Fears of Euro Zone Domino Effect: Will Greek Contagion Bring Portugal Down?

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Socrates is getting less support from the unions, however, as the government wants to freeze civil servants' salaries. There are plans to reduce personnel costs by 10 percent by 2013, which would save the state about €100 million a year. Taxes will also be increased. The only workers who will be exempt are those who earn no more than €518 a month, according to the television station RTP. According to the mass-circulation daily Correio da Manha, Socrates' austerity program "will crush the middle class."

Trade unions have therefore let the prime minister feel their power. On Tuesday, Portuguese railway workers went on strike, as did ferry and bus workers. The industrial action led to numerous traffic jams in Lisbon's metropolitan area as commuters were forced to travel to work by car. "The protests will grow," threatened Manuel Carvalho da Silva, the head of the largest union in the country, the CGTP.

Observers do not expect many political consequences, however. Angry riots like those in Greece are rather unusual in Portugal.

So the political situation is comparably stable. But the question remains: Is Socrates' savings plan realistic? Will he be able to save enough money quickly with his plan? Ultimately, Portugal wants to cuts its record deficit of 9.4 percent of gross domestic product to 2.8 percent by 2013. To do so, the country will need to find savings of €13.5 billion.

"It's ambitious," said Francesco Franco, an economics professor at the New University of Lisbon. "But not impossible." Socrates actually has one decisive advantage: He can sell off valuable state holdings to raise money. It would admittedly be a one-time effect, but it would guarantee that the country could quickly eliminate debts.

Debt Reform Is Only the Beginning

The government has said it wants to sell its holdings in 17 firms, including its shares in the energy firm Galp and Portuguese national airline TAP. The sale of these shares is expected to raise a total of €1.2 billion by the end of 2010.

Socrates wants to save further money by delaying previously planned major infrastructure projects. The planned high-speed railway line between Spain and Portugal, for example, is to be delayed by two years. It is also hoped that the economic upswing will increase tax revenues and decrease unemployment and bring further money into the government's coffers.

So the government has good chances of regaining control of its debt problems. But one still can't say that the country has been economically reformed. Ever since it joined the euro zone in 1999, Portugal, like Spain and Greece, has had a growing structural problem. "Triggered by the commitment by Portugal to join the euro, a sharp drop in interest rates and expectations of faster growth both led to a decrease in private saving and an increase in investment," MIT economist Oliver Blanchard wrote in his classic analysis, "The Difficult Case of Portugal."

For years, this meant that wages grew faster than the economy and consumption also increased. But the growth was deceptive: It was largely driven by an increase in imports. At the same time, Portuguese productivity sank.

"Portugal lived beyond its means for decades," says Ricardo Reis, an economics professor at New York's Columbia University. "The crisis has caused this imbalance to become unbearable." He says that as the country embarks on its austerity course, it must also quickly increase its productivity.

The Portuguese constitution prohibits making cuts to public sector wages, so other solutions need to be found. The bloated public sector needs to be shrunk, competition needs to be boosted and it needs to be made easier for people to set up companies. "Otherwise consumption will collapse in three to five years and the quality of life will decline," says Reis.

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• Part 1: Will Greek Contagion Bring Portugal Down?
• Part 2: Austerity Measures 'Will Crush the Middle Class'