Bad things can still happen to ‘good pupils’ in the Eurozone

Neil Dooley - PhD student at the Centre for Global Political Economy, University of Sussex

Ironically, it’s precisely this commitment to being the eurozone’s ‘good pupil’ that helps us understand why Portugal is suddenly making headlines.  Following an inconclusive general election on October 4th, President Aníbal Cavaco Silva delivered a speech that was widely received as alarmist.  In it, he implied that he would prevent the Communist Party (PCP) and the ‘Portuguese Syriza’, Bloco de Esquerda (BE), from forming a historic majority coalition with the Socialist Party (PS).  Instead, he handed the mandate to what many claimed was an unworkable minority government led by his own party, the PSD (Social Democratic Party).  A vote of no-confidence on November 10th swiftly toppled that minority PSD administration. At 11 days, Passos Coelho holds the record for leading the shortest-lived government in Portugal’s post-war history.

Weeks of political instability followed. Seemingly content to procrastinate, Cavaco Silva reminisced about how “[i]n 1987 I was Prime Minister of a caretaker government for 5 months”.   Finally, on Tuesday the 24th of November the President had no choice but to appoint António Costa as Prime Minister, but not before requesting commitment on a number of crucial issues. These include a guarantee from the new government that they will respect EU budget rules. The Communists have accused Cavaco Silva of ‘subvert[ing] the constitution’ by ‘demanding conditions and guarantees’ and have not committed on paper to Socialist pledges to stick to EU budget goals. So much for the air of calm that surrounds Portuguese politics.

For PS leader António Costa, Cavaco Silva is responsible for creating an “unnecessary political crisis”. Yet, the President’s interventions are better understood as a familiar, if intemperate, effort to signal to the world that Portugal will not head down the same road as Greece.  In his own words, Cavaco Silva has a constitutional duty to ‘to do everything possible to prevent false signals being sent to financial institutions, investors and markets’.  The problem is, as Mehreen Khan of the Telegraph has noted, that Costa’s left-wing alliance is ‘nowhere close to the bogeyman painted by Cavaco Silva’.  If anything, the wrong lesson has been learned from Syriza, with a Socialist-led coalition far more likely to display the kind of resigned compliance exhibited by Tsipras et al since their September re-election.  In reality, it is Cavaco Silva’s over-zealous attempt to exhibit his country’s ‘good European’ credentials, not the Portuguese left, that could be a catalyst for unprecedented political and economic instability.

There is also a deeper irony to this saga.  Long before the eurozone crisis, Portugal’s political elites have demonstrated an eagerness to create, as former President Mário Soares once put it, ‘genuinely European patterns of life and welfare [for the Portuguese people]’.  Europe has long been seen as a benchmark for what it means for Portugal to be modern.  However, specific efforts to restructure Portugal as ‘European’ actually brought about the very types of debt-led growth that most closely locate it within Europe’s beleaguered periphery.

This story begins 40 years ago, in the aftermath of the 1974 ‘Carnation Revolution’. Successive short-lived and unstable Socialist governments sought to create a type of political economy in Portugal that leaned towards to the radical left, constitutionally ‘irreversible’ nationalisations and all.  ‘Revolutionary austerity’, a fragile democratic settlement and two IMF bailouts in five years meant that this early socialist vision ultimately failed to take root.

As a result, by the mid-1980s, an opportunity arose for PSD-led governments to present a new vision for Portugal’s political economy.  Cavaco Silva first became Prime Minister in 1985 and formed a minority government with a mandate to solve the political and economic turbulence of the revolutionary years.  His solution largely worked, and he and the PSD remained in power for the next 10 years.

The substance of this new vision was defined against the political and economic turmoil of the 1970s.  But, crucially, it was to be achieved through deepening European integration. Portugal acceded to the EC in 1986 at precisely the moment that Europe was launching its ‘one market, one money’ project, beginning the completion of the Single Market and moving to the introduction of the euro.

For Portugal this meant committing to a reform agenda which emphasised privatisation, deregulation and liberalisation.  Crucially, these reforms were to have a particularly striking impact on banking and finance which, up until then, were characterised by pervasive public intervention and control.  From the 1980s onwards, PSD governments introduced reforms in compliance with the EC/EU that led to the raising of banks’ opportunities to take on more risk, provide new products and access new sources of financing.  As a 1993 World Bank Report recognised, the banking and financial system in Portugal was completely transformed within a very short period.

These reforms contributed to a very new kind of economic trajectory for Portugal in two main respects.  First, domestic demand became the main engine of growth.  This was fuelled by an increasing supply of credit, facilitated by the rejuvenated banking sector.  Household debt grew well above the euro area average and approached 71 per cent of GDP in 2002 – up from just 15 per cent in 1990.

Second, this trajectory of credit-fuelled economic growth contributed to the expansion of particular sectors of the Portuguese economy.  João Rodrigues and José Reis note that the incentives provided by the structural reforms geared investment and capital inflows to the newly profitable non-tradable sectors, including construction, retail and privatised utilities, and not to the more risky export sector.  In other words, Cavaco Silva’s vision for a modern European Portugal ended up, in practice, creating patterns of non-productive and debt-led growth.

As early as 2000, the limits of Portugal’s new economic trajectory were evident.  Households and businesses were severely overleveraged and spending and investment plummeted. Because domestic demand had so far been the main driver of growth, the country slid into a recession that lasted right up until the eurozone crisis (although other factors such as falling export competitiveness certainly also played a role).  A decade of stagnation and indebtedness later, Portugal became an obvious target for international market anxiety following the Greek and Irish bailouts.

As such, playing the ‘good pupil’ can now be seen to have contributed to two kinds of crisis in Portugal today.  Anxious to signal that ‘Portugal is not Greece’, Cavaco Silva may well have brought about exactly the kind of political instability he was trying to avert.  Eager to transform Portugal into a ‘modern European’ economy, successive governments have inadvertently generated toxic patterns of debt-led growth.  As a consequence, despite years of painful reforms, Portugal’s economy is still highly vulnerable and, according to the IMF, its much lauded ‘export miracle’ remains narrowly based.  The important point is that, in practice, good behaviour can be counterproductive for small peripheral states.  Bad things do happen to good pupils.