Wednesday, September 14, 2011

Why Spain?

A friend of mine asked me why Spain, which has a low debt-to-GDP ratio, was attacked by the market in the same way Italy is.  For the debt/GDP ratio,  here is the evolution over the last decade, via Eurostat(Spain is in pink):
Now, as I mentioned here before, Paul Krugman, Martin Wolf and Paul De Grauwe convincingly argue that Spain and Britain have a similar trend in debt to GDP ratio(though as I mentioned earlier, the maturity profiles of the two countries might also be a factor) but Spain pays a far higher interest rate on its 10-year bonds because they do not have the option to devalue their currency. Now, the comparison with Italy is trickier. First, a graph of 10-year bond yields since the beginning of the year: 
Now, here is what I quickly answered(with some probable mistakes along the road, sorry)
  • I think there are several things that matters. First, without talking about the papers  I am currently reading, there are various weird things about Spain. Unemployment is extremely high. It fell because of the construction bubble before, but Spain usually had an unemployment rate of more than 15%. Now it's around 20, I think, with a 40% unemployment among young people. Structurally, they have problems. Second, their banks are indebted. Spain had the majority of failed banks in the two stress tests the EU has conducted. Third, Spain provinces are quite independent from the central government and there's no cooperation. The central government has less power than other countries to control public debt. Try this article from today with Google Translate.
  • Now, actually, debt to GDP is not a big factor in bond spreads, from what I gather from articles, so it is not clear we should look at those numbers. A recent  NBER paper has that debt/taxbase has a significant impact, though.  Growth prospects are important, and you see that Italy, Greece, Spain have structural pb(I think it's less the case with Ireland). We don't know what are their comparative advantage(although tourism is probably one of them). Trade is important, and Spain had a HUGE trade deficit in the second part of the decade. Exports gets you reserves and helps you pay your debt, especially if it's dollar denominated. Being in the Eurozone also means that the terms of trade(how much imports you can pay for a given amount of exports) have been quite bad for a while. This is the trade balance, via Eurostat again: 


Update(09/15/11): I forgot to list a couple of things. First, via Brad Plumer, the list of countries with the highest share of small businesses is quite amazing




Still, it does not say anything about Spain vs. Italy, which both rank at the top. A report by the IMF has some nice numbers and figures. For instance, in 2007, Spain had the second highest current account deficit, after the US(numbers are not adjusted by GDP)
(Source: IMF, World Economic Outlook database, as of August 21, 2007.)

If you go look at table 3 of the report, you'll see that Spain has one of the lowest reserves to GDP ratio.

Finally, on the structural problems in Spain and the fact that restoring competitiveness appears to be hard, the graph of startups in the last 5 years is telling:

















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