Spain: Austerity, Yes Please

“Rather than attempting to return to Their artificially inflated GDP numbers from before the crisis Governments need to address the flaws in Their Underlying economies” R.Rajan, Univ Chicago

“Governments are always Keynesian when it comes to spending. When it comes to saving They Become Stalinist “

We have read some terrible economic news for Spain . Unemployment of 27.16% and a deficit that reached 10.6%. A 7.1% excluding banking aid. Spain, for the fourth consecutive year, reached a deficit of more than 100 billion euro. That’s a level some politicians want to relax!!! . However, we have also received great news that we should not forget. The banking sector has recovered 25% of the deposits lost in 2012 and the corporate debt has fallen to 2006 levels.

Germany is right

The cleansing processes of overly indebted, low productivity economies are painful, but the greatest risk we face, without a doubt, is trying to perpetuate it.

What I have not read in most media analysis is that these unemployment figures are dramatic result of the same atrocious, unjust and anti-social policy we want to repeat .

What did Spain do when the housing and civil works bubble burst?. Double the bet, giant stimulus plans that took the country from a surplus of 5% to an 11% deficit, which today generates almost 60 billion euro per year of structural deficit. Perpetuate an unsustainable model, creating a social and economic situation that is practically insurmountable, playing “next year everything will be solved” and “blame it on the Germans-Draghi-Cameron or whoever.” Today, lo and behold, the fault lies on everyone but us and the solution, of course, can only be to repeat the same disaster of the government-led stimulus.

Look at this chart on the growth of spending throughout the housing bubble and the myth of lost tax revenues.

Indeed, Spain should be the first to avoid useless formulas, in a country that has suffered the devastating effect of competitive devaluations in the 90s and today suffers the brutal impact of the bet to give even more money to spend to the same politicians that have brought us to the brink of bankruptcy.

Germany is right … because their model works . Their adjustment process lasted from 2004 to 2010. The focus on competitiveness and high productivity sectors is precisely what has led them to be successful today. Something we wrongly call austerity and that it is nothing more than prudence, common sense and balancing the budget .

We say that Germany was the first to breach the stability pact. Sure, by a percentage point … not six. And making hugely significant reforms. But in Spain all we hear is “Germany has to undertake fiscal expansion to help the periphery” and “the ECB has to print money and let us borrow more”.

This analysis from Cubism Economics is very telling

Let’s do the numbers for the impact of a German expansionary policy in Spain:
– German imports from Spain were Eur 22bn in 2012, 2% of Spain’s GDP.
– Let’s be optimistic and say that a fiscal expansion in Germany would lead to a 5% increase in its imports from Spain. This amounts to 0.1% of Spanish GDP.
– Let’s say that Spain’s foreign trade multiplier is 2.5. This would lead to an increase of 0.25% in Spanish GDP.
– Let’s be optimistic and further assume that the fiscal expansion in Germany by having an impact in its imports from other countries, leading to an increase in their GDP, which in turn would lead to an increase in their Spanish imports set the Spanish foreign trade multiplier at 5.
– The result would be an increase in Spanish GDP growth of 0.5% as a result of a German fiscal expansionary policy.
– A similar exercise could be run for Portugal (0.75% GDP growth) and Greece (0.25% GDP growth).
All nice to have, but it wouldn’t solve the EU periphery’s underlying problems. If anything, it would only perpetuate them by delaying necessary reform implementation.

We should emphasize several factors:

  • The risk premium with the Bund below 300 points basic is good news, but it is not a blank check to spend and get Spain back into a debt shock. We should not confuse global excess liquidity with signs of recovery.
  • Monetary policies do not replace inefficient and subsidized models, or allow the substitution towards high productivity models. In fact, it perpetuates an economic system where the Spanish public spending consumes 50.2% of the country’s GDP (including public enterprises).
  • Relaxing deficit targets does not improve the economy. Spain has been allowed to miss its deficit target five times and nothing has improved.

Solving debt with more debt is simply enlarging the hole created by a hypertrophied welfare state.

Any economist, Keynesian or not, knows that a process of massive indebtedness ends only in three ways. With a debt default, massive devaluation or financial repression. We forget that if we continue building debt and keep spending the budget cuts will be more severe when the saturation ends and drastic measures are taken. No, there is no other solution but austerity.Excel Sheets and magicEuropean leaders have jumped to call against austerity because studies by economists Ken Rogoff and Carmen Reinhart contained a miscalculation, though their conclusion, that the most indebted states grow less, has not been denied.

Look, it’s simple. If we have any doubts about whether countries with debt above 90% of GDP grow less or enter recession, wait a few weeks and we will will check it in all its glory in Spain (where, on the other hand, the debt to GDP exceeds 110% taking all elements).

Where is the austerity?

In 2007, in the middle of the bubble, the Spanish government spent 413 billion euros. In 2012, 494 billion. After all the “cuts”, and 32 tax increases, public spending is still about 80 billion higher.The debate over austerity or growth is, therefore, useless. Because there is no other solution. because there is no austerity, just moderation of excess spending.”We have to spend more” … “relax the deficit” -hey, it was only 110 billion euro in 2012 – to “get out of the crisis.” Are we sure? What do they want?,? A deficit of 12%, 13%? A debt of 120%, 130% of GDP?… To stimulate demand … what demand? Ah, of course, the demand of crony sectors living off grants and subsidies which have lost 20 billion of government spending for unneeded high speed trains, empty airports, ghost towns and idle bridges.

If Spain grows next year it will be a miracle. But even if it does, the structural weaknesses remain in a country that cannot generate net job creation unless it grows by 2% its GDP.

Chart courtesy of in austerityThere is no growth without public spending? Untrue. Without crony government led investments Spain can replace an economic model based on construction and civil works for one based on services, technology and exports.

Let businesses grow, they are behaving admirably when you look outside the huge conglomerates. Stop the crowding out of the state on the real economy.

Spain must lower taxes urgently
Spain suffers one of the highest fiscal efforts in Europe, affecting mostly SMEs and middle class households.

Spain is not going to get out of the crisis led by the sectors that got the country in recession, a disproportionate public spending and highly indebted savings banks. It has never happened. But if the State recognizes that the only thing that will get us out of the crisis is the middle class, what they have to do is increase the disposable income of families by cutting taxes, and the solution will begin from the consumption side.If the State recognizes that the companies that lead the economic model change can not be sabotaged with a confiscatory tax policy and bureaucracy, we will have the solution to employment. To create jobs, not to ‘moderate the rate of destruction’. The labour reform is not going to be successful without a business environment of absolute clarity, legal certainty and low taxes to attract capital.If the State recognizes that the principal financier of future projects can only come from foreign private investors , it will implement the reforms that curtail the bureaucratic assault on entrepreneurs that we see on a local, regional and state levels. Not reduce it, not mitigate it. Sever it. Open windows. Show that Spain is open for business.

The capital that will create jobs will not be from the Ibex 35 companies, which have a much higher number of employees than their European and global peers. In addition, almost 50% of private debt in Spain is concentrated in 28 companies of this index. The capital that will create jobs will not come from a State that still holds many more employees and advisers than needed (3 million public workers, 20,000 advisers).It will come from those companies that did not borrow aggressively, allowing them to grow cutting taxes and helping create new companies.

There is no worse policy than uncertainty. We must put Spain open for business . Open to attract capital and grow, not attract debt and subsidies. If not, we will make the same mistake we made in 2007.

This article below was published in El Confidencial in Spanish.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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