Waiving the Rules for Portugal

In the colonies it used to be said of Britain that Britannia did not rule the waves as much as it waived the rules. If the European Union now accedes to Portuguese prime minister José Sócrates’ request last night for emergency funding to tide Portugal over until after its June 5 election, it will demonstrate that the European Commission is offering the Britannia of old some serious competition in the realm of disregarding its own rules.

In the absence of an effective Portuguese government it is difficult to see how the EU can maintain the pretence that, when bailing out the European periphery, it does so only with the strictest of credible conditions attached.

Last year, under the threat of impending damage to the European banking system from potential debt defaults in the periphery, the EU effectively abandoned the "no bailout" clause of the Lisbon Treaty. It did so by combining with the IMF to provide first Greece and then Ireland with massive financial support packages. However, it managed to sell these packages to a reluctant German electorate, by demanding that Greece and Ireland implement the most stringent of budget and structural adjustments.

The very reason that Portugal finds itself in its present predicament, and that Mr Sócrates has to do the most embarrassing of u-turns in going cap in hand to the Commission, is that his government was unable to secure passage of adequate budget measures that might have averted a crisis.

It would seem that if the Commission now accedes to Mr Sócrates' request, in the midst of a Portuguese political vacuum, it would be making a huge leap of faith. However, faced with the alternative of a Portuguese default that could trigger contagion to Spain, one can well understand why the EU is very likely to provide the money.

At a more basic level, one has to wonder whether Portugal is not providing yet further proof that the EU and International Monetary Fund are misguided in treating the periphery’s economic problems as those of liquidity rather than of solvency. Even if Portugal were able to commit credibly to the 5.3 per cent of gross domestic product in tax increases and public spending cuts in 2011 that the EU wants, could Portugal turn around its public finances within the straitjacket of the euro and without the benefit of a debt restructuring?

If there was any doubt on that score, all one needs to do is look at the Greek and Irish experience with IMF-style fiscal adjustment. Over the past two years, under the weight of draconian fiscal adjustment, real GDP in Greece and Ireland has contracted by 6 per cent and 11 per cent respectively. This is now seriously undermining those countries’ tax bases as well as their political willingness to stay the course of adjustment.

If the past is any guide, one must expect that the fear of triggering an immediate bank crisis in Europe’s core will trump considerations of how much sense in the long run it makes to require unsustainable economic adjustment in the periphery. For that reason, I would be seriously surprised if the EU does not turn yet another blind eye to any semblance of rules in the way it bails out the periphery.

Desmond Lachman is a resident fellow at AEI.

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About the Author

 

Desmond
Lachman
  • Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund's (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
  • Phone: 202-862-5844
    Email: dlachman@aei.org
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