World Economy

Spain Pain to Remain

Spain Pain to RemainSpain Pain to Remain

Madrid’s unemployment figures, released Friday, showed Spanish joblessness dropped to a four-year low of 21.2% in the second quarter of the year.

The numbers are more evidence that Spain is the current superstar economy of the euro. The former bail-out country, which was embroiled in one of the worst banking and house price collapses in Europe just four years ago, is now proudly held up as the EU’s model economic pupil, NewsNow reported.

The economy will be the fastest growing of the eurozone’s “Big Four” – Germany, France, Italy and Spain – over the next two years, expanding by 3.2% and 2.5% respectively, according to the International Monetary Fund. This compares to just 1.5% and 1.6% in Germany, and a paltry 1.2% and 1.5% in France. Madrid’s growth rate will also surpass the bloc’s average of 2% and 2.2% over 2015-16, as it races ahead of the rest.

The secret of this success lies in the implementation of belt-tightening measures and structural reforms, as demanded by Brussels, or so the story goes. Yet the economic turnaround has attracted high-profile critics. The recently-departed chief economist of the IMF has rubbished talk of a growth “miracle” in Spain. In a new report, Simon Tilford at the Center for European Reform also pours cold water over the dominant narrative of the Spanish recovery.

“There is no evidence that (growth numbers) are the result of austerity, and not much evidence that they are the product of structural reforms,” writes Tilford.

Spain’s exports have been held up as the backbone of its stellar growth performance since 2013. Buoyed by a cheap euro, exports have boomed over the past two years. Key to this growth has been the economy’s “remarkable cost adjustment process” – where it has managed to slash wage costs – helping to “transform the export sector into a lean and mean machine, able to compete at a high level”, says Angel Talavera at Oxford Economics.

 Cause for Concern

But buoyant exports have also been accompanied by falling imports, as suffering Spaniards have endured lower living standards and high unemployment, notes Tilford. The composition of the exports is also a cause for concern. More than half of the growth has come from “low-value” goods like food and fuel.

Economists say this undermines the claim that the country’s export success is directly linked to structural reforms and a drive towards deregulation. If export industries are to really power a sustainable and robust recovery, they will have to rely less on temporary factors such as a weak currency and low wages, and move towards more advanced manufacturing. So far, there are few signs of this.

Spain remains mired in deflation. Falling prices are an ostensible boon for economic growth as they bolster consumer income. But with consumer prices falling by -0.9% in September, this descent into deflationary territory has dangerous implications for economic growth and debt costs.

Spain’s nominal GDP – a measure of growth which includes inflation – is now lower than where it was seven years ago. This measure is an important gauge for central banks, who target an implicit rate of around 45 to 5%, finds Tilford.

 More Pressure

Falling prices are particularly pernicious in an economy with a high debt burden. Spain’s current debt-to-GDP ratio stands at 94%. The process of paying down this debt is doubly hard when prices fall, increasing the real value of the liabilities and placing more pressure on the public finances.

“Despite firms, households and the government trying to save more and spend less, and banks shrinking their balance sheets, Spain’s overall debt level is higher than in 2008,” the CER report says.

Spain’s cyclical recovery is not to be sniffed at. But its economic fundamentals – such as unemployment, productivity and debt – mean it is vulnerable to another major “external shock”. Tilford notes that “business cycles seem to be getting shorter and downturns deeper”. In this regard, Spain “will have few policy tools at its disposal to combat a renewed weakening of domestic demand”.

 Political Risk

As ever in the eurozone, political risk also looms. Elections later this year are set to shatter Spain’s long-dominant two-party rule. Ascendant parties – the pro-reform Citizens’ movement (Ciudadanos) and anti-austerity Podemos – will complicate the business of coalition forming.

But, regardless of who takes power, fiscal expansion is off the cards. The European Commission has already sent back Madrid’s draft budget plans, demanding more cuts and higher tax revenues. Meanwhile the ECB’s QE program is set to expire at the end of 2016, and record low interest rates are on course to tighten.

In the words of Tilford: “Spain faces plenty more pain.”