World Economy

Spain Returns to Recovery

Spain Returns to RecoverySpain Returns to Recovery

There has been some recent buzz about the economic performance in Spain. Bloomberg reported that Spain posted its best quarterly performance in eight years and June home sales was up 14%, which was the best performance since March 2014.

Indeed, euro area statistics show that Spanish GDP growth has improved considerably. Labor costs have nosedived since 2008, and Spain is becoming more competitive. The unemployment rate has begun to improve, though it remains painfully high compared to the rest of the eurozone, Cam Hui wrote for Seeking Alpha.

One example of this is cars and trucks. Spain has long been the second-biggest manufacturer of vehicles in Europe. (The plants are all owned by the major German, Japanese, American, Korean, and French labels, but the cars are made in Spain.) However, the trade surplus has increased since the crisis.

At the 2007 peak, Spain made around 2.9 million cars. Now it makes closer to 2.6 million. Meanwhile, domestic car sales collapsed from about 1.6 million before the bubble to around 900,000 now, although Spanish new car registrations are now growing by more than 20% annually. More than 80% of the cars currently made in Spain are exported elsewhere.

 Productivity Boom

In addition, the country is undergoing a productivity boom as the financial excesses of the last cycle have been repaired.

At the peak in the middle of 2008, Spanish banks were sending about 3.4% of Spain’s GDP to foreigners. Now they send less than 1%. Meanwhile, Spain’s banks still receive almost as much income from abroad, as a share of GDP, as they did before. The overall difference between payments to foreign holders of Spanish assets and income received by Spanish holders of foreign assets has shrunk by about 2 percentage points of GDP between the start of 2009 and the end of 2014.

Despite the extensive deleveraging in the aggregate, particularly among Spanish businesses, the most productive and export-oriented firms actually increased their borrowing to expand capacity and invest in domestic production. This could help explain the post-crisis Spanish productivity boom.

 Grand Plan

A recent Bloomberg View article outlined and applauded Prime Minister Mariano Rajoy government’s efforts. First, there was the macro leg of government austerity:

His government bowed to austerity demands, cut public-sector wages and benefits, and increased VAT to 21% (with exemptions) from 18%. Had he stopped there, Spain might have bumped along the bottom for a good while longer, rather than seeing the recovery it’s now enjoying.

The second, and equally important, part was the micro-economic solutions of structural reform:

Spain’s recovery today also owes a lot to hard reform aimed at particular failings in the economy. The Rajoy government braved street protests and the rise of an anti-reform left-wing opposition and persisted in a deliberate rewiring of the Spanish economy, with an emphasis on far-reaching labor-market and tax reforms.

In 2014, the government said it would gradually lower the corporate tax rate to 25% from 30%. The top marginal rate on personal income will fall to 45% from 52%. The government is limiting deductions, broadening the tax base and making a serious effort to curb evasion.

Companies have been given more flexibility to set wages and working conditions. Wage growth that had run ahead of productivity has moderated. The barriers that created Spain’s notorious two-tier labor market, with its underclass of workers on temporary contracts, have begun to fall.

The draconian approaches began to pay off, though there was an element of luck involved. Low inflation, a cheap euro, the fall in energy prices and renewed financial stability in Europe have supported consumer spending and lifted Spain’s beleaguered retailers. Holidaymakers have favored Spain this season, too–in part because visiting Greece without bundles of cash has presented difficulties. Put much of all that down to luck.