in spades.

    • Hi flawse,

      Of course, *ideally* you would want to close the credit tap when times are good and open it when times get tough (counter-cyclical policy).

      The problem is nobody wants to close the tap when times are good. Then it follows that a depression, and the misery that accompanies it, is virtually inevitable.

    • Good post, flawse. I especially liked “The problem is that the structure of their economy, their social system, their education system, that brought these debts into existence in the first place.”

      This is indeed the problem in a nutshell. It is not hard to see why countries with different economies, social structures and cultures, which have encouraged productive endeavour and saving, are reluctant to bail out the spendthrifts even further.

      • +1 flawse and Alex.

        Euroland has not restructured it’s economies of it’s own volition.They are being intimidated into doing so by the debt markets. Govts and the people were happily milking away, until they couldn’t.

    • Due to the common currency, the PIIGS countries cannot adjust their economy through currency devaluation. However, internal deflation will lead to a deflationary spiral without default on debt. So now they’re stuck in a deflationary spiral that will last decades.

      The best way to fix their economic imbalance is to exit the Euro. The common currency was the biggest reason why those countries were able to consume beyond their mean.

        • The other issue ,which the Euro architects should have paid more heed to, is the past history of the southern euro nations. Greece defaulted on its loans in 1826, 1843, 1860, 1893 and 1932. (There was an effective default by inflation in 1944 as well, but that was down to the Nazi occupiers looting the Treasury.) The eurocrats took too much notice of the post-WWII “Greek miracle” and seem to have assumed it would continue.

    • Yes, as Ronin8317 said flawse, the common currency is the main source of the ills that currently afflict the region. The euro led to interest rate convergence across nations with vastly differing levels of competitiveness. The architects of the currency union simply hoped that competitiveness would also converge between participating states. What a calamitous hope that was.

      I agree completely that there are serious underlying structural issues in these economies, and blaming the euro is not to absolve them of this responsibility, but that’s really the whole point: An structurally inefficient economy like Greece would have faced much higher international borrowing costs had it not been for the euro. It may well have sunk into profligacy anyway, as plenty of other nations have, but the costs would have manifested in a tumbling currency. So Greeks still would have become much poorer, but competitiveness would have been quickly improved by this mechanism, unemployment would never have risen as far, and the country could have reformed itself without enduring such a crippling depression. Or, it could have continued down the path of financial mismanagement, and continued to see its wealth erode. I believe Argentina is a good example of this; as I understand, it was the only country to be relegated from high-income status over the 20th century.

      Regardless of which path it chose, the key is that the consequences of its choices would have been reflected in its currency and borrowing costs. The common currency grossly distorts this mechanism and draws in a continent when it really ought to be a domestic issue.

    • Flawse as usual I find us agreeing on the issue but not on the resolution.

      Absolutely the structure of the economy is the issue, although in a fixed currency monetary union this is as much an issue with the creditors as the debtors, and the ultimate aim of the policy needs to be a re-balance of consumption and production across the zone, again in the creditor as well as the debtor nations.

      The “austerity” of the kind we see in Europe is implemented with this in mind simply by pushing down wages in debtor nations in order to increase productivity but there is no investment to reshape the economies towards greater production of tradable goods and services. There is simply wage deflation and unemployment which means foreign debts continue to rise as production falls. This is the error I see in the plan.

      That doesn’t mean I don’t agree that there is too much debt and over-consumption, there definitely is, it means I disagree that the solution in its current form is not the best way to attempt to resolve the problem,

  4. The social safety blanket in most major mainland european countries is ridiculous.

    People have basically shaped their lives to fit around the handouts they get. A personal friend of mine got laid off in 2001 from company in Munich, he spent 10 YEARS unemployed getting enough money for rent/utilities food and a beer or 2 a month he was reasonably happy to slide along.

    No one receiving this is willing to ask the question about how its funded. Pension model is so totally out of date regarding life expectancy increases that it just cant be sustained.

    My father in law retired 65 with full pension from Govt as he worked for Deutsche Bahn he gets 2500Eur per month and has been receiving this for over 10 years now thats 300k Eur do you think he even paid half of that over 30 years on a meagre eisenbahner salary not a chance.. he probably has another 10-15 years left in him so thats about 700k pension return based on contribution of maybe 150-200k no fund in the world generates returns to keep that afloat. This is Germany which actually is a little better than the pensions doled out in Gre/Esp/Fra/Ita

    Politicians are quite happy to borrow from the future generation to keep the current one happy. I have never taken a cent from the Govt and dont plan to either, I raise my daughter in exactly the same way. Until the political system changes to stop vote buying/lobbying then we have no hope. Even a 5 year old can figure out that if you get 2Eur per week pocket money that you can only spend 2 Eur even though you might try to ask your parents for more chances are you will see the back of a hand before you see any extra cash!

    • “Politicians are quite happy to borrow from the future generation to keep the current one happy.”

      Well, the future ones have no votes. Only the current ones do. And in democracy, MPs are constitutionally ONLY responsible to the current electorates, rightly or not.

    • People have basically shaped their lives to fit around the handouts they get. A personal friend of mine got laid off in 2001 from company in Munich, he spent 10 YEARS unemployed getting enough money for rent/utilities food and a beer or 2 a month he was reasonably happy to slide along.
      It is unfortunate your friend is so lacking in aspirations and ambition.

      However, I question the implication that it is an attitude most people would have. Certainly no-one I know would enjoy a life where luxuries only extended to the “a beer or 2 a month” level.

      (This is not to say the pension scheme you described doesn’t need addressing.)

      Politicians are quite happy to borrow from the future generation to keep the current one happy. I have never taken a cent from the Govt and dont plan to either, I raise my daughter in exactly the same way.
      So no publicly funded education ? Don’t drive on public roads ? Don’t use public transport ? Never used publicly funded medical services ? Never had to call the police ?

      There’s a lot more to “Government handouts” than just welfare. Indeed, welfare – and particularly welfare to people like your friend – is a relatively minor component of Government expenditure.

      http://www.abc.net.au/news/2012-05-08/interactive-budget-2012-how-its-spent/3971410

      • Let’s not forget also doc the REVENUE PROVIDERS for all that expenditure – yes the taxpayers who get squeezed to pay for all that Govt spending. Especially the top 10% who provide 60%+ of all income taxe in Australia, subsidising vast numbers of Govt employees and welfare beneficiaries.

        Let’s also not forget the DEBT accumulated for spending ABOVE and beyond all that “income” , which again falls due against the sorry Taxpayer. No prizes for guessing who will foot most of THAT bill.

        There are indeed a lot more to those Govt handouts you keep trotting out as you say. Like the explosion of Govts own Employment Growth Scheme : the Public Service. I can see why so many love Govt spending living on handouts from a benevolent leftist Govt. It’s been a very profitable gig for some;

        “Within the lowest equivalised private income quintile, the share of income received by households increased from 2% using the equivalised private income measure to 13% using the equivalised final income measure. For households in the highest quintile, the income share decreased from 46% for equivalised private income to 35% for equivalised final income (Table S2).”

        “The payment of taxes on income and, to a lesser extent taxes on production, increase with income. Households in the lowest quintile paid 0.1% of total taxes on income while households in the highest quintile paid 61%”

        http://www.abs.gov.au/ausstats/[email protected]/Latestproducts/6537.0Main%20Features22009-10?opendocument&tabname=Summary&prodno=6537.0&issue=2009-10&num=&view=

        • Let’s not forget also doc the REVENUE PROVIDERS for all that expenditure – yes the taxpayers who get squeezed to pay for all that Govt spending. Especially the top 10% who provide 60%+ of all income taxe in Australia, subsidising vast numbers of Govt employees and welfare beneficiaries.
          Pretty sure they hold more than 60% of the wealth, so they’re getting a good deal.

          But that’s hardly surprising, since taxes – particularly for the wealthy – have been trending down for decades (so it should hardly surprise anyone that contemporary Governments are underfunded).

          Let’s also not forget the DEBT accumulated for spending ABOVE and beyond all that “income” , which again falls due against the sorry Taxpayer. No prizes for guessing who will foot most of THAT bill.
          High income, childless households, like mine.

          “The payment of taxes on income and, to a lesser extent taxes on production, increase with income. Households in the lowest quintile paid 0.1% of total taxes on income while households in the highest quintile paid 61%”
          Maybe if all those “wealth creators” were distributing the wealth they “created” more equitably, rather than providing their labour a steadily-decreasing piece of the pie, said labour wouldn’t be so dependent on “handouts” and/or debt to maintain their living standards.

          As usual, the Far Right never misses a chance to blame the victim. When you’re willing to argue as vehemently that the dual-income household earning $100k+ a year doesn’t deserve welfare as you are the single mother on the poverty line, I’ll believe you’re interested in objective rationality.

          • “As usual, the Far Right never misses a chance to blame the victim.”

            Stupid moronic extremist BS!

          • Stupid moronic extremist BS!

            GSM’s focus on “welfare waste” is consistently focused almost entirely on the poorer end of the demographic – single mothers, part time workers, etc.

            Trying to pin Government debt problems to poor people on welfare, the vast majority of whom have little _desire_ for a welfare-funded subsistence lifestyle, but are in fact forced into it because of a lack of alternatives, is a textbook example of blaming the victim.

            The stereotypical “dole bludger” – someone who could work, but chooses not to because they have no ambition in life other than welfare subsistence – is a tiny minority, despite conservative voters’ sadistic fantasies to the contrary.

            The extremists here are the ones who think a great way to reduce Government debt is punish poor people more (and gift even more to the well-off and wealthy). If only they attacked middle-class welfare and ultra-wealthy tax minimisation strategies with the same gusto, we might be able to get somewhere.

          • http://theconversation.edu.au/shame-or-sham-assessing-poverty-in-australia-10149
            This is irrelevant.

            http://www.hoover.org/publications/policy-review/article/123566
            Just from the intro I can guess what the tone of this is going to be.
            “To that end, the focus of public policy should not be on equality of income but on equality of economic opportunity.”

            You want equality of economic opportunity ? Establish a 100% death tax.


            I happen to sure many of GSMs concerns.

            Now there’s a surprise. You’re two peas in a pod, after all.

            The wealth redistributive model of social democracy risks death by excess and requires paring back.
            Yet strangely all the best places in the world to live are social democracies.

          • doc,

            “GSM’s focus on “welfare waste” is consistently focused almost entirely on the poorer end of the demographic – single mothers, part time workers, etc.”

            This is an outright lie.

            Put up your proof or retract it. You consistantly misrepresent , spin and distort. Your comments are worthless therefore.

          • smithy, The Conversation was relevant in the sense that it highlighted the welfare vested interest sector propensity to talk up (or is it down?) poverty which diminishes the plight of those in genuine need. The Hoover Institute article ties in neatly with some recent Tyler Cowan pieces, worth the hunt.

            I agree that social democratic system generally are pleasant places to live – and why not – needs attended to with or without commensurate participation in society. Perhaps it would have been better to call it substantive democracy which focusses on economic redistribution(with no corresponding obligations). I myself prefer a liberal democracy.

          • doc,

            “As usual, the Far Right never misses a chance to blame the victim”

            Typical Leftist obfuscation and deceit. The shrill claims of “victimisation!” (almost as prevalent as “mysoginist!”)are designed to divert attention from the waste , accruel of Debts and abuse of hard earned taxpayer money. for the holey grail of “wealth distribution”. The makers and the takers indeed. You have a plethora of ways of defending and spinning leftist waste doc- not one of how to conservewealth.

            The Fabians must be proud of such a fervent member.

          • smithy, The Conversation was relevant in the sense that it highlighted the welfare vested interest sector propensity to talk up (or is it down?) poverty which diminishes the plight of those in genuine need.

            The “genuine need” line is a common Libertarian rationale to justify not trying to help anyone who isn’t starving and living in a cardboard box, and usually goes hand in hand with a similarly specious argument about how even the poor today “live better” than the kings of a few centuries ago, as if that makes it ok. Like most Libertarian ideals, it’s aimed at further concentrating wealth and creating desparation (and from there dependency).

            The Hoover Institute article ties in neatly with some recent Tyler Cowan pieces, worth the hunt.
            I had a quick scan through it and one thing that leapt out at me is that they’re basing their inequality measure on consumption, yet appear to make no mention of the massive levels of private debt that the middle and lower classes have funded their consumption with over recent decades, instead attributing this to transfer payments (which, given plummeting tax revenues, particularly in recent years, seems a rather flawed argument).

            I agree that social democratic system generally are pleasant places to live – and why not – needs attended to with or without commensurate participation in society.
            No, they’re pleasant places to live because people are more equal and opportunities are greater. These are the kind of things class mobility are made up of, something which is studiously ignored by the study you cited (unsurprisingly, since class mobility in the US is amongst the worst in the developed world).

  5. We inferited roads, trains, ports, education all pretty much with no debt. We’re going to hand it to our kids saddled with debts, sold off, deteriorated and not up to the population pressure that has resulted from the misallocation of resources that itself resulted from two generations of negative RAT interest rates.
    At the same time we have sold off every worthwhile business and mine to fund our consumption.
    We have little to be proud of in terms of what we are handing on.

  6. LOL
    I doubt any of you can read Greek but this article came out in greek MSM yesterday
    http://www.tanea.gr/ellada/article/?aid=4759957
    it basicaly said IMF just discovered they’ve been using the wrong GDP multiplier for Govt spending, 0.5 instead of 1.8
    ooooops 🙂

    Means they now need to basically double all their recession forecasts for next year because of the planned austerity measures which is about 5% of GDP for FY13
    They also need to add more austerity measures to make up for lost tax revenue (about 40% of GDP for Greece)

    You gotta love IMF man, would be so funny if it wasnt so tragical
    Here’s in English from the Telegraph:
    http://www.telegraph.co.uk/finance/comment/9600467/Why-the-IMF-has-got-it-so-hopelessly-wrong-on-the-euro-crisis.html

    • Great article which sums up why the heavily indebted Euro nations are making little headway in fiscal consolidation – “it’s the Euro, stupid”. If they had control of their own currency and monetary policy, they would be making progress.

      • It is pretty obvious, really. And that is precisely why Brits opted out of Euro in the first place.

        If an economy is as inhomogeneous as that in the Eurozone, how on earch can the ECB select an optimal interest rate at any given time?

        Guaranteed to fail.

  7. Good article by Theodore Dalrymple http://www.theaustralian.com.au/national-affairs/opinion/if-theres-a-nobel-for-strife-perhaps-eu-should-win-that-too/story-e6frgd0x-1226496598957.

    Opening words:

    “MY friend Peter Bauer, the distinguished development economist who died in 2002, used to say that the only true unemployment in a modern economy was among satirists: for satire in the modern world was prophecy. You had no sooner to think of an absurd idea than for someone somewhere to make it the basis of policy.

    The award of the Nobel Peace Prize to the EU, however, shows that the spirit of satire is not quite dead …”

    If you only get the opening words when you click on the link, copy the headline, paste into Google search, then click on the first link. Usually brings up the whole article.