By Michael Sanibel, Investopedia.com
Tuesday, August 17, 2010
The recent financial crisis and recession have been a worldwide occurrence. The events in the United States since 2008 have garnered most of the headlines because the U. S. has the world's largest economy and national debt, but the reality is that many countries in Europe are in worse financial shape and continue to deteriorate.
There are various ways to rank indebtedness, such as debt per capita and deficit or debt as a function of gross domestic product (GDP). This ranking is based on cumulative debt as a percentage of GDP and is limited to an analysis of the 25 largest economies. It is further limited to "external" debt, which is the portion of the national debt that is owed only to foreign creditors. The source for the debt and GDP amounts is the Central Intelligence Agency World Factbook most recent numbers from mid to late 2009.
1. Ireland - Debt/GDP: 997%
The days of Ireland enjoying one of the fastest growing economies in Europe are over, at least for now. The story is all too familiar, as easy credit fueled a housing bubble that burst and damaged consumer confidence.
After recording budget surpluses in the prior two years, the economy reversed course in 2009 and contracted 7%. This eroded tax revenues and sent the annual deficit to a record 14.3% of GDP. The European Union set a target for Ireland to reduce that figure to 3% by 2014, but the International Monetary Fund has indicated that the deadline will be missed. Moody's has subsequently lowered its bond rating.
2. Netherlands - Debt/GDP: 467%
The national debt in the Netherlands has reached record levels as a result of the world financial crisis and recession. Much of the added burden was caused by significant government support for the country's banking sector. The increase in debt per capita is second only to that experienced in Ireland.
The Netherlands joined the eurozone with a hard guilder a decade ago, but its current debt would likely disqualify it for membership.
3. United Kingdom - Debt/GDP: 409%
Investment bank Morgan Stanley fears that Great Britain could face a severe debt crisis in the near future if it continues down its current path. According to the bank's report, this is a case of not putting aside sufficient reserves when the economy was sound. During the peak of the boom, it still ran a budget deficit of 3% of GDP when other European countries were running surpluses exceeding 2%.
Like many other countries, Britain bought time during the financial crisis by implementing massive fiscal stimulus and forcing the public to fund losses in the private sector. Without the restoration of fiscal credibility, there is a significant danger of a government bond sell-off, pound weakness and a flight of capital.
4. Switzerland - Debt/GDP: 273%
Generally regarded as having one of the world's most stable economies, Switzerland has taken its budget crisis seriously. When the national debt began to escalate in the last decade, the Swiss voted to approve a constitutional amendment forcing the government to balance expenses and revenue during each economic cycle. While annual deficits may still occur, this has instilled discipline in the process and lowered the country's borrowing costs as investors rushed to safety.
This so-called "debt brake" was implemented in response to increasing debt stemming from a slowdown in economic growth. Deficits climbed as spending rose for unemployment benefits and tax revenues declined. While government expenditures were cut across the board, rising revenues have not been sufficient to pay down the incurred debt.
5. Portugal - Debt/GDP: 228%
With last year's deficit coming in at 9.4% of GDP, the Portuguese government has instituted a growth and austerity program with the objective of reducing that number to 2.8% by 2013. These measures have sparked strikes in the public sector including postal and transportation services. Those events have been further propelled by unemployment above 10%, the worst in 40 years.
The root problem has been low productivity and virtually no economic growth in the past few years. Portugal ranks last in GDP growth among countries that adopted the euro as a common currency. Demand for goods and services has stalled, along with innovation and business momentum. In addition, Portugal's exports have been undercut by cheap labor in countries such as China. (For related reading, see The Economics Of Labor Mobility.)
6. Austria - Debt/GDP: 214%
The recession and government assistance to banks have contributed to the budget crisis in Austria. The finance minister has rejected the notion of higher taxes in favor of administrative reforms to cut spending. He has predicted that the annual deficit would grow from 3.5% to 4.7% of GDP between 2010 and 2012 before starting to decline. That peak would be the third-highest since 1976 when such data were first recorded.
Rising unemployment has resulted in increased expenditures for unemployment compensation and other government benefits. In addition to the reduced payrolls, tax reforms have driven down overall tax revenues.
The Bottom Line
While the U.S. and Canada have large economies, their respective debt-to-GDP ratios are 93% and 62%. The U.S. gets most of the attention because of the size of the numbers that comprise the ratio - $13.5 trillion debt (June 2009) and $14.4 trillion GDP (2009 estimate).
By comparison, China and India have ratios of 7% and 20% respectively. Their economic growth rates have also exceeded the western nations over the past few years, thereby keeping their debt ratios relatively low. If the western nations don't implement policies to reduce their debts, they run the risk of jeopardizing future economic growth and prosperity.
