Wharton's Joao Gomes and Joao Borges de Assuncao of Católica Lisbon School of Business and Economics discuss what led to Portugal's economic recovery and what more needs to be done.

Portugal is celebrating an economic recovery after a prolonged recession that began in 2003 and worsened after the 2008 Great Recession. The nation’s GDP grew 2.7% in 2017 — the highest in many years — and while that is projected to taper off some this year, growth should still hit 2.2%.

There are a least two views about what has led to the recovery. One suggests that Portugal’s decision to end the harshest IMF/EU austerity measures in 2015, and boost spending and investment led the charge. Another is that Portugal simply benefited passively, along with others, from a strong recovery in Europe overall.

As a New York Times report observed, with various officials quoted to support the view, “At a time of mounting uncertainty in Europe, Portugal has defied critics who have insisted on austerity as the answer to the Continent’s economic and financial crisis.”

The austerity measures demanded of Portugal via the International Monetary Fund and the European Union were widely viewed as tough, and entailed severe spending cuts, cutbacks of wages, pensions and social security. In return for accepting the cutbacks, the IMF/EU agreed in 2011 to bail out Portugal with $90 billion to manage its fiscal deficit, capitalize weak banks and reduce nonperforming loans, improve employment, and gain greater access to world financial markets.

The Times’s story goes on to note that in 2015 Portugal took a “daring stand” when it “cast aside the harshest austerity measures its European creditors had imposed, igniting a virtuous cycle that put its economy back on a path to growth.”

The country reversed the cuts noted above and instead “offered incentives to businesses.” That reversal and a willingness to boost spending “had a powerful effect. Creditors railed against the move, but the gloom that had gripped the nation through years of belt-tightening began to lift. Business confidence rebounded. Production and exports began to take off,” notes the Times’s story.

“When the tide comes in, all the boats go up and that’s what happened to the Portuguese economy.”–Joao Borges de Assuncao

But Wharton finance professor Joao Gomes, a native of Lisbon, said that Portugal’s economic recovery is better understood in the context of the broader recovery across Europe, which he rated as “excellent.” Portugal has benefited from Europe’s economic recovery in a few ways: tourism, exports and increased domestic investment. These have helped reduce the unemployment rate from its peak of 17.5% in the first quarter of 2013 to 7.9% in the first quarter of 2018.

Joao Borges de Assuncao, a professor at the Católica Lisbon School of Business and Economics in Lisbon, said Portugal’s ongoing economic recovery has made it “a poster child for what could be done differently in the context of the European recovery.” His view is that the country’s rebound began when some of the austerity measures were ended, allowing it to bounce back from the 2008 Great Recession and three years of negative GDP growth and high unemployment. De Assuncao was formerly economic advisor to the Portuguese President in 2006-2016 and to the Portuguese Prime Minister from 2002 to 2004.

Portugal’s recovery was helped by “a benign external environment,” which made possible “a job-rich and broad-based growth,” according to the view of the IMF in its latest report in February, echoing the view of Gomes. Suggesting the nation is not out of the woods entirely, the report also noted that it still faces vulnerabilities with potentially higher interest rates, high public debt to GDP ratios, bad loans on bank balance sheets and the possibility of “cyclical downturns” in its trading with its partners. The IMF called for “durable expenditure reforms,” and stronger bank balance sheets to make it possible for Portugal to provide new credit for investment.

De Assuncao and Gomes discussed Portugal’s economic growth and the challenges on the Knowledge at Wharton radio show on SiriusXM. (Listen to the full podcast at the top of this page.)

Big Stimulus Programs Helped

Portugal had much to gain from the European Commission’s Investment Plan for Europe that European Commission President Jean-Claude Juncker unveiled in November 2014. “Europe committed to this plan to effectively stimulate or subsidize investment throughout various parts of the EU, mostly in the South but not exclusively, by just essentially providing matching funds to a number of programs that qualified under certain criteria,” said Gomes. One feature helping Portugal is financial aid for small businesses enterprises. That added some 2 billion euros to the economy, or about 5% of total investment.

Gomes also pointed out that the biggest boost Portugal received from Europe’s recovery came via exports, with the continent taking up 75% of the country’s exports of goods and services. De Assuncao agreed: “The big change is essentially exports, including services,” linked to the overall improvement in Europe’s economy, particularly over the last two years. “When the tide comes in, all the boats go up and that’s what happened to the Portuguese economy.”

A Tempered View

Gomes also brought a sobering note to the excitement over Portugal’s economic recovery. “You can call it a recovery, but we’re still far below where we were just before the crisis. Look at every single number. Taxes relative to GDP are 44% — they haven’t budged one bit. The government collects the same amount of revenue that it did; it spends the same amount that it did, except for some one-offs in aid to the financial sector. The deficit is basically the same. Public investment is basically the same.

“There’s just not a lot of room to go forward, if we don’t increase productivity.”–Joao Gomes

“The boom has been mostly because of housing to some extent, hospitality and some side benefits of the Juncker plan for Europe, which has really subsidized investment in Portugal in the last couple of years.” Still, investment remains 25% below 2008.

Productivity Is Key

Gomes said productivity growth is critical if Portugal is to continue its economic rally. “The real cloud in the story over the last 20 years or so is that [Portugal is] just not more productive. There’s just not a lot of room to go forward, if we don’t increase productivity.” With higher employment, it is important to have higher productivity as well to improve wage rates and living standards, he explained.

De Assuncao noted that Portugal has seen increased investment, most of that has come from the private sector. But that, too, has left something to be desired. “It should have been much, much higher,” he said. “Investment went down as much as 40% from its peak, or 44% cumulatively from 2002, and we have only recovered 25% of that. We need a few quarters of growth of around 10% to catch up and bring back the levels that the Portuguese economy requires.”

And more investment is essential to achieve productivity gains, de Assuncao added. “Last year, the growth in employment was much larger than the growth of GDP, with the consequence that we had negative productivity gains. And for us to get productivity gains we need private investment – most public investment is not productivity enhancing.”

One reason for that skewed impact of investments on productivity is that the Portuguese economy is not sufficiently broad-based. “We need a lot more diversification in our in our economic base,” de Assuncao noted. But for now, the recovery has boosted economic sentiment, which in itself could provide further impetus. “It affects the outlook of people and all the surveys indicate that the public mood is a lot better, so there is a lot more confidence and that also helps the recovery,” said de Assuncao.

The Tourism Opportunity

Gomes saw tourism as “the only obvious place” for fresh economic growth, and said that could benefit from growth in Europe, although if Britain’s planned exit from the European Union proceeds, it could dampen that optimism some. Tourism is important also from a productivity standpoint because Portugal has an aging population, made worse by outward migration of its youth in recent years, said Gomes.

De Assuncao elaborated, agreeing that tourism is the most obvious source of economic growth — in the short term. “The problem is that tourism is small in Portugal and it will never be very large.” Thus, tourism cannot provide the engine for economic growth Portugal needs. He added that it would be hard to extract productivity gains in tourism because it is labor-intensive and most of its capital investments are linked to real estate.

Against that backdrop, de Assuncao reiterated his call to diversify the economy. But doing so requires public policy steps and the tendency is for the government in charge to select favorites, and thus make mistakes, he said. Portugal’s “best bet”: Increase eurozone participation. “The more we participate across all projects with other European countries that share the same regulatory environment, the same currency, and the same market rules, we can spread to many other industries.”


Among the main challenges Portugal faces is its “very fragile banking sector,” saddled by non-performing loans given to “friends of the government,” said de Assuncao. Many of those loans are linked to real estate and higher real estate prices will make it easier to regularize them. De Assuncao echoed the IMF view in noting that the economy is “extremely vulnerable” with its debt-to-GDP ratio of 126%. “If interest rates go up – and they will they will pretty soon – it will be a huge problem because we would lose quite a bit of interest income to the outside world.”

“It’s great to see people doing so much better, so much happier, and so much more confident of the future.”–Joao Gomes

“Portugal is maxed out on [its] credit cards,” said Gomes, adding that higher interest rates could spell doom. In that scenario, “the focus has to be relentlessly on growth.”

Among Portugal’s remaining woes is that the global financial crisis led to many among its millennial generation to migrate to other parts of Europe, Africa, Brazil and the U.S., Gomes noted. “They are some of the most talented, most highly educated individuals — the ones who have the option to move somewhere else. It’s a deficit of talent that we will not recover from in a generation. I think we’re not going to attract them back.”

Like others, Portugal also faces its share of global risks, such as the fallout from the U.S. trade war with China, said de Assuncao. “The countries that are weaker, like Portugal and Italy, will be extremely vulnerable to those developments. So we need we need to prepare for that.”

Enjoy the Party

Meanwhile, Portugal should take a pause and “stop complaining” de Assuncao suggested. “We are enjoying this boom. It has been unusual and so people are happy. Maybe right now the best thing to do is to enjoy the party. At the same time, do not destroy the gains — do not allow the deficit to get out of line. We need a very steady hand by the government.”

He also cautioned the government against giving handouts in the form of bonuses to civil servants and tax discounts to restaurant owners, as it has done in the past. Added Gomes: “It’s great to see people doing so much better, so much happier, and so much more confident of the future.”

“We are still in many ways an example for other countries that hardship can be overcome,” said de Assuncao. “In many ways, we were able to overcome that with limited internal strife, especially compared to other European countries which are still in a very dire situation.”