The politics of fiscal adjustment in small European states: The eurozone crisis in Ireland and Portugal

Abstract

In the context of the euro crisis, several member states of the Eurozone were forced to implement so-called Economic Adjustment Programmes. The implementation of these programmes was supervised by a troika consisting of the European Commission, the European Central Bank, and the International Monetary Fund. Fiscal adjustment was one cornerstone of the adjustment programmes. The objective of the programmes was to reduce previously soaring public deficits and to stabilise and reduce public debt in the long term. All programmes primarily aimed at cutting government spending. Increasing government revenues was to play only a secondary role. However, a look at the adjustment programmes for Ireland and Portugal shows a striking difference in the fiscal adjustment strategies. Different Irish governments pursued an adjustment strategy with a strong focus on expenditure cuts. By contrast, Portugal's adjustment strategy changed over the course of the programme and was increasingly driven by increases in revenues. How can we explain these differences? To answer this question, my dissertation provides two in-depth case studies of the adjustment programmes for Ireland and Portugal. I argue that fiscal adjustment strategies are determined by the activity of coalitions of different economic actor groups at the domestic level. These actor groups have different fiscal policy preferences. On the one hand, they differ in terms of their preferred level of redistribution and the economic risks to which they are exposed. On the other hand, sectoral actor groups have different preferences based on their prioritisation of international competitiveness and domestic demand. Actor groups with similar preferences form coalitions to influence the government’s policy-choice. Two logics determine which coalitions ultimately prevail. On the one hand, some coalitions are involved in policy-making through social pacts and other institutional arrangements. On the other hand, sectoral coalitions are influential due to their importance for economic growth. Although national coalitions have decisive influence, governments in a globalised world are constrained in their actions by international financial market actors. In Ireland, coalitions that favoured an adjustment strategy with a focus on spending cuts were more assertive. This is mainly due to the Irish growth model, which has been based on exports and foreign direct investment for more than two decades. Trade unions, which would have preferred an alternative adjustment strategy, were not able to prevail against the influential coalition of export-oriented actor groups and high-skilled workers. In Portugal, such a coalition was feasible. Here, trade unions and actor groups exposed to high economic risks were successful in preventing several attempts to cut public spending. In the face of this resistance, the government increasingly decided to resort to revenue increases. These results show, on the one hand, that domestic political processes were crucial for fiscal adjustment during the euro crisis. On the other hand, it shows that these processes differ greatly due to different national growth models and different economic dynamics.