Portugal pays now for not keeping its economy in line

BUDGETARY rigour demanded by international lenders may be the proximate cause of Portugal’s political crisis, but Lisbon is also paying the price for not whipping its economy into shape in better times.

The survival of Prime Minister Pedro Passos Coelho’s centre-right coalition is hanging by a thread as the rightist Democratic and Social Centre People’s Party debates whether to withdraw its support and leave the government without a majority. Like ordinary Portuguese, the CDS-PP is resisting further spending cuts needed to keep Portugal on track to meet the debt-reduction goals laid out in its à78- billion (about R1-trillion) bailout programme with the European Union and International Monetary Fund.

Patrick Artus, chief economist with French bank Natixis, fears Portugal is battling a lost cause, because as its economy keeps contracting, so does the tax base needed to put the public finances on a stable footing. The result is a recessionary spiral — as Greece has already discovered.

Portugal needs to grow out of its debt, but its potential growth rate is less than 0.5% a year, according to the Organisation for Economic Cooperation and Development. Yet economic performance was poor even in the years after the launch of the euro in 1999, when credit was flowing freely. GDP growth averaged just 1.3% a year between 1999 and 2008.

Artus traces the stagnation to the structure of the economy. Portugal has lost more than 15% of its manufacturing capacity since the launch of the euro as competition from eastern Europe and China crushed low-end industries. And with a poorly skilled workforce — two out of three Portuguese left school at 15 or 16 — labour productivity growth has averaged about just 1% a year.

Rigid goods and services markets, which have kept the price level high in Portugal despite a drop in wages, thus throttling domestic demand, compound the gloomy picture.

Optimists point out that Portuguese exports have performed well. Evidence of stabilisation in neighbouring Spain, Portugal’s biggest market, is encouraging. Manufacturing held steady in June after a two-year slide, according to the latest purchasing managers’ index, and services contracted at the slowest pace in two years.

Edward Hugh, an independent economist based outside Barcelona, said Portugal’s case was not that different from Greece in that both countries needed a debt restructuring from the outset. Instead, Portugal plumped for overly rapid fiscal adjustment that generated a depression and, by sparking a wave of emigration, was putting the country’s long-term future at risk.

Just as the IMF had acknowledged making excessively optimistic eco- nomic projections in the case of Greece, Hugh expects a similar mea culpa from the fund in relation to Portugal. This was likely to be followed by tense negotiations with European governments after September’s German elections on how to make up funding shortfalls in both countries.

The crumbling of political support in Portugal for continued austerity reduces the chance of a smooth exit from the current bailout programme in mid-2014 and makes a second rescue package more likely.

Portugal’s political strains invite comparisons with Italy, where former prime minister Mario Monti has threatened to withdraw support from the coalition of his successor, Enrico Letta.

There are worrying economic parallels, too, starting with a woeful track record since the launch of the euro. Italy is the only one of the OECD’s 34 member states whose GDP per capita fell between 2000 and 2011. Like Portugal, Italy had lost about 10% of its output since the financial crisis, and this would reduce the economy’s capacity to stabilise its debt-GDP ratio, Artus said.

“In a regular recession, GDP goes down and then recovers back to the level of potential GDP. In this crisis, potential GDP is converging down to the level of GDP, so there’s a permanent loss of potential output. And with smaller economies it’s hard to service large old debts. Italy and Portugal are very similar in that respect,” he said.