In the book turned film, Night Train to Lisbon, a worthy but worn-out Swiss classics schoolteacher gets a new lease of life in Portugal. Now the progressive-minded in Europe are gaining inspiration from the minority Socialist government that has been in power in Lisbon since late 2015. Peter Mandelson, an architect of New Labour’s “third way” between the extremes of right and left, recently praised Portugal for charting “a fourth way” for European social democrats.
Has the land of explorers really discovered a new nostrum for managing the economy and public finances? Something to replace the third way that died with the financial crisis a decade ago?
The idea that António Costa would now still be prime minister, let alone be lovebombed by centrist fellow-travellers, would have seemed preposterous in November 2015. His Socialist Party had come second in the inconclusive general election called by Pedro Passos Coelho, the centre right prime minister who presided over Portugal’s bailout between 2011 and 2014 (which was requested by José Sócrates, his Socialist predecessor). Unexpectedly, Costa managed to cobble together a minority government backed by the radical Left Bloc and the Communist Party. Even more unexpectedly, it has survived.
Just as surprising has been the government’s ability to run what appears to be a wildly contradictory set of economic and fiscal policies. On the one hand, Costa has undone reforms painfully pushed through by Passos Coelho as the price for releasing emergency loans from the Europe and the IMF. This has included crowd-pleasing measures such as restoring four public holidays, a rise in the minimum wage and a reversal of pay cuts in the state sector together with the reinstatement of a 35-hour working week (raised to 40 hours during the bailout) for most civil servants.
Despite this tilt to the left, Costa’s government has won favour rather than disapproval in fiscally conservative Europe. Indeed when Jeroen Dijsselbloem from the Netherlands stepped down as president of the powerful Eurogroup of finance ministers at the start of this year, it was Mário Centeno from Portugal who took his place. That was the first time since this influential role was created in 2004 that a politician from southern Europe was entrusted with it.
This reflects the continuing fiscal progress under Costa’s government. The improvement has been sufficient for Portugal to emerge last year from the “excessive deficit” procedure of the Maastricht Treaty into which it had lapsed in 2009. The headline deficit has fallen from 4.4 per cent of GDP in 2015 to 3 per cent in 2017 and is expected to decline to 0.9 per cent this year according to the European Commission in May. These figures include one-off measures to clear up banking messes (worryingly, a recurring theme). Excluding those, the deficit has dropped from 3 per cent of GDP in 2015 to just under 1 per cent in 2017 and is forecast by the Commission at only 0.5 per cent this year.
The underlying improvement is remarkable, but it owes little to the government other than the caution of its actual net giveaway. Thanks to various offsetting measures, this amounted to only around half a per cent of GDP. If anyone deserves to take credit for Portugal’s improved public finances it is Mario Draghi rather than Costa.
First, Portugal has benefited greatly from the European Central Bank’s ultra-loose monetary policy, which has driven down the cost of government borrowing across the currency union and especially on the periphery. The interest paid by the Portuguese government on public debt has fallen from 4.6 per cent of GDP in 2015 to 3.9 per cent in 2017 and 3.5 per cent this year, according to the Commission’s forecast. Lower interest costs have thus contributed nearly half of the improvement in the underlying budget balance between 2015 and 2018.
“If anyone deserves credit for Portugal’s improved public finances it is Mario Draghi”Second, the ECB’s policies have spurred the Portuguese economy, which grew last year faster than the euro area as a whole. For the eurozone its growth of 2.4 per cent was the fastest since 2007. For Portugal its expansion of 2.7 per cent was the fastest since 2000, the year after it joined the single currency as a founder member. In an indication of the toll that the successive financial and euro crises have taken on the economy, GDP in 2017 was still around 1 per cent smaller than at its previous peak, in 2008.
The expansion, fuelled by tourism and construction, has been jobs-rich, too, causing unemployment to fall sharply, in turn bringing down the cost of benefits. The jobless rate, which had peaked at 17.5 per cent of the labour force in January 2013, stood at 12.2 per cent when Costa took over. In June it was just 6.7 per cent, the lowest since the autumn of 2002.
The government has reaped a rich fiscal dividend from the strong economy. Taxes have been buoyant, growing by 4.1 per cent in 2017. At the same time current spending (which includes interest payments) rose by only 0.5 per cent last year.
Timing matters in politics. Costa’s good fortune was to take over as the ECB’s policies started to bear fruit in an economy that had already become more competitive and export-oriented. Portugal has also been helped by the impressive recovery in Spain, its biggest trading partner, and a shift among tourists to destinations in southern Europe. Costa’s contribution has been to limit the ambition of any budgetary easing as the public coffers have started to fill again.
The windfall fiscal gains are now ending as the recovery weakens. GDP growth slowed to 2.1 per cent in the year to the first quarter of 2018 and is likely to flag further as the ECB ends its quantitative easing programme at the end of this year. Despite its recent strength, the Portuguese economy retains familiar weaknesses. Public debt stood at 126 per cent of GDP at the end of 2017, only a little down from its peak of 131 per cent three years earlier, and the third highest in the euro area, after Greece and Italy. Corporate debt is also too high for comfort. Portuguese banks have been disconcertingly wobbly, requiring repeated injections of public funds that have blotted headline budget balances.
Costa has played a weak political hand well. But what has mattered most of all is that the economy has for once turned up trumps. It is fanciful to think that he has managed to reinvent politics not just for Portugal but for post-crisis Europe. The “fourth way” turns out in large measure to have been the lucky way—and fortune is fickle, as the Portuguese know only too well after the rollercoaster ride they have had in the past decade.
