By Professor Arturo Bris - October 2012, IMD website
Professor of Finance, IMD / Research Fellow, Yale ICF and ECGI. Expert in Corporate Governance, Banking and Financial Strategy
(@arturobris (Bris on Deanstalk 15 April, 2012)
Is there a future for the people of Spain once the current sovereign bond crisis is over? Is there any hope for Spanish youth, more than 50 percent of whom are unemployed? While the current outlook does not seem to call for optimism, I believe that with a fundamental shift in Spanish mentality, there are several promising indicators suggesting that this time Spain's real recovery might be in sight.
The release of the central government budget for 2013 is not among these promising indicators, unfortunately. The expectation is that tax increases will result in increased revenues and that together with drastic cuts in expenses, the public deficit will be reduced so as to appease the European institutions that are supposed to bail Spain out. However, with up to 25% of the budget used to pay interest on outstanding debt, there will be less investment in education and infrastructure, a reduction in the number of public employees, higher VAT and higher income, corporate and wealth taxes.
In plain English—public policies will hardly contribute to the creation of employment and wealth. And in a country where 52.1 percent of job seekers under 25 are unemployed and where the overall unemployment rate is 24.6 percent, this is discouraging. Spain now ranks 39 out of 59 in the 2012 IMD World Competitiveness Report (it was number 35 in 2011), below poorer economies such as Estonia, Kazakhstan and Mexico. Unlike in the U.S., the government cannot help the real economy; there is no central bank that could print money. And with bond spreads exceeding 400 basis points the prospects for the recovery coming from the private sector seem gloomy.
Spain's pensions and salaries are already lower than the European average. However, although the retirement age is 65, many start enjoying their retirement benefits much earlier, from as young as 55. This is compounded by the fact that about 70 percent of workers live off the government.
What to do?
- There is no question that those who can pay for the cost of the crisis should do it—this includes public employees who enjoy a lifetime of job security, and the wealthy. Transfers that do not represent an investment in the future of the economy (subsidies, tax advantages to certain sectors and professions) should be eliminated in favor of investments in education and job creation.
- Likewise, the service sector must be liberalized. The ECB Monthly Bulletin argued in August that one explanation for the higher labor costs in Spain is the lack of flexibility in the service sectors (architects, doctors, pharmacists, lawyers) which are quasi-monopolies controlled by professional organizations.
- Raising taxes is unavoidable, but it should be accompanied by taxes on financial transactions and restrictions to financial institutions on dividend and bonus payments. The emphasis on investments rather than certain transfers should result in a massive reduction of the public sector and in particular of the local and regional governments, removing duplications and promoting institutions that foster employment and innovation.
But first and foremost, all these decisions must have the objective of changing the Spanish culture of subsidies and government support. This must be a change that convinces Spaniards that everything—health, education, pensions, highways, libraries and electricity—comes with a price. Last July the government implemented measures so that with some exceptions, people have to pay 40% of their pharmacy bills (these were 100% covered before). As a result, consumption of pharmaceutical products fell by 24% in the first month, which suggests that when medicines are free, people spend more than necessary. Hopefully this change in mentality can come from within Spain, rather than developing as a result of further conditions imposed by the European Union.
There are some good reasons to be optimistic. The recently released analysis of the Spanish banking sector from Oliver Wyman concludes that the total capital needs of the system are €57.3bn, half of what was originally estimated. This is the capital injection that would be needed in the worst possible scenario, one that assumes a 6.5% drop in GDP, unemployment reaching 27.2% and drops in house and land prices of 25% and 60% respectively. Even then, only 7 out of 14 institutions would then need help, and the three largest financial institutions in the country currently display sufficient capital surpluses.
Unlike Italy and Greece, Spain enjoys a strong government that earned an overwhelming majority in last year's general election. While it is true that the recent decisions have upset many people, the government can certainly engage in a massive reform program without the need to reach political consensus.
The weak domestic Spanish economy is balanced with an external sector that has remained resilient during the last few years. Spanish companies have continued exporting, mostly services, since 2008, and Spain is a massive exporter of knowledge and human capital. Between 2007 and 2011, domestic demand dropped by 10 percent in terms of GDP, while the external demand grew by 8 percent.
There are also some positive signals from the outside. First and foremost, the clear statements by ECB President Mario Draghi that the euro would be supported as much as necessary; this has dissipated any doubt on the sustainability of the common currency. What is good for the euro is good for Spain. The recently announced Quantitative Easing program in the US, which will float the market with cheap dollars, will also help Spain by strengthening the euro and thus making Spanish imports of goods and services cheaper.
At the end of the day, Spain's best asset is its people. The IMD World Competitiveness Report shows that in "Availability of Skilled Labor," Spain ranked 41 in 2008 and is number 13 in 2012. The quality of Spanish engineers is sixth in the world, and we have improved 20 places since 2008 in protectionism.
We need the world to believe in us, but we need to start by believing in ourselves.