These days, when talk turns to the Portuguese economy, “crisis” is the word people use most often. Portugal, which has fewer than 10 million people, violated the European Pact of Stability and Growth in 2001. Then it officially went into recession at the end of 2002. This year, prime minister Durão Barroso confronts some very important challenges, and their outcome will have a profound impact on the economy in the short and medium run. These challenges include the creation of the Iberian Market of Electricity on April 20; the expansion of the European Union to 10 Eastern countries on May 1; and Euro 2004, the football championship, which will take place in Portugal from June 12 to July 4.


“The cyclical evolution of Portugal has more to do with fluctuations in the country’s emotional state than its economy,” says João Cesar Das Neves, economics professor at the Catholic University of Lisbon. “When it comes to the economy and everything else, the Portuguese are either euphoric or discouraged. At the moment, they are feeling discouraged after years of euphoria. In reality, things are not as bad as they want us to believe, just as they were not as good as they thought they were, earlier on. Fortunately, the country’s productivity does not fluctuate along with the state of its political and social emotions.”


In recent years, Portugal’s economy has made extraordinary progress. In less than 50 years, it has been gone from being a traditional, backward economy, to one with a modern, dynamic structure very close to its neighbors. Nevertheless, the country is undergoing a period of slow growth. The slowdown in the economy of Europe, on which Portugal depends so much, is not the only factor responsible for this stagnation. According to Das Neves, “Our growth rate had already been falling. The economy grew at a rate that exceeded 4% during the 1950s, and by close to 5% during the 1960s and 1970s. However, it grew by only 3.6% during the 1980s; and by 2.9% during the 1990s. In recent years, our country, has dropped to about the same rate as other European countries – especially that of Spain, our neighbor.”


Budgetary Hole

Ever since 1986, the economies of the two countries have followed parallel paths. During the second half of the1990s, both countries grew at a higher rate than the average in the Euro zone. Contrary to what many analysts predicted, both countries managed to join the European Monetary Union from its outset. Nevertheless, over the past two years, Portugal has followed a different path from Spain. Its downward cycle has barely allowed the country to keep growing – by 0.4% in 2002.


Why have the two countries diverged? The answer lies in Portugal’s budgetary policy. During its cycle of expansion, Spain adjusted its public accounts and cut its taxes, spending and indebtedness. Portugal expanded its public spending, but did not reduce its deficit. In 2001, Portugal broke with the European Pact of Stability and Growth by recording a budget deficit of 4.1%, above the 3% limit stipulated by the Pact. Last year, Portugal engaged in a major belt-tightening effort and managed to reduce its deficit to 2.8%.


According to Das Neves, the current setback in public finances “was not created by a revolution or cyclical crisis or external shock, as in earlier cases. It was the result of feudal interests, who forced their priorities on the public good. Pressure groups satisfied themselves at the cost of [higher] public spending, and they created a budgetary hole. A significant portion of the elite appears to have stopped producing; it dedicated itself to dividing what already existed. That’s why there was a slowdown.”


Now Portugal faces a crisis of indebtedness – in an international context that is not stable. “Raising taxes or selling public property are emergency measures that can be justified in public terms, but they contribute little to the solution of the problem. The problem is not a shortage of revenues; it is excessive spending. In a country where taxes amount to 38% of the GDP, something is wrong when public spending amounts to 48%. We need to take emergency measures that are useful and painful,” says Das Neves. Although the country has laid out many plans and reforms, they have not been carried out. “The Ministry of the Economy should not be blamed for this failure to act, even though people often say that. The problem is in Portuguese society, which is not prepared for the cuts.”


Despite everything, Das Neves is an optimist. “It’s true that there are problems, as there are in every country. However, Portugal has an economic structure that is balanced, dynamic and competitive.” One advantage is the country’s political stability; nearly 90% of the electorate supports the government’s approach to basic issues. Other advantages are the country’s capacity for initiative and improvisation, and the creativity of its productive sector. “Portugal’s great economic triumph is its flexibility. The transformations that business [here] has undergone in recent decades demonstrate that capacity.”


The Menace of European Expansion

Beginning on May 1, Portuguese companies will have to deal with one more challenge – the expansion of the European Union from 15 member-countries to 25 nations. Expansion will bring important benefits for the EU’s new members – including reduced cost for their imports, consumer products and industrial inputs. It will also mean that exports of new members will enjoy greater competitiveness in foreign markets. Moreover, expansion will raise the diversity of products in the new members’ domestic markets, and raise their quality of life. For Portugal, however, expansion will mean additional competition for the EU’s structural funds as well as for incoming [foreign] investment because labor costs in the new members average about 50% less than in Portugal.


“The EU exports about 4% of its total exports to the 10 new members of the EU, while those 10 countries send more than half their exports to the EU,” notes Antonio dos Reis, professor of strategic management at the Lusiada University of Lisbon. For the EU as a whole, Eastward expansion is expected to have a positive impact of 2.2% on the GDP [in 2004]. However, the benefits will not be distributed uniformly; for the new members, the impact on the GDP is expected to be 5.3%.


According to Abel Mateus, a professor at the New University of Lisbon, the European countries whose exports will benefit the most from expansion will be Germany (whose exports to the new members will rise 34%), France (up 19%), and the United Kingdom (up 14%). “The only country that will be affected negatively is Portugal, because of its specialization in textiles, clothing and footwear.”


Nevertheless, Das Neves says, “This threat is a good thing. It is the only way to force our companies to improve and develop. They have already proven that they can figure out how to survive and prosper under demanding conditions. The only concerns now are about whether the forces of the European bloc will let [Portuguese companies] make decisions and take action.”


Integration of Iberian Market

The EU’s latest round of expansion means that the center of gravity in Europe is moving eastward. That could mean greater isolation for Portugal, a country on the Western periphery of the continent. However, Portugal has an ace up its sleeve. Together with Spain, Portugal is launching a true Iberian market, which will allow both economies to become more competitive in the new European space. The peninsula’s communication network – via the high-speed train (the TGV) – and its electricity network (the MIBEL project), will both be fully integrated.


The first such project to see the light of day is MIBEL. Beginning on April 20, electricity producers in Spain and Portugal will take the initial steps toward integration. Within a relatively short time, a family in Barcelona will be able to contract for light from EDP, the Portuguese electric company, under the same terms as a family in Lisbon or Braga [Portugal] can contract for power from Spain’s electricity providers – Endesa, Iberdrola, and Union Fenosa. The same changes will affect electricity contracts made with companies in the two countries.


The complete unification of the Iberian market will take place in 2006, following a process that involves an exchange of shareholdings. It will begin this year with an exchange of 10% of capital. Several pitfalls remain to be overcome. First, electricity rates are different in the two countries. Some suppliers will have to receive compensation – at rates that have yet to be settled. Although energy costs in Iberia have tended to get closer, “residential energy costs in Portugal are 20% higher than in Spain, while industrial energy costs are 12% higher,” says Dos Reis.


A second problem involves concentration in the sector: Four companies control 75% of all [electricity] production and 93% of commercial electricity sales in the entire peninsula. According to a report by independent regulators from both countries, this situation “constitutes an obstacle for the development of a competitive market, and it runs the risk that each company will defend its own territory.”


Moreover, the Iberian market is less of a reality than a series of formal declarations. In Spain, deregulation of electricity for families and companies does not appear to have been a convincing success. Deregulation in Portugal will begin in July 2004.


According to Dos Reis, Portugal will be able to derive major benefits from the [integrated] Iberian market. “Some people argue that, to be competitive in global markets, you have to be involved in markets that have at least 50 million people. In reality, the Iberian market is close to that critical mass. From that perspective, Portugal would be the main beneficiary by gaining critical mass.”


Implementing this plan will involve an extremely complex process. However, “the hope is, once the initial phase is over, benefits will emerge both in terms of competitiveness for industrial customers and lower costs for consumers. That will reinforce the move toward real convergence,” says Dos Reis.


Although the high-speed train [known as the TGV] will help to offset Portugal’s isolation and other effects of the EU’s expansion, “during the investment phase, [the TGV] will represent a heavy burden on public spending in terms of how much the Portuguese government can undertake. Once the train is used, the outflow will have only a tiny impact on the Portuguese economy. However, the impact on growth is still unclear.”


Euro 2004: Both Sides of the Coin

Although Portugal is concerned about cleaning up its public accounts, the country is nevertheless undertaking another project involving huge expenditures by the public sector. Euro 2004, the second most important event in European sports – after only the Athens Olympics – will take place in Portugal this summer. Euro 2004 is the European championship round of football. During this event, the Portuguese people may manage to forget the debate that has emerged about the nearly 800 million euros the country is spending on sports infrastructure. That is especially likely if the Portuguese team, which stars Figo and Rui Costa, becomes the European champion.


Before Portugal can celebrate a victory, organizers of Euro 2004 hope to achieve other kinds of triumphs. They want to send a positive image of Portugal around the globe and spread the word about the country’s great potential as a tourist destination. Nine billion spectators will watch the event worldwide, which will mean a payoff of between 300 and 500 million euros [for Portugal]. Moreover, according to Dos Reis, “More than 500,000 tourists will visit Portugal. That will mean direct revenues of at least 50 million euros. Tourism revenues directly stemming from the event will amount to between one-third and one-half of the [country’s] total expenditures [on Euro 2004].”


Optimists hope that the “Barcelona effect” will repeat itself in Portugal. After the 1992 Olympics in Barcelona, that Spanish city enjoyed annual tourism revenues amounting to between 180 and 360 million euros over the following six years. However, observers disagree about the impact of Euro 2004 on Portugal. According to Dos Reis, “it could be of enormous value to the economy, not only by spreading the word about Portugal but also through its impact on the GDP and on foreign-exchange revenues. It could also reaffirm the prestige of Portugal throughout the world by clearly demonstrating the country’s ability to carry out great events. Or maybe not…”


For Das Neves, Euro 2004 may represent a worthwhile investment when it comes to counting ticket revenues and boosting Portugal’s image. Nevertheless, “the construction cost of most football stadiums – unavoidable because a combination of forces – winds up ruining any chance that the project will achieve profitability.” In addition, the infrastructure required for this particular championship will not prove to be useful in the future, unlike the case with other events of this sort, such as Oporto Capital Cultural and Expo 98.


Das Neves recommends that Portugal “manage the [financial] hole well and exploit every opportunity to make money from this event. The costs involved [in Euro 2004] are spread out over several years but the revenues are concentrated in this year alone. The football championship will have a positive impact on the current [economic] situation. It is another case of a ‘ruinous’ project that winds up looking sensible.”


Reflecting on Portugal’s condition, Das Neves concludes: “The Portuguese economy did a commendable job of overcoming the imposing challenges of the past 50 years. Portugal never believed in itself, and it always regretted the results. Yet the fact is, Portugal has surpassed every expectation. Growth has been impressive and the transformation has been considerable. Achieving these results wasn’t easy, but Portugal has become a country that early generations would not recognize. The challenges that the country faces today are equally demanding and intimidating, but Portugal must respond in the same way.”