Eurozone crisis: How Portugal popped its cork

18 November 2010
Il Foglio Milan

Kerplunk
Kerplunk

The woes of crisis-stricken countries are not only due to international speculation and mismanagement of public finances, but also to their inability to create wealth. That’s what happened in Portugal, which never really adapted to the euro.

Let’s call it the cork parable. It takes place in Portugal, but applies mutatis mutandis to other European countries too. What’s it about? The Portuguese, the biggest producers and exporters of cork for bottle stoppers. Something made from the bark of cork oaks and the earth that nurtures them. Now what could be more solid and down-to-earth, unlike loans, debts, bills of exchange, derivatives – in a word all that “devil’s dung” that caused the crisis. If these bucolic premises were correct, the economic crisis on paper should not have spread to the cork. But what actually occurred was the opposite.

Why is it that little European nations like Portugal are now staggering under the blows of market speculation? The first reason is their size: in our day, their treasury bonds are bought and sold by financial leviathans with bigger budgets than many a state.

Secondly, they’ve got too much public and private debt on their hands: however austere their fiscal policies may be, the governments just can’t get a grip on it. Ireland’s economy accounts for 1.7% of the eurozone, and yet Irish banks grabbed a quarter of the funds made available by the European Central Bank (ECB). Greece, with 2% of the zone’s GDP, took in 17.3% of the cash from Frankfurt. Portugal, which accounts for 1.8% of Euroland’s gross product, was less greedy, now holding 7.5% of the loans. However, the fact is the Portuguese are even more indebted than the Greeks: taking households, private and public sector together, their debt comes to triple the GDP, as against 240% for Greece.

The third and definitely most important reason in the long run is that these countries fail to produce enough revenue to pay their debts. Portugal, with a 7.2% shortfall between GDP and debt, is looking for a 0.7% increase in GDP this year, but Standard & Poor’s, which moves the markets, is expecting to see a 1.8% recession there next year.

Things started going seriously awry in 2001

Which brings us from paper finance to the real economy, to the nuts and bolts of the Portuguese economy. Portugal took a long time to claw its way out of the underdeveloped hole in which António Salazar’s dictatorship had kept it stuck for so long. The 1975 Carnation Revolution brought democracy, not prosperity, at least not right away: the country had to wait till the 1990s to get its economy off the ground. Even so, it still has a marginal economy that exports goods with low value added. Its closest ties are to Spain, to which it has become an annexe of sorts, then to France, Germany, and Angola, its old African colonial dominion, which now mainly supplies oil. Portugal’s main manufactures are textiles, which remained competitive thanks to its low cost of labour…until Eastern Europe barged in on the scene.

And then came the euro. All of a sudden, Portugal found itself having to live, produce, sell and export on a strong currency, rather like the Deutschmark. So it’s no coincidence things started going seriously awry in 2001.

Real growth over this past decade was five points lower than the average for the eurozone as a whole. The country couldn’t even capitalise on the Spanish boom, which, in the first phase, wasn’t only on paper. And Portuguese industry lost market share across the board. In a comparative study going from 1995 to 2005, the International Monetary Fund shows a drop in every major Portuguese industry, from textiles and clothing to cork production. Growth was negative in services as well, even in tourism, the mainstay of the Portuguese tertiary sector. These are long-term trends that can’t all be blamed on the euro. But the advent of the single currency required a sea change in the economy, a quantum leap to quality-based competitiveness, not just competitive prices: in short, a full-scale economic overhaul.

This is where the banks come in

In the meantime, however, those double-crossing vintners, starting with the French, began switching to silicone bottle stoppers and even, horror of horrors, the tin screw cap for white wines that don’t need to age. So Portugal couldn’t even hold on to a niche it excelled in thanks to natural gifts and industrial specialisation: hardly anywhere else in the world do men and machines know how to work the cork as well to make bottle stoppers the way they’re supposed to be made. Further proof, then, that David Ricardo’slaw of comparative advantage and industrial specialisation has not held out against changes in tastes, winemaking strategies and the need to cut costs.

Cork, port, vinho verde, garments, electronic components, tourism – in a word, all the Portuguese mainstays have frayed and the wealth of the nation is sinking. Even before the property bubble burst, Portugal was fingered as a country in trouble. The fact is the cork business entered the crisis zone before the paper economy did, and the financial panic did the rest.

This is where the banks come in. Portuguese households, which used to be as thrifty as their Italian counterparts, have run up debts at their banks. With the aggravating factor that the latter have resorted to borrowing massively abroad. That heavy dependence has made the Portuguese economy, which was already weak and uncompetitive, as vulnerable as the Greek. No-one is proof against the great contagion of the crisis, but countries with a more fragile economic structure are more exposed. Economies which, while specialising in quality goods, succeed in maintaining an ample diversity of manufactures and services, always stand a better chance of pulling through.

So here’s another country that’s been living beyond its means, not so much due to public profligacy and private laziness, but to its inability to adapt the system to the new environment created by the single currency.

Translated from the Italian by Eric Rosencrantz

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