This article aims to analyse the consequences of the structural reforms and expenditure cuts in Spain. It starts from a theoretical debate of why are these measures taken, continues with the details on the reforms and discussing whether Spain is going to achieve the EU deficit objectives, and finishes proposing a change in the approach at Spanish and EU level.
Too big to fail
Over the last months, a lot of political and media attention on the future of the Euro has been put on Spain, the 12th largest global economy, and 5th within the EU. Likewise Italy – the 7th largest global economy and also subject to financial turbulences- the magnitude of the Spanish economy is of systemic importance for the European Monetary Union.
Both Italian and Spanish economies are too big to allow their failure, as such an event would cause an even greater problem than those of Ireland, Greece or Portugal, despite the two last being on the verge of requiring a second rescue package. These rescue packages are conditional on deep structural reforms and budgetary adjustments in the public sector, based on a short-term drastic deficit reduction aims. But as for Italy or Spain, the European fire-wall mechanism is simply not big enough to allow an eventual rescue on such a scale.
The stated aim for these measures is to regain ‘market confidence’ to allow for debt refinancing. The concern seems sensible: higher deficit means higher financing need, and thus an increment in debt levels, with higher expenditure in interest rate payment (especially if the economy is not doing well), generating an even higher deficit. This risks undermining the performance of the public service in the long-term. Nevertheless, the model of social devaluation is not working in these countries and there is no sign of an imminent recovery.
On the contrary, the current austerity regime is creating a contraction of aggregate demand, provoking a contraction of the economy, resulting in depressed government revenues. The current deep recession period increases in turn the possibilities of default, which in the case of Spain or Italy would be devastating for Europe. Thus, right decisions must be taken, incorporating feedback on the lessons learnt in the recent years about the management of the Euro crisis. The question now is how to avoid an economic collapse, and what remains under debate here is how to balance sustainable public finances with the need for economic policies that create growth and recovery, namely Keynesian anti-cyclical policies.
Spain in the Eurozone growth model
As explained by the economist E. Stockhammer, the Eurozone has institutionalised a monetarist model, with passive States seeking price stability exclusively relying on market mechanisms. This is due to the inflation-capping mandate of the ECB, combined with a very limited Member States’ fiscal policy margins due to the Stability and Growth Pact. This entails labour market flexibility and balanced public accounts, whereas a wage policy at the Eurozone level is not recognised. This has logically led to a steady loss of wage-weight in GDP (for the first time ever capital profits are a bigger part of the GDP).
In this framework, before 2008 the growth model was based on a two-pronged strategy: on the one hand there was a group of export-led countries (centre and northern Europe), namely net exporters to euro and non-euro countries, which gained further competitiveness through a reduction in real labour costs. On the other hand, a group of debt-led countries (the periphery) that grew by expanding internal demand, through public or private debt helped by the deregulation of the financial system. However, after the financial crisis and the changes in global economy, the export-led countries faced a contraction of global demand and lost one of its main consumers: the US. Moreover, the debt-led countries faced huge financial turbulences, followed by socialisation of private losses of their financial institutions.
The current deep recession period increases in turn the possibilities of default, which in the case of Spain or Italy would be devastating for Europe. Thus, right decisions must be taken, incorporating feedback on the lessons learnt in the recent years about the management of the Euro crisis.
The current crisis is therefore a consequence of a clearly unsustainable economic growth model and an extremely deregulated financial sector. And furthermore, the Eurozone has caused high unemployment rates and heavy adjustment policies in the periphery, with high pressure on wages to get a real devaluation, without any other counter-cyclical instruments. Spain is in the periphery group, with a clear debt-led model based on private debt, a property bubble and a weak banking sector. In recent years, public debt has been rising due to the collapse of the private economy. It is worth pointing out that the level of public debt in relation to GDP before the start of the financial crisis was almost optimal and there was even a budget surplus. Thus, the current budgetary imbalances should rather be taken as a consequence of the recession and not its cause or a structural problem of the Spanish economy, as Nobel Prize winner Paul Krugman points out.
What about the economic growth nowadays?
Unfortunately, recent advances in European economic governance have not changed the model. The economic package (6-pack), the new agreement for a fiscal pact and proposed 2-pack seek to prevent and punish deviations from the deficit and public debt rules, as if those were the main and only cause of the recession. Indeed, the structure of the Eurozone and certain ideological orthodoxy, combined with financial anxiety, lead to such a conservative approach. This is namely trying to secure the payment of the credit obligations through public expenditure cuts, before fostering economic growth. We call it the Euro Dogma, and it is supported by monetarist economics, which implies a lack of self-confidence on the strength of the real economy by the EU leaders. This perception caused further speculative financial movements against Euro, leading to a vicious cycle.
It might also be noted that the EU regulates the deficit and debt as a ratio to GDP and not in absolute values. This means that a certain total debt figure (in euro) could be meeting the EU targets under certain values of the GDP (namely in case of economic recovery that would boost the GDP), whereas the exact absolute deficit would not be accomplishing it in case of further recession (GDP decreasing).
But still when focusing on GDP-relative ratios, two main possible strategies appear to reduce the debt weight: the deficit can be reduced through budget cuts or alternatively focus can be put on public investment in economic growth. The second entails an increase in GDP, thus directly lowering the debt ratio. Moreover, the multiplying effect of a recovery also generates more revenue for the State, contributing further to narrowing the absolute deficit. In any case the choice of the term ‘austerity’ itself denotes already a clearly one-sided approach (reducing public deficit through cuts) in front a polyhedral challenge. This is based on the ideological assumption that the market “will adjust” and will provide automatically (and even more efficiently) all what the public sector fails to warrant.
In our opinion, the core focus of the EU and Member States economic policies should be growth, which the EU has for many years preached as its core priority, namely with the Europe 2020 Strategy (and the former Lisbon Strategy). Nevertheless the obsession with austerity is, it seems, conflicting with this strategy. We are facing a horizon of contraction across the whole European economy. The future of the euro is at risk to keep playing the Euro Dogma. The only possibility to break this negative cycle would be firm and devoted action from the Government’s side and the EU institutions to return growth to a priority.
However, Spain is confronted with the only way out allowed by the current Euro Dogma: fiscal discipline, universally understood as expenditure cuts. But the previous austerity measures have deepened the economic crisis where the economic growth was based on the internal market. As the average income is getting lower and lower and unemployment rates are skyrocketing, the average purchasing power of citizens is reduced. Hence, the aggregated demand perspectives are expected to drop heavily, thus strangling internal demand. This is logically having a side effect also in the recovery of export-led economies, such as Germany.
The labour reforms as the proof of mistaken measures
The conservative Popular Party (PP), back in power after the seven year rule of social democrat (PSOE) Prime Minister, Zapatero, has enforced even more severe austerity policies than those already done by the previous Government. But despite the PP winning an absolute majority, these severe measures are making the new Premier Mariano Rajoy lose popularity – PP recently lost two crucial regional elections, worsened by an absolutely chaotic and opaque communicative strategy. Indeed, the lack of public appearances by Rajoy, neither in front of the media nor the Spanish Congress, is not helping to calm the markets: the risk premium (benchmarking their confidence) has not decreased after the reforms, but rather worsened. The PP has always claimed to focus on increasing Spanish competitiveness, whose poor performance is usually blamed for the country’s high labour costs and market rigidity. Consequently, the ‘necessary’ solution was to lower wages and to make firing easy so as to attract national and foreign capital. Again, the Euro Dogma hides the real problem of the lack of credit access for SMEs and the debt-led model.
Already the previous Government introduced in 2010 reforms of the labour market with the aim to simplify the contracting conditions, mainly by favouring flexibility. They introduced temporality mechanisms, especially among youth, with the aim of encouraging the hiring of new employees. However unemployment continued to rise.
The harshest reforms were introduced by the PP, without regard to social dialogue. It extends the programme of deregulation, minimising the compensations for dismissal, giving almost fully discretional power to employers to decide based on alleged economic difficulties. The arbitration of the public authorities is reduced and the bargaining power of unions is heavily undermined: with the new legislation enterprise-based collective agreements overrule the previously prevailing sectoral agreements between employers and trade unions. Of course this in a context of over five million unemployed people which results in fierce competition for jobs. Fundamentally, it provides a strong incentive for employers to undermine working conditions. With a shortage of job offers, and with many unemployed people in desperate family positions, the labour market dynamics are likely to generate a downward pressure on wages. This new reform provoked a new General Strike and massive demonstrations on the previous 29th of March, with larger turnout than the demonstrations against the 2010 reforms. Spain cannot (and should not) compete on the basis of cheap labour costs because this social devaluation only generates an increase in inequality and it closes the way for a consolidated growth strategy in the mid-term.
The true challenges of Spanish competitiveness problems
The structural reforms never aimed to change the economic growth model, though the stagnation is mainly due to the lack of reinvestment in technological sectors and in research and development. There are still fiscal incentives to invest in the real estate sector and in banking, which remains deregulated and there are no incentives to improve the technological capability of the economy. Despite the property sector being the origin of the speculative bubble which increased the level of private debt and ultimately caused the banking crisis, the Government intends to modify planning laws that will foster construction in protected areas.
The future of the euro is at risk to keep playing the Euro Dogma. The only possibility to break this negative cycle would be firm and devoted action from the Government’s side and the EU institutions to return growth to a priority.
However, Spain has enough human capital to undergo a major productive transformation: there are highly educated researchers with almost fully funded public education. Yet the lack of expectations is motivating a phenomenon of brain-drain with a growing emigration of technically qualified youth abroad. This is a major loss for the Spanish economy and a big mortgage towards future development. The only economic answer of the PP Government to this situation has been increasing the tuition fees for higher education by 50%.
Finally, energy is a key element for Spain’s future economy. In a vast country like Spain, with lots of sun and wind, there exists a high potential for renewable energy, and a Greenpeace study states that 100% renewable source energy would be possible by 2050 if the proper investments are carried out. In a context where the oil-related energy is the main source in economic inflation (3,2% in Spain in 2011, due to a 15,7% price increase by the energy sector itself), missing this opportunity is rather uneconomical, leaving ecological consideration aside. Conversely, the PP decided to suppress the financial support to renewable energy, excluding from grants many small and medium producers of photo-voltaic and wind generation electricity. The huge lobby of the electricity giants, like Endesa or Iberdrola, produced a favourable outcome for their corporate interests. Moreover, the fees in the energy bill have been notably increased (7% in electricity and 5% for gas).
Budget cuts in a recession context
The EU Economic Governance framework forced Spain into the Excessive Deficit Procedure, meaning that the Commission and the Council are conducting a strong control and follow-up on Spain’s economic performance. Spain has been also identified by the Alert Mechanism in 2012 as posing a high risk to the stability of the Eurozone, particularly due to the high unemployment rates. But overall, the main pressure exerted by Commissioner Rehn and Council Members led by Chancellor Merkel is on the public deficit figures. After negotiations, Spain has committed to achieve a 5,3% of GDP deficit for 2012 and 3% for 2013.
But these figures have already been questioned by the IMF 2012 World Economic Outlook report and the Roubini Economic Institute, which estimate that Spain is more likely than Italy to default on its debt. Despite the recession and these pessimistic forecasts, the EU and the Spain are maintaining the line that Spain will achieve a 3% deficit by 2013 by sticking to this Euro Dogma. The market does not have faith in these targets anymore, and it seems to accept that these cuts are pushing the deficit targets beyond reach.
Analysing concrete figures, education and health bear the biggest brunt of these cuts, despite being the two main pillars for social cohesion and welfare state. Concretely, the 2012 budget entail a contraction of more than €10 billion, plus the burden directly transferred to citizens, as with the mentioned tuition fees (averaging €600 per student and per year). These measures will create many future economic drawbacks throughout the society (increased social exclusion and risk of poverty, increased sickness, etc.) and they clearly affect those sections of society with lower income, who cannot afford private support.
Conversely, the military budget faces one of the smallest cuts, with only an 8% of reduction, in comparison to an average cut of 17% in all other ministries or the 50% cut in the department of Cooperation and Development, which shows a clear ideological priority in terms of foreign affairs. It is has to be noted that the new Defence Minister used to be one of the key executives in the Spanish weapons industry.
However, Spain has enough human capital to undergo a major productive transformation: there are highly educated researchers with almost fully funded public education. Yet the lack of expectations is motivating a phenomenon of brain-drain with a growing emigration of technically qualified youth abroad.
Furthermore, the Science Ministry has disappeared in this new executive and €600 million in scientific research has been cut; the total cut in the R&D amounts to 25,5% compared to 2011 and over 41% if compared to 2009 levels. On the contrary, the economic grant to the Catholic Church (amounting up to €11 billion in the 2012 budget, including some transfers for semi-public religious education) remains untouched. This a clear strategic mistake, especially if the Government wishes to increase Spain’s competitiveness.
What about raising the public revenues?
Fiscal consolidation can be achieved through State expenditure and revenue. Unsurprisingly, the decision is to focus only on cuts, with a particular emphasis on the public services. But balanced accounts could be equally achieved by increasing taxes. Of particular importance from a social justice perspective would be the contribution of the wealthiest sections of society. It is important to recall that Spain is at the bottom side on fiscal pressure within Euro Area. It is also one of the countries with the highest tax evasion (with over 60 billion euro of lost revenue, an amount far above the deficit reduction targets). Big corporations and wealthy fortunes have fiscal engineering methods to escape the expected heavy taxation, namely through secondary companies, and based on the core fact that the capital profits attract a lower rate of taxation than income (around 21%, compared to over 40% for high income levels). Thus, the total hidden economy volume is estimated to be over 20% of GDP.
In other words, there would be a margin to increase the revenues raised if decisive action was taken, but this would involve assaulting the privileges of the top financial and corporate sector. Actually, despite having increased the corporate tax revenue by 5 billion euro (basically by lowering existing deductions for companies), the Government introduced a ‘tax amnesty’ that excused the non-payment of 22.5 billion euro in return for the Government receiving 2.5 billion euro.
Using the crisis context for political objectives
The Government is clearly not acting with the same passion in all fields, and the consequences of this are born by the most vulnerable citizens. And actually, the Euro Dogma is also affecting the power correlation between the Central Government and the Regional authorities: the reduction of the deficit is a problem transferred also to the regions, which hold the competences on basic services provision, particularly health and education.
Yet the reforms explained before have also a political background The PP is starting to introduce medicine co-payment into the public health system and already PP regional Governments have introduced large increases in public transport fares, namely 11% on average and between 25% and 50% for the most popular tickets and packages. They are clearly raising indirect taxes instead of direct taxes, which are not only affecting those with the lowest income; this approach is also a part of the recentralisation strategy of the PP.
This is of course a major attack on the constitutional pact with the regions with strong national identity. Moreover, in Catalonia, the new right-wing Government of Catalan nationalists (CiU) since November 2010 already applied drastic cuts in the public sector, so far much deeper than those envisaged by the PP. In the same spirit of breaching the constitutional consensus, the exclusion of trade unions from the dialogue around labour reform suggests a unilateral rupture from the idea of developing a consensus for a joint way out of the crisis. This is actually happening at the whole European level, where the tacit social pact in post-war Europe between capital and labour for social peace in exchange for increased quality of life, guaranteed by a strong welfare state model, is cracking.
Growing social opposition and tension climate
With such an authoritarian approach, added to the growing social discontent caused by unemployment and collapse of the public services, it is only natural that social unrest increases. Already the defeat of the outgoing PSOE Government and the ‘Indignados’ movement born from the May 15th protest showed a clear lack of confidence by the average citizen in traditional politics, with massive protests calling for democratic regeneration. Besides, the budgetary cuts in education have created massive student demonstrations. One of them, last February in Valencia, lead to the shaming image of brutal police repression, one of the toughest in the post-Franco era- towards minors, as a response to peaceful secondary-education students protests on the lack of decent infrastructure, resulting in many injuries.
The continuation of reforms and particularly the new labour laws are likely to result in an escalation of social conflict. As mentioned, the trade unions are left with no option but to organise protests, as shown by the General Strike of May 29th, and with future ones expected given the inflexible approach of the Government. The sole response from the Government’s side to this climate has been to prepare a law where, among others, the call for peaceful assembly and demonstration is penalised, which is a clear violation of fundamental rights, or in other words, Gandhi would have been prosecuted nowadays in Spain, and civil disobedience can be treated under terrorist law.
How to go out of the Euro Dogma and boost the Spanish Economy?
To sum up, the situation in Spain, mainly created by the panic of the financial market, is starting to be socially risky. First of all socioeconomically, because of the more than a million households without any employed member, and without the prospects of this changing in the short to medium term, and secondly because of the increasing disappointment with the Government and the frustration, generating social tensions, which can end up turning into desperation and strong street mobilisations as witnessed in Greece.
The exclusion of trade unions from the dialogue around labour reform suggests a unilateral rupture from the idea of developing a consensus for a joint way out of the crisis. This is actually happening at the whole European level, where the tacit social pact in post-war Europe between capital and labour for social peace in exchange for increased quality of life, guaranteed by a strong welfare state model, is cracking.
In our opinion, it does not make sense to stick inflexibly to a certain debt percentage on a certain deadline, the accomplishment of which cannot be guaranteed anyway, at the expense of ruining millions of lives and leaving social cohesion behind. We are convinced that the future socioeconomic and political cost of this for Europe of it will be much higher than the current debt figures, the fear around whom started mainly due to the financial bubble.
We need rather to focus on the real economies of the peripheral countries, and try to adopt proper anti-cyclical strategies to help them recover. This has to be done both at the State but moreover at the European level, leaving national interests aside, and in the spirit of true European federalism. We are convinced that there are enough funding mechanisms within the current legal framework (Eurobonds, fiscal harmonisation, Financial Transaction Tax…) to achieve this objective and it is just a matter of political will. We need strong leadership to proceed, escaping from the easy blame on the stereotypical ‘Latin culture of laziness’, and understand that we have to redefine the meaning of competitiveness inside the EU. After all, the commercial balance in an internal market is a zero-sum game, where one partner can only win if the other loses. This is why we should not look at the size of each portion but rather increasing the size of the whole cake. And this can only be done if we manage to solidify the internal economies of the countries, achieving an aggregated internal demand boost. And we will of course not achieve that by strangling the purchasing power of consumers. Either empathising with the overall approach or not, everyone should realise that the contraction of the economy goes against the core logic of capitalist theory, still at the heart of policy making. We can say that Euro Dogma entails at least a fundamental contradiction.
 In 2007 government debt was 36.1% GDP and public surplus was 1.9% GDP (Eurostat)
 The weight of labour incomes over GDP has dropped by around 15%, progressively during the last thirty years and in the end of 2011 the capital gain were already than the aggregated labour gain. The unitary labour cost has dropped by 1,9%. http://economia.elpais.com/economia/2012/02/16/actualidad/1329424061_546148.html
 Eurstat figures show that in 2010 Spanish tax revenue over GDP was 32,9% while Euroarea was 40.2%