Has Spain’s Economic Contraction Now Become Self Perpetuating?

Spain’s political leaders are in cheerful, almost jubilant, mood at the moment. Economy minister Luis de Guindos, speaking in Davos, declared the tide had turned, and forecast that the Spanish economy would return to growth in the second half of 2013.“The perception of the Spanish …

Spain’s political leaders are in cheerful, almost jubilant, mood at the moment. Economy minister Luis de Guindos, speaking in Davos, declared the tide had turned, and forecast that the Spanish economy would return to growth in the second half of 2013.“The perception of the Spanish economy has improved and will continue to do so over the coming weeks and months,” he told his audience at the World Economic Forum. In similar vein, he told Spanish journalists in Moscow last weekend that Spain’s economy no longer being a key theme at G20 meetings was another welcoming sign of the times.

As ever, Spain’s economy sage is hedging his bets – earth shattering the growth will not be, but grow the economy will, this is his mantra. Put another way, the bottom in Spain’s economic collapse has now been passed. From here on in the road may be winding, but it will be up. Perhaps, he suggested, the economy will be stationary in the third quarter, and then we will see growth, albeit ever so slight, in the fourth one. And quite possibly he is right. The core of the issue is not whether the country could see one, or even two, quarters of positive performance, but whether any faltering recovery will be sustained out into the future, through 2014 and beyond. It is here that all the old doubts really emerge.

The brunt of the argument which says the country is now about to see a resurgence rests on the idea that Spain’s government have now enacted sufficient reforms to enable the economy to return to a strong growth path. Optimists claim they will, which the skeptics like myself are not convinced at all.

Certainly Mr de Guindos can point to occasions where he has carried the argument. Back in October last year, when he told an audience at the London School of Economics that Spain didn’t need a bailout they simply laughed. Four months later it is looking increasingly unlikely that the country will seek additional EU aid in the short term. “Spain doesn’t need any sort of bailout,” he told Bloomberg TV recently, and this time no one laughed.

Perhaps the key point here hangs on your interpretation of the word “need”. If paying around 5% on your 10 year bonds is considered to be an acceptable cost for financing your country’s debt – Germany, for example is paying around 1.7% – then there is no need to apply to the EU and trigger ECB bond buying via the Outright Monetary Transactions program. If, on the other hand, you think the country could well benefit from lower funding costs, and the kind of pressure for reform which would be exerted from the outside though a Memorandum of Understanding, then clearly a bailout is needed.

Personally I take the latter view, since personally I think the country still has a long way to go in terms of reforms and since it is clear that introducing more measures that bite would be massively unpopular (and especially in the context of all the recent corruption scandals), the shelter provided by a troika driven program would make implementing them a lot easier.

Pension reform is a case in point. With the country’s elderly dependency ratio rising rapidly, and the number of people paying contributions into the pension fund going down by the month, the whole system is badly out of balance and urgently needs some deep structural reform. According to estimates provided by EU economics commissioner Olli Rehn at the last Euro Group finance ministers meeting, shortfalls in the pension system added more than 1% to the fiscal deficit in 2012. And without major changes in the system this problem will only get worse. Yet Spain’s political leaders are apparently incapable of addressing this problem in public…

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