Spanish Financial Crisis

There were many causes of the Spanish financial crisis, and the damage wrought to the wider economy. Much like th case of Ireland, Spain underwent a huge property bubble in the early ‘00s. Home ownership, traditionally very high in Spain, caused property prices to soar to unprecedented heights. However, the labour market remained stagnant, and so the levels of indebtedness of households rose dramatically. High levels of public spending, was endemic among the majority of Spain’s regional authorities, who spent lavishly on infrastructure. Chief amongst these was Valencia, who spent over €150 million on the Castellón–Costa Azahar Airport, which at the time of writing, has had a total of one flight depart (Villareal’s football team). Spain’s banking sector, while historically very well respected, had its restrictions severely loosened by Congress during the bubble.  Many borrowed recklessly from international markets to fund developers at home, leaving them liable to huge losses. The Great Recession, when it hit, ravaged through Spain like the perfect storm. The property bubble burst, leaving thousands in negative equity, unemployed and unable to pay their bills. Banks suffered catastrophic losses, while Spain’s regional governments, so reliant on property taxes, saw their deficits balloon to unsustainably high levels.

Austerity Mark 1

In reaction to the contraction of the Spanish economy, the government set out to implement the countries first austerity measures in 2010. This was a 15bn-euro plan to harness public deficit and ease the financial crisis within the red state. The cost cutting plan consisted of:

·         A pay cut of 5% for public workers within the state. (This cut was planned to be frozen for 12 months but lasted 3 years)

·         Birth pay-outs to parents were removed

·         A bank bail-out fund, known as the FROB, with firepower of up to €99bn was created and urged weaker savings banks to merge to improve their solvency.

·         inflation-adjustments for retirement pensions adjourned

·         1.2bn euros of expected funding for the regions of Spain were void

Initially these measures seemed to help Spain avoid the brunt of the financial crisis, as it exited recession in the first quarter of 2010. However, the public deficit had grown to an alarmingly high rate of 11.42% of GDP, which led to intensive speculation of a bailout. To sooth the markets, Prime Minister Zapatero announced austerity measures worth around 1.5pc of GDP. €15 billion of spending cuts were announced over two years including;

·         A two percentage point rise in VAT, are worth an estimated total of 5pc of GDP.

·         Labour Market reform

·         Retirement aged raised from 65 to 67

·         Constitutional amendment requiring governments to keep balanced budgets

·         New transparency rules for banks

·         Civil Service Salaries cut by 5%, Ministerial Salaries reduced by 15%

Unfortunately, the austerity measures contributed to a rise in unemployment and a double dip recession. The scale of the government cut banks and wage freezes led to huge social unrest and protests in major Spanish cities. The measures taken did not succeed in reassuring markets, as Spanish bond yields remained very high. The budget deficit shrunk by a smaller amount than expected, as nominal GDP fell.

In November 2011 Zapatero and his Socialists were swept from power and replaced by Mariano Rajoy and his Centre-Right People’s Party

Austerity 2.0

Prime Minister Mariano Rajoy, in July 2012 announced further austerity measures totalling to €65 Billion, further sinking the Spanish population’s burden. This was the largest fiscal adjustment in Spain in the 30 years since democracy was restored in the country

·         Sales tax increases from 18% to 21% and some reduced rate products such as food rise from 8% to 10%.

·         Cuts in unemployment benefits and civil service salaries.

·         Ministry budgets cut by €600 million

·         Proposal for 20% cut in subsidies for labour unions and political parties

·         Reduction is size of public administrations, aimed to save close to €3.5 billion. Many inefficient public companies were scrapped, while plans were made for many more to be privatized.

The budget, while on the face of it harsh, proposed backlash from European leaders for being too soft. Under the rules of the Euro, countries must keep their budget deficits below 3%. The above budget reduced Spain’s deficit to a very gentle 5.8%. This was largely a result of the previous government’s denial of how large the deficit was.

The bailout that wasn’t

However, rising unemployment and the bailout of the banking conglomerate Bankia led to Spain entering a double dip recession in early 2012. Yields on Spanish debt rose to 7%, leading to Spain effectively being shut out of the international bond markets. On the 9^th of June 2012, amid mounting political pressure, Spain’s government agreed to €100 billion bailout from the Eurogroup. As Europe’s 5^th largest economy, the collapse of Spain would have put the whole Euro project in doubt, with ECB president Mario Draghi saying he would do ‘whatever it takes’ to save the currency. Spain’s bailout differed from the bailout of other Eurozone countries as the IMF were not involved and the funds provided were used to rescue Spain’s banking sector and not the country itself. However, this distinction is largely pedantic, as the bailout was required because Spain could not afford to pay for the debts of its banks. The rescue package came with the requirement that Spain reform its banking sector.

Key Fiscal Aggregates

Household debt ballooned in Spain during the early days of the 21^st century. Since the Great Recession, many homes have fallen into negative equity and so have struggled to pay it off. While it has declined in recent years, this high level of indebtedness severely hinders growth, and the austerity and tax rises imposed by the Spanish government has not helped this.

Unemployment in Spain reached record high levels following the fiscal contraction. Much of this was due to Spain’s stubborn labour market, with a clear distinction between temporary workers, who are easily fired, and long-term employees, who are much more difficult to remove. In addition, with Spain so heavily reliant on property for growth, the bursting of the bubble led to huge knock-on effects throughout the economy.

However, this is dwarfed by its Spain’s youth unemployment, which reached a staggering 55% in 2012. Much criticism has been leveled at Spain’s education sector. No Spanish university is among the top 200 in the world. During the economic boom, one in three people were early school leavers, flocking to easy jobs in the construction sector. Research, development and innovation spending, at 1.3% of GDP, is way below that of other developed economies.

Spain’s government was heavily reliant on taxation from property sales in the pre-crisis years. When this dried up, government revenues shrank, at the same time expenditure on unemployment benefit was soaring. The guarantee of the banking sector further increased the debt, which is now just over 93% of GDP.  Austerity has done little to ail this problem, which goes some way to explaining why Spain’s gross debt has reached record highs in recent years.

The deficit was cut to be below the 3% target mandated by the ECB. But in the years following the Crash, it has increased drastically. While the austerity imposed by successive Spanish governments have reduced this somewhat, the record unemployment levels have eroded much of these gains.

GDP was strong in Spain for many years prior to the ’08 recession. Because of its reliance on its property sector, Spain largely managed to avoid the tech crash of ’00, unlike other Eurozone countries such as Germany, who suffered sharp fiscal contractions. When the crash hit Spain was plunged into negative growth rates. As the government tried to cut the budget deficit, Spain entered a double-dip recession. While Spain has now exited recession, growth nevertheless remains elusive. It has propped up its economy mainly through exports, leaving it vulnerable to a supply shock or a contraction in global demand.

Spain is home to few natural resources, and so in pre-crisis years it ran huge trade deficits and focused on its property and tourism sectors at home. Key exports for Spain are car parts, machinery and chemicals. High unemployment (and thus lower wages) and a falling euro have made Spain very attractive exporter, but this is not without its drawbacks. Spain and the Eurozone will not remain in the doldrums eternally, and though it may take some time, unemployment will fall and wages will once again rise. If Spain becomes overly reliant on its export sector, this could leave it prone to cyclical shocks.

  

Fiscal Outlook for the next 5 years.

Spain’s economy has overcome the worst of the financial crisis and now is on the rocky road to recovery. What the country really needs is a large fiscal stimulus to boost growth and create jobs. However, the ECB and the Germans remain fiercely opposed to such expansions, and so the idea must be shelved for the time being. Perhaps the most immediate threat to Spain is political; Rajoy and his People’s Party face re-election later this year, and many voters are eager to punish them for the harsh austerity measures imposed. Set to make major gains is Podemos (‘We Can’), a far-left anti-austerity party which allies itself with SYRIZA in Greece. The danger is that should Podemos gain power, they will undue many of the labour market reforms or drag Spain out of the Eurozone, both of which would cause major contractions. One positive for Mr Rajoy is that SYRIZA, despite offering hope of reversing the ECB’s policy of Austerity, has thus far proved utterly incompetent in its negotiations with the Euro leaders, and so Spanish voter’s may be reluctant to hand Podemos power.

The recession and its aftermath have also threatened the very existence of Spain itself. The prosperous Catalonia region has become ever more demanding of independence. Less well known, the coastal region of Galicia also yearns for nationhood. High unemployment, Austerity and laggard growth have only strengthened cries that both these regions would be better off alone. he loss of either would be devastating to Spain, and so it is of vital importance that the country return to a positive economic climate.

Looking at the more long-term future, Spain needs to alter its primary economic focus to something more sustainable. Property is far too volatile, while export-led growth, as mentioned above, in not an ideal situation for an economy to be in. Instead, Spain should focus on improving its quality of education across the board to make it more in line with EU averages. It is no coincidence that a country which spends so little on education has such high youth unemployment, and is something which needs to be redressed. The Spanish market, if one includes Mexico and South America, is huge and Spain is ripe for becoming a world-leader in producing highly-educated, Spanish speaking individuals.