Debt development in Ireland and Spain: The sameor different? Pre- and post-crisis analysis

Abstract

(ProQuest: ... denotes formulae omitted.)IntroductionIn years 2008-2012, the Eurozone found itself in a deep financial and economic crisis. The crisis was caused by the accumulation of effects of many negative phenomena, such as the collapse of the mortgage market in the US in 2007-2008, high public debt and rampant expansion of bank credit in some Euro Area countries, excessive speculative investment in areas such as construction, real estate and financial services, as well as rapid growth in market prices of raw materials, petrol and food. But the most important factor differentiating the recent crisis from many earlier cyclical downturns was the excessive debt of both public and private sector, which led to a sharp drop in confidence in financial markets. Some countries have even stood on the verge of bankruptcy. Greece, Ireland and Portugal were forced to apply for financial assistance from international institutions. As a result, the crisis turned into a sovereign debt crisis. The combined effect of these developments was an increase in public debt on a scale not seen since the end of the World War II. Indeed, in years 2008-2012, the relation of public debt to GDP in the Eurozone increased from 68.5% to 91.3% and continued the upward trend until 2014. According to the most current forecasts, 2015 will be the first year when decrease in debt-to-GDP ratio in the Euro Area is expected [European Commission 2016a].It should be noted that for some countries, the primary cause of the Eurozone sovereign debt crisis was not over-indebtedness of the public sector but an excessive emission of bank credit and over-indebtedness of the private sector. Ireland and Spain constitute examples of such countries. Despite significant differences in terms of structure and size of the economy between the two countries (Ireland and Spain), in the light of the recent crisis and its causes, there are some features in common that unities these countries. In both, the crisis was triggered in the real estate and in the construction market. In Spain the private sector generated an excessive debt in banks in order to invest in these market, whereas in Ireland there was an excessive and risky expansion of the banking sector financing investment mainly in those sectors. In addition, against the whole Eurozone, Ireland and Spain were one of the fastest growing countries. Ireland was developing three times faster and Spain two times faster than the Eurozone on average. Furthermore, in both countries the level of public debt in relation to GDP before the crisis was low respectively: 23.9% in Ireland and 35.5% in Spain - so well below the permissible limit of 60% of GDP. However, more detailed analysis carried out in this article leads to different results obscuring this positive fiscal picture resulting from the general indicators of debt and deficit-to-GDP ratios. It is to note that regardless of whether the primary cause of the sovereign debt crisis was over-indebtedness of the public sector or the private sector, as a result of having to rescue domestic banks by governments, most of the debt ultimately goes to the public sector. Governments of both countries were forced to ask for international assistance.However, what differs significantly the two countries apart is the course and pace of fiscal consolidation along with the accompanying process of growing out of debt. While the increase in debt-to-GDP ratio in Ireland was much higher (in years 2008-2012 debt increased by 78 pp.) than in Spain (in years 2008-2012 by 46 pp.), Ireland has already managed to lower it and put it on a downward path. Spain, on the contrary, records a high debt-to-GDP ratio which is still on the upward path [European Commission 2016a].The major aim of this article is to demonstrate the development of general government debt in two Eurozone countries: Ireland and Spain. Secondly, the article attempts to diagnose the factors responsible for the given course and pace of fiscal consolidation aimed at growing out of debt. …