The Consolidated Public Sector

Portugal Table of Contents

After the revolution, the Portuguese economy experienced a rapid, and often uncontrollable, expansion of public expenditures--both in the general government and in public enterprises. The lag in public sector receipts resulted in large public enterprise and general government deficits. In 1982 the borrowing requirement of the consolidated public sector reached 24 percent of GDP, its peak level; it was subsequently reduced to 9 percent of GDP in 1990.

To rein in domestic demand growth, the Portuguese government was obliged to pursue IMF-monitored stabilization programs in 1977-78 and 1983-85. The large negative savings of the public sector (including the state-owned enterprises) became a structural feature of Portugal's political economy after the revolution. Other official impediments to rapid economic growth after 1974 included all-pervasive price regulation, as well as heavy-handed intervention in factor markets and the distribution of income.

In 1989 Prime Minister Aníbal Cavaco Silva succeeded in mobilizing the required two-thirds vote in the National Assembly to amend the constitution, thereby permitting the denationalization of the state-owned banks and other public enterprises. Privatization, economic deregulation, and tax reform became the salient concerns of public policy as Portugal prepared itself for the challenges and opportunities of membership in the EC's single market in the 1990s.

The Nonfinancial Public Enterprises

Following the sweeping nationalizations of the mid-1970s, public enterprises became a major component of Portugal's consolidated public sector. Portugal's nationalized sector in 1980 included a core of fifty nonfinancial enterprises, entirely government owned. This so-called public nonfinancial enterprise group included the Institute of State Participation, a holding company with investments in some seventy subsidiary enterprises; a number of state-owned entities manufacturing or selling goods and services grouped with nationalized enterprises for national accounts purposes (arms, agriculture, and public infrastructure, such as ports); and a large number of over 50-percent EPNF-owned subsidiaries operating under private law. Altogether these public enterprises accounted for 25 percent of VA in GDP, 52 percent of GFCF, and 12 percent of Portugal's total employment. In terms of VA and GFCF, the relative scale of Portugal's public entities exceeded that of the other West European economies, including the EC member countries.

Although the nationalizations broke up the concentration of economic power in the hands of the financial-industrial groups, the subsequent merger of several private firms into single publicly owned enterprises left domestic markets even more subject to monopoly. Apart from special cases, as in iron and steel, where the economies of scale are optimal for very large firms, there was some question as to the desirability of establishing national monopolies. The elimination of competition following the official takeover of such industries as cement, chemicals, and trucking probably reduced managerial incentives for cost reduction and technical advance.

As hybrid institutions, public enterprises find it difficult to separate market choices from political considerations. Their poorer economic performance may partially be explained by public management's frustration at attempting to reconcile impossible goals: on the one side, a concern for the "bottom line"; on the other, coping with the distributional struggles of interest groups. Special interest groups that shape the policies of state-owned firms include "elite" public enterprise unions aspiring to guarantee employment and above-market wages; consumer groups desiring goods and services at below user cost or market price; oversight ministries intent upon expanding their authority; and politicians, including chiefs of state, seeking to expand patronage opportunities. As a vehicle for redistribution, public enterprise often becomes the servant of special interest groups--those who are politically connected--rather than a guardian of the public or general interest.

It was not surprising that numerous nationalized enterprises experienced severe operating and financial difficulties. State operations faced considerable uncertainty as to the goals of public enterprises, with negative implications for decision making, often at odds with market criteria. In many instances, managers of public firms were less able than their private-sector counterparts to resist strong wage demands from militant unions. Further, public firm managers were required for reasons of political expediency to maintain a redundant labor force and freeze prices or utility rates for long periods in the face of rising costs. Overstaffing was particularly flagrant at Petrogal, the national petroleum monopoly, and Estaleiros Navais de Setúbal (Setenave), the wholly state-owned shipbuilding and repairing enterprise. The failure of the public transportation firms to raise fares during a time of accelerating inflation resulted in substantial operating losses and even obsolescence of the sector's capital stock.

As a group, the public enterprises performed poorly financially and relied excessively on debt financing from both domestic and foreign commercial banks. The operating and financial problems of the public enterprise sector were revealed in a study by the Bank of Portugal covering the years 1978-80. Based upon a survey of fifty-one enterprises, which represented 92 percent of the sector's VA, the analysis confirmed the debilitated financial condition of the public enterprises, i.e., their inadequate equity and liquidity ratios. The consolidated losses of the firms included in the survey increased from 18.3 million contos in 1978 to 40.3 million contos in 1980, or 4.6 percent to 6.1 percent of net worth, respectively. Losses were concentrated in transportation and to a lesser extent in transport equipment and materials (principally shipbuilding and ship repair). The budgetary burden of the public enterprises as a result of their overall weak performance was substantial: enterprise transfers to the Portuguese government (mainly taxes) fell short of government receipts in the forms of subsidies and capital transfers. The largest nonfinancial state enterprises recorded (inflation-discounted) losses in the seven-year period from 1977 to 1983 equivalent to 11 percent on capital employed. Notwithstanding their substantial operating losses and weak capital structure, these large enterprises financed 86 percent of their capital investments from 1977 to 1983 through increases in debt, of which two-thirds was foreign. The rapid buildup of Portugal's external debt from 1978 to 1985 was largely associated with the public enterprises.

The General Government

The share of general government expenditure (including capital outlays) in GDP rose from 23 percent in 1973 to 46 percent in 1990. On the revenue side, the upward trend was less pronounced: the share increased from nearly 23 percent in 1973 to 39.2 percent in 1990. From a modest surplus before the revolution in 1973, the government balance swung to a wide deficit of 12 percent of GDP in 1984, declining thereafter to around 5.4 percent of GDP in 1990. Significantly, both current expenditures and capital expenditures roughly doubled their shares of GDP between 1973 and 1990: government current outlays rose from 19.5 percent to 40.2 percent, capital outlays from 3.2 percent to 5.7 percent.

Apart from the growing investment effort, which included capital transfers to the public enterprises, government expenditure patterns since the revolution reflected rapid expansion in the number of civil servants and pressure to redistribute income, mainly through current transfers and subsidies, as well as burgeoning interest obligations. The category "current transfers" nearly tripled its share of GDP between 1973 and 1990, from under 5 percent to 13.4 percent, reflecting the explosive growth of the social security system, both with respect to the number of persons covered and the upgrading of benefits. Escalating interest payments on the public debt from less than half a percent of GDP in 1973 to 8.2 percent of GDP in 1990 were the result of both a rise in the debt itself and higher real effective interest rates.

The narrowing of the government deficit since the mid-1980s and the associated easing of the borrowing requirement was caused both by a small increase in the share of receipts (by two percentage points) and the relatively sharper contraction of current subsidies, from 7.6 percent of GDP in 1984 to 1.5 percent of GDP in 1990. This reduction was a direct consequence of the gradual abandonment by the government of its policy of curbs on rises in public utility rates and food prices, against which it paid subsidies to public enterprises.

Tax reform--comprising both direct and indirect taxation--was a major element in a more comprehensive effort to modernize the economy in the late 1980s. The key objective of these reforms was to promote more efficient and market-oriented economic performance. Beyond considerations of efficiency, a good tax system also should be simple (i.e., easy to administer), fair, and transparent.

Prior to the reform, about 90 percent of the personal tax base consisted of labor income. Statutory marginal tax rates on labor income were very high, even at relatively low income levels, especially after the revolution. The large number of tax exemptions and fiscal benefits, together with high marginal tax rates, entailed the progressive erosion of the tax base through tax avoidance and evasion. Furthermore, Portuguese membership in the EC created the imperative for a number of changes in the tax system, especially the introduction of the value-added tax (VAT).

Reform proceeded in two major installments: the VAT was introduced in 1986; the income tax reform, for both personal and corporate income, became effective in 1989. The VAT, whose normal rate was 17 percent, replaced all indirect taxes, such as the transactions tax, railroad tax, and tourism tax. Marginal tax rates on both personal and corporate income were substantially cut, and in the case of individual taxes, the number of brackets was reduced to five. The basic rate of corporate tax was 36.5 percent, and the top marginal tax rate on personal income was cut from 80 percent to 40 percent. A 25-percent capital gains tax was levied on direct and portfolio investment. Business proceeds invested in development projects were exempt from capital gains tax if the assets were retained for at least two years.

Preliminary estimates indicated that part of the observed increase in direct tax revenue in 1989-90 was of a permanent nature, the consequence of a redefinition of taxable income, a reduction in allowed deductions, and the termination of most fiscal benefits for corporations. The resulting broadening of the income tax base permitted a lowering of marginal tax rates, greatly reducing the disincentive effects to labor and saving.

Macroeconomic Disequilibria and Public Debt

Between 1973 and 1988, the general government debt/GDP ratio quadrupled, reaching a peak of 74 percent in 1988. This growth in the absolute and relative debt was only partially attributable to the accumulation of government deficits. It also reflected the reorganization of various public funds and enterprises, the separation of their accounts from those of the government, and their fiscal consolidation. The rising trend of the general government debt/GDP ratio was reversed in 1989, as a surge in tax revenues linked to the tax reform and the shrinking public enterprise deficits reduced the public sector borrowing requirement (PSBR) relative to GDP. After falling to 67 percent in 1990, the general government debt/GDP ratio was expected to continue to decline, reflecting fiscal restraint and increased proceeds from privatization.

The financing structure of the public deficits had changed since the mid-1980s under the effect of two factors. First, the easing of the PSBR and the government's determination to reduce the foreign debt/GDP ratio led to a sharp reduction in borrowing abroad. Second, since 1985 the share of nonmonetary financing had increased steeply, not only in the form of public issues of Treasury bills but also, since 1987-88, in the form of medium-term Treasury bonds.

The magnitude of the public sector deficit (including that of the public enterprises) had a crowding-out effect on private investment. The nationalized banks were obliged by law to increase their holding of government paper bearing negative real interest rates. This massive absorption of funds by the public sector was largely at the expense of private enterprises whose financing was often constrained by quantitative credit controls.

Portugal's membership in the EC resulted in substantial net transfers averaging 1.5 percent of annual GDP during 1987-90. The bulk of these transfers was "structural" funds that were used for infrastructure developments and professional training. Additional EC funds, also allocated through the public sector, were designed for the development of Portugal's agricultural and industrial sectors.

After 1985 the PSBR began to show a substantial decline, largely as a result of the improved financial position of public enterprises. Favorable exogenous factors (lower oil prices, lower interest rates, and depreciation of the dollar) helped to moderate operating costs. More important, however, was the shift in government policy. Public enterprise managers were given greater autonomy with respect to investment, labor, and product pricing. Significantly, the combined deficit of the nonfinancial public enterprises fell to below 2 percent of GDP on average in 1987-88 from 8 percent of GDP in 1985-86. In 1989 the borrowing requirements of those enterprises fell further to 1 percent of GDP.

In April 1990, legislation concerning privatization was enacted following an amendment to the constitution in June 1989 that provided the basis for complete (100 percent) divestiture of nationalized enterprises. Among the stated objectives of privatization were to modernize economic units, increase their competitiveness, and contribute to sectoral restructuring; to reduce the role of the state in the economy; to contribute to the development of capital markets; and to widen the participation of Portuguese citizens in the ownership of enterprises, giving particular attention to the workers of the enterprises and to small shareholders.

The Portuguese government was concerned about the strength of foreign investment in privatizations and wanted to reserve the right to veto some transactions. But as a member of the EC, Portugal eventually would have to accept investment from other member countries on an equal footing with investment of its nationals. Significantly, government proceeds from privatization of nationalized enterprises would primarily be used to reduce public debt; and to the extent that profits would rise after privatization, tax revenues would expand. In 1991 proceeds from privatization were expected to amount to 2.5 percent of GDP.

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Source: U.S. Library of Congress