Spain vs. Portugal

Two countries share the Iberian Peninsula (unless you count the tiny areas of Andorra and Gibraltar), Spain and Portugal. Both have been counted as the poorer countries of Western Europe-and both still are, but to wildly varying extent. As the graph (taken from this story of The Economist) below illustrates, while Spain's per capita income during its entry to the Euro-zone has risen from 92.1% to 97.7% of the EU25 average, Portugal's per capita income has fallen from 80.3% to 70.4% of EU25 average. The gap between Spain and Portugal has in other words risen from 15% to 39%.

Portugal's growth is the lowest in Europe and as a result, Portugal has fallen behind not only the one member state of the original 15 which was poorer than them (Greece )in per capita income, but also three of the new member states ( Slovenia, Czech Republic and Malta). While the title "the sick man of Europe" has been given alternatively to Germany, France and Italy, Portugal's economy is sicker than any of these.

What is Portugal's problem? To some extent it is bad luck. Like Italy, Portugal's exports are to a large extent composed by goods (like textiles) which competes directly with super-competitive China. The inflow of cheap goods from China have benefited countries which had no textile industry to begin with, like Sweden and Britain, but hurted countries that previously exported textiles to Sweden and Britain, such as Italy and Portugal. But the main factor is that while Spain have had budget surpluses and a falling burden of government, Portugal's government have been on an unprecedented spending spree, quickly increasing the burden of government.

As they put it in this report from 3 years ago:
"Why have the two countries diverged? The answer lies in Portugal’s budgetary policy. During its cycle of expansion, Spain adjusted its public accounts and cut its taxes, spending and indebtedness. Portugal expanded its public spending, but did not reduce its deficit. In 2001, Portugal broke with the European Pact of Stability and Growth by recording a budget deficit of 4.1%, above the 3% limit stipulated by the Pact. Last year, Portugal engaged in a major belt-tightening effort and managed to reduce its deficit to 2.8%.

According to Das Neves, the current setback in public finances “was not created by a revolution or cyclical crisis or external shock, as in earlier cases. It was the result of feudal interests, who forced their priorities on the public good. Pressure groups satisfied themselves at the cost of [higher] public spending, and they created a budgetary hole. A significant portion of the elite appears to have stopped producing; it dedicated itself to dividing what already existed. That’s why there was a slowdown.”

If you look at numbers from Eurostat, you can see that the already large difference in burden of government between Spain and Portugal have widened further in recent year. While government spending in Spain fell from 38.7% to 38.2% of GDP between 2002 and 2005, Portugal saw government spending rise from 44.3% to 47.8%. And while Spain had a budget surplus of 1.1% of GDP, Portugal had a budget deficit of 6.0% of GDP.

This latter fact illustrates that while some people have feared that in the European Monetary Union, countries would gain and shift the negative effects on others by running budget deficit. In fact, the empirical pattern is in fact the opposite: countries with budget surpluses, like Ireland, Spain and Finland to be successful, while countries with large budget deficits like Portugal, Italy and France have big troubles.