In Which a Business Person in Portugal Shows More Knowledge of Economics Than the Credentialed Ones in the U. S.

Common Sense Doesn’t Stop Bad Policy

One of the quieter stories about Europe has been the austerity program in Portugal.  That country has needed a European bailout and has accepted the austerity policy that accompanied it.  Portugal has not been in the news because there has been general acceptance of the misery that misguided economic policies have brought.  Here is the policy.

Since taking office in June 2011, Mr. Passos Coelho has closely followed instructions from lenders—the EU, the International Monetary Fund and the European Central Bank. He has cut wages, raised taxes, privatized state-owned companies and overhauled labor-market laws that discouraged businesses from hiring.

Portugal's budget deficit has shrunk from 9.8% of gross domestic product in 2010 to an expected 5% this year.

And here is the misery.

But the cutbacks have also led to a rise in unemployment and bankruptcies, which in turn have hurt tax revenue. The 15% jobless rate has lifted government spending on social benefits.

But now the government of Portugal may have gone too far.  It has decided to make employment less expensive for Portuguese businesses by shifting a large portion of the payroll tax away from employers and onto the workers.

Under the plan, employees would pay 18% of their salaries to the social-security system, up from 11%, allowing companies to cut their contributions to 18% from 23.75%.

And the rationale for such harmful action on workers,

Mr. Passos Coelho said the shift on pension-fund contributions would tackle those problems. "We will reduce substantially the costs of labor, providing incentives to investment and job creation," he said.

So what’s the problem?  Shouldn’t lower labor costs lead to high employment.  Well, no,  the demand for labor is based on the demand for goods and service labor produces.  And one Portuguese businessman summed up the problem with the policy like this.

Some business owners questioned Mr. Passos Coelho's new pension plan. They warned that an increase in workers' pension payments would depress already-fragile demand for consumer products and services, offsetting any savings to companies.

"What is the use of a company paying less contribution if people don't have the money to buy shoes?" said Fortunato Frederico, president of Kyaia, which employs 600 people and is one of Portugal's largest shoe makers.

Mr. Frederico said his sales had fallen 25% this year. He hasn't calculated how much money he could save from lower pension contributions but added: "As companies face a sharp fall in demand, we would hire more workers to do what?"

Wow, somebody actually realizes that if workers do not have money to buy shoes, they won’t buy shoes and even if the cost of employment goes down why hire people to make shoes that nobody will buy.

Mr. Frederico understands basic economics, why don’t all those smart policy maker do also?

Portugal can be an economic success, because it is a small country.  As a small country it can experience a big increase in exports, but because that increase is so small in the entire world trade sector it can easily take place.  This would offset government policy to contract the economy, unless the government is so stupid as to enact such bad policy that even an export boom won’t work.  Looks like Portugal could be that stupid.