Beginning in 1974 Portugal’s balance of payments, which had traditionally been in surplus, moved into substantial deficit. An external current account surplus equivalent to 3 per cent of gross domestic product (GDP) in 1973 was turned into a deficit equivalent to 6 per cent of GDP in 1975 and 9 per cent of GDP in 1977. The overall balance on nonmonetary transactions changed from a surplus of US$328 million to deficits of US$1,013 million and US$1,430 million over the same years (Table 9). External shocks accounted for part of this result; however, these were superimposed on more fundamental difficulties that can be traced to the characteristics of the expansion that preceded them and to the wage pressures to which they gave rise.
Rapid Expansion
In the five years through 1973 real GDP growth in Portugal averaged 7.4 per cent (Table 3). This very high rate was accommodated in part by a rapid expansion of exports, particularly of manufactured exports, which in real terms averaged 6.5 per cent per annum. The main thrust of the export drive was directed toward Western Europe, which provided, in addition to expanding markets, an increasing stream of tourists and employment for a growing number of migrant workers. As the nine countries now in the European Community increase their share in Portuguese exports from 40 per cent to 49 per cent, that of the African territories fell from 25 per cent to 15 per cent (Table 10), eroding their economic link with Portugal.
Apart from the impressive performance of exports, it was mainly emigrants’ remittances that supported the surplus in the external current account. Without these remittances, the deficit on goods and nonfactor services would have risen from 5 per cent of GDP in 1968 to 7 per cent of GDP in 1973, as the increase in imports outpaced that of exports. Fearing increasingly keen competition from imports of manufactures as well as of agricultural products if the currency were to appreciate, the authorities held the effective exchange rate steady throughout the period. Even so, by 1973 commodity exports covered only 49 per cent of imports of goods and services, gross tourist receipts some 15 per cent, and workers’ remittances fully 30 per cent.
While Portugal had long exported labor as well as goods, gross emigration accelerated sharply in the mid-1960s, and by 1973 some 14 per cent of the combined Portuguese labor force was employed in the European Community, leaving less than 2 per cent unemployed at home. The possibility of emigrating to better paying jobs elsewhere put upward pressure on wages in Portugal. Even without any help from currency appreciation, real wage increases weighed heavily on the more exposed sectors of the economy such as agriculture, where by 1973 value added had dropped below its level in 1968 (Table 2). Nevertheless, the increase in real wages, which reached 3 per cent per annum in the late 1960s, still fell short of the rate of growth of productivity for the economy as a whole.
Although stable exchange rates succeeded in preserving competitiveness for a while, they could only be maintained by adding substantially to gross official reserves. These doubled between 1968 and 1973 to an amount that covered more than 12 months’ imports (Table 15). The consequent increase in bank liquidity permitted domestic credit expansion as a ratio of the money stock at the beginning of the year to rise from just over 10 per cent in 1968 to no less than 25 per cent in 1973. Real GDP growth increased to more than 11 per cent, spurred by an increasingly speculative boom in construction and stockbuilding as hedges against inflation. The average rate of price increase almost doubled to 11 per cent in 1973, while interest rates remained close to their traditionally low levels.
The acceleration of economic activity stretched labor markets as much as product markets, with the increase in money wages outpacing that of prices by an increasing margin. Real wages, which had failed to keep pace with productivity before, now began to catch up, almost reversing the earlier shift in the distribution of income. As workers were not free to form independent trade unions, and the right to strike was severely circumscribed, their mounting impatience took a mainly political form. Thus, one of the primary objectives of the April Revolution was to raise the standard of living of workers and small farmers as quickly as possible.
Wage Explosion
The international economic environment in which the Revolution took place was not propitious. A fourfold increase in the price of petroleum contributed to a 14 per cent deterioration in the external terms of trade between 1973 and 1975 (Table 9). Since imports equaled 33 per cent of GDP in 1973, this meant a 5 per cent reduction in the real purchasing power of the national product. However, the drive for a higher standard of living could not be turned back. In an attempt to remove some of the perceived barriers to this drive, about 23 per cent of cultivable land excluding forests, as well as major industries accounting for 27 per cent of GDP, 50 per cent of investment, and 20 per cent of the labor force, was taken over by the state.
In response to popular pressures, wages jumped by 25 per cent in real terms between 1973 and 1975, while effective exchange rates continued to be held stable. The loss of international competitiveness induced producers to shift from exports to local markets, and consumers from domestically produced to imported goods. The opposite would have been required to compensate for higher import costs and the recession in export markets abroad. Exports to Africa would have fallen in any case. But the loss of market shares now became general and did not begin to be corrected until competitiveness was eventually restored (Chart 1). Perhaps for confidence reasons, the increases in tourist receipts and especially in workers’ remittances were also arrested and then reversed.
Portugal: Index of Export Volumes and Markets, 1973–79
(1973 = 100)
Sources: Fund staff calculations; and Bank of Portugal, Annual Report.Portugal: Index of Export Volumes and Markets, 1973–79
(1973 = 100)
Sources: Fund staff calculations; and Bank of Portugal, Annual Report.Portugal: Index of Export Volumes and Markets, 1973–79
(1973 = 100)
Sources: Fund staff calculations; and Bank of Portugal, Annual Report.Had the momentum of growth been maintained, external deficits would have emerged far higher still than those that were experienced. Investment also fell, however (Table 3). The catch-up in real wages produced a major shift in the distribution of income, raising the share of wages in the national income from 52 per cent in 1973 to 69 per cent in 1975, and squeezing profits. The external deficit, by draining liquidity from the banking system and producing a credit squeeze, reinforced the deflationary effect of the decline in profits (Table 6). Despite liberalized rediscount facilities, the increase in domestic credit as a ratio of the initial money stock fell to 17 per cent in 1975, from 25 per cent in 1973.
In consequence, the growth of the economy slowed to 1 per cent in 1974 and in 1975 real GDP declined by over 4 per cent (Table 3). The wage explosion had clearly played a major role in precipitating this loss of employment opportunities. In earlier circumstances the excess labor supply might have been added to the flow of workers abroad but as a consequence of the energy-induced recession the flow of migrant workers to the rest of Europe had virtually dried up. By the time wage increases were being realized, therefore, the conditions that would have made them appropriate had disappeared. On top of this, the independence of the former colonies prompted a return of settlers that added substantially to the civilian labor force (Table 1). Unemployment accordingly rose to at least the rate of 6 per cent officially recorded.
The fall in GDP would have been larger had not the same redistribution of income that produced the profit squeeze also boosted consumption. Public and private consumption combined rose from 76 per cent of domestic expenditure in 1973 to 85 per cent in 1975. The reduction in potential saving from full employment income did not match the drop in actual investment, but it shrank sufficiently to moderate the decline in aggregate demand, and to produce a deficit on external current account equal to 6 per cent of GDP in 1975, compared with a surplus equivalent to 3 per cent of GDP two years earlier. Apart from the relative decline in workers’ remittances, the external deficit on goods and nonfactor services alone nearly doubled to 12 per cent.
The drop in private saving could not by itself have been enough to cushion the decline in output to this extent. A major contribution came from the public sector. The social goals of the Revolution required a considerable expansion of public sector expenditures; increases in tax rates and in social security contributions could not keep pace with them. Accordingly, the public sector’s current account shifted from a surplus in 1973 to a deficit equivalent to just under 3 per cent of GDP in 1975 (Table 5). The overall fiscal balance similarly swung into a deficit equivalent to 5 per cent of GDP. The liquidity created by it offset much of the drain through the external accounts and into cash, but not enough to avoid a squeeze on the banking system, despite the prompt liberalization of rediscount facilities.
Much of the fiscal deficit financed additional expenditure on consumption and subsidies to faltering enterprises, thus adding to the difficulties of borrowing abroad. Nevertheless, to protect real wages, the exchange rate continued to be held firmly constant, although to ease the pressure on the exchanges an import surcharge was introduced in May 1975. All the same, by the end of the year the stock of official reserves (with gold valued at its official price of SDR 35 an ounce) had fallen to 54 per cent of its level at the end of 1973 (Table 15). Even at this level, however, official reserves covered the equivalent of five months’ imports, sufficient, it was thought, to support an economic recovery that might validate existing real wages by raising productivity.
Exchange Crisis
In the spring of 1976 the Portuguese authorities took that chance and opted for reflation. Government spending was sharply increased. At the same time, a legal limit was imposed on nominal wage increases and price controls were liberalized to help the private sector. The nationalizations of the preceding two years had concentrated on industries producing intermediate goods and had left the consumer goods and export industries largely untouched. Thus, the private sector remained the main source of employment as well as of foreign exchange. There was some unannounced depreciation of the escudo early in 1976, but this experiment with exchange rates was quickly abandoned when it led to speculation.
The restoration of profit margins still seemed to have been modest on balance. Accordingly, interest rates were kept low in order to hold down the cost of working capital, and thus to encourage a recovery in construction and also, some hoped, in exports. Apart from providing needed housing for returning settlers and demobilized military personnel, construction would provide increased employment at little cost in foreign exchange. On the basis of the liquidity created by massive central bank financing of government deficits, domestic credit was thus allowed to expand rapidly (Table 6). Relative to the initial money stock, it increased by 28 per cent in 1976 and by 40 per cent in 1977 (Chart 2).
Portugal: Money and Credit, 1973–79
(Annual increments as per cent of initial money stock)
Sources: International Monetary Fund, International Financial Statistics; and data supplied by Portuguese authorities.Portugal: Money and Credit, 1973–79
(Annual increments as per cent of initial money stock)
Sources: International Monetary Fund, International Financial Statistics; and data supplied by Portuguese authorities.Portugal: Money and Credit, 1973–79
(Annual increments as per cent of initial money stock)
Sources: International Monetary Fund, International Financial Statistics; and data supplied by Portuguese authorities.The response of growth to these measures looked impressive. The increase in GDP rose to nearly 7 per cent in 1976 and was maintained at 5 per cent in 1977 (Table 3). However, with an increasingly uncompetitive exchange rate, the recovery was mainly directed to more and more protected domestic markets rather than to markets abroad. Measured at international costs and prices, part of the apparent gain may well have been illusory. Inflation soon rose to an average of 27 per cent in 1977, and the share of labor in total income, after reaching a plateau of 69 per cent in 1975–76, fell back to 60 per cent (Table 4). Employment benefited little, as many enterprises had been holding excess labor because of legal barriers against dismissals. Instead there was an apparent increase in productivity per man employed.
The increase in productivity was to be sustained be yond the recovery phase by increased investment, and gross investment did rise substantially in 1976 and 1977 (Table 3). However, because of low interest rates and increasing inflationary expectations, this rise mainly took the form of speculative stockbuilding, especially of imported goods, rather than of fixed capital formation (Table 4). Housebuilding was held back by rent control and zoning problems and by the increasing competition of inventories and foreign currency holdings as hedges against inflation. Not surprisingly imports boomed, while exports and workers’ remittances continued to lag.
In consequence, the deficit on external current account widened inexorably to the equivalent of 8 per cent of GDP in 1976 and to 9 per cent of GDP in 1977. An import surcharge was introduced to stem purchases abroad as early as May 1975; expanded early in 1976, it raised effective protection to a range of 40 to 60 per cent (Macedo, 1979). Under severe pressure the authorities devalued the escudo by 15 per cent in February 1977, but again found that without supporting measures the move only fanned speculation. By the end of 1977 the country’s initial foreign exchange reserves had long been exhausted, and nearly 50 per cent of a dwindling gold stock had been pledged against short-term loans.
