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Portugal is cutting its way deeper into crisis. Could Britain follow?

A year ago, the UK economy was nothing like Portugal's. Now there are some unsettling parallels.

The British people were never going to sit idly by and watch their government tear the country apart. They came in their hundreds of thousands - young and old, firm and infirm - to join what the police have called a "peaceful and well-stewarded" protest march and rally in London on 26 March. They came from all political parties, from north, south, east and west, to show that they opposed the coalition's damaging and unnecessary cuts to public services. At last, the public has joined the debate.

In the days following the Budget and ahead of the march, the shadow chancellor, Ed Balls, made it clear that the economy had begun to improve under Labour. GDP growth was rising, inflation and unemployment were falling and the public finances were looking up. He was backed up by Jonathan Portes, the new director of the National Institute of Economic and Social Research, who was until recently chief economist at the Cabinet Office. In testimony to the Commons Treasury select committee on 24 March, Portes pointed out that between 1997 and 2010 - including the recession - GDP per capita grew faster in the UK than in any other G7 country except Canada.

Under George Osborne, by contrast, growth is falling, unemployment and inflation are rising and consumer confidence has collapsed to levels lower than it reached in the depths of the recession in 2009. Rather than evidence of an "expansionary fiscal contraction", we are observing a "contractionary fiscal contraction". New data shows that all of the countries that have im­plemented fiscal austerity policies experienced negative GDP growth rates in the fourth quarter of 2010: Greece (-1.4 per cent), Iceland (-1.5 per cent), Ireland (-1.6 per cent), Portugal (-0.3 per cent) and the UK (-0.5 per cent).


Moody's blues

The day after the Budget, the Office for National Statistics released the latest retail sales figures. The total volume of sales had fallen by 0.8 per cent on the month in February, a bigger drop than expected. On the same day, the credit ratings agency Moody's, which has underestimated risk in the past, suggested that the UK's AAA rating was in doubt because Osborne's policies are likely to lower growth even further. "Although the weaker economic growth prospects in 2011 and 2012 do not directly cast doubt on the UK's sovereign rating level," Moody's said, "we believe that slower growth, combined with weaker-than-expected fiscal consolidation, could cause the UK's debt metrics to deteriorate to a point that would be inconsistent with a AAA rating."

Osborne has said we should take comfort in the support that his chums at the Organisation for Economic Co-operation and Development have given to what he is doing. But I wouldn't crow too loudly about the OECD's support if I were him, given its abysmal forecasting record. In June 2008, it predicted that UK GDP growth would "slow to a trough of around 1 per cent, on an annualised quarterly basis . . . before rebounding through 2009". In fact, it fell by 6.3 per cent between the second quarter of 2008 and the second quarter of 2009.

According to the OECD's latest economic survey of the UK, growth will be "subdued this year and next" but the government "must continue its difficult fiscal consolidation and structural reform programmes to return the economy to a sustainable path". This prescription echoes the one that the OECD gave to Portugal last autumn - "It is essential that the consolidation measures continue to be implemented swiftly" - and the result of cutting too fast there was lower growth and a public backlash.

On the day of Osborne's Budget, Portugal's prime minister, José Sócrates, was forced to resign after further austerity measures - the fourth package of spending cuts and tax rises in a year - were rejected. Standard and Poor's has downgraded Portugal's credit rating to BBB-, which is close to junk, and there are growing calls for the government to agree to a bailout. But providing an over-indebted nation with more highly priced debt that it can't afford is unlikely to prove a sustainable long-term strategy.

How did Portugal come to this? GDP fell by 2.6 per cent in Portugal in 2009, a smaller contraction than in the eurozone as a whole (-4.1 per cent), in part because it had no real-estate bubble. The Portuguese government responded to the drop in output with a stimulus package that included tax cuts, faster VAT refunds, a temporary increase in social and employment support, increased public investment, subsidies to promote renewable energy sources and other forms of support to economic activity, such as lines of credit to small and medium-sized enterprises.

The fiscal deficit, which had begun to deteriorate in 2008, reached 9.3 per cent of GDP in 2009, making investors more reluctant to buy Portuguese debt. In response, the government implemented an austerity programme that included heavy cuts and, it turns out, overly ambitious deficit targets from 2010 to 2013. But the OECD claimed it was "essential" that the consolidation measures be implemented as planned and that, "if acute market stress were to resurface, further fiscal tightening measures may need to be contemplated".

Stressed out

Unsurprisingly, a strategy to make one of the poorest nations in western Europe even poorer hasn't gone down well. Bond yields have jumped alarmingly to over 8 per cent, which indicates investors' grave concerns about the country's ability to pay back its debts. This makes the need for a bailout package of as much as $100bn almost inevitable. Portugal faces bond repayments worth about €9bn in total on 15 April and 15 June, and is looking to sell as much as €20bn of bonds this year to finance its budget and cover maturing debt.

A major problem is that it remains unclear what powers an interim Portuguese government will have to negotiate any settlement. As in Ireland, the new government will no doubt try to restructure any loan and may even want to default. The crisis is likely to be exacerbated further by the second round of bank stress tests now under way, designed to assess the ability of banks to survive future economic shocks. The EU's March summit on the region's debt crisis did nothing to calm fraught nerves.

A year ago, the UK economy was nothing like Portugal's. Now there are some unsettling parallels.

David Blanchflower is NS economics editor and a professor at Dartmouth College, New Hampshire, and the University of Stirling

David Blanchflower is professor of economics at Dartmouth College, New Hampshire, and a former member of the Bank of England's Monetary Policy Committee 

This article first appeared in the 04 April 2011 issue of the New Statesman, Who are the English?