The full scale of the economic declines in Ireland and Greece, under the impact of the debt agreements and consequent contractionary fiscal policies agreed by their governments, is shown in Figure 1 below. This illustrates the change in GDP, since the peak of the previous business cycle, in the so called ‘PIGS’ economies (Portugal, Ireland, Greece, Spain) compared to Germany and France.
GDP in Greece has fallen by 8.9% since its peak. In Ireland the decline is 14.6%. Both countries saw GDP in the 4th quarter of 2010 fall to its lowest level in the recession – i.e. no recovery had begun. In contrast GDP in Germany is 1.4% below its peak and in France 1.6% below - in both economies recovery has been taking place for seven quarters, since the 1st quarter of 2009.
Considering Portugal, the latest country to apply for an EU economic package, it is clear that to date its economy has more closely followed the performance of France and Germany than Greece or Ireland.
Portugal has also outperformed Spain. In the 4th quarter of 2010 Portugal’s GDP was 2.0% below its peak level compared to Spain’s decline of 4.3%.
Furthermore until the 4th quarter of 2010 Portugal’s GDP had been recovering.
Based on the experience of Ireland and Greece, and basic economic analysis. the imposition of a fiscally contractionary debt agreement on Portugal, after its request for an agreement with the EU, will lead to sharp economic decline.
The deep economic contraction in Greece and Ireland has already made it more difficult for them to repay their debts according to the terms agreed. The problem in both economies is not liquidity but their balance sheets. The debt to GDP ratio in Greece, for example, is 140% of GDP. In Ireland exposure to bank bail outs is several times GDP.
The rationale for the loans organised by the EU for Ireland and Greece would be that their economies would grow and therefore make possible repayment of the loans at a future date. In fact the severe economic decline resulting from the contractionary fiscal policies makes this implausible. Figure 1 therefore also indicates the likely consequences if such policy spreads to Portugal.
The depth of the recessions in Ireland and Greece therefore confirms that the EU package to be developed for Portugal is likely to contribute to worsening the consequences of the EU debt situation rather than alleviating it.