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Industrialized
Sovereigns in Trouble
BY
PETER G. HALL 
EDC Vice-President
and Chief Economist
News
about worsening public finances in Western Europe rocked global
financial markets last week, and revealed an underlying fragility in
confidence. Apparently, patience with the on-again, off-again approach
of policymakers to the problem zones wore thin. Was the reaction
overdone, or overdue?
Prior to the recession, fiscal management in the Western world generally
seemed to be going well. Public debt as a share of GDP was close to the
60% Eurozone Maastricht debt target in both Germany and France during
the 2002-07 period. Although not bound by this target, US public
debt-to-GDP was bang on 60% for the same time period. Britain’s ratio
was exemplary at 40%. Ongoing prudent fiscal management in Canada
lowered our ratio to 63% in 2008. Other Western nations had higher
ratios, but they were generally converging to acceptable levels, thanks
to more responsible annual fiscal planning and management. If things
were going so well, what happened?
Global recession changed everything. Economic activity plunged,
decimating public revenues and increasing transfers to the casualties of
recession. Instantly, we all became Keynesians again, pouring vast
amounts of cash into stimulus programs and financial sector bailouts,
with little apparent initial regard for the financial consequences. The
truth is now clearer: overnight, small surpluses and single-digit
deficits became whopping, double-digit monoliths in the US, Japan and
the UK, and both France and Germany strayed well away from the 3%
Maastricht deficit target for the Eurozone.
Where the damage is most obvious is on debt levels. What was quite
manageable is suddenly in a danger zone. IMF projections have debt as a
share of GDP escalating in most G-7 nations beyond the critical 90%
level by 2013, with the US nudging above 100% and Japan at an
unthinkable 240%. Talk of ratings downgrades is circulating, adding to
the growing unease. Worry is warranted, but only to a point. In contrast
with emerging markets in the same straits, these economies have much
greater ability to raise taxes, far deeper domestic capital markets, and
significantly lower levels of political risk, among other factors that
greatly increase their capacity to manage higher debt levels.
A greater concern is the weaker industrialized markets. Their fiscal
situations have also deteriorated, but from a lower base. Greece has
been a focus of market angst due to high debt levels, a swollen current
deficit and shocking new revelations of past excesses, a situation that
has brought it to the brink of default. Greece’s problems have brought
to light the fiscal woes of Portugal, and the larger economies of Spain
and Italy. Last week, there was worry that contagion could go even
further afield.
Market jitters were exacerbated by mixed policy signals. Failure to act
rapidly, aggressively and in tight co-ordination raised the risk of ugly
outcomes and a damaging, widespread domino effect. Over the weekend,
this was acknowledged in the crafting of a $1 trillion rescue package
that for the moment has placated markets. In the coming days, markets
will digest where the money is coming from, and the increased
deterioration in overall fiscal health that will result. While not a
cure-all, the transfer of fiscal burden from weaker to stronger members
will mollify markets at this critical moment.
The bottom line? Ongoing bailouts are a key sign that we are not yet
through the economic downturn. Paying for the bailouts will signal
recovery, and remind us of this downturn for a long time to come.
The
views expressed here are those of the author, and not necessarily of
Export Development Canada.
©2009
EDC
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