Academic journal article Brookings Papers on Economic Activity

The Portuguese Slump and Crash and the Euro Crisis

Academic journal article Brookings Papers on Economic Activity

The Portuguese Slump and Crash and the Euro Crisis

Article excerpt

ABSTRACT Between 2000 and 2012, the Portuguese economy grew less than the United States during the Great Depression and less than Japan during its lost decade. This paper asks why this happened, with a particular focus on the slump between 2000 and 2007. It describes the main facts of Portugal's recent economic history, evaluates some possible explanations for its dismal performance, and proposes a new hypothesis based on the misallocation of abundant capital flows from abroad. I put forward a model of credit frictions to show that if financial integration exceeds financial deepening, productivity will fall, generating a slump as relatively unproductive firms in the non-tradables sector expand at the expense of more productive tradables firms. This explanation can also potentially account for the similarities and the differences between Portugal on the one hand, and Ireland and Spain on the other, during this period, and for some features of the crash in Portugal after 2010.

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Writing 10 years after the introduction of the European common currency, the vice president of the European Central Bank, Lucas Papademos, stated unequivocally that "the euro has been a resounding success" (Papademos 2009, p. 16). The euro was by then a reserve currency, and inflation was stable and on target. Economic growth in the euro area had not fallen relative to the previous two decades, and employment had increased significantly, while capital markets had become more integrated, and southern Europe had benefited from sustained low interest rates. Papademos (2009) further argued that the countries within the euro area had been better protected from the financial crisis of 2007-08 than others in the European Union.

Yet even before the global financial crisis, there were warning signs about some of the countries in the euro area. One of the more pressing alerts came from the small country of Portugal and was brought to the attention of economists and policymakers in a notable article by Olivier Blanchard (2007). Portugal, Blanchard observed, had been in a slump since 2000, with anemic productivity, almost no economic growth, and increasing unemployment. At the same time, wages had been rising and the country's competitiveness falling, and both the government and the country's private sector were accumulating debt at a rapid pace. Most, but not all, of the same issues were also present in Greece, Ireland, and Spain, but did not seem so pressing since their economies were growing and, with the exception of Greece, fiscal consolidation was under way.

Many dismissed these alarm signs at the time. Portugal's extensive borrowing from abroad could be justified as borrowing against expected future growth, as the Portuguese economy converged with the European core. Or perhaps Portugal was becoming the Florida of Europe, to which wealthy northern Europeans were sending their capital in the expectation of migrating for their retirement. The Portuguese slump was greeted with recommendations for structural reforms that are as often repeated as they are sterile--the constant verdict on the country regardless of the state of its economy.

The severity and extent of the crisis that has affected so many European countries since 2009 dismiss this complacency. Understanding what has been happening in Europe--and the European periphery in particular--is one of the great challenges facing macroeconomists today (Shambaugh 2012). Portugal in the 2000s experienced neither a housing boom like Spain and Ireland, nor as rampant an increase in public debt as Greece, nor does it suffer from Italy's chronic political instability. Yet since 2010 all five countries have been in a similar state of crisis. Because Portugal was one of the first countries where the symptoms were identified, it is a good place to look for clues on what is behind the crisis.

There are a few more reasons why understanding what has happened to the Portuguese economy since 2000 is of interest. …

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