"Portugal is a harbinger of the end of social democracy"

Financial Post
Welfare state crack-up
By George Bragues

LibertarienPortugal has suddenly become something of a player on the world stage, if for all the wrong reasons. With Ireland having gone the way of Greece in needing an IMF-EU bailout, the financial markets are betting that Portugal will be next. Though its banks are no way near in as bad shape as those in Ireland, and though its public debt/GDP ratio is well below that of Greece, bond traders have taken to record levels the yield spread on 10-year Portuguese government bonds versus the benchmark German bunds.

This cannot be explained away as an irrational contagion process abetted by so-called bond vigilantes. Portugal shows little sign of being able to generate the wealth necessary to manage its debt. It has suffered its own “lost decade” of anemic growth, while the competitiveness of its export sector has fallen. Noting that this has taken place over the same period that the country has been using the euro, many of those trying to make sense of the market’s movements argue that investors have simply figured out that the European currency union puts countries like Portugal in a bind from which it cannot export its way out via an exchange-rate depreciation.

Portugal’s difficulties, though, run much deeper than the existing currency framework. Its problems are the culmination of a three-and-a-half decade project to erect a social-democratic welfare state.

That project evolved out of the 1974 Carnation revolution that overthrew an authoritarian regime known as the New State (“Estado Novo” in Portuguese). Dominated by the figure of Antonio Oliveira de Salazar, who ruled Portugal as a dictator from 1932 to 1968, the New State was officially committed to a corporativist economic system that envisioned the replacement of individualistic competition by the collaboration of vital social groups in production decisions.

In practice, the Portuguese economy fell short of this ideal and so the revolutionaries of 1974 ended up confronting a state-directed capitalism privileging a narrow business elite loyal to the dictatorship. Numerous industries owned by this elite, starting with insurance and banking, were nationalized in the immediate aftermath of the uprising in what would become the first of a series of political acts to define the post-1974 economic structure.

Most critical among these acts was the 1976 constitution that established Portugal as a modern democracy. Its preamble affirmed the necessity of “opening a path to a socialist society,” while entrenching the nationalizations undertaken after the revolution. Labour was constitutionally empowered, buttressing existing laws that make it extremely onerous to dismiss full-time workers.

Citizens were additionally granted a multitude of social and economic rights, including the right to work, housing, education, culture, health, and social security. These provisions were heeded by Portugal’s political classes, as the state apparatus progressively grew to fulfill the newly assumed constitutional obligations. Prior to the 1974 revolution, the government spent about 20% of GDP, mostly on the traditional functions of military defence, domestic administration, and infrastructure. Since then, driven by social expenditures, the weight of government has risen to 46% of GDP, higher than the European average. Over the same period, the number of public-sector workers quadrupled.

To anyone who remembers what Portugal was like in the 1970s and visits the country now, the economic progress that has been made is patently obvious. But its social-democratic experiment has delivered far less than meets the eye. It has never matched the growth rates witnessed from 1945-74, the best in Portugal’s modern history, when the New State opened the country to foreign investment and trade. GDP per capita rose from 30% of the European average to 50%. After 1974, this figure reached 66% in 2000, but has since fallen back to 60%.

Not only has the convergence been smaller in the post-revolutionary period, it has been significantly purchased with the assumption of debt. Right from the start, both in 1978 and 1983, the IMF was brought in to deal with external imbalances. Since the 1990s, Portugal’s current-account deficits have once again dangerously accumulated, thanks to high corporate and household borrowing.

By contrast, balance of payments troubles never arose during the New State while Salazar, formerly an economics professor of the pre-Keynesian school, was consistently balancing the budget. But under the sway of Keynesian thinking, and with its politicians not daring to upset voters by imposing the taxes necessary to pay for the country’s growing welfare state, Portugal has astonishingly never once managed to avoid a fiscal deficit in the 36 years since the revolution.

With any debt-fuelled activity, the day of reckoning can take a while to arrive. In Portugal’s case, it was delayed by the provision of limited-term work contracts, which attenuated the impact of its labour laws. Even so, the rigidity of these is still very great by world standards, deterring the capital investment needed to raise productivity. During the 1980s, too, the constitution was amended to allow the privatization of previously nationalized firms. Combined with Portugal’s entry into the EU in 1986, this reflected a shift toward free markets that, up until the early 1990s, led the country to its best economic performance of the post-revolutionary era.

Alas, this turn proved ephemeral, as Portugal’s ranking in the Heritage Foundation economic freedom index fell from 38th place in 1995 to its current standing at 62nd. The country’s adoption of the euro also bought some time by reducing debt-servicing costs. Figuring that giving up its own currency would force the government to implement market reforms, instead of resorting to the previous ways of depreciation, the bond market lowered the risk premium charged on Portuguese debt. But few reforms were made.

Unlike other developed nations, Portugal built its welfare state on a relatively weak economic foundation. Hence, it is among the first to have run into difficulties, making it a harbinger of the coming crack-up in social democracy. What Portugal can, and must, do is show the way out of this morass by truly completing its revolution and extending the freedom that its people won in the political sphere to their economic lives as well.

George Bragues is program head of business at the University of Guelph-Humber in Toronto.