Spain Remains Mired in Recession

The long road ahead for Spain just got a little longer as the country’s seasonally adjusted unemployment rate rose slightly in July, up to 20.3 percent. Meanwhile the country’s socialist prime minister is attempting to reassure markets that Spain will be able to meet its target of reducing its budget deficit to 6 percent of GDP next year.

Last March Prime Minister José Luis Rodríguez Zapatero was forced to admit that his government’s interventionist policies hadn’t managed to improve the economy’s long-term prospects at all. Unemployment rates have been hovering near 20 percent since the summer of 2009 with little hope of them dropping any time soon.

In December, Zapatero announced labor market reforms, among them reductions in high dismissal costs and working hours to preserve employment. The country’s labor regulations remain inflexible however. Non-salary costs of employing a worker are high and regulations on work hours rigid.

In Tokyo on Wednesday, the prime minister blamed workers for their lack of flexibility. “All countries make sacrifices today for a better tomorrow,” he said. A general strike is likely to be called by unions on September 29 unless the government repeals it plan to make it easier for businesses to hire and fire workers.

Total government expenditures, including consumption and transfer payments, have skyrocketed in the wake of the crisis. Government spending already amounted to nearly 40 percent of GDP in the years preceding the downturn; a stimulus package enacted last year to promote a recovery equaled a little over 1 percent of Spain’s total economic output, providing for public works investments, support of the auto industry and increased social benefits.

As Spain struggles to emerge from recession and fend off worries over its ability to fund its debt, Zapatero has promised significant spending cuts. The opposition is out for his head though. Conservative foreman Mariano Rajoy Brey suggested earlier this year that both the prime minister and his proposals lack credibility. “It’s not Spain that inspires lack of confidence,” Rajoy told Zapatero in parliament last February; “it’s you and your government’s way of handling the economy.” The prime minister is struggling to keep his government in power until the 2012 elections.

Markets have worried over Spain’s rising public deficit which peaked at 11.2 percent of GDP last year, dreading that the country could suffer the same fate as Greece. Zapatero assured investors that Spain does “not need assistance from the EU or IMF” however, adding: “we have never thought it will be necessary.” Nevertheless, Spain has recently seen firm demand for its bonds issuance on abating investor concerns over the nation’s ability to cut its fiscal gap.

With one in five Spanish workers unemployed, Zapatero’s popularity has plummeted in his second term in office, to 26 percent.

Long Road Ahead for Spain

Prime Minister José Luis Rodríguez Zapatero of Spain speaks at the European Parliament, Brussels, July 6, 2010 (Pietro Naj-Oleari)
Prime Minister José Luis Rodríguez Zapatero of Spain speaks at the European Parliament, Brussels, July 6, 2010 (Pietro Naj-Oleari)

Spain is the last major economy of Europe still mired in recession as its government remained committed to socialist doctrine throughout 2009. Massive deficit spending has only worsened the country’s predicament however, forcing Prime Minister José Luis Rodríguez Zapatero to finally start reining in Spain’s mounting debt.

Last month, Professor Niall Ferguson of Harvard University warned that “the contagion” currently rocking Greece would spread to other eurozone members, Spain foremost among them. The markets had woken up, he announced, realizing that the fiscal policies of countries as Spain had not been “credible”.

In the wake of the economic turndown, the Spanish government maintained a deficit on its budget of so much as 10 percent, refusing to cut on expenditures. The country’s pre-crisis growth has largely been carried by a boom in real estate. When construction came to a standstill, nearly 20 percent of Spanish workers lost their jobs. The country as a whole continues to face an enormous trade deficit on top of that.

The government simply has got to start spending less. According Bob Holderith, CEO of Emerging Global Shares who appeared on the Fox Business Network on Tuesday, “They’re going to have to get their economy under control.”

Holderith’s solution is investment, which is exactly what Prime Minister Zapatero has been hoping for. But with literally millions of people out of a job and millions of homes unoccupied there is little incentive to invest in Spain right now. Holderith admitted that the road to recovery for Spain will be a long one.

There have been some encouraging signs from domestic demand and exports recently and the country’s economy minister is supposed to be working out an austerity package that will bring the deficit down to the European maximum of 3 percent by 2013. Zapatero said that his government is “committed to these projects,” although conservative opposition leader Mariano Rajoy suggested that both the prime minister and his proposals lack credibility.

“It’s not Spain that inspires lack of confidence,” Rajoy told Zapatero in parliament last month, “it’s you and your government’s way of handling the economy.”

The conservatives are especially resistant to a proposed increase in value-added taxes which will only diminish the slight surge in consumer demand, they warn. Household consumption was up by 0.3 percent in the quarter of last year — pretty much the only good news there has been for the Spanish economy in some time now.

Bubbles, Deficits and European Arrogance

With Greece in despair and worries about mounting national debts rampant throughout Europe, it is easily presumed that those eurozone members still struggling with recession can all blame their troubles on deficit spending spun out of control. Paul Krugman notes however that there are different circumstances to be taken into account.

Spain, for instance, unlike Greece, is no victim of fiscal irresponsibility, opines Krugman. Its problems mainly stem from a decade-long housing bubble that ultimately burst in 2007. Up until then, its economy grew steadily with 4 percent a year, driven almost exclusively by a rapidly expanding real estate market. Now that construction has come to a standstill, millions of Spaniards are left unemployed with so much as two million of them living off unemployment benefits.

Krugman blames the situation on the euro. He cites the “arrogance” of the political establishment that “pushed Europe into adopting a single currency well before the continent was ready for such an experiment.”

If Spain still had its old currency, the peseta, it could remedy [its problems] quickly through devaluation — by, say, reducing the value of a peseta by 20 percent against other European currencies. But Spain no longer has its own money, which means that it can regain competitiveness only through a slow, grinding process of deflation.

The inflexibility of the euro, writes Krugman, “not deficit spending, lies at the heart of the crisis.” He doesn’t tell the whole story however. Although he is correct to point out that Spain’s massive deficit spending is more of a result than a cause of its current predicament, that same plunging into the red is doing very little to alleviate the crisis. Also, the supposed inflexibility of the euro deserves further attention.

Well before the euro went into circulation, European governments agreed, in 1997, to protect the stability of the Economic and Monetary Union through fiscal responsibility. Member states are bound by the Stability and Growth Pact to keep deficit spending under control. Greece and Space, however, among others, repeatedly violated this decade-old agreement. There is no mechanism in place to punish these countries or even stop them from doing so, which might be argued is a shortcoming of the European system.

Other member states are understandably reluctant to bail out Greece. Doing so would create the same moral hazard the banking sector, especially in the United States, is now confronted with: the expectation that if one screws up, a bailout will always be available.

This is not inflexibility; it is European countries looking after their own interests before anything else. If helping out Greece comes at considerable expense of their own prosperity, there is no reason why they should suffer for the sake of rescuing a neighbor that repeatedly disregarded treaty and behaved in an irresponsible matter that now threatens to harm all of the eurozone.

Spanish Socialism is Hampering Europe

Most of the economies of the European Union are slowly moving out of recession. Both Germany and France are boasting modest growth rates and they are pulling other countries, like Italy, on the road to recovery. There is one country that seems utterly incapable of keeping pace however and that is Spain.

Government stimuli have been of some help but the Spanish national bank warns that early signs of recovery are misleading: because imports have fallen even more dramatically than exports have, BNP-figures might appear optimistic but in truth, the country lacks a solid foundation for economic growth.

During the ten years between 1997 and 2007 the Spanish economy was almost exclusively driven by a rapidly expanding real estate market, producing a stable growth rate of 4 percent annually. In the same period the country attracted almost four million immigrants. Now that construction has come to a standstill many of these people are moving away while millions of Spaniards are left unemployed with so much as two million living off unemployment benefits.

Spain’s prime minister Rodríguez Zapatero came to power in 2004 promising to diversify the country’s economy. He intended to invest in renewable energies, bioengineering, high-speed infrastructure, construction and logistics to encourage innovation and the emergence of a solid services economy. Now, five years later, the prime minister continues to repeat his promise will little progress made in the meantime.

“My government’s ambition is to make this an innovative, creative, entrepreneurial country while upholding the social welfare state,” said Zapatero last July. He foresaw no trouble combining the two at the time. “Some people will say that a social welfare state and a competitive economy are incompatible, that innovation is incompatible with workers’ rights. They want to deregulate workers rights, deregulate social rights. That is exactly the same tune as people who say we have to deregulate the financial markets and I do not dance to that tune.”

As a result, Spain faces both an enormous trade deficit and a deficit on the state’s budget of almost 10 percent with the public debt, of course, mounting fast. Zapatero nevertheless counts on foreign investments to carry his country out of recession although no one in their right mind would entertain the notion of investing in Spain nowadays.

It’s not just money from abroad that is lacking however. Spanish banks are hesitant to borrow which is hurting small businesses and the whole of the real estate market because people can’t a mortgage.

Today, finally, the Spanish government announced long awaited labor market reform after unemployment reached a staggering 19.3 percent in October this year. Zapatero proposes to provide for greater flexibility, reducing high dismissal costs but also reducing working hours to preserve employment: a controversial step that seems unwise considering how little it did to once ail Britain’s economy during the 1970s.

Spain’s lack of recovery left the European Central Bank with a difficult choice to make. As the French economy grows once more it is expected to see inflation go up above the European average next year. France has proposed to temper it by increasing the interest rate (a step Australia and Norway have already taken) although this would hurt the Spanish economy terribly by further depriving it of credit. The Bank had to chose between serving France, whose recovery is helping other European economies also, and supporting wearisome Spain because its own government lacks the political will to do so. For the time being, it elects do to the latter, maintaining the interest rate at 1 percent.