Academic journal article Independent Review

Portugal's Plight: The Role of Social Democracy

Academic journal article Independent Review

Portugal's Plight: The Role of Social Democracy

Article excerpt

Portugal has never quite managed to regain the influence it once had on the international economic scene when it parlayed Vasco da Gama's discovery of the sea route to India into a global trading empire. Yet by late 2010 the small Iberian nation had come to be seen around the world as a crucial corridor through which, if the so-called bond vigilantes were to pass, the euro sovereign debt crisis would imperil Spain, a much bigger economy whose distress might spell the end of European currency union. If the trouble plaguing the euro zone were ever going to stop, many had come to the conclusion that it had to do so in Portugal. By the spring of 2011, that prediction was being put to the test as Portugal was compelled to follow Greece and Ireland in seeking to tap the 750 billion[euro] European Union (EU) and International Monetary Fund (IMF) bailout fund.

The immediate cause of the country's arrival at this unenviable position was escalating interest costs. Yield spreads on ten-year Portuguese bonds, steadily climbing since the onset of the 2007-2009 financial crisis, pierced the 500-basis point level in the first quarter of 2011. This increase meant that Portuguese long-term interest rates, which had begun 2010 at 4 percent, had catapulted higher than 8 percent, well beyond the threshold that market observers widely view as unsustainable for the government to finance (Wise 2011). In driving up rates, traders and investors were moved by a debt to gross domestic product (GDP) ratio that had grown to exceed 90 percent, a budget deficit to GDP ratio at 8.6 percent, and a government that, despite promises to the contrary, had not shown the discipline to keep spending from rising in 2010. Worse yet, in view of recent experience, markets still doubt Portugal's ability to create sufficient new wealth to pay this debt: the country has recently experienced its own lost decade of anemic real GDP growth. From 2000 to 2010, the Portuguese economy grew at a mere 0.5 percent per year on average ("The Winter of Living Dangerously" 2011).

A common view of Portugal's difficulties is that it is now paying the price for having entered the euro framework without having the economic fundamentals in place to survive the rigors of a currency regime alongside nations such as Germany that have stronger histories of fiscal probity (Blanchard 2007; Krugman 2011). Although this view has a measure of truth, at least insofar as Portugal's economy was structurally vulnerable, the question remains as to how it got into this condition and why its problems were never fixed over the two decades in which it was either preparing for or already using the euro. Figure 1, which shows the historical movements in the debt/GDP ratio, provides a clue as to the underlying source of the country's problems.

What is immediately striking here is that the country's debt bottomed in 1973 at 13.6 percent of GDE Since then, it has steadily trended upward. That year, 1973, happened to be the year before a long-standing dictatorship, ruled first by Antonio Oliveira de Salazar and then for a shorter period by Marcelo Caetano, was overthrown in the "Carnation Revolution." Out of this 1974 regime change, a social democracy was constructed. Approaching this transformation as a natural experiment to test the impact of a robust welfare state and democratization on economic life holds the key to understanding the country's predicament. In thus analyzing the country's history before and after the 1974 revolution, while putting into sharper relief both the political and economic variables that endured and changed, I find that social democracy is the prime culprit of Portugal's plight.

[FIGURE 1 OMITTED]

Before the Revolution

At the dawn of the twentieth century, Portugal was a poor country, largely illiterate and for all intents and purposes a vassal of its centuries-old ally, Great Britain. Soon after the ruling monarchy yielded ignominiously to a British ultimatum in 1890 concerning the drawing of boundaries in the African colonies, declining demand for Portugal's exports precipitated a financial crisis in 1892. …

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