Yet again the eurozone crisis is butting heads with national democracy

After a lengthy absence Portugal returned to the headlines over the weekend with the Constitutional Court ruling that some of the government austerity measures were unconstitutional. Here are the key details:

• The court found that four out of nine key savings measures included in the government’s latest budget were unconstitutional. These measures focused on cuts to public sector wages and pensions – the court deemed these unconstitutional since they hit public sector workers disproportionately hard. They also ruled against cuts to unemployment and sickness benefits.
• The measures amount to savings of €1.3bn (0.8% of GDP) which will now need to be found elsewhere. If they are not found, then Portugal’s deficit this year could reach 6.4% rather than the 5.5% currently targeted.

What does this mean for Portugal and the eurozone?

• The ruling was the cherry on top of a bad week for the government after a close ally of Prime Minister Pedro Passos Coelho resigned and the government faced a no-confidence vote in the parliament. Fortunately, it has so far survived these problems (new elections would bring huge uncertainty) but its support continues to be eroded.
• The previous political consensus in favour of the bailout and the accompanying austerity has now vanished, the opposition is likely to become increasingly vocal in its anti-austerity approach.
• The Commission has warned that the extension of the bailout loans agreed recently will be under threat if the government does not meet its targets.
• The cuts are likely to be found elsewhere but they may have more of a negative impact on growth, although this remains uncertain. One thing that is clear is that the public sector wage and pensions do need to be adjusted if Portugal is to become competitive and particularly if it is to recover through export led growth as the bailout programme currently targets. The inability to adjust these areas could harm Portugal in the long run.
• That said, this is not the first time this has happened. Last July, the court made a similar ruling on public sector wage cuts. The fact that this has happened again suggests the government may be struggling to find savings elsewhere (why else push on with cuts it knows stand a good risk of being blocked), and doing so may take longer than some expect.
• Legal points aside, experience (particularly in the Baltics) suggests that wage cuts in the private sector often follow or go hand in hand with public sector ones – at the very least, buy-in is needed across the economy and the private sector is unlikely to lead such an adjustment unless prompted to (wages are sticky on the downside). In this sense, although the cuts may have disproportionately hit public sector workers initially it may be necessary part of the internal devaluation approach taken (whether this approach is correct or not is another question).
• And of course, this adds further delays and uncertainty in the eurozone – along with lack of government in Italy and capital controls/bailout in Cyprus.

This is likely to rumble on for a while yet as the Portuguese government searches for savings elsewhere which will meet the requirements of the troika. Yet again, the eurozone crisis is butting heads with national democracy, in this case specifically constitutionality. Plenty more of that to come we expect.