Reform of the State
One of the main items of the Adjustment Program is the Reform of the State. The IMF has already produced a report on the subject. IMF-Expenditure review And OECD has also contributed to the same theme. OECD – Portugal Reforming State
The reports of IMF and OECD on Structural Reforms of the Public Sector are important pieces for studying the issue with a view to improve efficiency and equity of the expenditure side of the Government budget. These documents complement the Memorandum of the Program. Here are some of the issues covered and comments on these reports.
Comment: Most of the issues of structural reforms had already been addressed in our book Economia Portuguesa, 3rd edition, 2006 and 4th edition, 2013, in the chapter “Convergência Real e Reformas Estruturais”.
The Report of the IMF can be systematized in two areas: general measures/principles and specific measures:
1. On the efficiency of the Portuguese education system, as an example of inefficiency in some public services:
“the state has been falling behind in providing quality education: of the 50 top schools, 44 are private, 4 are charter schools, and only 2 are public schools.” (pg. 13)
What are the fundamental functions of the state? Example for the education sector:
“the Portuguese state still attempts to do (almost) everything: it provides education, sets standards, evaluates (its own) performance, and enforces standards”, while “In many countries, the state has moved away from being a provider of services (or the sole provider of services) and toward being a setter and enforcer of service standards, while service provision itself is [may be] handled by the private sector”. (pg. 13)
Comment: We would add that the state does not need to be the sole provider of public goods, but it should ensure and efficient and equitable provision of public goods. On the functions is important to emphasize that they need to be entrusted to different institutions: a provider of a service cannot at the same time be a regulator (set standards and enforce those standards).
2. “Public sector pay and employment policies need to emphasize competitiveness and providing value for money to the population” (pg 13)
Comment: this requires that remuneration combined with other employment benefits should be in line and competitive with the private sector. But any comparison needs to be done by matching job to job in the different departments of the public sector with the private sector. This is a result of detailed job comparison survey. Some of the work that has been done on aggregates is misleading (by the ECB and others).
A recent study by the European Commission, Government Wages and Labour Market Outcomes, Occasional Paper 190, April 2014, shows that Portugal had in 2010 one of the highest wage premiums in the public sector vis-à-vis the private sector, but it differed substantially with the level of education (and wage scale): it was 18.6% for low level, 8.2% for medium and only 4.5% for high level. With the 5% wage cut and suspension of one month-subsidy there was a cut of 14%, which turned the premium in favour of the private sector for the medium and high level. The trade-off between concerns for equity and efficiency led to the postponement of adjustment in the low level of education. Another interesting conclusion from the study is tha Portugal was one of the countries were a 1% increase in government wages led to a high response from the private wages (1.6 impulse, with Italy the only case with a higher response). The moderation of wages by the public sector is fundamental to maintain competitiveness in the tradables sector, as the study demonstrate.
3. Need to look at the systemic impact of policies and its impact on short term and long-term impact on incentives of economic agents:
“For example, unemployment benefits need to link automatically to retraining and job search support to facilitate finding employment. Child benefits need to be designed to enable, rather than hold back, mothers that wish to return to work and increase their incomes.” (pg. 14)
Comment: There is an urgent need to analyse the major programs using an integrated approach, but there is a need of highly qualified experts to carry out these studies. Should external experts and university research teams be hired for these studies? For example, no in depth study has been carried out of the efficiency and impact of training programs using EU funds that have spent a large share of the structural funds totalling billions of Euros spent every year.
4. Need to target social programs:
“The problems faced by the young—both in entering the labor force and in facing greater income and employment insecurity once they get there—imply a growing distance between those entering the labor market and the more mature population. The issue of intergenerational equity is already important but is likely to increase dramatically in the next decade.” (pg. 15)
Comment: Besides the targeting of programs to fight poverty in a country with one of the highest levels in the EU, the problem of youth unemployment is of a major importance. Another issue that has not been paid enough attention has been the intergenerational equity (in pension reforms and in public debt and public investment issues)
5. Pensions: sustainability and automatic mechanisms
Comment: This is one of the worst analyses of the IMF report. First, it infers that the replacement ratio in Portugal is about 27% above a sample of countries. However it does not take into consideration the characteristics of each system, mainly if it is a mandatory public system or is a mix of public-private systems. Second, there is a contradiction in their statements that the system is quite inequitable when about half of this difference was due to the increase in lower pensions in the last decade. Third, they compute the distribution of old age pensions by income group to conclude that is inequitable because 41.6% accrues to the upper quintile. But the old age pension system should reflect the lifetime income of workers. No pension system around the world is equalitarian! And surprisingly, this reasoning has prevailed in the analysis of the IMF/EC/ECB and government.
Where equity comes in is in ensuring that all participants of the social security system have a minimum pension that allows the person/family to live with dignity. This is the principle of solidarity that prevails in all modern systems from Chile to Sweden.
The main instrument to reduce income inequality is the income tax structure. A flat rate system with a basic deduction is already a corrective system and is used in several countries. Introducing an increasing rate of tax with income levels makes the system even more progressive. If on top of such a system pensions are cut according to the income level then there is even more than “double progressivity”.
The intergenerational and across sectors inequality problem in Portugal is the large differential between public sector pensioners and pensioners of the general regime, to the extent that they receive a pension that is higher than their respective contributions.
Finally, all social security systems – pay-as-you go or capitalization – have to be actuarially balanced, otherwise they would need to be financed by general taxation, which raises inequality problems across generations. In order to avoid discretionary interventions by governments, these systems should have automatic balancing mechanisms like the Swedish system or the recent reform of the Spanish system.
To ensure that the systems remain fully funded they need to be periodically simulated to determine their actuarial balances by and independent body.
Moreover, because the reforms of social security systems are necessarily of a long-term nature, they should be studied by by-partisan or politically independent committees (like in the US or in the recent Spanish case).
Finally, the construction of any old age pension system must take into consideration its impact on incentives to work and to save by the different generations and classes of workers.
6. Project analysis of investment projects
This is an area totally missing from the review of the IMF. In the Portuguese case it is extremely important because of the large amount of resources allocated to state investments and PPPs with an extremely low (may be even negative) rates of return, with serious consequences on the capacity of the economy to grow.
In our view, all projects above a given amount of investment, e.g. 100 Million Euros, should be subject to a rigorous cost/benefit analysis, and in the case of investments above 1 Billion Euros subject to analysis by an independent international team of experts of reputed competence. These studies should be afterwards open to democratic scrutiny by academics and Parliament.
7. Budget unity: quantification of all liabilities of the state, including contingent liabilities. Multiannual planning of maintenance and investment expenditures.
Specific Measures Proposed to Reduce Expenditures:
Reform of Public Administration
“This could include three main elements:
(i) reforming public pay rates—including basic salaries bonuses, working hours and overtime compensations, with a view of encouraging meritocracy;
(ii) targeting a permanent reduction in the number of employees while opening space to attract skilled younger workers; and
(iii) increasing shared services and technology in order to limit duplications and overlaps.” (pg. 23).
Reduction in wage bill
(1) “To avoid the temporary nature of past measures (the 5 percent reduction introduced in 2011 and the suspension of the 14th month pay), starting in 2014, a permanent cut in base salaries could be introduced across the board, that would aim (at a minimum) to attain the same savings generated by the wage cuts of the 2013 budget.” (pg. 23) This measure should affect mainly the lower pay scales where there is a wage premium vis-à-vis the private sector (savings of 350-700 ME). Moreover, “The relative flat wage structure is costly and impairs talent attraction”, “the wage premium is explained by the relatively high pay provided to workers with low qualifications”, and “pay reductions have focussed on high earners which have further flattened the wage structure”. (pg. 22-23) Extension of the pay cut to salaries between 700 and 1200 Euros: done, but implementation of the new salary scale delayed to the course of 2014.
(2) Reduction in wage supplements (200-300 ME). Partially done.
(3) Extend work week of government employees from 35 to 40 hours. Cut overtime pay to a flat 15%, affecting largely the health sector – doctors (150-300 ME). Work week extended, reduction in overpay partially achieved.
(4) Reduce the workforce of public sector by between 10-20% (795-2700 ME) [From 2010 to 2013 there was a reduction of 8%, mainly by attrition] by
- Enhanced use of the Special Mobility Pool. Not effective.
- Voluntary separations programs. In place for the last 2 years, but very low results.
- Reduction by attrition. Implemented (replacement ratio of 1:3 increased to 1:5 would achieve a 2% reduction in employment). (300-500 ME). Implemented [generated about 45 thousand reduction]
- Merge similar services (like inspections) of different ministries or establish consolidated departments providing services to different ministries. Not implemented
- Reduce the number of non-teachers in public schools (presently 70 thousand for 160 thousand teachers) and increase the ratio of students per teacher from 8 to close to 14, leading to a cut in staff in primary and secondary education of 50-60 thousand. Reallocating students from schools with low number of students to larger ones will contribute to this objective. (1,070-1,280 ME). Partially implemented ?? How much??
- Reduction in security forces, bringing them more in line with European averages (e.g. about 20% would generate savings of 3.4% of wage bill equivalent to 300-450 ME). Not implemented.
Implementation: Portugal was the country with the highest reduction in the wage bill from 2008 to 2014, according to the data of the European Commission (Data base Ameco). It decreased by 3.3 pp of GDP: The top five decreases, after Portugal, were: Latvia (2.8), Lithuania (2.7), Romania (2.7), Ireland (2.2) and (Estonia (2.1). Greece comes next with 1.8.
Increase in fees for public services
- Increase in fees in tertiary education (100 ME). Not implemented
- Increase in fees in health system (100 ME). Not implemented
Total budgetary impact of IMF proposed measures: 1895 to 4400 ME.
PPPs and Public Enterprise Reform
According to the Ernest Young audit to the PPPs, required by the Program of IMF/EC/ECB, there were seven concessions ex-SCUT, implying a cost of 5.5 Billion Euros, at 2012 prices, to the State. The rates of return for shareholders varied from 8.2 to 17.4%, with traffic usually much lower than projected and with a large bank debt. The sub-concessions amounted to 7.2 Billion Euros, with rates of return for shareholders varied from 7.3 to 11.6%, also with large bank debt and high bank debt over EBITA. The Program required the renegotiation of the PPPs given the high rates of return that the State gave to shareholders, taking the traffic risk and with over-estimated demand, culminating in a system that gave a certain and sure monthly payment “to reward availability of the infrastructure”. It is surprising how representatives of taxpayers (state officials) could agree these contracts with concessionaires.
Implementation: Renegotiations started in May 2012. In May 2013 the state reached an agreement with 7 out of 9 concessions, except Euroscut (Norte-Litiral and Algarve), in which concessionaires accepted a reduction of the rates of return from an average of 14 to around 8%. The savings, when Euroscut accepts would be around 311 ME per year. (Negocios, 21/4/2013). According to the 12th Report of the IMF the savings accumulated over the lifetime would be about 2.8 Billion Euros of a total of 12-18 BE expected liabilities (around 30% if the lower limit is taken). Not all the reductions will be real savings since part of that cut in revenues to the concessionaires are in the form of reduced maintenance and improvement costs. However, the other contractual agents also need to agree on these negotiations: the EIB has in principle agreed, but the consortia of financing banks have yet to agree. According to Negocios the Government expects a final agreement in June 2014.
A rapidly aging population and stagnation of the economy for two decades, after four decades of strong growth, in a benefit defined pension system is a recipe for disaster. Solutions adopted so far have been cuts in medium and high pensions and imposing special taxes on pensions, which have been required to rapidly cut the public deficit lead to the loss of confidence in the system. If the social security system is not actuarially balanced either contributions increase or benefits have to be reduced, there is no alternative. But the system needs to be reformed and embodied with automatic correction mechanisms to reach long-term balance. And, as we pointed above, this is not a measure to be taken by a given government, but needs to be undertaken in a bi-partisan context.
The reforms undertaken in the last twelve years (Decreto-Lei 277/1993, Decreto-Lei 329/1993, Lei 32/2002, Decreto-Lei 35/2002, Lei 60/2005, Lei 4/2007, Decreto-Lei 187/2007, and Lei 52/2007) have decreased substantially the unsustainable deficits of the two main regimes of the old age pension systems, but current projections continue to show a deficit of about 30% of GDP of the GCR and about 120 to 160% of GDP (for 15% of the total pensioners!) of the CGA of the civil servants. There also substantial problems in the short to medium term because the measures for savings have been back loaded. The large deficit of the CGA is due to a regime that guaranteed a pension equal to the last wage, granted generous anticipated retirement.
What are the solutions proposed? To solve the short-term deficit the IMF proposes three options: 10% cut of pensions across the board (savings of 2.25 Billion Euros), cut of 15% of pensions above 1500 Euros (savings of 1.5 Billion) and reinstitute the 13th and 14th month pension contingent on GDP nominal growth of 3% (savings relative to full restoration of 500 Million to 1 Billion depending on the level of pension reinstituted).
Structural reforms for future pensioners are: the increase in retirement age from 65 to 66 years (400 Million Euros). Implemented
Convergence of the regimes of the CGA to the GCR. Currently under implementation for future pensioners. The convergence was applied for all civil servants joining after 2002.
Additional structural reforms:
(i) apply a “sustainability coefficient” to all pensions starting in 2000 and afterwards of 4% (savings of 500 to 800 Million Euros depending on the starting level);
(ii) to restore the excessive deficit of the CGA requires a 20% cut in public servant pensions relative to 2012 (600 Million Euros)
(iii) other measures like imposing a pension cap for existing or future pensioners only make sense for new entrants in the system, in our view, and as part of a system moving towards a capitalization system.
The IMF Report identifies three main problems: (i) reduce the number of teachers and non-teacher personnel per student by increasing class size, increasing the workload of teachers and concentrate small schools, at primary and secondary levels, (ii) rationalize the school network due to major shifts in demand for education and population migrations, (iii) increase autonomy of schools, reward good performance through the financing system, increase mobility of teachers and make the remuneration system rewarding good performance.
The Report also advocates more private managed schools in detriment to public schools, which has been considered a highly charged ideological problem by the political parties. There is statistical evidence that they are more efficient, but there are serious limitations in any comparison. E.g. there are quite a number of private universities that have a very low quality of education with dismal record in the labour market. But it is also true that private secondary schools are usually the best performers. More autonomy, differentiation in financing and better control of quality by parents may increase substantially the quality and efficiency of the public school.
The OECD Report touches four other important problems: (i) lack of balance between supply and demand of skills: in a recent survey Portugal had one of the highest rates of young workers declaring that they were over-qualified for the job but it did not translate into over-skilling, which means that the educational system does not give the right skills to the students and there is a large waste of educational resources, (ii) there is too much waste by repetition in the obligatory system, instead of putting the required resources for students that fell behind, (iii) a greater focus on progress in the evaluation and assessment system, as initiated for the 2012-13 school year; collecting information over time on individuals and cohorts; instituting development appraisal to complement the current assessment appraisal for teachers; and shifting resources towards a system-wide analysis of outcomes, (iii) need to develop and improve the vocational training, by programs that provide both basic business skills and preparation for self-employment, and help to cope with the demands of new industries and technologies. This needs more integration with enterprises through internships and participation of industries in the program, and (iv) improve the link between research conducted in universities and public laboratories and enterprises to increase innovation.
Implementation: In 2012 compulsory education was extended from 9th to 12th grade (up to 18 years old).
In the last three years savings reached 1 Billion Euros. Reform of curricula increased the times of Portuguese, Mathematics, History and Geography and Sciences and Physics-Chemistry. New national exams have been introduced in the 4th and 6th years of school, New programs, more demanding, have been introduced by subject. The work week of teachers increased from 35 to 40 hours (but without impact, so far, on the teaching hours). A new exam for a 4-year cycle of evaluation of teachers was introduced in December 2013, but it has been opposed by unions. 610 primary schools with less than 21 students were closed and a reorganization of the school system was reorganized by creating organic groups of schools. There has been no increase in the autonomy of schools because the imposition of strong centralization of budgets, but in February 2013 the government announced that would start a contract with 212 schools for increasing autonomy. Vocational training is given high priority and a two-year technical program is going to start in September 2014. Creation of 120 centres for qualification – vocational training.
The average number of students per class increase by 1 student from 22.3 to 23.2 in the basic education and from 23.2 to 24.7 in the secondary. The number of teachers in the primary and secondary schools decreased from 150 to 122 thousand and the number of non-teaching personnel from 59 to 54 thousand.
There have been significant improvements in the performance of the education system. The drop-out rates between 18 and 24 years old decreased from 28.7% in 2010 to 19.2% in 2013 and the grades in Math in the secondary increased from 100.6 tp 108.2 and in Portuguese from 97.6 to 104.4, although the grades in biology, geology and history have deteriorated.
The schools of reference have not yet been created and the contracts between schools and enterprises for internships are difficult to implement.
The IMF identified, by comparing with other countries and rest of civil servants, the high costs of overtime with doctors (60 million hours in 2011, representing between a third and half of overtime paid by the state). The spending in health is also tilted towards doctors and nurses could play a larger role. Decentralization of administration and the corporatization of major hospitals was a step in the right direction but still needs to bear more fruits in terms of efficiency. “Reforms are needed to achieve a more efficient input mix (e.g., more tertiary care/less hospital care); better economies of scale (e.g., by integrating into the National Health Service (SNS) the health system of the security forces); and greater cost recovery” not at cost of universal coverage (p. 8). Other important measures were the reliance in more tertiary care facilities instead of primary care and also non-emergency care instead of over-burned emergency care. The different health care systems should be further integrated.
The Memorandum stipulated measures in three areas: (a) cuts in pharmaceutical spending, (b) reduction in operational costs of hospitals, and (c) increase in co-payments. More specifically: (i) reduce government spending with pharmaceuticals to 1% of GDP, in line with OECD average, by 2013, (ii) reduce the benefits of civil servants in ADSE, ADM and SAD and cut budgetary costs by about 50%, (iii) increase “taxas moderadoras” (health fees) and index them with inflation, (iv) cap the price of generics to 60% of branded products and change the system of reference-price of medicines to the 3 EU countries with lowest prices, (v) use the core substance for prescriptions, monitor closely the use of medicines and expensive diagnostics and incentivize the use of generics, (vi) change the system of profit margins for pharmacies based on a regressive mark-up and a flat fee, encouraging the use of less expensive pharmaceuticals, and if it does not reduce distribution costs introduce a “pay-back” contribution by pharmacies and wholesale companies, (vii) centralize procurement and purchasing, (viii) increase coverage of primary health care units, and (ix) improve management and cost control of hospitals and establish a program for clearing up arrears.
Implementation: (i) negotiations with wholesalers, use of generics and other measures led to a reduction of 900 M Euros from 2010 to 2013 (500 public and the remaining for private agents), (ii) the central government transferred 1.9 B Euros to settle arrears of the hospitals and to pharmacies. The accumulation of further arrears has stopped in 2013 and the government will set a program for its clearance, (iii) the working hours of doctors have been extended from 35 to 40 in line with the rest of the public servants, and reduction in other operational expenditures reached 400 M Euros in 2010-2013, (iv) the government is currently negotiating a further reduction in distribution costs and threatening to use the payback contribution in case it does not materialize. No measures have been taken on the revenue side, so revenues have decreased by 9% in 2010-2013. Measures on prescriptions have all been implemented. Progress has been achieved in centralizing procurement and purchasing. However, further structural measures are still needed.
Reforming the Judicial System
Neither the IMF nor the OECD Reports address problems in the Portuguese Judicial System. However, the Memorandum of the IMF/EC/ECB that started the adjustment program has detailed recommendations for reform.
The Memorandum set: “Improve the functioning of the judicial system, which is essential for the proper and fair functioning of the economy, through: (i) ensuring effective and timely enforcement of contracts and competition rules; (ii) increasing efficiency by restructuring the court system, and adopting new court management models; (iii) reducing slowness of the system by eliminating backlog of courts cases and by facilitating out-of-court settlement mechanisms.”
The main problems identified were the slow judicial process and consequent backlog of processes and courts weak management practices. Reforms should focus on reducing backlog of processes especially in debt and tax enforcement cases, streamlining civil case processing and promoting alternative dispute mechanisms.
Proposed solutions were: (i) to establish special teams to solve the backlog, (ii) speed up the implementation of the new map of the judicial system with an improved personnel management system, (iii) present a law on arbitration and make arbitration a fully operational form of resolution of debt cases, (iv) review the Code of Civil Procedure, and (v) develop an workplan of allocation of resources based on court performance, among others.
Implementation: The 12th Review considered that all the measures under the adjustment program had been taken. Pending procedures relating to debt cases had been cut by half. The Code of Civil Procedure was revised (entered into force in 1/9/2013) and the Code of Administrative Procedure is currently under revision. Most observers say that is still too early to evaluate the impact. The new map of the judicial system will start implementation in September 2014, with around 26 courts been extinguished and another 26 created in more populous counties. In the last 4 years the budget was cut by 24% from 1.7 BE and costs with personnel were also cut by 19%. The freezing of bank accounts can now be implemented without the intervention of a judge. The number of bankruptcies by mutual agreement has increased but the last IMF report says that the overall process for solving these cases has not produced intended results (mainly the process for recuperation of firms).
The Memorandum establishes “The Government will accelerate its privatization program. The existing plan, elaborated through 2013, covers transport (Aeroportos de Portugal, TAP, and freight branch of CP), energy (GALP, EDP, and REN), communications (Correios de Portugal), and insurance (Caixa Seguros), as well as a number of smaller firms. The plan targets front-loaded proceeds of about €[5.5] billion through the end of the program.” (p. 13). The aim of a privatization program is: (i) to maximize Treasury revenue in the short-term, and stop budget dependency for loss-making firms, (ii) improve efficiency over the medium and long-term of the firm, and (iii) contribute to the construction of competitive and efficient markets.
Implementation: In terms of revenues the government has exceeded the expectations. According to the following table, up to April 2014 the privatization program generated 8.7 Billion Euros. The only case that failed so far was TAP, and one of the reasons is the requirement by the EU laws that the majority be held by EU citizens. It is remarkable that the program was accomplished in times when the country was considered of high risk with few FDI flowing towards South Europe. However the program was less successful in reaching the other objectives. About half of the capital was given to China which so far is not considered a technological or managerial leader globally and especially on an EU scale. Institutional investors took about 500 B Euros. But it has been argued that in the large privatizations the premium paid was around 50% or higher.