Nita Ghei is policy research editor at the Mercatus Center at George Mason University.
A major motivation for the rivers of funds poured into the Greek bailouts was a grim determination to preserve the single currency within the European Union. As Greece remains mired in recession, the benefits of the outpouring of debt remain questionable at best. Now, Portugal is challenging the value of remaining a member of the eurozone, with an economics tract perching on its bestseller lists. Joao Ferreira do Amaral, a professor at Instituto Superior de Economia e Gestao, has sparked a much overdue debate in that crisis-wracked nation about the purported benefits of keeping the euro in his book "Why We Should Leave the Euro."
While the majority of Portuguese citizens continue to support staying in the Eurozone, 20 percent of respondents supported the idea of a return to Portugal's domestic currency, the escudo, in a poll conducted a year ago. There is also some support from the left, with the Communist party turning against euro membership.
Exiting the eurozone expands policy options for Portugal, but does not mean that the adjustment will be quick, easy or painless. There are no painless or easy options left. The calculus now is which is the least costly way to return the economy to growth and create jobs – particularly for the almost 40 percent of youth currently unemployed.
Portugal, whether it stays with the euro or exits, still has to fix the mess its financial markets are in, undertake structural reform – including increasing labor market flexibility – and consolidate its fiscal outlook. Undertaken with sufficient political will, returning to the escudo would allow it to devalue.
The devaluation would restore competitiveness to its exports, particularly tourism and the manufactured goods that compete directly with many Asian countries in the global market. This will be less painful and more successful than enduring the deflation needed to correct the overvaluation of the exchange rate to make its exports competitive again if it stayed within the eurozone.
Iceland's recovery from its crisis, triggered by the failure of three large banks, was initially fuelled by its ability to let its currency depreciate, which in turn was necessary to correct the appreciation from an overheated economy. Iceland abandoned its peg to the euro in October 2008, and the krona declined rapidly after that. Iceland struggled with the inflation that inevitably follows massive devaluation, just as the economy dealt with skyrocketing interest rates, recession and soaring unemployment.
Iceland's government shrank through the crisis, with government spending as a share of gross domestic product falling from 56.7 percent in 2008 to 46.1 percent in 2011, and the budget deficit declined from an eye-popping 13.5 percent in 2008 to a relatively sustainable 4.4 percent in 2011. Unemployment, after peaking at 8.3 percent in 2010, declined to 7.4 percent in 2011. In that year, Iceland's economy grew 3.1 percent in a performance that far surpassed Portugal, Greece or any of the southern eurozone nations.
Iceland's recovery was preceded by bitter medicine, including devaluation. And, as the experience of Cameroon, Cote d'Ivoire and the other west and central African members of the CFA Franc monetary zone shows, a devaluation alone is no guarantee of recovery. The CFA Franc, which was then pegged to the French franc, was devalued in 1994 to correct the massive overvaluation caused by the peg. Initially, the countries – especially the cocoa exporters – were boosted by an increase in world commodity prices. But efforts to push structural reform withered away, and so did any possible gains from the initial devaluation. The CFA Franc zone members – and their poverty stricken citizens – paid the price of inflation, but reaped few benefits.
Exchanging the euro for the escudo is exchanging one piece of paper for another, but it allows the national government one further degree of policy freedom. That degree of monetary policy freedom, however, does not reduce the urgency and necessity of the need for reform on the real side: fiscal, regulatory and labor. Without real structural change, and a reduction in the burden of government, getting rid of the euro might simply be adding the risk of inflation to an almost intolerable burden of woes.