The European Union was flawed in its conception. The idea that more than a dozen disparate European nations could come together permanently in a monetary union without a much tighter fiscal and political union was always unrealistic given the gapping differences between the member nations in terms various criteria: economic, social, political, and, perhaps most important of all, cultural.
Now the member states of the EU are reaping the frightful harvest of this extraordinary misadventure in ways that will harm them for at least a generation.
Back in the summer of 1992, I cautioned my Portuguese MBA students about the entry of Portugal into such an alliance, but my concerns were brushed off as those of a foreigner who didn’t know what he was talking about. Understandably, those were days when the Portuguese people were proud to join a modern and wealthy Europe, when the future was golden with hope. For me to attempt to dampen anyone’s enthusiasm about entry into the EU monetary project was seen as unnecessarily pessimistic. Granted, since those long-ago days, Portugal has gained by the membership. One need only consider the improvement in the physical infrastructure of the country to see that at least that aspect has worked in favor of the Portuguese. My concern however is about the present and future of countries such as Portugal if they attempt to remain in the EU, and about the future of the EU project itself.
Portuguese friends and colleagues point out to me that currency unions can work successfully, adducing as evidence the example of my home country, the United States. In the US, the US dollar has been in continuous circulation and use for the nearly 150 years since the Civil War. If the single currency works in the US, why would it not work in the EU? It’s true that both the US and EU share single currencies. The important difference, however, is that in the US there is very tight fiscal and legal union as well. That is, when some states, such as the poorer states in the southern part of the US (e.g., Mississippi, Louisiana, Kentucky, Arkansas) require financial assistance from the wealthier states (e.g., New York, California, Connecticut, New Jersey), there is a legally-mandated flow of funds from the rich to the poor in the form of welfare, food stamps, Medicaid, aid for dependent children, subsidized housing, subsidized education, aid for highway construction, agricultural support programs, and so on. In effect, the wealthy support, or subsidize, the poor, often for decades, sometimes even for generations. The reason the currency union works is because the governors of New York and California (and the rest of the rich states) are never asked about whether they approve of this redistributional arrangement; nor are the citizens of New York or California asked to vote on the issue. The issue simply never comes up. While the citizens and political leaders of the wealthier states would rather not see part of their wealth and income channeled to the poorer among the fellow citizens, they are resigned to it. It has become a matter of established precedent, of settled law.
This of course is exactly what the EU lacks: a provision for the transfer of funds from the wealthier to the poorer nations during periods of economic distress. Moreover, the financial support system in the US typically does not take the form of loans; the movements of money from wealthy to poor are actually transfer payments that are not repaid. Nor are the payments laden with conditions (insisted upon by the money providers) that the states achieve some level of deficit reduction by firing their own state employees and cutting the salaries of those who remain employed; and by reducing support to the indigent, the elderly, the young, and the sick. On the contrary, the leaders of the wealthier EU countries are reluctant, even unwilling, to channel the wealth of their own citizens to the southern countries, such as Portugal. And they make their views known, vocally and forcefully, as the German Chancellor has been doing for a while. Nor are the citizens of the Netherlands or Germany eager to transfer their own funds to the south. In the EU, the issue does come up, it isn’t established precedent, it isn’t settled law. And that is a major problem.
Compounding this problem is the fact that, in the US, it is much easier for citizens of the poorer states to ‘vote with their feet,’ moving from low-opportunity areas like Mississippi to states with more promising economic prospects, such as California. The English language is spoken in both places, and the culture, while always somewhat different, is not so different as that between Greece and, say, Germany. In the US, this type of geographic mobility is accepted, even encouraged. But is this also the case in the EU? While it is legal to immigrate between EU nations, it is not nearly so easy as it is in the US.
What can Portugal do?
Assuming the Portuguese elect to remain in the euro, there are several inescapable realities they must face. (I leave aside the larger question of whether Portugal should remain in, or exit from, the euro at all; my even raising the question to my Portuguese friends and colleagues elicits such strenuous and emotional resistance to the idea that I have chosen not to revisit the subject here.) Chief among these realities is that Portuguese businesses will find it very difficult to sell their products at price-competitive levels in international markets. The reason of course is that they are stuck with an expensive currency, the euro, which cannot float in a way appropriate to Portugal’s situation, either up or down relative to other major currencies when allowing prices to adjust in the normal and natural way. Compounding this, of course, is the problem of very low domestic demand from the Portuguese population, brought upon in part by wave-after-wave of punitively impactful “austerity measures.” Accordingly, Portuguese businesses struggle to sell their products to foreigners, who shy away from European products priced in expensive euros (unless those products are, say, Mercedes-Benz sports sedans or Prada or Hermes fashion accessories) because they can find comparable products elsewhere priced more competitively. Moreover, Portuguese companies cannot sell as much as they would like to the domestic market in part because the government has resorted to punitively conceived and executed austerity measures. Since, by some estimates, 60% to 70% of national demand results from government spending, one can easily imagine the double impact of (1) increased levels of taxation combined with (2) large reductions in public sector salaries and expenditures. Ironically, the very financial stability the government desires may prove elusive as the country moves into a deflationary spiral by which businesses shrink, or disappear altogether, with the result that tax revenues fall ever lower. There may simply be very little economic activity remaining that the government can tax. Naturally, this would result in lower tax revenues than before the austerity programs were implemented, and this could end up exacerbating the dreaded government deficit even more.
The point is that it will be very difficult for Portugal to save its way to prosperity. Their attempt to rein in the deficit by reducing government spending (at all levels) while simultaneously raising all types of taxes and fees, while praiseworthy, may prove to be entirely ineffective in the end. I hasten to add that no one, not a foreigner like myself and, no, not even the “policy elites” here in Portugal, knows for sure what will be the ultimate outcome. That is inherently unknowable. But given the penchant, even enthusiasm, shown by Standard and Poors and the other rating agencies for punishing countries no matter what they do, no matter how responsibly they try to act, Portugal can almost depend on facing higher borrowing costs in the future as a result of continued and unrelenting bank and sovereign debt ratings downgrades. How then do the Portuguese outrun lighting? How can Portugal find a way out of its conundrum?
One approach I hear very little about is that of finding new paths to economic growth that would involve both commercializing new and existing Portuguese products as well as targeting the emerging markets around the world. I am convinced that this is the most promising path to the future for the Portuguese people, and while it may require new ways of thinking, and some new cultural predispositions, I see real promise among the younger generation.
In a recent issue of Forbes Magazine (November 21, 2011), Peter Cohan wrote an article entitled, “How Portugal Can Grow,” after attending the Silicon Valley Comes to Lisbon Conference recently held in Lisbon where he comments on the reaction to a talk he was invited to give. Here is an excerpt from that article:
That talk got to the heart of Portugal’s biggest challenge if it seeks to grow---a culture of inertia. Unlike in India, whose entrepreneurs have no hesitation in getting on an airplane and flying to Silicon Valley to raise capital for their start-ups, Portugal’s young entrepreneurs have not yet shown that they can do that. But based on dozens of entrepreneurs I met at this conference, there is a significant amount of energy, passion, and technical skill that has come out of Portugal’s universities---many of which have world-class technologies.
Thus what Portugal needs most at this time when her people are plagued with low confidence in, and optimism about, their economic future, is a change in culture. Hard questions must be raised and answered about what we do well as well as what we don’t do so well. What are those aspects of Portuguese culture that, though they have served us well over the centuries, might be holding us back in a modern globalized world that is characterized by wrenching changes, discontinuities, and technological revolutions?
In my opinion, as alluded to above, the future belongs to the younger generation. They are the segment of society that is most technologically-savvy, and (as such) are more aware than most of what is being done elsewhere in other countries as they too struggle to find their own unique paths to growth and to the future. I also believe that that segment of the older generation---that group of internationally-oriented policy “elites” from business, academia, and government---can play an important role in setting the tone for change. Given that they have the advantage of travelling to other cultures, they should try to become keen observers, skilled in observing what it is about these other countries that seems to work well…as well as what does not appear to work. Armed with this knowledge, when they return to Portugal they are in a position to work for changes in the culture that need changing while retaining those aspects of the national culture which represent the best the country has to offer.
One is reminded of the John Le Carre character, George Smiley, at the end of his classic spy-thriller novel, “Tinker, Tailor, Soldier, Spy,” when asked who it was “who ruined England. “ He answered that it was those “elites” who “stayed the same, refused to see the changes, left the future up for grabs.”
In my view, Portugal is at the same cross roads today as those faced by England after the Second World War. In the case of England, once the Nazis and Japanese had been defeated, and peace restored, the British faced a changing world in which their colonies no longer belonged to them, and new national powers around the world emerged to challenge the role in which they had so long played a comfortable part. The sun had indeed set on the empire. But the “elites” in Britain choose the part of the ostrich, head in the sand, refusing to face the changes. The people of England ultimately saw their influence, power, and wealth drain inexorably away: British industry was decimated, competitiveness at all levels was sapped of its strength and vitality, and the ordinary citizen paid a high price in terms of diminished standards of living, even of self-confidence in their place in the new world order.
Which direction will Portugal take?
author: Robert Stinerock