What Went Wrong in Portugal? The Need for Big Changes



Compared to Europe’s other ailing states, Portugal did everything right. It adopted steep austerity measures in exchange for international aid, but now nearly a year later, Portugal’s economy is shrinking and the nation is struggling to repay its debts. What went wrong?

The Need for Big Changes

Vanessa Rossi is an independent consultant and global economics adviser to Oxford Analytica.

Whether a debt burden is massive (Greece) or simply heavy (Portugal), cutting debt will not resolve a problem of chronic twin deficits — that is, living beyond your means. Rising debt is just the symptom of the underlying disease for Greece and Portugal, which are still failing to adjust not just excessive budget deficits but also large current account deficits.

Greece has seen a sizeable internal devaluation (probably similar to that of Latvia) but, unsurprisingly, this has not generated much adjustment in its external deficit: it still needs to borrow money abroad to pay for its appetite for imports. It simply has insufficient exporting capability. Total goods and services exports are less than 20 percent of G.D.P., but competitiveness-sensitive exports are probably about 10 percent of G.D.P.: this is the reason a euro exit would also fail to solve the Greek problem, as illustrated by its pre-euro crises.

Debt restructuring alone is insufficient and may even encourage a return to laxity.

Portugal has failed to cut its external deficit for a different reason: it has had virtually no internal devaluation. Nominal G.D.P. remains at its 2008 peak. The nation has export capability (over 30 percent of G.D.P.), but it must do more to boost net trade. Portugal may actually be a country that would find adjustment a whole lot easier if it could have a little more wiggle room on its exchange rate.

By comparison, Ireland may be struggling with the sudden appearance of bank bailout debt, but early fiscal austerity coupled with internal devaluation were effective in stimulating net exports and eliminating its boom-time current account deficit. And export-led growth will at least help to stabilize the Irish economy and improve a budget position now saddled with debt servicing costs.

So if Portugal and Greece are going to make the grade, they must find ways to tackle their chronic twin deficits. Debt restructuring alone is insufficient and may even encourage a return to laxity.