Effects of the Euro on Spain and Portugal's trade and investment

¶ … European Union or EU is an intergovernmental organization of European countries, the most powerful regional organization at present (Wikipedia 2005). The EU has resembled a federation or confederation, where member states have transferred a degree of their sovereignty to the Union. These member states must first agree to transfer additional powers and maintain their own policies in major areas of national interest, like foreign relations and defense. The EU was established by the Treaty of European Union in 1992, although many aspects of the Union existed through predecessors since the 1950s. Its activities cover all policy areas, from health and economic policy to foreign affairs and defense. It functions as a federation as regards monetary matters or agricultural, trade and environmental policies; as a confederation as regards social and economic policies, consumer protection and internal affairs; and an international organization as regards foreign affairs. The chief activity of the EU covers the establishment and administration of a common single market, which consists of a customs union, a single currency called the euro, a common agricultural policy and a common fisheries policy. The treaties between member states constitute the legal base of the EU and these are subjected to a lot of amendments through the years. The first was the Treaty of Paris of 1951, which established the European Coal and Steel Community among the first member states, which later expired and superseded by the Treaty of Rome of 1957. This 1957 Treaty was substantially amended, notably by the Maastricht Treaty of 1992, which established the European Union and named it so. There are currently 25 member states of the Union, and among them are Portugal and Spain (Wikipedia).

The Republic of Portugal or Portugal is a democratic republic located west and southwest of the Iberian Peninsula in Southwestern extreme of continental Europe (Wikipedia 2005). It is bordered by Spain to the north and east and by the Atlantic Ocean to the west and south. It was a major economic, political and cultural world power during the 15th and 16th centuries and described as "beautiful port." In the 10 years before joining the EU, Portugal had a per capita gross domestic product equal to two-thirds of that of the four big Western European economies and continued to enjoy strong economic growth, decreasing interest rates and low unemployment levels. Its economy became increasingly service-based since it joined the European Union in 1986, a trend that began with the boom of the 1960s. Successive governments in the last decades privatized many of the state-controlled firms and liberalized key areas of the economy, such as the financial and telecommunications sectors. Portugal qualified for the Economic and Monetary Union or EMU in 1998 and was enjoying a comfortably low inflation rate of 2.4% when it joined the other countries in launching the euro on January 1, 1999 (Wikipedia).

The kingdom of Spain is located southwest of Europe and shares the Iberian Peninsula with Portugal, Gibraltar and Andorra (Wikipedia 2005). It borders France and the small principality of Andorra in the northeast and includes the Balearic Islands in the Mediterranean Sea, the Canary Islands in the Atlantic Ocean, the Ceuta and Malilla cities in the north of Africa. Its mixed capitalist economy supports a GDP per capita at 87% that of the four leading West Europe economies. Its center-right government of former President Aznar managed to gain admission into the group of countries that launched the single European currency, the euro, on January 1, 1999.

II Changes in General Performance and Structural Economy

Portugal. Its official development assistance/gross national product ratio stood at.26% and it ranked 16th out of 22 Development Assistance Committee member countries in 1999 and with the lowest per capita GNP (OECD 2001). Due to its colonial history, which ended in 1971, Portugal's aid program has been largely based on institutional and personal relationships, with the maintenance of historical, linguistic and cultural ties as underlying basis. Its bilateral ODA was exclusively directed at the five Portuguese-speaking countries of Angola, Cape Verde, Guinea-Bissau, Mozambique and Sao Tome and Principe. High-level public support recently went to East Timor as the largest recipient of bilateral aid to Portugal. The programme was also decentralized and spread among its 17 ministries and agencies, universities and municipalities. The Portuguese Institute of Cooperation of the Ministry of Foreign Affairs manages the entire program and conducts policy reviews and evaluation. The Portuguese Development Support Agency was created in 2000 to support social and economic infrastructure. Portugal's main achievements in exercising control over and enhancing coordination and integration within its decentralized programmed consisted of the creation of a Council of Ministers for Cooperation Affairs to approve an annual aid programme and an aid budget; the re-establishment of an inter-ministerial Committee for Cooperation to strengthen the cooperation policy among the ministries through regular meetings; and a database system, which consolidates all budgets and expenditures of development cooperation projects. Portugal also played a key role in responding to the East Timor crisis in August 1999 and established the Office of the Commissioner to Support the Transition in East Timor as well as increased its budgetary allocation to $68 million

Poverty reduction is a major goal in Portuguese cooperation, which has yet to be sufficiently addressed (OECD 2001). In tackling this goal, Portugal places top priority to education and health. Unfortunately, these allocations do not strictly target the poor and there has not been a focus on prominent sector-wide approaches. As to debt actions, Portugal has made higher payments at $126 million in 1999, which was 35% of the total ODA gross disbursements. The DAC average was only 4%. Most of its actions come from defaults on state guaranteed private export credits and loans. Its ICP's strategic role in coordination likewise remains insufficient in minimizing overlaps of aid programmes by the different ministries and other agencies. Operating tools and useful guidelines still have to be developed and evaluations undertaken in a comprehensive and effective way. In addition, the increase of ICP financing of non-governmental organizations has been slow in recent years. With limited resources, these organizations are unable to function properly as a political force or presence.

Spain. After World War II, Spain was one of the few surviving fascist regimes in Europe that was politically and economically isolated (Wikipedia 2005). It was kept out of the United Nations until it became important for the then U.S. President Dwight Eisenhower to establish a presence in the Iberian peninsula. This shift of attention to Spain was also accomplished through the anti-communism posture of Spain's Franco. Spain began to enjoy economic growth more than a decade later than other western European countries the 1960s. It gradually changed into a modern industrial economy with a vibrant tourism sector. It continued growing into the 1970s under the rule Franco, exerting great efforts to stave off the effects of the oil crisis. Upon his death, Franco was succeeded by Prince Juan Carlos as king and head-of-state, Juan Carlos led the country into becoming a modern democratic state, particularly in resisting a coup d'etat in 1981. The following year, it joined the NATO and the European Union in 1986 (Wikipedia).

II. Impact of the Euro on Portugal and Spain

Portugal. After a recession in 1993, the economy of Portugal grew at an average annual rate of 3.3.%, which was higher than the averages established by the EU (Wikipedia 2005). It agreed to cut its fiscal deficit and install structural reforms in order to qualify for entry into the Economic and Monetary Union or EMU. In return, the EMU stabilized Portugal's exchange rate and induced the fall of inflation and interest rates. Falling interest rates reduced cost of public debt and assisted the country in attaining fiscal targets. As a consequence, household debt rapidly expanded and the European Commission and the Organization for the Economic Cooperation and Development and others cautioned the Portuguese government to observe fiscal restraint. In 2001, Portugal's public debt went beyond 3% of the EU's imposed limit and opened Portugal to EU sanctions or restrictive financial supervision. Its overall growth rate slowed down in late 2001 to 2002 and made fiscal austerity more difficult and more painful.

The economy has been based on traditional industries, like textiles, clothing, footwear, cork and wood products, beverage, porcelain and earthenware, glass and glassware (Wikipedia 2005). It made a good showing in Europe's automotive sector and services, particularly tourism, have played a significant role in Portugal's economy. It managed to raise its standard of living to the level of its EU partners. Its GDP per capita on a purchasing power parity basis went up from 51% of the EU average in 1985 to 78% in early 2002 at $182 billion. Unemployment was fixed at 4.1% by the end of 2001, a figure that was comparatively low by EU averages. Real wages have been flexible, but high social costs and severance raise fixed labor costs and made new job creation hard. The economy contracted by 1.2% in the first quarter, according to the National Statistics Institute (O'Flynn 2003). GDP went down due to weak domestic demand, which went further down after a decline. Somehow, it again rose by 0.1% in the first quarter and appeared to have pulled the economy out of recession. But Portugal retained big trouble. In the last quarter of 2002, its GDP plummeted.8% from the third quarter and in the last quarter, it contracted by 1.3% from the previous year until the.3% in the third quarter of 2002. The economy continued to sag until the Bank of Portugal itself observed the fall of business confidence to its lowest recorded level since the 1993 recession. Official unemployment rate increased to a high 49.6%, rising by 26.3% from 2001 (O'Flynn).

Unemployment was 6.7% in 2003, compared with 4.3% in 2002 (O'Flynn 2003). Labor unions in Portugal claimed it was more than 7.6% as against the 5% ceiling set by the EU, despite the fact that the unemployment rate was more than 7% for most members of the EU. Portuguese men aged 25 to 34 were the most affected sector, which increased to 81%. The situation was made worse by an increase in workforce by 700,000 in 2002 and a further projected increase at the same volume when more graduates poured in. Employment centers noted that the best qualified graduates were the hardest hit. Jobless university graduates increased from 24,000 in 2001 to more than 30,000 by the end of 2003. When Portugal announce its intention of joining the euro zone, interest rates were even beyond the levels of Germany and France. Perceiving that there was money to be realized from the interest rate gap, it began to borrow huge amounts in deutschmarks and francs at lower rates than it could domestically do. The loans were then converted into domestic currency to finance a lending boom. With large sums flooding the country, interest rates swiftly began to converge with those in Germany even before the launching of the euro. In reaction to this credit boom and the inflation in Portugal, the European Central Bank cut the euro interest rate from 2.5 to 2% to put an end to it (O'Flynn).

The credit boom stopped and the economy slowed down, but the problem went uncontrolled (O'Flynn 2003). Portugal was berated for violating fiscal policies and the Stability and Growth Pact budget deficit rules for continuing to borrow in an attempt at saving its collapsing economy. It confronted a huge deficit of 4.1% by the end of 2002, which was higher than the 3% GD limit set by the Mastricht Treaty. Portuguese banks used foreign currency to finance its lending and it appeared that it did not have enough money to pay is debts. Anti-euro critics saw this as the result of Portugal's adoption of the single currency, but other critics believed that the true and ultimate cause was the modified global position of Portugal. In the 1990s, Portugal assumed the cheap labor platform of Europe from Spain and was ahead of other EU countries at an average economy growth of 3.5%. Reduced unemployment and improved public services won the majority of seats for the Socialist Party, led by Antonio Gutierrez, in Portugal's 1999 elections. But within the succeeding two years, Gutierrez's party lost in the municipal elections of December 2001 to its opponent of seven years, the Social Democrats or PSD.

The present Portuguese government under Jose Manuel Durao undertook severe austerity measures, such as a two-percent increase in value added tax or VAT at 19%, reduced subsidies for the youth, a public-private finance initiative for 10 new hospitals, opened up social security pensions to insurance corporations, and radical anti-immigration laws (O'Flynn 2003). Durao attributed the rise in Portugal's exports by 6%, not to a problem over the euro but to the stimuli inherent to its economy, which compelled its government to undertake measures within their reach and capability, regardless of the strength or weakness of the euro. Durao's government reform plan included managing budget deficit by further throwing the burden on to the working class and reducing corporate tax from 30 to 25% in 2004 and to 20% in 2006. In maintaining its status as a cheap labor platform for Europe, Portugal must take in the poorest workers in Western Europe and reduce their living standards to less than those of workers in the east. Approximately two companies fold up and leave Portugal each month for the Eastern countries with cheaper labor cost and taxes. The average salary paid to workers in Portugal is 750 euros, compared to only 350 euros in the Czech Republic and only 100 euros in Bulgaria. The enlargement of the EU was viewed as deepening the crisis confronting Portuguese capitalism, when EU would provide more substantial subsidies to poorer European countries investing in Portugal to discourage or prevent their leaving the country and prevent the impending social explosion that could result from continued economic decline (O'Flynn).

Spain. After joining the EU, the Spanish government under Jose Maria Aznar continued with its programs of liberalization, privatization and deregulation of the economy and some tax reforms consistently (Wikipedia 2005). Unemployment steadily decreased but remained high at 11.7%. It had a satisfactory growth rate of 2.4% in 2003, considering that it had an unstable economy. Incoming President Rodriguez Zapatero planned to reduce government intervention in business, fight off tax fraud and support innovation, research and development efforts. He also, however, intended to reintroduce labor market regulations scrapped by the Aznar government. Following its membership in the EU in 1986, Spain experienced strong economic growth and trade expansion, which made it the 10th largest in the world in 2002. Sanitation, infrastructure, and health care have been at optimal levels, although its GDP has remained at 87% of that of the four leading European economies.

IV. Expectations

The enlargement of the European Union was calculated to deepen the crisis of Portuguese capitalism (Wikipedia 2005). Companies investing in poorer European countries would receive less substantial support or subsidies from the EU, far less than what Portugal receives from the EU or can afford to give these companies to prevent them from leaving Portugal. Portugal now confronts new challenges, mainly this slowdown in foreign investments and a growing budget deficit that threatens to exceed the limit established by the EU for countries using the euro (Internal Study Programs 2004). These new problems could be made worse by the imminent loss of EU funding to poorer member states in Central and Eastern Europe. Many expect that the Portuguese government would cut corporate and income tax, cut back on government spending, which is said to be among the highest in the EU, and reform state health service (ISP).

Meantime, the next few years would be a crucial test to a new Socialist government in Spain with the enlargement of EU membership, which will open greater competition for Spanish companies from developing nations under the EU (Kollmeyer 2005). Many expect that the Socialists would continue reasserting themselves within Europe. Aznar's government was often accused of being too soft and pliable with the U.S. At the expense of fellow member states in the EU. Many would not expect Spain's economy to dramatically suffer from feared terrorist attacks, such as those of 9/11, which could take out a tenth up to two-tenths of a percentage off Spain's growth. The cost in terms of human lives could be very high, but not in terms of infrastructure, which was the case of the U.S. terrorist attacks on September 11, 2001 (Kollmeyer).