The government of Portugal collapsed Wednesday night, an unfortunate event that will likely rekindle the euro zone debt crisis. Prime Minister Jose Socrates resigned after the parliament rejected a slate of austerity measures he was promoting to rein in the country’s budget deficit and debt. Portugal’s borrowing costs were already astronomical, and as soon as markets opened in Europe Thursday, the yields on its government bonds rose to a new euro-era record. That makes it almost certain, barring something unforeseen, that the country will have to seek a European Union bailout like Greece and Ireland did last year.
The implications of what has just happened in this small European nation are huge for the developed world. Portugal gives us a glimpse into the political dangers facing the budget-cutting leaders of the indebted industrialized economies, while also showing us the folly of how Europe is trying to resolve its sovereign debt crisis. Here’s what I mean:
The opposition in Portugal didn’t do their nation, or Europe in general, any favors by rejecting what the country will at some point have to implement anyway. Whoever wins upcoming elections will be forced to put in place austerity measures or face the punishment of the markets. We can argue whether or not that is fair, but it is a reality nonetheless. And if the action of the opposition leads to Portugal seeking a bailout, then the country will have Germany on its back enforcing austerity measures in return for rescue money. In other words, Portugal’s politicians only delayed the inevitable while heightening the pain for everyone.
Beyond that, the fate of poor Socrates also may await many other political leaders in the West who try to fix their troubled finances. The drive to reduce debt and deficits is going to determine the fates of political leaders and reshape the political map of the developed world. The problem is that even though the voters in the U.S. and Europe are worried about rising national debt, they simultaneously don’t care much for the austerity measures needed to get it under control. Polls in the U.S. (see here, here and here) clearly show that Americans don’t want to see any significant social programs cut in the process of budget reduction. That means Medicare, Medicaid, Social Security, unemployment benefits, education, and so on. The only cut that enjoys widespread public support is to foreign aid (which wouldn’t make any difference in closing the hole in the budget). Nor are Americans big fans of higher taxes, either. So political leaders are walking into a dangerous paradox – in order to maintain the approval of voters, they need to reduce budget deficits without reducing spending or raising taxes. This, of course, is ridiculous, but it is political reality all the same. Those politicians who firmly believe austerity is necessary are very simply putting their necks on the chopping block. Those who favor cutting the budget over cutting unemployment are going to have an especially hard time the next time voters have a go at the ballot box. I’m not saying the likes of David Cameron and John Boehner are doing the wrong thing. I’m just saying that I wouldn’t be surprised if they join Socrates on the unemployment line come election day.
The basic point here is that the need (perceived or real) to fix the state of state finances is likely to determine the winners and losers of national politics from Washington to London to Madrid to Tokyo.
The political chaos in Lisbon also sheds some light on why the euro crisis hasn’t been resolved. Investors don’t believe that politicians of the troubled countries will have the political will to implement the drastic reforms necessary to reverse the deterioration of their national finances, or that their citizens will be willing to accept such pain if they try. Nor is there really any way of forcing governments to implement such policies if they choose to delay them. Portugal’s politicians have a bailout staring them in the face, but that wasn’t enough to make them vote in favor of austerity measures. Here we can find the reason the euro zone’s entire approach to its debt crisis is flawed. Shifting the full pain of reform and financial adjustment onto its weaker members is not sustainable (or for that matter even humane). Imposing new rules onto them to force that to happen isn’t likely to work either. That, however, is exactly what Europe’s leaders are intending to do. In their summit, starting today, they are planning to increase fiscal control and coordination in the euro zone by implementing new regulations that would slap fines onto countries that fail to meet guidelines on budget deficits and sovereign debt levels. I can’t see how such measures can be enforced, nor can I imagine the elected leaders of penalized nations going along with them if the euro zone tried. My guess is that the voters at home will prove much scarier than the folks in Brussels.
Making the weaker economies of Europe stronger is exactly the way to fix the euro zone and end the euro crisis. Doing so by beating the struggling nations with sticks isn’t the way to do it. Politicians will end up resisting to keep their jobs. Wouldn’t you?