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SPIEGEL ONLINE

07/27/2011 01:10 PM

At the End of Europe

Seeking a Path out of the Crisis in Portugal

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After living beyond its means for decades, Portugal is now feeling the full brunt of the crisis. The government is responding with a brutal austerity package. But savings alone won't do the trick -- the country needs to find ways to expand industry and make itself more attractive for investment. The good news is that positive models already exist within its own borders.

The air smells salty at Cabo da Roca, about 30 kilometers (19 miles) from Lisbon. It is the westernmost point of mainland Europe, and a lighthouse is perched on the cliffs, high above the roaring sea. The sign in front of it reads: "The End of Europe." These words sound strangely prophetic at the moment.

On the way there, a two-lane bike path hugs the coastline for several kilometers between Cascais and Guincho. Special streetlights spaced only 50 meters apart illuminate the brownish-red special asphalt at night. But cyclists are rarely to be found along this route, even during the day, because the wind is simply too strong.

The luxury bike path is a reminder of better times, of the years when the Portuguese were still able to draw on unlimited resources. They built the Colombo in Lisbon, Europe's largest shopping center at the time. They also built state-of-the-art football stadiums and many new roads, including 2,700 kilometers of motorways in two decades, many with six lanes -- which are often completely empty.

Many things in Portugal are oversized, and the dramatic consequences of this exorbitant lifestyle are now manifesting themselves. The country had to resort to the euro zone's bailout fund in April, but it only provided Portugal with a brief respite from its financial woes.

The gravity of the situation became abundantly clear when the Moody's rating agency, after questioning whether the country could still service its debts, downgraded Portugal's government bonds to junk status earlier this month. Portugal has overreached financially, and it will have trouble coping with the crisis. Could the euro zone be facing a second Greece?

Brutal Austerity Measures

The new center-right government headed by Prime Minister Pedro Passos Coelho assembled a brutal austerity package, which includes reductions in healthcare benefits and a pay cut for government employees. Two weeks ago, Coelho expanded the list of painful cuts even further, after new holes in the budget had opened up. Before that, the prime minister had announced that the Portuguese people would have to prepare themselves for "two difficult years."

Margarida Sá Pereira, a businesswoman in Lisbon, is getting ready for leaner times. Her family has sold candles on Rua do Loreto since 1789. The shop sells egg-shaped candles at Eastertime and candles shaped like pine trees at Christmas, each handmade with the finest wax. Sá Pereira, a petite woman with conspicuous glasses, stands behind the counter. Wood-paneled display cases reach to the ceiling on both sides of the shop. As the minutes pass by, not a single customer enters the shop.

Customers have been holding on to their money for months, says Sá Pereira, and now the new government wants to tax Christmas bonuses, of all things. Sá Pereira, who makes at least a quarter of annual sales in the days leading up to the holiday, says: "Christmas will be very difficult for us."

Portugal Has Lived Beyond Its Means for Decades

The Portuguese have lived beyond their means for decades, but they were also misled into doing so. At first, the European Union tempted Lisbon with generous aid programs. Since Portugal joined the union in 1986, Brussels has sent about €55 billion ($79 billion) to the country. Then the introduction of the common currency gave the economy another boost.

Suddenly Portugal was enjoying the same access to credit as major countries like Germany and France. As a result, its people became accustomed to fast cars and fancy apartments, all paid for with borrowed funds. But Portugal's apparent affluence was deceptive, because it bore no relationship to the country's real economic strength.

Now the Portuguese have no choice but to save money in every possible way. Even smokers have cut back, as evidenced by a 20-percent decline in tobacco tax revenues in May. Signs in shop windows that read "Liquidição total," or total liquidation, especially in smaller communities, are another indicator of decline.

The country is in a deep state of crisis, but it seems foreseeable that the worst is yet to come. Interest rates are going up, borrowing is getting more expensive, banks are lending less money, companies have stopped investing, some are going under as a result of the credit crunch, and the unemployment rate continues to rise. Surprisingly enough, there is hardly any sign of resistance in the country. Many Portuguese are simply shocked.

Unlike the Greeks, the Portuguese did not become involved in questionable business practices. Their banks did not issue nearly as many high-risk loans as their Irish counterparts. And a real estate bubble did not develop in Portugal, at least not to the same extent as it did in Spain. But now the Portuguese are in the same boat as several other ailing European economies. They are hopelessly in debt and their economic future seems questionable at best. Concerned citizens are asking themselves how this could have happened.

Portuguese Victims of Globalization

One answer can be found in Figueiró dos Vinhos, an attractive town in a hilly and densely forested landscape near Coimbra in central Portugal. Gerry Weber, a German clothing company, built a factory there in 1993, where about 160 workers, all of them women, produced jackets and trousers. The women were paid low wages and Gerry Weber benefited from EU subsidies, with Brussels paying about half of the roughly €3 million ($4.35 million) the company invested in the plant.

The factory suddenly closed its doors 10 years later. Local council member Jorge Domingues, the right-hand man of Figueiró's mayor, remembers how surprised they were by the news of the plant closing. "We were all extremely disappointed," he says.

Domingues is standing in front of the entrance to the factory, a white, two-story building. The blinds are lowered and there is a "For Sale" sign in the window. The German managers used to stay in a top-floor apartment, says Domingues, pointing up at the building. In 2003, they decided to move production to Romania, where costs were 40 percent lower than in Portugal. The women of Figueiró became victims of globalization.

Many Portuguese have suffered similar fates in recent years, as one international company after another shut down its factories in the country. Some 50,000 jobs were lost in the shoe industry alone.

One in four of the jobs lost between 2003 and 2006 was blamed on outsourcing, particularly to Eastern Europe and the Far East. By comparison, outsourcing was responsible for only about seven percent of jobs lost in Germany.

During this time, Portugal failed to climb further up the ladder of economic development, as the Southeast Asian Tiger economies had done previously, transforming themselves from makers of cheap, mass-produced goods to efficient suppliers of high-tech products. Instead, the Portuguese economy has been treading water for years, but without keeping pace with rapidly rising incomes. As a result, unit labor costs have increased by more than one-third compared to German levels since 1996.

In other words, Portugal is too expensive for what it is capable of producing.

A Country that Produces Too Little and Consumes Too Much

There are, of course, exceptions. Volkswagen operates a successful plant in Palmela, south of Lisbon, where about 3,000 workers assemble the carmaker's Sharan, Eos and Scirocco models, almost exclusively for export. VW has worked out flexible rules with the works council, a powerful employee-elected panel that represents the interests of workers, that permit the company to eliminate up to 22 working days a year during an economic downturn.

But there is so much work at the moment that the period in which the plant shuts down for summer vacation has been reduced this year from three down to two weeks. The Palmela plant generates about €1.6 billion in annual revenues for VW, which corresponds to one percent of the entire country's gross domestic product. That makes the plant, which is on the small side by VW standards, the biggest foreign investment in Portugal.

"We are at the eye of the storm," says Jürgen Hoffmann, chief financial officer of VW's Portugal operation. His words also describe the central problem of the Portuguese economy, which lacks a broad industrial base. It needs many more companies to invest in the country and produce goods for export. Portugal's gross domestic product of €166 billion is roughly equal to the combined sales of two major German companies, automaker Daimler and electronics giant Siemens. Portugal's problem is that it produces too little and consumes too much.

A Lack of Competition and Entrepreneurship

This imbalance is partly attributable to historic circumstances. The country lacks a tradition of competition and entrepreneurship. The government has assumed a dominant role for generations, a legacy of the right-wing dictatorship that came into power in 1936 as well as the country's Carnation Revolution in 1974, which brought an end to decades of authoritarian rule. Little remains of the daring that characterized the discoverers of the world's oceans centuries ago.

Today Portugal is a country with an oversized bureaucracy. Of its labor force of 5 million, some 750,000 work in the public sector, and they are well paid. According to the Organization for Economic Cooperation and Development (OECD), salaries for Portuguese civil servants are "far above" incomes for comparable work in the private sector.

Nevertheless, many government agencies are inefficient and ineffective. The processing of tax returns is often delayed, government offices are chronically late in paying invoices and the permitting process can be a waiting game. For example, it takes an average of 287 days to complete all the formalities required to build a warehouse in Portugal. The OECD average is 157 days.

The new government has declared war on inefficiency, at least to the extent of its abilities. It aims to reduce the backlog of pending cases in the court system, but even the targeted new waiting period would still amount to two years. This nonchalant or even negligent approach is also evident in the private sector.

A brochure for potential investors published by the Bavarian Foreign Trade Center points out that in Portugal senior managers "normally arrive at work between 9:30 and 10:00 a.m." Besides, the brochure continues, lunch and the midday break are "sacred to the Portuguese." Its advice to potential investors in Portugal? "Don't try to interrupt the customary routine between 1 and 3 p.m."

A Dearth of Qualified Workers

Another deterrent for some investors is the lack of qualified new workers. Only 15 percent of the Portuguese working population has attended a university. The EU average is twice as high. In addition, many young people drop out of school. According to a survey by the German Chambers of Commerce Worldwide Network (AHK), many German companies in Portugal are not satisfied with the qualifications of entry-level employees. Manager Paul Van Rooij drew what he felt were the necessary conclusions.

Van Rooij manages Gametal, an automotive supplier that is part of the multinational Kirchhoff Group, based in the western German city of Iserlohn. Workers at the Gametal plant in Ovar, south of Porto in northern Portugal, produce metal parts for companies like Volkswagen. They operate heavy presses that plunge onto pieces of sheet metal, molding them into parts as if they were sticks of butter. The impact is so great that the floor shakes at every downward stroke of the presses.

A few temporary offices in containers were recently installed at one end of the building, where Van Rooij has set up a small tool-making school. There were 20 young trainees at first. The program has been so successful that some of the graduates have already been lured away by other companies. Many years ago, AHK also established a dual system based on the German model, which is still an unusual approach in Portugal.

"Industry is not considered sexy here," says Van Rooij, seeking to explain the lack of interest in industrial jobs. Even banks have sometimes shown little interest in working with manufacturing companies, after years of having financed primarily retail projects, such as shopping centers.

It's no surprise that Portugal lacks solid industries capable of producing exportable products. But what should those industries be? The answer that António Rios de Amorim proposes sounds deceptively simple: "This country must build on what it does best."

A Model for Portugal

Amorim, 43, is the chairman of Corticeira Amorim, the world's largest producer of natural cork. One in four cork stoppers comes from his factories, which produce about 3 billion units a year. The cork bark comes from southern Portugal, where it has long been peeled from the trunks of old cork oaks. The procedure is repeated once every nine years. At the company's main plant, in a northern village near Porto, the corks are punched out, washed and bleached.

A mural in Amorim's office, about eight meters (26 feet) wide, depicts a forest of cork oaks. What is unusual about the image is that the trees are planted in neat rows. When Amorim became chairman of the company in 2001, screw caps and glass stoppers were threatening the dominant position of cork stoppers. To confront the challenge, he reorganized the family operation.

Amorim expanded the business into emerging winemaking countries like Chile, Australia and New Zealand, thereby enlarging his sales base. He invested in research to determine what makes up the unique taste of cork. Most of all, Amorim expanded the company's product line to include the use of cork soundproofing for floors, wall coverings, seals for oil pans in cars, insoles and even heat shields in spaceships. As a result of his restructuring, the company recently had the best year in its history -- in the midst of a nationwide downturn.

Amorim believes that his approach could serve as a model for the entire country, and that Portugal should identify and build upon its original strengths. "We have so many treasures," says Amorim. "We just have to unearth them."

Austerity measures alone will not get Portugal back on its feet -- or Greece, Ireland or Spain, for that matter. One approach to jumpstarting the economy would be to define the wood and paper industry as a productive core of the economy, especially given that a third of the country is forested. In the shoe industry, a few companies have already shifted their focus to the production of high-quality designer goods. "Portugal must achieve higher productivity by specializing in quality products," the OECD economists recommend in their report on Portugal.

The economists have also identified additional potential in tourism. In Portugal, the tourism sector is only half as productive as it is in France, for example, with too many budget options and weak capacity utilization. A few years ago the chief economist at the International Monetary Fund, Olivier Blanchard, came up with the idea of establishing Portugal as a retirement destination -- the so-called Florida model.

Jorge Domingues, a city council member in the former textile manufacturing center of Figueiró, envisions a similar strategy. He hopes to attract tourists to the region, which is blessed with pine forests and waterfalls, preferably for the long term. Domingues, who estimates that about 100 foreigners already have vacation homes nearby, says: "Even an Australian has settled here."

Translated from the German by Christopher Sultan

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