LONDON – Spain is the eurozone’s latest poster child for austerity and structural reforms. Its economy has expanded for eight consecutive quarters, steadily gaining momentum and easily outperforming the rest of the currency union.
Export growth has matched that of Germany; unemployment has fallen by over a million people in two years; investment is picking up; and industrial production has jumped 5% in the last 12 months.
But Spain’s recovery is not quite what it seems, and there is scant evidence that what progress the country has made is the result of austerity and reforms.
Little evidence of improvement
In fact, far from adhering to the usual austerity narrative – according to which fiscal consolidation revives business confidence and thus investment and job creation – Spain’s return to growth partly reflects the easing of austerity since early 2014. The country has sensibly resisted pressure from the European Commission to take more aggressive steps to reduce its deficit, which, at 5.9% of GDP, was the European Union’s third highest last year.
Likewise, there is not much evidence that structural reforms have spurred Spain’s recovery. True, the OECD reports that Spain’s markets for goods and services are freer than they were before the crisis; but the country has made no more progress than Italy, whose exports have performed poorly.
Moreover, though OECD data point to modest deregulation of Spain’s labor market, there is little evidence linking deregulated labor markets with improved competitiveness and exports. Germany’s exports, for example, have performed strongly, even though the country’s labor market is more tightly regulated than that of France, Italy, or Spain.
In any case, Spain’s recovery is less robust than it seems. Even if the Spanish economy grows by 3% in 2015 and 2.5% in 2016, it will not return to its pre-crisis size before 2017. Had the economy expanded by 2% annually since 2008 – that is, at half its average growth rate from 1999 to 2007 – it would be over one-fifth larger than it is now. Furthermore, consumption and investment are still down 12% and unlikely to recover that lost ground before 2020.
The gulf between GDP and domestic demand can be explained largely by a collapse in imports, which were 15% lower in the second quarter of 2015 than they were in the final quarter of 2007, owing to declining living standards, mass unemployment, and depressed investment. Strikingly, industrial production is still lower than it was at the depth of the crisis in 2009.
While Spanish exports have increased by 18% since the fourth quarter of 2007, this largely reflects the fact that Spanish export prices have risen much less than those of the other large EU countries. And Spain’s export growth has been powered by price-sensitive low-value-added sectors like fuels, foods, and raw materials, not Spanish firms’ movement up the value chain.
The biggest driver of growth in Spain over the last year has been increased private consumption, fueled by falling unemployment and rising real wages. While this is all good news, it requires some context.
For starters, the fall in unemployment over the last two years includes the 300,000 people who have departed from the labor force. Most of the jobs created during this period have been in low-paid services, especially tourism, while overall employment remains 14% lower than its pre-crisis peak – the worst performance of any eurozone country except Greece.
The rise in real wages, meanwhile, is being driven partly by temporary factors. While nominal-wage growth has picked up, real-wage growth reflects the slide into deflation. As economic actors adapt to weaker inflation, real-wage growth will likely decline. Indeed, growth in nominal wages slowed sharply in the second quarter of this year.
Low inflation may have helped to boost the price competitiveness of Spanish exports, but it is far from benign. Nominal GDP is lower than it was seven years ago, meaning that debt is being serviced from a stagnant or declining income. Spain’s overall level of debt (government, households, financial firms, and non-financial corporates) is barely below its 2012 peak and still far higher than in 2008.
Five reasons to be skeptical
There are plenty of reasons to be skeptical about Spain’s growth prospects. First, inflation is likely to remain very low, with many more years of high unemployment bearing down on prices and the European Central Bank unwilling to pursue the aggressive monetary easing needed to raise them (making it difficult to reduce the real value of the country’s debt burden).
Second, with low inflation pushing up real borrowing costs, capital and skilled labor are heading to stronger countries where inflation is higher. The Spanish government lacks the funds to counter this effect with public spending, and the eurozone lacks fiscal mechanisms to compensate weaker member states.
Third, recovering domestic demand will lead imports to rise more rapidly than exports. That will renew the current-account deficit and worsen Spain’s already weak net-external-asset position.
Fourth, Spain’s working-age population is set to shrink rapidly. Amid high unemployment, this may not seem like a problem; but it typically leads to weak economic growth that undermines a country’s debt-reduction prospects.
Fifth, the combination of unfavorable demographics and overhang of empty homes will prevent a strong recovery in the housing market. As a result, construction activity is set to stagnate at low levels.
Another deep recession is likely
Finally, Spain is likely to enter the next downturn having barely recovered from the previous recession, with high levels of public- and private-sector indebtedness and unemployment well above pre-crisis rates. Given the paucity of policy tools available to boost domestic demand, another deep recession is likely.
The story of Spain’s recovery is not quite “lies, damned lies, and statistics”; but nor is it the inspiring narrative of policymaking courage and vindication that many observers make it out to be.
The reality is that Spain now faces the daunting challenge of boosting productivity amid persistently low inflation, a heavy burden of domestic and external debt, restrictive macroeconomic policies, and serious demographic challenges. And that is a story that does not necessarily end well.