07 January 2013

IMF - Portugal: Rethinking the State—Selected expenditure reform options

This report discusses expenditure reform options in Portugal against the backdrop of the debate on the size and functions of the state, as well as the reform experiences of other countries.

The report focuses on efficiency- and equity-enhancing reforms in selected spending  areas. The Portuguese government seeks to enhance the efficiency of providing goods and  services to the population (including by reducing costs and the need for debt financing);  focus policies on achieving equitable outcomes; and stimulate economic activity and  entrepreneurship. In this context, it intends to achieve by 2014 significant permanent annual expenditure savings. To identify these savings, it intends to carry out, by February, an indepth expenditure review, and it has already completed an initial benchmarking exercise (which the mission team broadly agrees with). Also, within the scope of the current  constitution, the government is assessing the functions of the state to guide the expenditure  review. Its goal is to increase spending efficiency and equity, while safeguarding social  cohesion and strengthening the sustainability of the welfare state. This report complements  the government’s analysis by discussing reform options that would improve equity and  efficiency of spending, while supporting social cohesion and strengthening social safety nets.

The government’s spending reduction target can only be achieved by focusing on major  budget items, particularly the government wage bill and pension spending. Together,  these two items account for 24 per cent of GDP and 58 per cent of non-interest government  spending. It would seem impossible to generate the government’s spending reduction goals  without changes in these two areas, and relevant related reforms should take priority.

Reforms related to the wage bill should target areas that promise potentially large  efficiency gains and budget savings. Over-employment is of concern in the education  sector, the security forces, and with respect to workers with little formal training, while high  overtime pay (for doctors) is of concern in the health sector. Other reforms are also important  for modernising the state (e.g. compensation and contract structures to attract talent better, equity between public and private sector employment by reducing the public wage premium,  and labour mobility in and out of the public sector), but can be given lower priority in the near  term. Focusing on the key areas above allows pursuing a targeted adjustment strategy with a  clear rationale and avoids across-the-board cuts.

The size of wage bill savings and related efficiency gains will depend on the tools used. To reduce employment, voluntary departures with financial incentives are the least  adversarial but also the most costly option, and may cause the best-qualified to depart. In designing a strategy for  employment reductions, the government should target specific areas  of over-employment, and it will not have the luxury to choose reform options on the expensive end. This calls for creating targeted redundancies based on careful analysis. To limit overtime pay, remuneration packages in the health sector should be geared towards achieving greater comparability with other EU countries. These considerations make it important to embed employment and pay reductions into meaningful reform strategies for the  relevant sectors. For example, reductions in education employment need to go hand in hand with a sector reform strategy that is clearly focused on improving education outcomes.

Full report

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