|Luis de Guindos, Spanish finance minister and Mario Monti, Italian prime minister and finance minister, at the Ecofin meeting of EU finance ministers, Brussels, July 10, 2012.|
Dr Peter Morici:
Mediterranean sovereign debt losses could top €2tn; Austerity and labor
market reforms are not reviving economies of Mediterranean states, undermining
efforts to save national government finances. Ultimately, to remain in the
Eurozone, these governments will require massive fiscal transfers, or may be
impelled to default on at least half their debt.
After the introduction of the euro in 1999, Italy and Portugal managed moderate
growth, and Spain and Greece enjoyed stronger progress; however, labor
productivity continued to lag northern European economies, owing to both
government policies and geography.
Labor laws made difficult workforce reductions during periods of weak demand and
to exploit new technologies. Consider Fiat - - in 2009, its five largest Italian
assembly plants produced 650,000 cars with 22,000 workers, while its Tychy
Poland plant produced 600,000 vehicles with only 6,100 workers.
Excepting northern Italy, these economies are hardly hotbeds of innovation that
permitted Germany and others to build technology sectors, and create advanced
products and services that instigate leaps in value-added per worker.
The Mediterranean region relied too much on tourism, banking, shipping and cheap
hands for assembly work, which increasingly moved to Eastern Europe destinations
benefiting from more flexible labor practices and national currencies that
adjust real wages to international competitive conditions.
Prior to the euro, market forces would have driven down Mediterranean national
currencies vis-à-vis the dollar and German mark, lowering real wages and
Instead, chronic trade deficits resulted, and Mediterranean governments shored
up employment through wasteful spending, and removed older workers from the
labor market through early retirement ages and generous pensions. They borrowed,
not merely from their citizens and banks, but also sold bonds elsewhere in
Europe and North America.
In Spain, real estate investment - - northern Europeans attracted to its warm
climate - - and the resulting inflow of cash to banks supplemented government
When the US real estate crisis caused a global recession and halting recovery,
investors saw that sovereign debt was increasing more rapidly than national GDP,
and interest rates on sovereign debt rose to unaffordable levels. Portugal and
Greece required bailouts - - loans from stronger European governments. Banks across
the region- - saddled with bad business loans - - required aid their governments cannot
afford, without external assistance.
Austerity and labor market reforms are essential to curb government spending and
raise productivity, but in the near term, lays offs, public and private, are
driving up unemployment and causing real GDP to stagnate or decline.
Consequently, government spending continues to outpace taxes, pushing up debt to
Recently, promised aid to Mediterranean banks through loans or equity purchases
from the European Stability Mechanism may temporarily ease pressures on
governments. However, ESM funds at €500bn may prove inadequate to cover
the funding needs of both troubled governments and banks; and the ultimate
liability of governments, if banks can’t repay loans and equity injection,
despite recent announcements, remains vague.
Investors recognize this.
Despite repeated EU efforts to stabilize the situation, 10-year Italian, Spanish
and Portuguese government bonds are yielding nearly 6, 7 and 10%
respectively - - those rates exceed nominal GDP growth, making government finances
absolutely unworkable. Greece can’t access capital markets at all.
The combined debt of all four governments is about €3tn, and shaky bank
liabilities add at least another €1tn to sovereign exposure. Half this
total would have to be forgiven for government finances to make sense.
Either Germany and the other rich nations write checks for €2tn - - not loans
but grants - - or a similar forced restructuring will be required.
Even if such debt forgiveness could be achieved without instigating panic, the
Mediterranean economies would have to endure many years of unemployment well
above 10 or even 20 percent to effect “internal devaluation”—wage reductions
large enough to attract industry, balance imports with exports, and end reliance
on large government deficits to maintain employment.
Also, that would require voters and governments in Germany and other northern
states to be sanguine about factories and jobs migrating south - - that is no more
probable than a €2tn grant from Germany and other northern states.
To say Club Med bonds are good only for wallpaper may be a slander on good wall
Professor, Robert H. Smith School of Business, University of Maryland,
College Park, MD 20742-1815,
703 549 4338 Phone
703 618 4338 Cell Phone
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