Portugal's plight: the role of social democracy.

• Author: Bragues, George

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.

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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. Both of these events, combined with a political crisis fueled by republican attacks on the regime and an intellectual zeitgeist marked by pessimism and doom about the country's prospects, laid the preconditions for the 1910 overthrow of the monarchy, last personified by King Manuel II (Sardica 2008, 19-22). In his place, a republican order was instituted that lasted only sixteen years, mired as it was in political instability, public disorder, and economic chaos. To fix the country's desperate finances, the military junta that had seized the reins of power from the republicans appealed to Dr. Antonio Oliveira de Salazar, then a professor of political economy and finance at the University of Coimbra, Portugal's oldest and most hallowed university. After initially rebuffing the military and then having been granted authority over all government spending, Salazar became finance minister in 1928. More quickly than anyone had expected, Salazar brought the country's finances under control. His reputation thus made both domestically and internationally, he adroitly cemented alliances with civilian elements in the regime and neutralized opposition from military factions in ultimately winning favor from President Oscar Carmona, the head of state. Carmona appointed Salazar as prime minister in 1932 (Meneses 2009, 62-82).

A year later Salazar introduced a new constitution that established the Estado Novo (New State), the political architecture that governed Portugal until the 1974 revolution. Under Article 5 of the 1933 Constitution, Portugal's Estado Novo was defined as a "unified and corporative republic" (Nova Publicacao 1971, my translation in all cases). For the economy, this republic entailed a corporativist system in which individual competition was rejected, and production was instead to be organized within and between groups deemed organic by virtue of shared characteristics, interests, and purposes. Each of these groups--the corporations--was to represent specific trades and industries. In an attempt to eliminate class conflict, employers and workers were supposed to resolve their differences in a cooperative spirit. To facilitate this resolution or at least to keep it from degenerating into antagonism, strikes and lockouts were prohibited by the Statute of National Labor (Kay 1970, 57). Although Salazar liked to emphasize the corporations' autonomy, the state reserved the right to coordinate their activity and indeed understood itself as possessing "the right and the obligation to regulate and direct economic and social life" (Nova Publicacao 1971, Art. 10).

The economic system that actually evolved over the following decades bore only a slight resemblance to the corporativist ideal. This difference was not surprising. Under the prevailing economic system, each corporation, precisely because it was free to determine the conditions of its respective trade or industry, did not need to conform to consumer preferences. Even if a corporation wished to do so, the lack of prices in a system where production decisions depended on negotiations among the plethora of groups meant it would be impossible to ascertain what consumers wanted. A corporation then would ineluctably opt for policies that benefited its own members to the detriment of outsiders. Because every corporation acted in this way, the economic damage inflicted on society would be enormous. The government is thus forced to step in and direct the various socioeconomic groupings to bring about a modicum of order (for more on this type of situation, see Mises 1996, 816-20). What ended up being installed in Salazar's Estado Novo was therefore a form of interventionism insofar as private property was retained, but the government sought to hinder and modify what market forces, left to themselves, would otherwise beget.

The Estado Novo maintained, publicly at least, that the higher spirituality of Catholicism and the nationalistic objective of enhancing Portugal's economic independence guided the intervention's constraints on economic materialism. Although these motives cannot be discounted entirely, the government's interference was significantly driven by the need to remain in power because the Estado Novo's policies aimed to foster controlled growth so as not to disturb the balance of socioeconomic interests, while simultaneously favoring a narrow commercial elite that consisted of forty or so families who supported the regime (Corkill 1993, 20-21). The features of the interventionist regime that produced this result involved a system of industrial conditioning in which entry into a given area of the economy required government approval. Cross-border trade was channeled to the colonies, principally Angola and Mozambique, which were treated as captive sources of raw materials and markets for the mother country's manufactured goods. Protectionist measures, too, served to promote industrialization by domestic firms via import substitution (Meneses 2009, 336-41).

Such intervention did not conduce to economic prosperity. Although Portugal survived the Great Depression relatively unscathed and successfully maintained neutrality during World War II, in 1950 it was in the same position relative to its wealthier European counterparts that it had occupied at the founding of the Estado Novo in 1933. Its GDP per capita remained at 42 percent of the GDP per capita of twelve developed western European nations (Maddison 2010). (1) However, in the 1950s the industrial-conditioning regime began to be reformed, and foreign investment and tourism were encouraged (Corkill 1993, 13-17; Neves 1996, 339).

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This liberalizing trend accelerated in the 1960s with Portugal's entry into the European Free Trade Association in 1960, the World Bank and the IMF in the same year, and the General Agreement on Tariffs...