The innovative proposal of the Portuguese government is to reduce social security contributions of businesses, from 23.75% to 18%, in return for an increase in employee contributions, from 11% to 18%, resulting in this proposed an overall increase of discounts, from 34.75% to 36%. According to forecasts announced this policy translates into an increase of 2800 million Euros of discounts for workers and a reduction in the discount business of 2300 million Euros. A first impact study by economists of Universidade do Minho suggests that the reduction in the employer TSU does increase external competitiveness and exports, the overall impact on growth is negative due to the reduction of worker purchasing power and demand for domestic products.
France will compensate a cut in employer SS contributions with increases in VAT, but VAT revenues have been falling in Portugal despite higher rates.
According to an article by Edward Hugh, dated 2011, "Latvia might be stuck in a peculiar kind of hell, possibly limbo would be a better term", due to a persistent debt overhang, despite fairly rapid downward ajdustments in ULC unit labor costs. Thus, reducing ULC may be a necessary but not suficient condition for the an economy to develop a sustainable export sector, and reduce their external debt load.
When a country suffers from a persistently excessive "external debt overhang", even a sharp internal devaluation may be not enough to achieve a enduring adjustment.
In a corporate debt workout, the borrower tightens its belt, cutting all non-essential spending, but the creditors also provide tangible debt relief in the form of longer tenors, lower interest rates, debt forgiveness, if needed, AND new money debt to keep th company going to repay more later.
This has not happenned in the current Eurozone crisis, and small economies with their policy hands tied cannot do all the heavy lifting of the intra-Eurozone Balance-of-Payments adjustment.
We are in uncharted policy territory indeed.
What is a country to do when it needs to boost domestic savings and cut Consumption/GDP from 86% to a more sustainable 76%, without having to resort to reducing disposable income?
What if it can't devalue, can't impose import tariffs, can't increase interest rates, can't subsidize exports, and cumulative tax increases are driving away both labor and capital?
Cutting wage costs may promise to increase export competitiveness somewhat, but it is no panacea.
Nowadays, productivity gains and export performance have a lot more to do international marketing and multinational supply chain management than with relative unit labor costs. In the current credit contraction, competitiveness also depends on the availability of pre-export finance, though, sadly, the ECB has not yet gone into the trade finance business.
When VW Autoeuropa and Peugeot Citroen suspend production in Portugal for a few days or weeks, you can be sure that decision was not made either in Palmela or Mangualde.
TSU impact study by U.Minho http://static.publico.pt/docs/economia/estudoempregoeTSU.pdf
Edward Hugh on Latvia http://fistfulofeuros.net/afoe/bells-in-hell-that-dont-go-ting-a-ling-a-ling/
Quicker internal devaluation http://ftalphaville.ft.com/blog/2012/09/18/1164781/well-settle-this-internal-devaluation-question-quicker-than-we-thought/
Debt workout 101 - part 1 to part 16