SERIOUS MONEY:VASCO DA Gama, the renowned Portuguese navigator, set sail during the summer of 1497 on an expedition that opened the sea route to India by way of the Cape of Good Hope, a discovery that transformed Portugal into a world trading power.
The Lusitanian country’s global influence has long since waned and, in April, it became the third euro zone state to seek financial assistance from the European Union after a political crisis pushed borrowing costs to punitive levels.
Portugal’s ills differ from those of Greece and Ireland in so far as it is not so much excessive government debt or a troubled banking sector that troubles investors, but a weak economic fabric that calls into question whether the nation can grow itself out of difficulty.
The Lusitanian economy was a notable laggard following the launch of the euro in 2002 and registered an annual average growth rate of little more than a half percentage point before the financial crisis struck.
Portugal did enjoy a mini-boom in the half-decade that preceded the launch of the single currency, as real interest rates dropped from 6 per cent in the early-1990s to zero by the decade’s end. Easy money combined with understandable optimism that the euro would accelerate convergence in Portugal’s lagging income-per-capita towards the European average precipitated a consumption and investment boom. This saw non-financial private sector debt jump to almost 240 per cent of gross domestic product (GDP) – roughly 70 percentage points higher than the euro zone average.
Strength in the domestic economy fuelled increased demand for labour that saw the unemployment rate drop from over 7 per cent in the mid-1990s to under 4 per cent by the end of the decade. The resulting labour shortages were met with wage demands that were well ahead of productivity increases, and the rapid decline in competitiveness was evident long before the euro’s launch in 2002.
Excessive domestic demand drove a current account balance – that had been close to zero relative to GDP in the mid-1990s – to double-digit numbers by the end of the last millennium.
Persistent deficits that are plain for all to see have led Portugal to build a net international investment position – the net amount that it owes the rest of the world – that is so high that it cannot possibly finance it given reasonable assumptions.
Domestic demand cannot save the Portuguese economy given high levels of private debt and a government that will be encumbered by a deal secured in Europe’s centre. That means that Portugal’s only avenue of escape is its sale of goods and services to the rest of the world.
The notion is appealing but undermined by facts. Portugal entered the euro zone with a current account deficit in excess of 10 per cent of GDP.
That gives credence to the fact that it was uncompetitive from the start of monetary union. The focus on low-value-added exports from clothing to shoes paint the same picture, and the loss of market share to Asia and eastern Europe is truly shocking. Exports are hardly the answer for Lusitanian difficulties.
A close examination of the fabric that underlies the Portuguese economy is revealing. Little more than one-in-four people receives upper secondary education and, even then, the quality of education is low. Not surprisingly, labour productivity is a joke and attempts to transform a backward economy should be considered likewise.
Portugal is deep in recession and faces a shrinking economy both this year and next. Europe has saved the Lusitanian economy for now, but investors are right to question whether the Portuguese can grow out of difficulty. Careful analysis suggests not.
charliefell.com
