The endemic disease: the portuguese economic problems

Let's now talk about the third country of PIIGS to request financial help.
Unlike its "partners" in the PIIGS, the portuguese economic boom associated to the accession to the euro area fade quickly. In fact, in that time Portugal reached one of the highest GDP annual growth.
This was the result of a demand boom caused by a big decrease in interest rates and consequent expansionary fiscal policy.
But this wasn't followed by an increase in the supply. Because of that, the loss on international competitiveness quickly led Portugal to a sharp in economic growth.
Despite Portugal is beeing able to control its budget deficit and public debt better than Greece, the truth is that Portugal has troubling issues that make it bery vulnerable to any problem in the economic environment, such as:
- poor long-term growth prospects;
- drastic loss of competitiveness;
- high public and private indebtedness;

• Pre and euro adoption: from big increase to big decrease

The decrease in the interest rates caused by the pre-euro adoption, led to a consumption boom in the following years.
The private saving decreased but in other hand, the investment and gross fixed capital formation increased a lot.
The convergence for the German economy has increased considerably.
However, this situation was accompanied by a duplication in the household and non-financial sector debt.
Also the current account deficit increase from near-zero in 1995 to 9.0 percent in 2000.
All this scenario occured in a short period of time, between the early 90s and the beginning on the XXI century.
And what was the government reaction?
Despite the increase in the tax revenues, the fiscal policy was pro-cyclical. Adding to the expansionary conditions, the primary balance deteriorated.

With the euro adoption, the consequences were dramatic. Te household spending was in high levels of debt and the prospects were to deterioration of the situation, the investment and consumption boom came to an end, together with the decrease in the house investment as a percentage of GDP.

• The causes of the stagnation:

When Portugal adopted the euro, its export structure was almost concentrated (and nowadays remains almost equal) in traditional slow.growing sectors in which the emerging economies in Asia was now the comparative advantage.
The problems remained during all the first decade of the 20th century: excessive concentration in the low-tech industries, weak business climate and inflexible labour market.
All these facts led to a deterioration of competitiveness, causing the end of the Euro boom.
In this period, the wages per capita rose twice as fast as the Euro average.
The consequence of this excessive wage growth was the appreciation of the real effective exchange (REER), when in Spain and Ireland, for example, remained almost unchanged.
This big increase in REER had a good consequence - the favoring of domestic demand over exports - but also bad consequences - the build-up of macroeconomic balance and consequently the deterioration of the current account deficit and the decrease of the FDI inflows.
After the mid-90s, the FDI inflows fell below the Euro area's average average, because the century became less attractive for investment. In the same period the productivity suffered a sharply fall, being below the EU average in all the economic sectors.
The low productivity is partly explained by the low human capital formation and limited use of information technology (Portugal has one of the lowest labor force participation in tertiary education and spending on R&D as a percentage of GDP).
And of couse, its governance and business climate indicators are today among the lowest in the euro area.

Today the endibtness is one of the biggest barriers to good performance of the Portuguese economy

 

• Policy: what could have been done?

The portuguese organs of political decision and making had many opportunities presented by the boom to move into an high-income economy, investing in higher value-added and faster growth sectors and a more outward-oriented production structure. But the country remained specialized in the production of hand-labour intensives goods and with low technology incorporated.
Also the government missed the opportunity to build a budgetary surplus, wich would have balanced the budgetary surplus, wich would have balanced the budget, moderated the domestic demand boom and the excessive concentration in non-tradable activities. Alongside this, should have been imposed a tax structure weighted toward discouraging consumption and investments in non-tradables.
Facing the currently debt crisis, the government plan to reduce the dificit from 9.4 percent of GDP in 2010 to below 3 percent of GDP in 2013 is based on:
- privatizations;
- raising taxes on high earners and capital gains;
- cutting civil servant wages;
- public investment spending;
But, the growth assumptions associated to the deficit reduction projections are overly optimistic, because the strong growth expecations are based on observed historically data but don't have into account the fiscal policy's potential deflationary effects.
Also the intention of raise taxes may fall far short of expectations because Portugal has one of the highest leakage of skilled labor in Europe.
This is a reasonable short-term solution because can help to dampen wage growth and reorient the economy toward exports but hardly can resolve the country's low productivity and slow growth.

• Solutions for the future:

Apart from this, the policy needs to concentrate efforts in these aspects:
- short-term: boosting competitiveness (especially through increased flexibility in labor markets) and increased competition in relatively sheltered backbone services.
- long-term: improving Portugal's human capital base (in order to improve the productivity and attract the foreign investors).