Mediterranean Debt Losses Could Top 2 Trillion Euros

NEW YORK (TheStreet) -- Austerity and labor market reforms are not reviving economies of Mediterranean states, undermining efforts to save national government finances. Ultimately, to remain in the eurozone, these governments will require massive fiscal transfers, or may be impelled to default on at least half their debt.

After the introduction of the euro in 1999, Italy and Portugal managed moderate growth, and Spain and Greece enjoyed stronger progress; however, labor productivity continued to lag northern European economies, owing to both government policies and geography.

Labor laws made it difficult for firms to effect workforce reductions during periods of weak demand and to exploit new technologies. Consider Fiat -- in 2009, its five largest Italian assembly plants produced 650,000 cars with 22,000 workers, while its Tychy Poland plant produced 600,000 vehicles with only 6,100 workers.

Excepting northern Italy, these economies are hardly the hotbeds of innovation that permitted Germany and others to build technology sectors and create advanced products and services that instigate leaps in value-added per worker.

The Mediterranean region relied too much on tourism, banking, shipping and cheap hands for assembly work, which increasingly moved to Eastern Europe destinations benefiting from more flexible labor practices and national currencies that adjust real wages to international competitive conditions.

Prior to the euro, market forces would have driven down Mediterranean national currencies vis-à-vis the dollar and German mark, lowering real wages and sustaining employment.

Instead, chronic trade deficits resulted and Mediterranean governments shored up employment through wasteful spending, removing older workers from the labor market through early retirement ages and generous pensions. They borrowed, not merely from their citizens and banks, but also sold bonds elsewhere in Europe and North America.

In Spain, real estate investment -- from northern Europeans attracted to its warm climate -- and the resulting inflow of cash to banks supplemented government foreign borrowing.

When the U.S. real estate crisis caused a global recession and halting recovery, investors saw that sovereign debt was increasing more rapidly than national GDP, and interest rates on sovereign debt rose to unaffordable levels. Portugal and Greece required bailouts -- loans from stronger European governments. Banks across the region -- saddled with bad business loans -- required aid their governments cannot afford, without external assistance.