This paper documents some of the recent economic history of Portugal, since its accession to the EEC, to the adoption of the Euro and more recently to the financial and economic crisis. In the first part of the paper we show the economic performance of Portugal during the last 25 years till now, from the fast growth of the late 1980s and early 1990s to the current recession. We point out some of the reasons for this trajectory – slow productivity growth, disconnection between productivity and wages, continued external and public deficits – and choose three areas that must be improved in order to reverse the current downward spiral – justice needs to be more effective and faster, education needs to improve its quality and distribution across the population, and the public administration must become more efficient.
When peripheral countries join rich countries to form a customs union, which also becomes a monetary union, they may be tempted to make use of perceived opportunities. Using some of the latter might be called “responsible”, while others might be called “irresponsible”. In the case of the European Union the “responsible” use of opportunities was the transfer of resources to the peripheral countries for the purpose of building up the country's infrastructure (Baer & Leite, 2003). Also “responsible” would be the use of these resources to improve the productivity of various sectors of the economy.
The “irresponsible” use of opportunities consisted of the government of the peripheral country to borrow from the rich country in order to finance a rapid rise in social benefits, which were not related to productivity. In the case of the European Union, funds were abundant and cheap as creditors from Europe's rich countries (mainly banks) had the perception that there was little risk in lending to countries that were in the same currency area and with no restrictions on capital flows.
The expectation, of course, was that the peripheral country would be able to service its growing debt because its GDP would also increase and therefore the country would be able to generate more resources to at least pay the interest on the debt stock. And to fulfill this expectation, the peripheral country would have to produce trade surpluses (perhaps combined with an inflow of direct foreign investments). Finally, to be able to produce trade surpluses, the expectation was that productivity in a number of sectors would rise to such an extent that the peripheral country would become competitive abroad.
As we shall show in this article on Portugal, one of the peripheral economies of the European Union, this good scenario did not occur.
In the last 25 years Portugal experienced a unique set of opportunities after becoming member of the EEC and more recently one of the countries sharing a common currency, the Euro. One of the advantages of joining the EEC was the initial access to large quantities of money that could be used to modernize the economy at no cost. That is, the country would not have to repay these amounts of money flowing into to the country. More recently, after the introduction of the Euro, Portugal had access once again to large quantities of capital at a very low cost. In this case, any inflows to the country in the form of external debt had to be repaid at some point in the future.
Despite the unique set of opportunities to become a modern and competitive economy, Portugal never took proper advantage of these opportunities. Instead it wasted them and, even worse, it compromised the future significantly for not having used all the resources it had available to improve its long term growth perspectives. As a consequence of this wasting of opportunities, Portugal was in a very serious financial crisis (2011/2012), which seriously compromised the long term perspectives of the country and its people.
If things were not bad enough, Portugal, in additional to the financial problem, also has an economic problem. That is, Portugal's overall low productivity and lack of competitiveness make it very hard to grow out of the financial crises. Because Portugal's economy is not sufficiently competitive, in order to solve the financial crisis it needs to make very harsh and politically costly adjustments. Namely, a sharp reduction of public expenditure on wages and pensions, elimination of some inefficient public institutions, alienation of non-performing public enterprises, higher taxes, etc. Such adjustments will create severe social tensions as these will lead, at least in the short run, to an increase of unemployment, reduction of disposable income for families and reduction of firms’ profitability, which in some cases will lead to bankruptcies. An important question is therefore how much of this austerity is going to be politically feasible?
Assuming that Portugal is able to impose these measures and with that solve the financial crisis, the country still has one big problem to solve which is its long run economic growth. Several measures aiming at improving competitiveness are part of the agreement signed between Portugal, the International Monetary Fund, the European Commission and the European Central Bank. Some, if not all, of these imply that certain established interests will have to give up some of the “benefits” they currently enjoy (the justice system and the public administration are two examples). Such transformations also have big political costs which may be too large for any government.
Another alternative is to leave the Euro and with that regain “full” control of monetary and fiscal policies. There is no doubt that leaving the Euro will have a big upfront cost as it would cause the entire banking system to collapse,3 a large devaluation of the currency which would lead to a very high inflation with all its negative consequences. Whether the long term benefits compensate the initial costs of leaving the Euro is a question that is almost impossible to answer. For instance, would Portugal leave the Euro and use that “buffer” to make the necessary adjustments to become more competitive, or, would that just be a way of avoiding having to make the necessary transformations?
