Did Austerity Work in Portugal?

Austerity works. That is the message of Pedro Passos Coelho, the Portuguese pm, to voters. After three years of recession, Portugal registered a return to growth of 0.9% in 2014, exited its three-year bailout and the economic climate is projected to expand a further 1.6% in 2015 and 1.8% in 2016.

Portugal’s growth numbers have led to labelling the nation a “star pupil” of the Eurozone turmoil. Advocates say the country demonstrates how the formula of “expansionary austerity” can function if prescriptions are followed closely. In addition, the current coalition argues that their successful implementation associated with austerity policies and structural changes have moved the Colonial economy from an import-led for an export-led model. Many consider recent economic growth a direct product of this.

However, it is by no means obvious that the formula of austerity and structural reform is responsible for Portugal’s return to growth. As the main opposition party points out, it had been the return of household demand that brought the actual turnaround. In addition, a longer view of Portugal’s economy shows that a shift in the structure of the economy has a longer history compared to government recognises with important ramifications for future prospects.

The export debate …

In the government’s favour, it is certainly true that the economy has witnessed a shift towards a greater share of exports throughout its time in office. In 2011, when it came to power the share of exports as a percentage of GDP stood at 34.3%. This has risen to 39.9% in 2014 – growth that compares favourably towards the OECD average, which stood at 28.6% in 2013 and 28.3% in 2011.

As the Banco de Portugal makes clear, this should continue “strengthening the recent pattern of reallocation of productive resources to the economic sectors that are more exposed to international competition”, which are therefore more likely to export products or services. This in turn will ensure that the “Portuguese economy’s net lending ought to remain stable and the reduction in external indebtedness should be sustained.” Considering it was a debt crisis that needed bailing out, this can only be a good thing and will play a larger role in GDP growth than had been the case within recent history.

… vs demand

Portugal’s resistance Socialist Party points out that the implemented austerity policies had a huge effect on domestic demand, as they eliminated people’s spending power. This year, domestic demand had developed by 1.9%. When the bailout was introduced in 2011, however, demand dropped by 5.7%, dropping another Seven.3% in 2012 and then 2.5% in 2013.

OECD

The socialists argue that demand only improved after Portugal’s Constitutional Court ruled that a number of the most important austerity measures were unconstitutional and overturned all of them in April 2013 and could 2014. These included cuts to state pensions and public sector income. It was only then that the return to growth began because domestic demand grew through 2.1%.

This argument is persuading, as it is unlikely that an economic climate based largely on an import-led growth model would find by itself altering the dominant basis pursuing growth in the midst of recession, growing unemployment, and international uncertainty.

The lengthy view

A longer view of Portugal’s economic climate also does damage to the actual government’s claim to have found the special moment formula for a sustainable economic path forward. Specifically, the actual government’s argument ignores the fact that Portugal had been experiencing steady growth in exports as a percentage of Gross domestic product from 26.7% in August 2005 to 31% in 2007.

This has been unparalleled since the late Eighties. Export growth stalled due to the financial crisis of 2007-08, falling in order to 27.1% in 2009. From this point, the actual steady march back to current highs continues unabated, a trajectory that would have likely continued had the financial crisis not taken place or been as severe.

OECD

In an important feeling, then, we can state that the actual Portuguese economy has observed a shift in its framework. However, this dates back ten years earlier than claims made by the federal government.

This occurred at a time when a significant fall in domestic demand saw GDP growth rapidly follow the same trajectory. In this stagnant domestic environment, the need for Portuguese companies to refocus their activities towards external markets became imperative. Nevertheless, factors such as China joining the World Trade Organisation in 2001 and the eastern enlargement of the European Union in 2004 have presented significant obstacles.

These changes to the global economy introduced much greater worldwide competition for Portuguese businesses, which produced products of a similar low value-added profile. Whilst a structural shift in the actual economy may have taken place in this particular early period, this in turn didn’t lead to a sustainable trajectory associated with export-led growth. This difficult changeover is ultimately, what led to the debt crisis.

An uncertain future

There thus remains still plenty to be concerned regarding when discussing the future of the actual Portuguese economy. The government is wrong to claim that the thesis of “expansionary austerity” has produced a shift from an import-led to an export-led model of growth under its watch. This structural change has been underway for some time but nonetheless seems to have yielded little when it comes to a shift in prospects for the economy to grow sustainably.

In addition, the damage inflicted by austerity policies is clear to see in Portugal when you look beyond the headline growth figures. Unemployment remains incredibly high at 13.9% (albeit down from its 16.2% peak in 2013) as well as long-term unemployment levels were from 60% in 2014, 30% higher than the OECD average. Portugal’s health service offers faced severe cuts impacting frontline services, emigration levels among young adults especially are soaring, and government debt levels stay at a worryingly high 130% of Gross domestic product.

Yet, the likely return to power of the current coalition will only add political weight to the failed reasoning of austerity. The damage done will require root and growth will ultimately stagnate in an uncertain worldwide environment. In its search for a environmentally friendly growth model Portugal can be a star pupil, achieving this label by learning bad lessons.

Is Portugal a poster child for austerity? is republished with permission from The Conversation