Photographer: Jack Ladenburg
Photographer: Jack Ladenburg

Anyone still in need of proof that austerity isn’t fixing the euro area’s debt crisis should visit Portugal.

Hundreds of thousands of Portuguese took to the streets of Lisbon to protest against economic austerity on March 2, and the only surprise is that they didn’t do so earlier. Portugal is the euro area’s clearest example of how austerity is killing the patient, with the ill effects of counterproductive fiscal retrenchment unfolding before our eyes.

We rarely hear about Portugal’s economic troubles. With a population of 11 million, the country is much smaller than Spain or Italy, and it has less public debt than Greece and less private debt than Ireland. Plus, the government has generally done as it’s told by its international creditors, and the people have -- until now at least -- quietly accepted their medicine.

Unlike Greece, though, Portugal’s continued decline into recession can’t be attributed to speculation about its potential exit from the euro area. (Ever heard of a Porxit?) Nor can the country’s lack of growth be blamed on a failure to implement the program that creditors set out to return it to sustainable growth. Portugal’s trajectory deeper into recession is unadulterated evidence that the euro area’s insistence on austerity isn’t leading to a recovery.

Some Success

Portugal can claim some successes since it entered an international bailout program in May 2011. On the fiscal side, the country is on track to achieve a primary balance later this year. In January, the government regained enough investor confidence to re-enter the medium-term bond market for the first time in two years.

Portugal also made economic adjustments. For decades, the country suffered from a bloated public sector, but since accepting its bailout program, the government has privatized EDP-Energias de Portugal SA and REN-Redes Energeticas Nacionais SA, two state-owned power and gas companies, as well as airport operator ANA-Aeroportos de Portugal SA. This stands in sharp contrast with Greece, which has completed very few privatizations since the start of its bailout program.

Portugal also succeeded in shifting from domestic demand to a more export-driven growth model. The government estimates that Portugal achieved a positive balance of goods and services in 2012 for the first time since records began in 1953. This is partly because imports collapsed in line with domestic demand, but it is also due to growing exports.

Despite these positive signals, Portugal remains overwhelmed by its debt overhang. Public debt is about 120 percent of gross domestic product, just below the level in Italy, and private debt is about 250 percent of GDP, one of the highest levels in Europe. In order to reduce these burdens, Portugal must find robust, sustainable economic growth. With the current policies, it probably won’t.

Whereas most of the rest of southern Europe loaded up on cheap credit and expanded during the 2000s, Portugal’s economy grew by a grim average of only 1 percent annually from 2001 to 2008. This rate of growth would be stall speed for most developed economies. If Portugal couldn’t find robust growth back when credit was cheap and the global economy was booming, how will it do so now?

The government hopes that if it shrinks the public sector, the private sector will step in to fill the vacuum and restore the country to export-driven growth. This could be difficult, as the majority of the Portuguese corporate sector is composed of micro-, small- and medium-sized companies, which are funded primarily by debt. With banks deleveraging, lending to smaller businesses has fallen significantly over the past year, and private investment has suffered.

Shoe Recovery

I asked a number of officials what export sectors could lead Portugal back to growth. It seems the government is pinning its hopes on traditional sectors, which have performed relatively well over the past two years. One area the officials mentioned repeatedly was footwear, which spurred Portuguese growth more than two decades ago. The country’s footwear industry is very export-oriented, with about 90 percent of its products sent abroad.

The odds on Portugal making a shoe-led recovery are long, though. The Portuguese footwear market is pretty small in terms of volume, ranking 21st globally. And shoes made in Portugal are the second-most expensive in the world, after Italian ones. In terms of export revenues, Portugal’s footwear industry jumps to 11th worldwide, but it’s still behind Italy, Germany, Belgium, the Netherlands, Spain and France in Europe. It will take much more than fancy footwear for Portugal’s exports to offset the drag on growth from domestic demand.

As Portugal has entered a self-reinforcing, downward spiral of retrenchment, followed by recession, missed fiscal targets and then more retrenchment, its international creditors have revised their targets and forecasts. In November 2012, the so-called troika of Portugal’s international creditors -- the European Commission, the European Central Bank and the International Monetary Fund -- granted the country an extension on hitting its fiscal targets, and the government now seeks a second delay. A few weeks ago, the European Commission cut its growth forecasts for Portugal from a contraction of 1 percent this year to a contraction of 1.9 percent.

Despite these negative revisions, Portugal’s creditors continue to praise the country to the heavens for its progress on implementing the terms of its bailout program. This is partly to distinguish Portugal from Greece, sending the message that Portugal won’t be allowed to write down its sovereign debt as Greece was.

Dissonant Praise

However deserved, such praise jars with the reality of Portugal’s economic performance, a dissonance not lost on the public. There have been few protests in Portugal since its bailout program began, with only one turning violent. This could be because unlike elsewhere in Europe, the Portuguese never experienced a spike in wealth as they binged on cheap credit in the years before the recession, so they don’t now have to lower their expectations as sharply.

Still, they suffer. Portugal’s economy is in a tailspin, with unemployment reaching 16.9 percent in the final quarter of 2012. This weekend’s protests were an indication that the people in Portugal -- like those in most other peripheral euro-area countries -- are fed up with austerity. The protesters in Lisbon last weekend sang “Grandola, Vila Morena,” the signature tune of the 1974 revolution that overthrew Portugal’s dictatorship. If the country’s creditors don’t wake up and ease off their demand for austerity, they risk facing much more than just a song.

(Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. Until 2012, she was the director of European economic research at Roubini Global Economics LLC. The opinions expressed are her own.)

To contact the writer of this article: Megan Greene at megan@maverickintelligence.com.

To contact the editor responsible for this article: Marc Champion at mchampion7@bloomberg.net.