Director’s take on Spain’s economic jeopardy, I’m So Excited should remind the Rajoy government that the end is still in doubt
A plane circles in the sky with a damaged undercarriage. The passengers get up to high jinks as they wait for the inevitable crash landing. A cast of call girls, gay cabin crew and a crooked banker on the run says this is your traditional 1970s-style Hollywood airline disaster comedy. In fact, it is how Spain’s most renowned film director, Pedro Almodóvar sees the current state of his country.
Needless to say, that is not the view of Mariano Rajoy’s government in Madrid. While not disputing that Spain has its problems, the administration say the wipeout that was looming last summer has been avoided.
Proof is that financial market conditions have eased since Mario Draghi said that the European Central Bank would do whatever it took to safeguard the future of the euro. Spain used the breathing space to patch up its creaking banking system with European money, and has subjected itself to an eye-watering austerity programme that makes George Osborne’s deficit reduction plan look like Keynesian largesse. Labour market reforms – wage cuts and more flexible working practices – have repaired the damage caused to competitiveness by the construction and housing bubble of the 2000s, resulting in multinational firms moving production to Spain from higher cost parts of the eurozone, such as France and Belgium.
Spanish policymakers also think Europe-wide developments are helpful. Governments are being given more time to put their public finances in order and there is growing confidence in Madrid that a banking union will be agreed despite German reservations. Spain, with its still-fragile banking system and bombed-out real estate sector, is desperate for a pan-European system for resolving bank crises and for guaranteeing deposits, and thinks that in the end Berlin will come round to the idea.
Indeed, Rajoy’s government favours not just banking union but fiscal union, with a European finance minister having control over a budget that could be used to boost growth in struggling parts of the eurozone.
Spain says two things are needed to make the single currency work better: economic reform at a country level and a more integrated macro-economic policy at European level. Madrid argues the single market can only work effectively with a fixed exchange rate system, because a floating rate system would allow member states to grab competitive advantages through devaluation. But giving up control of interest rates and exchange rates can be costly in terms of lost jobs and output unless there is a more activist fiscal policy. This, Spain believes, is what Europe lacks.
The political will to make this happen is often underestimated in Britain. Spain thinks it had no choice to join the euro once Germany and France had decided to go ahead with the project. What’s more, it is convinced monetary union will survive unless Germany decides to pull the plug on France: the one country that has always been able to rely on support from Berlin when the going gets really tough.
Beneath the surface in Madrid, there is simmering anger at the refusal of Germany to help struggling countries by importing more, and resentment that different rules seem to apply to unreformed France. But there is no deep-seated euroscepticism and certainly no nostalgia for the peseta; rather an acceptance that if Spain did regain control of the printing presses the country really would be in trouble.
Even so, the threat of a crash landing remains. That’s not just because unemployment in Spain has risen by three and a half million since the start of the crisis and has now reached 27%, or that the domestic economy has shrunk by a sixth. It is that Spain is up to its eyeballs in debt, with no likely improvement in prospect. Despite austerity, little progress is being made in reducing the budget deficit and national debt is heading for well over 100% of gross domestic product. In the absence of more rapid growth and a banking union being agreed swiftly, a Greek-style debt restructuring seems eminently possible.
Spain is perhaps the emblematic eurozone country. Its past performance reflects the design flaws in the single currency; it is trapped in a low-growth, high-debt vortex; and it can only recover if a reluctant Germany backs plans for integration.
Let’s take those three points in turn. Interest rates were cut when Spain lost control of its own monetary policy by joining the euro, leading to over-investment in the property sector. There was misallocation of resources on a grand scale as banks lent recklessly for commercial and residential property projects. Governments everywhere love construction booms because they generate the two things politicians like: jobs and tax revenues. Spain’s was no exception.
The dark side of the real estate bubble was that the private sector ran massive deficits, worth more than 10% of national output by the time the music stopped. Left to its own devices, Spain would have run a much tighter monetary policy during the first half of the 2000s, but the European Central Bank kept interest rates low, which at the time suited Germany.
Recession led to private sector retrenchment. Firms went bust, real estate projects were mothballed, banks stopped lending, investment plunged and consumers stopped spending. The private sector moved into surplus, but this was matched by a public sector deficit of 10% of GDP.
Spain’s boom was accompanied by higher inflation than in the rest of the eurozone, so its goods became uncompetitive. Devaluation was ruled out by membership of the euro so Spain opted for the German solution; grinding out improvements through structural reforms of labour and product markets.
This brings us on to the second problem; the lack of demand either at a domestic or European level. Madrid’s entire economic strategy is based around the idea of export-led growth. It sees no prospect of a pick-up in domestic demand until 2015 but is confident that the economy will start to grow in 2014 because hyper-competitive Spanish goods will clean up across the eurozone and beyond. Yet the improvements in the trade balance seen so far have largely been the result of falling imports rather than rising exports. This is hardly surprising given that every eurozone state is doing what Spain is doing: squeezing the domestic economy and relying on exports to take up the slack. This cannot happen.
Finally, there is the German question. Madrid is certainly right in its assumption that Berlin does not want to blamed for breaking up the euro, but Angela Merkel has been doing her best to slow down the pace of reform.
Germany is no hurry for a banking union, let alone a fiscal union, but will do just enough to prevent a crash landing. The risk, though, is not just of a crash landing, but that the plane hits the ground with an almighty thump because altitude has been lost without anyone realising it.