The euro zone dominoes seem to be falling, with Ireland following Greece and the spotlight now shifting to Portugal and Spain.
Superficial analysis would suggest that it is "all the euro's fault" and that none of the peripheral euro zone countries can ever regain competitiveness with a fixed exchange rate, so it is just a matter of time before the next one falls.
Such views falter however upon a more careful analysis, which reveals the vastly different causes for individual dominos to fall.
Greece went bust, as it was the worst managed economy in the OECD with a systemically corrupt government (in the words of PM George Papandreou himself), which managed to cheat itself into the euro zone at a time when financial markets were grossly mispricing sovereign credit risk in the euro zone.
Ultimately, Athens ended up with too much debt to cover up. At the same time, Greece exported about as little (merchandise exports of 6-8 percent of gross domestic product) before adopting the euro as it did with it.
Ireland went bust on a consolidated basis, because it – while unlike Greece doing almost everything else right on the supply-side – failed patently to control its banking system, ending up with having to issue the fatal blanket guarantee to private bank creditors for up to 176 percent of GDP.
If you let your banks and real estate developers roam free, soon enough nothing else will matter and even Celtic tigers end up having to request both "King and Kaiser" for a bailout.
Portugal faces the problem that even before the global economic crisis, it failed to grow (less than 1 percent on average in real terms from 1999-2008). Essentially, economic convergence never occurred with the euro and there are now concerns as to what it the true sustainable level of Lisbon's debt, which may be below current levels.
The Portuguese government definitely needs to do a lot more on structural economic reforms and do it quickly to avoid the fate of Greece and Ireland; collective bargaining needs to be liberalized, severance payments slashed, state-owned assets sold off and public wage levels reduced. A tough road ahead for any government in Lisbon.
Yet Portugal is not the systemic threat to the euro, as it has a size that makes a bailout feasible.
Good News About Spain
The real concern here is that for Spain, for which the actual total of euro zone firepower of about €350 billion (already depleted from Ireland, of which approximately €250 billion is available from the EFSF while retaining its AAA-rating and about €100 billion in total from the EFSM) will not suffice, even with realistic levels of IMF assistance on top.
Fortunately, the important news from Spain is good and the recent market punishment, which has seen sovereign spreads to Germany rise substantially, is unwarranted. In essence, Spain is none of the above.
General government debt is half Greece’s level, at 64 percent of GDP in 2010, and mostly domestically financed, with just 26 percent of GDP (40 percent of the total) held abroad. More importantly, the contingent liabilities associated with the Spanish government’s support for its banking system (large banks and the cajas) are less than 5 percent of GDP (in Ireland it was 176 percent of GDP).
As such, factoring in, too, that the large Spanish banks BBVA and Santander both have very large emerging market operations that could in an emergency be sold off before turning to the Spanish government, it is hard to see how on a consolidated "sovereign + private banks" basis, Spain is in serious trouble.
Certainly, Spain has seen a dramatic real estate bust, which weighs down the broader economy and the banking sector. Yet, given the in some ways draconian "re-course" Spanish mortgage debt laws, which gives a lender the right to seek repayment of a mortgage loan from the borrower’s (and/or guarantor’s) personal assets, it is not clear that the immediate cost to banks from the residential real estate collapse will be as high as in for instance the U.S.
Many people point to the hopelessly high Spanish unemployment rate of about 20 percent and infer that the country must be on the verge of a “social revolution”. However, sad as this testimony is to the ability of Spain to productively employ its population, this “merely” means that the unemployment rate is now back at the levels last seen in the mid-1990s, before the beginning of the decline in real Spanish interest rates and subsequent real estate boom associated with the country’s entry into the euro.
Spain 'Gets It'
As such, while definitely a monumental economic challenge for Spain, a 20 percent unemployment rate is not historically associated with large scale social unrest. Moreover, it is not the case that Spain is now basically set back 15-20 years in time. The Spanish labor market picture gets better when focusing on employment rates, rather than unemployment.
Here Spain has suffered a dramatic drop in employment from 66 to 58 percent in the 16-64 year age group. However, 58 percent employment is still the rate seen at late as in 2003 and more than 15 percent higher than in the mid-1990s. All the labor market gains of the boom have not been lost in the subsequent bust.
Then there is the issue of private sector foreign debt – just over 100 percent of GDP in 2010. Much higher than for the Spanish government for sure, but the real issue here is not so much the scale, but what type of liabilities and maturities we are dealing with. Fortunately for Spain, two-thirds of the private sector foreign debt is in long-term bonds, notes or loans. The actual immediate short-term private sector funding risk in Spain is consequently quite limited.
Most importantly, though, the Spanish government has since the Greek crisis peaked in May 2010 embarked on a very constructive policy trajectory. It forced publication of the EU banking stress tests over the summer and itself went considerably beyond what other EU members did in terms of the stress test assumptions and transparency.
The socialist government cut spending and public wages, thereby committing political hara-kiri in the process, and has finally begun liberalizing the Spanish labor market.
Moreover, for 2011, it has already announced further austerity, more labor market liberalization of collective bargaining and a pension reform raising the retirement age from 65 to 67. In sum – Zapatero "gets it" and Spain is taking its medicine preemptively.
Certainly, Spain faces serious economic growth and labor market challenges as it works its way through a devastating real estate collapse in the coming quarters. But it has neither the debt stock of Greece, the bust banks of Ireland or the complacent government of Portugal. Spain is fundamentally not part of the euro-zone periphery.
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Jacob Funk Kirkegaard has been a research fellow at the Institute since 2002. Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector.