The First Curse:
In 1974 the Carnation Revolution changed Portugal's destiny forever. In a revolt against the Estado Novo (New State); the authoritarian dictatorship headed by a council of ministers, the country's left rose up in unison to support a military coup to start a democratic process. The military had been fighting colonial wars and by 1974 when the revolution occurred, it was under-supplied, and overstretched. The proposed introduction of some new legislation to sustain the army's need for soldiers and equipment, perfectly coincided with the growing frustrations of the intellectual and political left winged forces in the country.
When the Carnation revolution occurred, the Portuguese economy had been growing at a steady pace. In 1973, the total output of the country had grown by 120% compared to 1961. A lot of the economic growth in the pre-revolution days could be attributed to the forward looking structural changes brought about by Antonio Salazaar; who served as the Prime Minister of Portugal for almost four decades. Salazaar was greatly concerned with financial reform, and under his leadership financial stability was given top priority (together with keeping the colonies in Africa intact), and in fact Portugal was one of the first signatories of the OECD. Under Salazaar, trade and foreign investment blossomed, and Portugal could break free of the shackles of slow and unorganized growth.
However, after the revolution, the economy once again fell into a tailspin. The much hyped freedom's of a democratic set up brought with it the complications of administration and planning. Hindsight is always too late, and by the time the new government woke up to the fact that there was a drastic loss in efficiency and competitiveness, Portugal was being outperformed by most of its trade partners, the biggest ones being Spain and Germany. In the quest for a socialist upheaval and a revolt against the ghastly consequences of colonization, Portugal managed to loose the economic momentum it had going from the later part of the fifties.
The Second Curse:
Portugal became a member of the European Communities in 1986. Membership brought along with itself, new opportunities for trade, and foreign investment. Portugal started growing at about 3% of GDP on a yearly basis, but never came close to the expansive growth before the Carnation revolution. However, its growth rates remained above the EU average consistently in the eighties and the better part of the nineties. Everything seemed rosy for the economy, even though it was asked to implement structural changes to reduce deficits before going on to join the European Economic and Monetary Union in 1999. On January 1, 1999, Portugal made its seemingly correct decision to be amongst the first 10 countries to adopt the Euro.
I do not think the reader's of this blog need to be explained how currency unions work and the disadvantages they bring about to member countries which are not structurally ready to adopt a common currency. Portugal's second curse has been playing out over the last decade, which has also been termed "the lost decade" for the country as a result of severe lack of trade and wage competitiveness. In 2006, Portugal grew at 1.3%, which was the slowest rate amongst the Euro zone members. The productivity gap in Portugal is largely a result of low wages compared to its competitors. Portugal's per capita income is estimated at approximately $24,000, while Germany boasts of $36,000. An interesting statistic to follow up is GDP per hour worked; this is $30.3 in Portugal as oppose to $53.3 in Germany.
The low wages in Portugal have been attributed to a variety of causes. One of the usual suspects is low population, and not enough immigrants leading to structural problems such as firms not being able to reach "optimal size" at low wage rates. The second contender is the influence of the gray economy in the country, which has been contributes to over 20% of GDP. The evasion of labour taxes is certainly not helping Portugal's ballooning deficits, and is in addition a disincentive for larger firms to be organised and law abiding. Another surprising problem is Portugal's public sector premium over private sector jobs is to the tune of 51%, while in Germany it is a more reasonable 7%. Lastly one may also note that Portugal's decent growth in the eighties after joining the European Commission up until the formation of the single currency union, is highly correlated with foreign direct investment in the country. The FDI flows have depleted as a result of the lack of the rigid labour market conditions and complicated regulations and red tape, and so has the country's GDP growth.
The Final Curse?:
Last week, the 12th of January was Portugal's date with destiny. Portugal conducted bond auctions for its October 2014 and June 2020 bonds. Many commentators had expressed concerns over Portugal's widening bond spreads, and over 7% yields on the 10 year bonds was largely touted to be the tipping point for the economy. The auction resulted in good bid/covers as expected and yields on the 10 year bonds remained below 7% (albeit not by much at 6.79%). So Portugal is not going to get bailed out just yet. The yield curve suggests however that this auction was just a matter of buying time:
The ECB and other domestic EU banks have been largely behind the good auction results. Japan and China have also bought into EU debt in a big way, and China in particular has had no qualms in announcing this to the world. The Euro has also reversed its losses since the start of the month against the dollar, and is once again trading above the 1.3 handle. However the question remains, how long can this quantitaive easing or rather quantitative pleasing of bond vigilantes prop up the dying European economies. It is more or less certain that Portugal will be in need of a bail out, and what is also certain is that the market's will not be surprised when it does get one and there will not necessarily be a big sell off such as the summer of gloom last year after the Greek crisis. The final curse that this country will face could be its most easily avoidable. It could try to hold out against bond vigilantes for months but would probably be better off asking for a bailout sooner rather than later. The cost of being stoic could be higher than the benefit, and as far as the ECB's buying programs are concerned, the vigilantes might want to remind Trichet of the old adage "in theory there is no difference between theory and practice, but in practice there is".
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