Institute for Research in Economic and Fiscal issues

IREF Europe - Institute for Research in Economic and Fiscal issues

Fiscal competition
and economic freedom


The chances of a successful recovery in Spain

At the beginning of 2008, Spain experienced an unprecedented bust in the housing market. The bust triggered a banking crisis and a recession. Moreover, Spain has dealt recently with political instability. The results of December 2015 and June 2016 election were inconclusive and only in October 2016 Spain’s parliament voted to allow conservative leader Mariano Rajoy to lead a minority government, after a 10-month political deadlock. Even if led by a powerless government, Spain has recently become one of the fastest-growing economies in Europe. The newly appointed government, however, now faces critical challenges. The next impending decisions will determine the chances of a successful recovery in the long run.

Is a government essential to ensure economic recovery?

Compared to last year, in 2016 the Spanish economy has grown 3.2% and has created 500,000 new jobs. Household consumption has also started to grow (0.6%), together with construction (0.2% and 0.5% in the last two quarters). Goods news comes in particular from a sustained increase in exports. Between 2000 and 2013, the overall value of Spanish exports rose more than 90%. Unemployment and the consequent reduction of wages have clearly helped Spanish firms acquiring competitiveness compared to other European exporters.

At the same time, Spanish entrepreneurs have been able to react to the challenges created by recession, and redirected sales outside of Spain, after the collapse of the domestic demand. The economy, however, still faces at least two critical challenges, namely the size of the national budget deficit and high levels of unemployment. The way the newly appointed government will deal with these challenges will define the chances of success for the country in the long run.

Challenges Ahead

Unemployment. The unemployment rate now stands at 18.9%. Although it is the lowest since the end of 2009, it is still one of the highest in the western world. Mr Rajoy has promised to create 1.5 million jobs, focusing in particular on getting the long-term unemployed back into the work. This is not going to be easy and, surely, this goal cannot be achieved only by inertia or uniquely relying on the tourism sector and the strong demand for temporary labour. A coordinated set of reforms will be necessary, covering the labour market (e.g. flexibility and productivity), education(e.g. apprenticeships) and welfare(e.g. a complete reassessment of the benefits system).

Budget and public spending. Mr Rajoy is currently negotiating a national budget for 2017 in a very hostile parliament. To add to this, there is pressure from Brussels to narrow the nation’s deficit (the Commission requires Spain to limit the deficit to 4.6% of GDP this year and 3.1% in 2017).

Contrasting statements and worrying actions

Spain’s Economy Minister, Mr de Guindos, has recently released statements that, on paper, appear to move in the right direction. He has urged European governments to look beyond fiscal stimulus and, rather, to target free trade. He has also expressed also concern regarding the banking industry.
At the same time, however, the Budget Minister, MR Cristobal Montoro, has said that only the corporate sector will be the focus of the tax reforms. The government already introduced new rules according to which companies with revenues of more than 10 million euros a year will have to pay taxes up front (23% for most firms and 25% for banks). It is, however, unclear whether additional corporate taxation is effective or fair. Mr Montoro is also promising to reduce the national budget by 5 billion euros, but it is still uncertain whether and how he will be able to achieve this goal.
Like in other European countries, the banking sector is closely watched by economists and regulators. Some banks and regulators have expressed concerns about the increase in competition in the lending market. It is not obvious that the increasing concern of regulators about the profitability of banks is appropriate at this stage. A competitive lending market, able to support the housing market with affordable mortgages and the business sector with loans, is essential for the recovery of Spain. In this respect, in particular, the slow pace at which the government is considering the privatisation of Bankia, (bailed out and nationalised in 2012) is rather worrying and frustrating, and will anger those private retail banks which have long argued in favour of the privatisation of bank.

The Spanish economy has managed to show signs of recovery on its own. What Spain and the international markets need now is clear intents and coherent actions by Mr Rajoy’s government. In particular, comprehensive reforms to reduce unemployment and bold actions toward a drastic reduction of the national budget are badly needed. Moody’s, one of the world’s biggest rating agencies, has released a warning. 2017 budget plan will be the “first key test” for the new government. Brussels and international markets are waiting. If Spain will not address these impending challenges swiftly and adequately, it will find itself again on the brink of a new crisis.

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