The following letter was posted in the May 9 edition of Financial Times:

Sir, Daniel Gros correctly emphasises that Portugal has more of an acute balance of payments problem, as exemplified by a gross external debt to gross domestic product ratio of around 230 per cent, rather than a public finance problem ("Portugal is delaying the pain it knows is inevitable", May 5). However, he does Portugal a great disservice by offering it the counsel of despair that it should follow Latvia's example to correct its large external imbalance.

It is true that over the past two years Latvia did turn around a very large external current account deficit, while maintaining its currency peg to the euro, through large public sector wage cuts and austere demand management policy. However, it did so at a staggering economic and social cost.

Latvia's real GDP fell by around 20 per cent while its unemployment rate increased to close to 25 per cent. At the same time, the weakening in Latvia's economy has thwarted the desired reduction in its budget deficit, which at 7½ per cent of GDP remains a far cry from the 3 per cent of GDP deficit needed to secure Latvia's entry into the eurozone.

In weighing its policy options, Portugal would do well to ask whether it is prepared to pay the social and economic costs that Latvia has paid to restore competitiveness and to correct its external imbalance within the straitjacket of euro membership. It might also consider that a collapse of its economy would highly complicate the attainment of its budget deficit targets and almost certainly raise its public debt to GDP ratio to well above 100 per cent.

These considerations might induce Portugal to conclude that the cost of continued eurozone membership is a price that is not worth paying and that exiting the eurozone might be a very much less costly way to restore international competitiveness.

Desmond Lachman,
American Enterprise Institute,
Washington