THE SPANISH REVIVAL / PROJECT SYNDICATE

The Spanish Revival

Helga Jung

JUN 3, 2014



MUNICH – After fighting for its life for the last two years, Spain’s economy finally seems to have moved out of intensive care. The banking sector has been deemed “cured”; demand for Spanish bonds has soared; and the country can once again raise capital at reasonable interest rates on the market. But much more work must be done to ensure a stable long-term recovery.

First, the good news. Investor confidence is on the mend, exemplified by the recent placement of €10 billion ($13.8 billion) in ten-year government bonds – which was over-subscribed by four times. While risk premiums on ten-year bonds remain far above pre-crisis levels, yields have dropped considerably, from 4% at the beginning of 2010 to 3.2% today. And a growing number of banks and companies are returning to the capital market.

Moreover, the Spanish economy returned to growth in the third quarter of last year, and is on track to grow by roughly 1% this year. If, as expected, GDP grows by about 2% next year, Spain will outperform the eurozone average and create an environment conducive to significant long-term employment gains.

Perhaps the most notable consequence of Spain’s recent reform efforts is its current-account surplus – the country’s first in more than two decades. At the peak of the crisis, Spain’s current-account deficit amounted to an unprecedented 10% of GDP.

Much of this progress reflects surging exports, which grew at an annual rate of 5.2% in 2013, outperforming Germany. Rapid export growth, together with a drop in imports, enabled Spain to halve its trade deficit last year. In fact, Spanish factories have boosted their productivity to such a degree that they are now taking orders away from their European competitors.

It should be noted, however, that productivity gains are partly attributable to a massive wave of employee layoffs – the dark side of economic remediation. Likewise, the reduced labor costs and falling inflation caused by recession and austerity helped to boost Spanish firms’ competitiveness within the eurozone.

To be sure, wage and price adjustments, including temporary developments affecting food and energy costs, have turned Spain’s inflation rate negative, at roughly -0.1%. But worries about potential deflation scenarios are unwarranted. On the contrary, by increasing Spaniards’ real disposable incomes, low inflation is helping to stimulate private consumption, fueling a corresponding improvement in economic sentiment indicators, including consumer trust.

And yet, despite these positive indicators, Spain’s long-term economic recovery remains far from certain. One critical test of its trajectory will be how investment activity develops over the next few quarters. Though investment stabilized in the second half of last year, it remains well below pre-crisis levels.

The challenge is not simply to increase investment, but also to ensure that it is sustainable, unlike before the crisis, when excessive allocation of capital to real-estate development caused construction and related sectors to become overheated. This time around, investment must be spread across all sectors, boosting their competitiveness and, in turn, their contribution to GDP growth.

Fortunately, the outlook appears promising, with increased private-sector confidence, rising capacity utilization, and an encouraging sales outlook for companies. Ongoing fiscal consolidation – and thus strong pressure to keep a tight rein on the budget – will, however, restrict public-sector investment.

The most potent threat to Spain’s economic recovery stems from the labor market. With an unemployment rate of 25.3% – and youth unemployment running at 53.9% – the situation appears grim. Making matters worse, despite considerable gains in the last quarter of 2013, employment growth is far too weak to make a significant dent in joblessness.

In 2012, the government implemented sweeping labor-market reforms to increase companies’ internal flexibility (making it easier to dismiss permanent workers and facilitating wage moderation), and introduced a model for reducing workers’ hours. But such changes take effect slowly, and often not until the recovery phase.

Given this, the government must do more to boost employment in the short term, especially among young people, whose knowledge, effort, and entrepreneurial spirit is critical to Spain’s long-term economic success. Additional measures to improve vocational training or extend part-time work, for example, could prove to be invaluable.

The final challenge facing Spain is government debt, which currently amounts to nearly 100% of GDP. So far, efforts to curb public debt have centered on painful austerity measures, including substantial cuts in the supply of public goods, especially health care and education. At the same time, pension reform – including adjustments in how benefits are indexed to inflation – will ease some of the pressure on the public budget. Such measures, together with further liberalization of protected domestic sectors, will strengthen Spain’s economic-growth model considerably.

The risk now is a relapse into reform fatigue. While a slowdown in the pace of reform might bring temporary relief, it would almost certainly reverse Spain’s hard-won achievements. Indeed, with the worst now over, complacency is the Spanish economy’s worst enemy.


Helga Jung is a member of the Allianz SE Board of Management.