August 16, 2022

Off the Charts: Where Private Borrowing Led to Public Debt

The outstanding countries were Spain and Ireland.

Today, of course, the picture is far different. The two countries’ national economies are shrinking, not growing. Ireland has received a bailout from Europe, and while Spain can still borrow money, it is forced to pay at least two percentage points a year more than Germany, a spread the Spanish government says it cannot afford to pay indefinitely.

At the time the two economies appeared to be impressive, there was one indication that could have provided a warning. Each country’s private sector was borrowing heavily overseas. Those loans were fueling rapid economic growth that, in turn, produced rising tax collections, allowing national governments to run budget surpluses.

In principle, there is nothing wrong with debt-financed growth. What matters is whether the borrowed money is going to create productive enterprises and purchase valuable assets that will generate future profits to repay the debt.

But in bubbles, that is not likely to happen. In Ireland and Spain, as in the United States, property booms led to overinvestment in housing, and to plunging property prices when the bubble burst. What was important was that during the boom years, the financial systems of many countries completely failed to channel money into productive investments.

Bad capital allocation was not the only way for a country to get into trouble, of course. The stories of Greece and Portugal are different.

Spain, fortunately, had relatively good regulation of its major banks, which has helped to limit the damage. But local banks have been hurt badly. In Ireland, virtually the entire banking sector collapsed, and was bailed out by a government that could not afford the cost.

The accompanying charts show the relative standing of the five largest economies in the euro zone — Germany, France, Italy, Spain and the Netherlands — and the three smaller countries that have sought bailouts.

The charts show the annual rate of economic growth over the years 2005 and 2006, as well as the average budget surplus or deficit during those years and the level of national debt, relative to gross domestic product, at the end of 2006. For comparison, similar charts show the same indicators for the years 2009 and 2010.

The fourth chart is an estimate of the amount either lent to or invested in the private sector, as a percentage of G.D.P. The figures are based on the logic that the current account, which includes international trade and other noninvestment-related transfers of funds, must balance with the capital account, which includes both investments and proceeds from previous investments. Whatever part of the capital account is not accounted for by the government budget deficit presumably is due to private sector activity.

One of the lessons of the financial crisis and its aftermath is that excessive private sector debt ended up being converted to public sector debt, through bailouts of financial institutions, through government spending to help sectors of the economy devastated by the collapse of a speculative bubble and through the loss of tax revenue from the failing companies and newly unemployed citizens.

Floyd Norris comments on finance and the economy on his blog at

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