1. Approaching the crisis and the aftermath
While the major part of European economies was going through a period of extremely high growth in the period approaching the financial crisis, the Portuguese economy was already showing increasing signs of severe macroeconomic imbalances. Most notably the imbalances were transparent in terms of persistent large external deficits, rising debt and budget deficits. Underlying these worrying outcomes, Portugal observed low rates of economic growth and of total factor productivity growth for a long period of time. Despite low interest rates, made possible by being part of the Euro zone, the real growth was hindered by the lack of labor productivity and reliance on low value added sectors. On the other hand low interest rates supported by high expectations allowed for an increase in asset prices. The increase in demand pushed wages well above what was originally sustainable for the economy and the bust was inevitable once the global outlook changed for the worst.
In 2000 Portugal was nevertheless a rich country by world standards, but the poorest of the 12 countries that initially formed the euro area. From then through 2007, real GDP per capita grew by a meager 4.3 percent, for a 0.6 percent annual growth rate. Consumption grew faster than output during this period, and real wages increased in spite of rising unemployment. The unemployment rate in 2007 was 8.9 percent, the highest it had been since 1960 with the exception of 1985, and almost half of that unemployment rate was generated between 2000 and 2007 (Reis 2013). Again from 2000 to 2007 the size of general government increased by 3.3 percent points to an aggregate of 44.4 percent of GDP, and all this increase was explained by growing social expenditures. Low growth and persistent deficits implied soaring public debt and higher debt serving charges. In just those seven years the ratio of debt to GDP increased from 48 percent to 68.3 percent of GDP. Therefore,...