I have spent the last two days here on the ground in Portugal and I leave with the distinct feeling that Portugal might be at the end of the road. The recent fiscal crisis actually provided the country with a unique opportunity to do something constructive about its state of affairs and its pervasive system of entitlements that has evolved since the Carnation Revolution of 1974.
Portugal is worse off than I thought – not only fiscally, but also due to the seemingly unshakable state of denial on the political front that is beyond compare. All political rhetoric starts with absurd palliatives attempting to tell voters that things could be worse, that there are other countries where the situation is far worse, etc..
No way, politicians! Things are plenty bad in Portugal. Including even my home country, Denmark, in a comparison, it’s hard to find a country that wastes more money maintaining state employment for the sake of keeping special interests happy rather than thinking about what's best for the public service. One example: Portugal is top three in Europe in terms of spending per capita on education, but ranks in the bottom three in terms of student performance scores.
Another example is doctors. Most of them work for EUR 4-5,000 per month for 30 years in order to get a state-guaranteed pension, and also work late evenings in order to afford their desired standard of living. There is no incentive and dynamic to leave the public sector as everyone, and I mean everyone, is only motivated to strive for the safety of the state pension – even if it doesn’t guarantee more than a tolerable standard of living.
But how can Portugal change – how can it detach itself from the ball and chain of state pensions and guarantees and become more dynamic and competitive? Here comes the special nature of the Portuguese in play: throughout history, Portugal has responded well when foreigners offer a wakeup call that can trigger a new direction. So, the EU and IMF setting the agenda with a tough set of conditions could be the start of something better, but the risk remains that the bailout only serves as an enabler or “extend and pretend” for the existing system by keeping it liquid for another few years. The June 5 election is key here – will Portugal’s politicians see the writing on the wall or simply take the easy way out and buy more time.
Taking a step back and applying the microcosm of Portugal to the bigger picture in Europe, the more it becomes clear to me that:
1. The market underestimates the willingness and ability of the EU political system to continue to play the delaying game that I now call "Quantitative Easing to infinity". QE to infinity means endless bailouts at every comer and a guarantee that the 'liquidity cavalry' is guaranteed to ride with every 10 percent correction in the stock market.
2. Related to the first point and giving it sustenance is the First Rule of Politics in a Democracy: the perceived political cost of doing nothing in the short term and buying time is nearly always lower than bold action. But all rules are meant to be broken, and once in a while, the choice for the politician becomes one of choosing between the risks of bold political action or certain political death. A case in point on the latter is Greece…
Greece was the first country that needed a bailout almost exactly a year ago. At this point, with Greek 2-year public debt trading at 25%, what is the potential for bold action (a massive restructuring of debt) rather than more extend and pretend? Sarkozy and Merkel need to start thinking about re-election in 2012 and 2013, so forcing the inevitable Greek default deal in the here and now will spare them the embarrassment of having to campaign on a pro bail-out agenda that will guarantee election failure. After all, what is more popular for Merkel/Sarkozy to do – send even more money into the fiscal black hole in Southern Europe or spend it on recapitalising German/French banks? You know the answer – hence my call is for a Greek restructuring of its debt before the end of September this year.
Trichet will probably not want this to happen on his watch but it is now matematically impossible for Greece not to restructure.
Back in Portugal, the impact of the First Rule of Politics is one where the grace period for not owning up to the structural issues needs to stop soon after the June 5 election, otherwise the grave fiscal math will ensure that Portugal, courtesy of the IMF/EU is forced into zero growth mode or worse, which means it is guaranteed not to be able to create the economic growth necessary to swell public coffers sufficiently enough to service public debt, much less reduce it.
The unfortunate risk here is that Portugal will take one step forward and then two steps back - but please prove me wrong, Portugal, and do the right thing. I have great faith in the individuals of Portugal, but as a society, the creaky and top-heavy system of entitlements is going to come crashing down if it is not made structurally sustainable. Entitlements need to be earned and they need to be affordable. The sooner the challenge is addressed, the better for the country.