PANOECONOMICUS, 2011, 2, pp. 195-218 Received: 3 June 2011. UDC 338.124.4 (469) DOI: 10.2298/PAN1102195A Original scientific paper João Sousa Andrade GEMF and Faculty of Economics, University of Coimbra, Portugal  jasa@fe.uc.pt Adelaide Duarte GEMF and Faculty of Economics, University of Coimbra, Portugal  maduarte@fe.uc.pt Paper by invitation The Fundamentals of the Portuguese Crisis Summary: This paper analyses the fundamentals of the Portuguese crisis. The financial crisis of 2007 worsened and triggered the current Portuguese crisis. We argue that the main problem the economy is facing is its output stagnation due to a kind of Dutch disease that has created high and increasing levels of indebtedness, low and decreasing levels of saving and has reduced Portu- guese competitiveness. Moreover, the existence of a dualist labour market and a new wave of emigration produce inefficiency, increasing unemployment of younger workers and the supply of human capital abroad funded by the Portu- guese taxpayers. Governance problems such as poor public budget gover- nance and lack of transparency and accountability are also at stake. These governance problems must be solved to allow the economy to return to its long-run growth path. Key words: Growth, Debt, Saving, Dutch disease, Unemployment, Budget policy. JEL: E21, F34, G01, H10, H63. The scope of automatic stabilization is too narrow in the face of a severe recession preceded by a long period of sluggish growth (Phillip Anthony O’Hara 2011). The elasticity of government receipts with respect to GDP is usually greater than the elas- ticity of government expenditures. Consequently, during an economic recession the automatic deficit tends to increase through government receipts reduction. More ag- gressive fiscal policies aimed to overcome a severe recession were conducive to greater deficits through government expenditures increases but their efficacy remains controversial (Alan J. Auerbach, William G. Gale, and Benjamin H. Harris 2010). This was the case mainly for the USA when compared with that of European coun- tries during 2007 crisis. The USA developed more ambitious stimulus plans; never- theless, the G20 budget deficit was 1% of GDP in 2007 and 9% in 2009. High budget deficits led to an unprecedented growth of public debt. This growth, most probably acting as a stability buffer for financial institutions, was not risk free when these in- stitutions sought safer assets. Debt accumulation and its downgrading put financial institutions out of the obliged ratios for assets and liabilities, creating a link of cau- sality from state solvency problems to private institutions. Portuguese financial insti- tutions are facing that problem. At the same time, the trade-off between consolidation and stabilization was destroyed for most of the countries in favor of consolidation producing recession episodes (Salvador Barrios, Sven Langedijk, and Lucio Pench 2010).