Trouble is - if a country descends into anarchy, the best plans for reform don't help you much. The bond market today definitely got worried, with Spanish 10-year yields pushing towards 5.5%. Not everything the markets do is rational (remember those rallies in Greek bond prices after each summit?), but this reaction has some good analysis behind it. Woo (1983) for example showed that countries with greater frequencies of strikes and other forms of unrest have bigger public debts -- a clear sign of an inability to cut expenditure and raise revenue in societies at the verge of fracturing. You can see how this kind of reaction can lead to a self-reinforcing downward spiral, with uncertainty undermining growth (a la Bloom), lower growth causing lower taxes and bigger deficits, resulting in more austerity (reinforced by some extra finger-wagging from Brussels and Berlin), and then you get round again with some more unrest plus so much less growth that the deficit actually goes up (as per the new and instant classic Delong + Summers paper). The final result? Greece. I don't think the probability of Spain ending up there is high, but give us half a dozen incidents like today, and the chances will go from, say, 5% to 25%.
I am Joachim Voth, formerly the director of the M.Sc. in International Trade, Finance and Development (ITFD) at UPF-BGSE (and now a member of the steering committee). This blog will keep current and prospective students updated with news and reflections. I'll also try to give people a taste of what (intellectual) life is like down here by the Med.