The Negative Effects of the 200 Global Financial Crisis on Portugal, Essay Example

The 2008 Fiscal Crisis had a significant impact on the global economy. Portugal was not immune to this influence. The credit crunch considerably impacted Portuguese banks in 2007 when the country attempted to expand its currency into the European Union and take on substantial external debt. Data shows that the Portuguese economy saw unprecedented economic growth between 2001 and 2007, which resulted in the country relying heavily on external financing to fund its operations (Kontiade?s, 2013, p. 13). Portuguese banks were forced to tighten credit policies, virtually stagnating the economy in 2008. The following will take a deeper look at the microeconomic and macroeconomic policies that influenced Portugal’s GDP, Inflation, Unemployment , trade balance and foreign exchange rates. Furthermore, the report assesses the efficacy of policy adjustments to recover from the 2008 fiscal crisis.

In Mankiw’s (1989) study on Real Business Cycles and Keynesian theory, the author defines Real Business Cycle as it relates to Keynesian theory. The author notes that, “the Keynesian school believes that understanding economic fluctuations requires not just understanding the economic intricacies of general equilibrium, but also appreciating the possibility of market failure on a grand scale” (Mankiw, 1989, 79). He further points out that Real Business Cycle theory assumes there are large random fluctuations in the rate of technological change and fiscal policies makers implementing RBC theory respond to these fluctuations, balancing levels of labor supply in accordance with market needs based on elements of production. The problem with the RBC method, as Mankiw (1989) argues, is that it doesn’t take macroeconomic factors into account that leave a market vulnerable to collapse. Pereira and Weman argues that the the macroeconomic theory of RBC as it was applied by Portugal fiscal policy managers between 1974 to 2011played a substantial role in disparaging fluctuations in the country’s GDP, Inflation, Unemployment, trade balance and foreign exchange data. The author suggest the real flaw in the country’s economy was failing to implement a form of Keynesian theory to counterbalance intangible factors that commonly arise with expansion into foreign markets like Portugal did with the European Union (Pereira &Wemans, 2012, p.7) .

Pereira and Wemans (2012), note their study on Portugal and the Global Financial Crisis that much of the country’s economic decline was attributed to faulty macroeconomic policy and short-sighted politics which deteriorated public finances and made the bailout an inevitable necessity. The authors note that data between 1974 and 2011 reveals that Portugal has long adhered to a macroeconomic policy of real business cycle theory that failed to account for “constitutional and institutional problems”.  Cardoso (2009) notes the reasoning behind Portugal’s use of RBC as opposed to implementing tenants of Keynesian theory in their fiscal policy is largely attributed to the fact that clear and concise translations of JM Keynes had yet to reach a level of significant distribution throughout Portugal until 2009 (Cardoso, 2009, p.6).

GDP

Between 2008 and 2009, Portugal experienced a considerable decline in domestic demand. As credit was not accessible and Portugal’s economy was largely dependent on foreign investment, debt financing led to a decline in domestic demand. Thiscaused a 2.7% declinein GDP (WorldBank.com, 2015).

In 2010, with the help of the stimulus package, GDP started an upward trend. In this case, the government employed the stimulus package so as to stimulate aggregate demand through the increase in government expenditure. This is further enhanced by improving the net exports position of the economy. The problem that arose from Portugal’s decision to accept a government bailout is that it resulted in a loss in confidence on the behalf of foreign investors and a subsequent decline in Aggregate Demand.

Aggregate Demand

Portugal suffered largely from a fall in aggregate demand, making it more difficult for the country to access external debt to finance its huge government expenditure, certain sectors of the economy failed, including the ability to import. As a result of this loss in confidence in 2010, unemployment increased.

Unemployment

Between 2002 and 2007, Portugal experienced a considerable increase in the rate of unemployment. Unemployment rose by 65%, where 270,500 citizens were unemployed in 2002 compared to the 448,600 citizens unemployed in 2007 (TradingEconomics.com, 2015).

As the economy was largely dependent on foreign investments and credit financing, most business, companies, factories and especially banks relied heavily on foreign financing (Lourtie, 2011, p. 35). The collapse of some of the major banks in the United States is credited as the spark to ignite Portugal’s economic downfall (Lourtie, 2011, p. 35). The author further supports this argument noting that between 2008 and 2009, the economy realized an increase in the unemployment rate to 9.47%. Employment decreased faster than Portugal’s GDP. By the middle of 2008, 66.7% of women were employed compared to 79.7% of men.   Data in Lourtie’s research reveals there has been a considerable exodus of highly trained units of labor to other European countries from Portugal, further reducing the country’s skilled labor market.

Wages

In Amaral’s (2008) study on the economic history of Portugal, he notes that prior to the 2008 global economic crisis, Portugal’s wages were increasing at a much faster rate than production. This made the Portuguese economy highly uncompetitive, further compounded with problems of inflation (Amaral, 2008, p.1). Furthermore, the high wages in Portugal became a problem to the point where the MoU for the bailout categorically expressed the need to mitigate the costs of labor within the Portuguese economy (European Communities, 2009).

Minimum Wage Freeze & Expansionary Policies

Portugal had instituted a minimum wage freeze after the 1974 revolution. This minimum wage made the Portugal highly uncompetitive based on increasing production costs. Under the Troika MoU, Portugal froze the minimum wage to reduce labor costs and make Portugal competitive in the EU (Kontiade?s, 2013, p. 13). Pereira and Wemans (2012) further support the view that Portugal’s attempts to expand their fiscal policies to be competitive within the European Union has long contributed to limiting the country’s growth.  These policies were implemented by Portugal in direct response to financial fluctuations in accordance with RBC theory and their failure to account for the external market factors, or macroeconomic factors, is a prime example of Mankiw’s (1989) argument proposing the ineffectiveness of RBC relative to Keynesian theory.

In 2010, Portugal implemented a new policy which entailed the used of austerity measures. This led to a decline in investment and consumption both by the public and private sectors within the economy.

National Debt

The main cause of Portugal’s current financial turmoil resulted from the rapid increase in the country’s national debt. Before joining the European Union, the economy’s debt was 60% of GDP. By 2009, when Portugal begun feeling the effects of the 2008 financial crisis, the level of debt had risen to up to 70% of GDP (European Communities, 2009).

As the country sought to stimulate its failing economy, the 2010 stimulus package introduced even greater debt to the Portuguese economy. At this time, the level of government debt per capita had increased by 117.70%, from $6,416.73 in 2008 to $17,819.00 in 2010.

Government Spending

Pereira and Wemans (2012) note that a key flaw within Portugal’s fiscal and monetary policy is government expenditures.  In 2007, government spending accounted for 44.36% of GDP. The new fiscal policy did not change this as government spending increased to account for 51.48% of GDP in 2010.

Policies

In a bid to save Portugal’s economy from the negative effects of the 2008 Global Financial Crisis, the government undertook some fiscal and monetary measures. While these fiscal and monetary policies have worked to help improve Portugal’s overall economic and financial position, it is important to comprehend the implications of applying the Keynesian model against the real business cycle model.  This application of the RBC theory is evident in the austerity measures enforced by the EU to save the failing Eurozone economies. Austerity measures sought to adjust and amend the structural policy component of the economy through the creation of lower paying jobs to reduce cost and significantly reduced government spending to reduce the increasing deficit experienced by the Portuguese government.

Fiscal Adjustment

As a member of the European Union, Portugal is obligated to adhere to the fiscal policies stipulated by the Union.  Larsen notes part of Portugal’s problem establishing sound economic competitiveness was attributed to the strict fiscal adjustments the country had to apply due this arrangement with the European Union. As Portugal’s economy largely suffered from deficits, the government agreed with Troika (the trio of the International Monetary Fund (IMF), The European Central Bank (ECB) and the European Commission (EC)) to reduce deficits swiftly (Laursen, 2013, p.12).  Despite the condition of Portugal’s economy, public expenditure increased from 44.8% of GDP to 49.7% between 2008 and 2009. This was largely due to the stimulus package. In 2010 the policy European governments employed were switched to austerity measures. Portugal’s public expenditure continued to increase during this time. However, in 2011, fiscal adjustment resulted in public expenditure dropping to below half of GDP. In 2012, it decreased to 47.5% of GDP. This trend is expected to continue in through 2013, 2014 and 2015. In a bid to mitigate further costs, the government has undertaken a reduction of the state labor force.

Fiscal Policy & Monetary Policy

In April 2011 Portugal became the third country in a row, after Greece and Ireland, to receive a bailout from the ‘Troika’ of the European Commission (EC), the European Central Bank (ECB) and the International Monetary Fund (IMF). Financial markets began to become suspicious about the ability of the country to fulfill its sovereign debt liabilities, risk premiums increased up to a point where access to capital markets was no longer an option and a debt default soon became imminent. At this point the Portuguese minority Socialist government of José Sócrates had no option other than to negotiate a bailout in the form of a memorandum of understanding with the three lending consortia – the EC, ECB and IMF Portugal chose to counter the recession through expansionary fiscal policy. As depicted in the table, government increased public expenditure. This is depicted in the graph below:

Monetary Policy

After the austerity measures took effect in 2010, Portugal managed to gain access to the international financial markets. This was achieved through the conversion of $4.43 billion of bonds that had a maturity of September 2013 with a 3.10% into new bonds. The new bonds would have a maturity of September 2015 and carry a 5.12% yield.

Conclusion

In conclusion, the negative impacts of the 2008 global financial crisis left Portugal unable to access international debt to finance government expenditure. Portugal employed the Austerity Measures under a MoU with Troika, to streamline its economy and gain control of the financial markets. It is still open for debate to whether or not this strategy was effective but economist suggest it might be working, as they note that, “the economy seems to have turned the corner in the second half of 2013, showing positive growth rates for real GDP and employment. These positive trends are expected to continue in 2014 and 2015, along with external rebalancing. Portugal’s recovery remains vulnerable to external risks and its high level of private sector indebtedness” (Europa.eu, 2014, p.90).  The authors do however note that the efficacy of the Austerity Measures as a fiscal policy will only be as successful as Portugal’s ability to limit Government spending.

Works Cited

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