What needs to be done in Spain?
12 December 2011
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Almost everyone expected the Socialist Party to lose the recent Spanish elections by a wide margin. Their mismanagement of the economic crisis destroyed their credibility with the Spanish people, regardless of their ideology.
This fact, more than any merits of the opposition, enabled the Popular Party – the right-wing party headed by Mariano Rajoy – to gain an absolute majority. However, because of legal requirements, they will not take charge of the government until 23 December.
The situation facing the Spanish economy is extremely complicated. Recent data suggest that the double-dip recession may already be a reality. The labour market situation keeps deteriorating, adding ever more people to the already huge pool of unemployed workers – about 5 million, which amounts to an unemployment rate of almost 23%, by far the highest in the EU (Eurostat).
Moreover, bond yields and the risk premium, despite dropping lately, remain at historically high levels. And it is very likely that the general public deficit goal of 6% will not be fulfilled – it might actually be closer to 7% – particularly as a result of actions by regional governments.
The Spanish financial institutions are also experiencing difficulties, with high exposure to bad housing loans, especially among the Cajas (largely politicised savings banks). The huge housing bubble of the last decade has not completely deflated yet. The banking sector and real estate developers, with the help of government, have avoided a sharp, quick housing supply and price adjustment. Thus, the problem has been temporarily postponed and therefore aggravated.
Given this economic outlook, Rajoy should implement urgent and bold – and, unfortunately, unpopular – measures in order to achieve these three inter-related objectives:
1) Bring the fiscal house in order by sharply cutting public spending and fostering economic growth to boost public revenues, through market deregulation and the removal of the many barriers to entrepreneurship. While some Keynesians defend increasing spending as a way to stimulate the economy, there are far better alternatives to do this. In addition, given that a big part of the government deficit is of a structural nature, deeper reforms of the currently inefficient welfare system should be considered.
2) Halt the disastrous job-loss trend and lay the foundations for a vigorous employment recovery. In this case, a radical reform of the very rigid labour market regulation is badly needed, so that labour relations become much more flexible and decentralised. Without this, individual firms can’t adapt to changing circumstances.
3) Fix the banking sector shortfall through clear and transparent mechanisms, with the aim to soften the sharp credit contraction that puts a further drag on economic activity. This implies that, first, financial institutions have to adjust the value of their assets – particularly loans to real estate developers – to more reasonable levels given the housing price deflation.
For these reforms to be effective they must be framed in a coherent and credible plan. Rajoy has to persuade international investors and observers that the Spanish economy and public finances are sound. This has to be done with real facts and a strong commitment to structural reforms.
However, let’s set the record straight: even if the right set of reforms is implemented, output and employment growth will be weak, given the overall economy’s need to reduce debt and adjust large imbalances created during the housing bubble period.
More positively, the current situation presents an historic opportunity for Spain to carry out the many and deep reforms that would make the country a more productive, competitive and financially sustainable economy.
Ángel Martín Oro is a PhD student in economics, research fellow of the Instituto Juan de Mariana and contributor to LibreMercado.com
This fact, more than any merits of the opposition, enabled the Popular Party – the right-wing party headed by Mariano Rajoy – to gain an absolute majority. However, because of legal requirements, they will not take charge of the government until 23 December.
The situation facing the Spanish economy is extremely complicated. Recent data suggest that the double-dip recession may already be a reality. The labour market situation keeps deteriorating, adding ever more people to the already huge pool of unemployed workers – about 5 million, which amounts to an unemployment rate of almost 23%, by far the highest in the EU (Eurostat).
Moreover, bond yields and the risk premium, despite dropping lately, remain at historically high levels. And it is very likely that the general public deficit goal of 6% will not be fulfilled – it might actually be closer to 7% – particularly as a result of actions by regional governments.
The Spanish financial institutions are also experiencing difficulties, with high exposure to bad housing loans, especially among the Cajas (largely politicised savings banks). The huge housing bubble of the last decade has not completely deflated yet. The banking sector and real estate developers, with the help of government, have avoided a sharp, quick housing supply and price adjustment. Thus, the problem has been temporarily postponed and therefore aggravated.
Given this economic outlook, Rajoy should implement urgent and bold – and, unfortunately, unpopular – measures in order to achieve these three inter-related objectives:
1) Bring the fiscal house in order by sharply cutting public spending and fostering economic growth to boost public revenues, through market deregulation and the removal of the many barriers to entrepreneurship. While some Keynesians defend increasing spending as a way to stimulate the economy, there are far better alternatives to do this. In addition, given that a big part of the government deficit is of a structural nature, deeper reforms of the currently inefficient welfare system should be considered.
2) Halt the disastrous job-loss trend and lay the foundations for a vigorous employment recovery. In this case, a radical reform of the very rigid labour market regulation is badly needed, so that labour relations become much more flexible and decentralised. Without this, individual firms can’t adapt to changing circumstances.
3) Fix the banking sector shortfall through clear and transparent mechanisms, with the aim to soften the sharp credit contraction that puts a further drag on economic activity. This implies that, first, financial institutions have to adjust the value of their assets – particularly loans to real estate developers – to more reasonable levels given the housing price deflation.
For these reforms to be effective they must be framed in a coherent and credible plan. Rajoy has to persuade international investors and observers that the Spanish economy and public finances are sound. This has to be done with real facts and a strong commitment to structural reforms.
However, let’s set the record straight: even if the right set of reforms is implemented, output and employment growth will be weak, given the overall economy’s need to reduce debt and adjust large imbalances created during the housing bubble period.
More positively, the current situation presents an historic opportunity for Spain to carry out the many and deep reforms that would make the country a more productive, competitive and financially sustainable economy.
Ángel Martín Oro is a PhD student in economics, research fellow of the Instituto Juan de Mariana and contributor to LibreMercado.com
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Ángel, good analysis of the actions that should be taken to fix the economy in Spain. However I’m afraid that Rajoy’s agenda doesn’t include many of them. Don’t forget that the Popular Party is just a conservative party, a bit less socialist that the socialists, but nothing close to something like a libertarian party. There are so many lobbies, associations, unemployed people, public servants and pensioners depending on public funds in Spain for a living, that no party willing to cut a significant fraction of their privileges would ever had won the elections. That’s sad, but true.
So, what is most likely to happen is that:
1) Just some cosmetic cuttings will be done in public spending, leaving the Estate structure and welfare state intact, trying to compensate the fiscal deficit with tax increases (starting with fuel, alcohol&tobacco, VAT…)
2) Again, only a partial reform of the labour market will be done. He will not dare to confront labour unions, neither end with their privileges and public funding.
3) The new government will create a ‘bad bank’ where the still politicized “Cajas” (many of them under the control of Popular Party officials), will pass all toxic assets to the taxpayer.
There’s no need to mention that with these kind of measures in place, Spain’s situation will not improve in the following years.