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An Own Goal in Portugal

Saturday, September 22, 2012

The Portuguese economy will be in for the roughest of rides in 2013 if the government goes forward with a proposal to change corporate social security contributions.

All is not well in Portugal. The Portuguese economy is mired in a deep economic recession, and tens of thousands of Portuguese recently took to the streets to protest the additional austerity measures being proposed by the government to bring the country’s IMF-EU program back on track. Of equal concern is the emergence of the clearest of cracks in the bipartisan support that Portugal has enjoyed up to now for its IMF-EU adjustment program.

The Portuguese economy has been in economic recession for nearly two years. In large measure, this has been the result of the major fiscal austerity that Portugal has been forced to undertake on top of a major credit crunch and the euro straitjacket that precludes currency devaluation as a means to promote exports. The Portuguese economy is officially projected to contract by more than 3 percent in 2012 and by a further 1 percent in 2013, while unemployment has risen to more than 15 percent of the Portuguese labor force.

What makes the Portuguese situation all the more lamentable is that the government now appears to be on the road to aggravating the country’s economic and political woes by proposing an ill-considered remedy to the loss of the country’s international competitiveness. In an attempt to effect an “internal devaluation” within Portugal’s euro straitjacket, the government is proposing a reduction in companies’ social security contributions from 24 percent to 18 percent in order to reduce those companies’ effective labor costs. And it is proposing to finance that reduction with an increase in employees’ social security contributions from 11 percent to 18 percent. This initiative is in addition to the fiscal austerity measures that the government is being forced to adopt under its IMF-EU program to make up for the 6-percentage-point loss in tax revenues that resulted from weaker than anticipated economic performance.

The Portuguese economy is officially projected to contract by more than 3 percent in 2012, while unemployment has risen to more than 15 percent of the Portuguese labor force.

The public outrage against the government’s social security proposal would suggest that it was ill-advised from a political standpoint in a way that is all too reminiscent of Margaret Thatcher’s poll tax in the United Kingdom in 1989, which cost her so dearly politically. However, the more disturbing aspect of the proposal is that it makes very little economic sense, especially when Portugal is in a deep recession and the IMF-EU program is already forcing it to pursue a pro-cyclical fiscal policy.

The last thing that Portugal needs right now is a further meaningful reduction of aggregate demand. Yet that is precisely what this social security proposal would do. A hike of as much as 7 percentage points in employees’ social security contributions will surely lead to an immediate substantial decline in household consumer spending. This would especially be the case considering how income-constrained most Portuguese households are.

And while the reduction of companies’ social security contributions might be expected to have a long-run salutary effect on the Portuguese economy, it is highly improbable that the prospective slump in household spending will, at least in the short term, be offset by increased corporate investment or exports by the companies benefiting from the contribution reduction. If there is one thing that we know about how exports respond to improved competitiveness, it is that they do so with a very long lag, typically in the one-year to 18-month range. This would be all more so the case now, given the global economic slump that is reducing demand for Portuguese exports.

One has to hope that the Portuguese government soon has a change of heart about its social security contribution proposal before it is due to come into effect at the start of next year. Otherwise, the Portuguese economy will be in for the roughest of rides in 2013.

Desmond Lachman is a resident scholar at the American Enterprise Institute.

FURTHER READING: Lachman also writes “President Obama’s Ticking Greek Time Bomb,” “Groundhog Day in Europe,” and “The Predictable European Summit Ritual.” Ike Brannon and Matt Thoman discuss “European Disunion.” Daniel Hanson asks “Can Europe Make it All the Way to November?” Sharon Kehnemui contributes “EU Bailout Big Enough to Pull Spain from the Muck?

Image by Darren Wamboldt / Bergman Group

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