Spain: Reform Reversal Could Threaten Recovery

The Spanish recovery from the worst crisis in decades has been impressive and an example for other European countries. In these five years, Spain has been able to recover more than half of the jobs lost during a crisis that was initially denied by the previous administration and afterwards deepened by misguided policies, spending more and increasing structural imbalances.

Since then, Spain has slashed its fiscal deficit by half and cut a dangerously high trade deficit to almost a balance. The fact that exports have risen to 33% of GDP is also relevant as Spain´s largest trade partners have remained stagnant or in recession in the period.

External factors have helped, of course. Support from the ECB, low interest rates and cheap oil prices support the economy, but those factors should have also helped European economies like Italy, Portugal or Greece, with similar sensitivities to energy and interest rates and neither of them have shown the growth and recovery seen in Spain.

In the past two years, Spain has created more than 1 million jobs and is the second country in the European Union in terms of full time job creation.

The reason for the difference in performance of Spain relative to other neighbouring countries has been a very ambitious set of structural reforms that were recently praised as an example for others by the president of the European Central Bank, Mr Mario Draghi. A financial reform that helped change the perception of risk of the Spanish financial system, a labour market reform that turned around a seemingly unstoppable trend of unemployment and recovered jobs and salaries, a moderation in government spending without reducing social expenditures and a fiscal reform in 2015 that reduced corporate and income taxes. Public debt, although elevated, has been contained relative to GDP in the past three years.

These have been deciding factors that have driven a recovery in which inflation was non-existent and global trade was slowing down. But they came at a cost, as we have seen in many other countries where tough decisions had to be made, and the new government was unable to secure an absolute majority in the past elections. Now, external and internal forces could put the recovery in danger and weaken the economy again.

A complicated political landscape that requires the conservative Popular Party government to negotiate with the opposition, the socialist PSOE and centrist Ciudadanos, means that reforms are already under attack. In Spain, the entire opposition demands large expenditure increases. Most of them aim to reduce deficts relying almost entirely on the elusive call to raise taxes “to the rich” and fight tax evasion. Two historical false solutions. Last year, Spain saw tax revenues rise more than nominal GDP and achieved record collection from evasion initiatives and the country still missed its deficit target. Spain has had deficits every year since 1980 except during the massive real estate bubble. Relying on tax increases and revenue measures has historically been a bad choice because spending rises above those revenues and estimates tend to be missed, as the ECB has pointed out in “Fiscal forecasting: lessons from the literature and challenges”.

As for the labour market reform, calls to re-introduce previous rigidities and eliminate the 2012 reform will not solve Spain´s structural problems. Spain has had an average 17% unemployment since 1980, with three different periods where it rose above 20%. Temporary jobs were already more than 25% of all contracts before the crisis. Going back to the mistakes of the past will not solve a long-term problem that has more to do with low productivity and small size of companies than promises of “workers´rights” that never happen. Solving Spain´s unemployment problem will only come from creating many more companies, attracting investment and letting SMEs grow.

But there are also external forces that could threaten growth and job creation. The IMF is requesting Spain to raise some VAT tranches, which could hinder the nascent consumption growth. Additionally, Brussels seems adamant on seeing Spain undertake anti-growth measures by returning to the old mistakes of rising taxes and spending on white elephants.

So far it seems that the agreements between socialists and conservatives is aimed at a “least harm solution”. The so-called tax increases are in fact just limits to the maximum amount that large companies can deduct from the tax base in a single year, so the corporate tax rate is unchanged. Meanwhile, the changes in labour law, including increasing minimum wage, are expected to have as little impact on SMEs and job creation as possible. But the Spanish government must remain vigilant and reject proposals to increase taxes and impose more labour market rigidities that go radically against the measures that leading countries are taking.

Spain cannot ignore that the global trend is to decrease, not increase, corporate taxes. Because it is proven that reducing the tax burden has a direct positive impact on investment, job creation and attraction of capital. The country cannot ignore either that the positive effects of the labour market reform have been noted by countries such as France, notorious for resisiting flexibility for decades, that is aiming to replicate a similar law to boost job creation.

The imbalances of the Spanish economy, an elevated public debt, large deficit and still high unemployment, will not be solved by looking at the past, but learning from the economies that have emerged from the crisis stronger and with higher job creation, such as the UK, Ireland and Germany. Supply-side reforms, attracting foreign investment, putting more money in companies and citizens´pockets and improving public sector efficiency while retaining a strong but sustainable social component.

Spain can grow more than consensus again in 2017, faster than the 2.5% expected, as it has done in the past two years. Spain has proven that it can create more than 500,000 jobs a year and that it is not a one-off. But the forces that put brakes on this trend are not small.

It is time to avoid the temptation of relying on low interest rates and fall under the trap of increasing imbalances, which has been Spain´s historical mistake. Every time that things start to improve, governments go back to excessive spending, debt and rigidity. The foundation for a more sustainable growth and higher job creation has been set. But, like in 2012, when many experts called for Spain to request a bailout that the government correctly rejected, this administration must be adamant at keeping the reformist agenda and avoid looking at the past errors. It will be challenging and difficult to agree, for sure, but history tells us that raising taxes and spending more will not add spice to a recipe of success, it will ruin it.

Daniel Lacalle is PhD in Economics and author of “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)


Picture courtesy of Google Images

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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