Submitted by Erico Matia Tavares of Sinclar & Co. [18],
It has been centuries since the Portuguese last dominated the world's seaways, but in glancing over recent headlines one would be forgiven for thinking that their pirates are still running around.
With the economy still reeling from the effects of the devastating financial crisis in 2010-11, Portugal has been rocked by a series of corruption scandals which go to the very core of the political and financial establishments.
None other than José Socrates, Prime Minister from 2005 to 2011, is being held in custody in connection with money laundering, tax evasion and corruption charges; the figures involved are rumored to be in the many millions. A number of top officials of the current government have also been detained on graft charges targeting wealthy foreigners – mostly Chinese – seeking Portuguese residency under the "golden visa" scheme.
Earlier in the year, Grupo Espírito Santo, a significant conglomerate that owned a large stake in BES, one of Portugal's largest private banks, failed spectacularly, after dodgy accounting practices and money transfers supposedly intended to fool regulators and investors could no longer remain hidden. Here we have the blue blood of Portuguese finance, with close ties to major domestic and international corporations and governments. The resulting losses are in the many billions.
Over the years there have been recurring allegations of corruption and unsavory dealings in the press, but these have been largely inconsequential. For one, Portugal is still perceived as being “cleaner” than its Southern European peers: according to Transparency International, in 2013 it ranked #33 "cleanest" country in the world, compared to Spain at #40, Italy at #69 and Greece at #80.
Which is why these latest scandals are particularly shocking. Judicial actions of this nature being taken against very high profile political and business figures are extremely rare, even unprecedented in Portugal’s contemporary history.
Now, will these scandals have an impact on the economy? And if so, how?
Jobs and income have disappeared since the breakout of the crisis – and many Portuguese with it. Last year more than 128,000 people left the country (official figure; the real number could be much higher), compared to just 21,000 in 2000; newborns are at generational lows; and immigration, which had been a key source of population growth, has been net negative since 2010. Those wealthy Chinese with golden visas will find an increasingly empty country upon arrival.
This dire demographic situation is symptomatic of a very challenging economic environment. After being one of the founding members of the Euro, Portugal has been a real laggard in terms of growth. Here's the relative performance of its GDP per head on a purchasing power parity (“PPP”) basis in recent decades:
GDP per Head on a Purchasing Power Parity Basis (USD): 1995-2013
Source: World Bank.
(a) Simple average of Cyprus, Czech Republic, Estonia, Hungary, Lithuania, Malta, Poland, Slovak Republic and Slovenia.
Portugal's economic divergence relative to Europe’s core is striking; it has even been overtaken by an average of the newcomers that joined the European Union in 2004, many of which are former communist countries. This in spite of Portugal receiving billions in structural reform funds from Brussels for almost three decades now – a process which is still ongoing.
So how did this significant underperformance come about?
Every year the World Economic Forum [19] publishes the Global Competitiveness Report, which ranks over 140 countries based on their Global Competitiveness Index (“GCI”), a comprehensive tool that measures the microeconomic and macroeconomic foundations of national competitiveness. In order to get a sense of why this is relevant, here’s how GCI correlates with GDP per head (also on a PPP basis) in the latest survey:
Relationship between the GCI and GDP per Head on a Purchasing Power Parity Basis (USD): 2014-15
Source: World Economic Forum.
Clearly there’s a positive relationship, suggesting that high income levels per head are generally accompanied by high competitiveness readings. Stated differently, a country is likely to get richer as it becomes more competitive and vice versa.
And here’s how Portugal is faring in terms of GCI and its variables and sub-components compared to the five most competitive economies of that newcomers group (the higher the ranking, the better the relative performance):
Source: World Economic Forum.
Portugal’s GCI is a little better than most others in this group, but that’s only because of the big jump recorded over the prior year, from #51 to #36 (driven by improvements in market efficiency). The variable that really stands out negatively for Portugal is “macroeconomic environment”, which accounts for things like fiscal balance, government debt, inflation and credit rating (the more negative they are, the bigger the burden on the economy going forward).
But we can dig a little deeper. The following graph compares the evolution of the main “basic requirements” sub-components, “efficiency enhancers” and “innovation factors” relative to the 2006-2007 survey, the oldest publicly available:
Change in Selected Variables 2006-07 to 2014-15 (%)
Source: World Economic Forum.
The drivers behind the deterioration of Portugal’s overall competitiveness since 2006 are fundamentally its institutions, where the robustness of its legal system and corruption are included, and macroeconomic performance. In contrast, the other countries have broadly improved on these variables. Most likely this differential would have been even more pronounced if we had gone further back in time.
The only thing holding up Portugal’s GCI over this period is the big improvement in infrastructure. Portugal now ranks #17 in the world, far ahead of the selected newcomers. In road quality, a sub-component of this variable, it actually ranks #2 (second only to the United Arab Emirates)!
And how were these world-class roads financed? In a country with chronic budget deficits, no doubt at the expense of macroeconomic performance – which as we have seen is now badly hurting its competitiveness. Profligacy, it seems, has a price.
With all of this in mind, let’s go back to the question we posed earlier: how will the recent corruption scandals impact the economy?
The Most Problematic Factors for Doing Business in Portugal: 2014-15
Source: World Economic Forum.
According to the results of a recent survey on the most problematic factors for doing business in Portugal, shown above, corruption ranked far lower than government inefficiency, the #1 concern. While this survey was conducted much before the latest scandals came to the fore, we could argue that these two factors are actually interrelated.
That large government bureaucracy gradually grew in order to handle, among many other things, the billions in development funds pouring in from the EU over many years. Coupled with a lack of transparency of government policymaking (Portugal ranked #81 here, right after Uganda), high favoritism in decisions of government officials (#54, after Kazakhstan) and a horrendous legal framework efficiency (#111, after Russia), the temptation for a select few to put their hands on the public purse may be just too great.
A likely consequence? A raft of infrastructure projects with dubious returns, and possibly many more other shadier dealings; in other words, spectacular roads – and a bankrupt economy.
This of course may be a gross oversimplification and we still don't know the extent of any wrongdoing; the judges need time to do their work. Moreover, the vast majority of public servants are (and should remain) beyond reproach. The fact is, however, that something went horribly wrong in Portuguese policymaking. After all, the country did go bust, and now millions of people are paying a heavy price, jeopardizing whatever’s left of their European aspirations.
Therefore, Portugal’s judicial system showing its teeth on politically sensitive cases is a good thing. Improving the credibility and effectiveness of its institutions is an absolute necessity to reverse the country’s misfortunes and enhance its overall competitiveness. So tackling these scandals may actually have a positive impact going forward.
For sure, much more needs to be done to get Portugal’s economy humming again. We have written previously on the de facto currency appreciation [20] which has left Portugal increasingly out of the world markets, as well as on its ballooning indebtedness [21]. Fixing these issues will require much more than just vigilant judges.
But hopefully, with some luck, from now on the pirates will be the ones leaving Portugal, instead of its hardworking citizens.
