Green shoots of recovery amid economic uncertainty in Spain

Spain is showing signs of recovery as the country shifts to an export-driven economic model, writes author.

"Spain's economy had been heavily dependent on the housing market and real estate construction since the time of the dictatorship of General Francisco Franco in the 1950s," writes Steven Hill [AP]
In a few short years Spain went from being a country with budget surpluses, a growing middle class and generous social supports for families and workers to one with a collapsed housing market and chronic unemployment rates north of 25 percent. In response, both socialist and conservative governments have enacted the most wrenching austerity policies in order to lower wages, make the country more “business-friendly” and shrink government deficits caused by the bailout of Spanish banks. Even as the first green shoots of economic recovery emerge, Spaniards are trying to regain their footing after the earthquake.
And yet, there is a noticeable lack of panic among many of the Spaniards with whom I have spoken. Beyond the news stories and official statistics, I have always been struck at how remarkably well Spaniards have coped with this challenging time. One does not walk around Madrid, Barcelona, Bilbao, Seville or the other regions and think, “Wow, this place is falling apart” – quite the contrary.

The streets still are teeming with people in the cafés, tapas bars and plazas, the public space still is energised by street musicians, sidewalk artists, and dramatic flamenco performances. The transportation systems, both within cities and the high-speed rail crisscrossing the country, are world-class (the train I rode recently from Madrid to Barcelona sped along at over 180 miles an hour). Spaniards still all have health care, unlike nearly 50 million Americans, as well as other social supports, and while I have noticed an increase in the number of homeless people, there are still far fewer than I see in downtown San Francisco or New York City. The protest movement of young people known as Indignados has transformed itself into an effective movement against foreclosures and evictions. That indomitable Spanish spirit of duende survives.
How did Spain arrive at this surreal place and moment? There are lessons for everyone in understanding what happened, for Spain has become the quintessential “canary in the mineshaft”, the country that did everything right and still ended up on its back.
Spain’s economic crisis – a diagnosis

When the global crisis struck in 2008, Spain was headed by the socialist government of Prime Minister José Luis Rodríguez Zapatero. Unlike Greece, the Spanish government was not a chronic over-spender; Spain’s debt was a mere 36 percent of its gross domestic product (GDP) in 2007, about half of the German and US governments’ debt at around 65 percent of GDP. The Socialist Party wasn’t stocked with bank industry shills, or slavish admirers of greedy capitalism, and yet they quickly disappointed their leftist supporters as they tried to cope with the collapse of not only their economy but of Spain’s decades-long economic model.

By 2007 the levels of private home ownership stood at 87 percent, one of the highest in the world.

Spain’s economy had been heavily dependent on the housing market and real estate construction since the time of the dictatorship of General Francisco Franco in the 1950s. This was an anomaly from the rest of Western Europe, which was enjoying a post-war boom in manufacturing growth. But all things considered, it was a fairly successful policy and when Franco died and the dictatorship ended in 1975, even the first socialist government under Felipe González (1982-96) continued the basics of this economic development model.

As noted by researchers Isidro López and Emmanuel Rodríguez, an ongoing property bubble, aided by an expanding European financial industry, remained Spain’s domestic motor for economic expansion, fostering rising aggregate demand and private consumption which boosted the broader macroeconomy.
For many years this strategy worked. Spain had high unemployment throughout the 1980s and 90s – often over 20 percent of the work force – yet in less than three decades it rose from being a poor, backward country run by a dictator to a modern, wealthy, technologically-advanced European social democracy. Starting in the 1990s, the Spanish bull economy grew at an annual rate of nearly 4 percent, much faster than other European economies or the US economy. Millions of jobs were created and by the mid-2000s the unemployment rate was in single digits for the first time in modern history. By 2007 the levels of private home ownership stood at 87 percent, one of the highest in the world (it’s never been above 70 percent in the US).
The Spanish middle class had arrived. But just as the American, Irish and British middle classes would soon discover, housing prices always rise – until they don’t.
The global economic collapse of 2008, the most destructive since the Great Depression in the 1930s, started in the housing markets of the US, fanning out around the world like a tsunami. Suddenly the sector that for decades had driven the Spanish economy crashed. For-sale signs were so abundant that one acquaintance joked to me they had become Spain’s national tree. 
From stimulus to austerity
In coordination with its US and European allies, initially the Zapatero government used stimulus measures to dull the worse effects of the global recession. The Socialists launched the largest stimulus package in the European Union, measured as a share of the economy. The specific policy interventions were exactly the type that stimulus hawks like Paul Krugman and others had called for to create jobs, boost consumer demand and counteract the stark decline in business activity. 

Despite that intervention, the Spanish economy was still stagnant by 2010, except now government deficits were rising at an astonishing rate. Regional banks and governments, which political parties had historically used to reward their cronies with construction projects (e.g. sports stadiums and “airports to nowhere”), began to fail en masse. It fell to the national government to take on these debts. 
Practically overnight, Spain’s debt burden doubled. As Greece’s own crisis raised fears of its default, European leaders feared a domino effect could engulf Spain, Portugal, Ireland and even Italy, and threaten the stability of the euro currency itself. European leaders were looking into an abyss and fearing an imminent collapse of the entire post-World War II project. The Zapatero government came under immense pressure from both its European allies and the bonds markets to cut its spending.
If Spain controlled its own currency, it might have printed money and risked inflation to pay off its debt. Instead, Spain is tied to the euro and has little control over monetary policy. So Zapatero felt he had no choice but to cut spending and raise taxes to win back the trust of the bonds markets from whom Spain borrowed to cover its debt. His plans included a 5-percent salary cut and a salary freeze for public employees, a cost-of-living freeze for pensions, a higher retirement age, the elimination of “kiddie stipends” (the widespread European practice of providing several hundred dollars per month per child to families), an increase in the value-added tax, and modest cuts in health spending.
These cuts weren’t merely painful – they hurt public employees and pensioners, the heart of the Socialists’ core constituency. Austerity, which had destroyed hundreds of thousands of jobs, would inevitably destroy the Socialists, themselves.
Easy to fire, easy to hire
Spain’s austerity program didn’t just exacerbate the recession, it also exposed a crucial rift at the heart of the economy between job-holders (insiders) and job-seekers (outsiders). Spain’s economy has long afforded strong protections to the insiders, making it harder for the outsiders to break in.
“Insiders, such as labour union members and public employees, strongly prefer employment protection schemes that protect their jobs,” says Professor Mariely Lopez-Santana of George Mason University, who studies Spain’s labour markets. “Outsiders, such as the unemployed or those with temporary employment, favour policies that reduce labour protections to pry open more jobs.”

Some estimates put the underground economy at 20 percent of overall GDP.

As the number of outsiders grew during the recession – including swelling numbers of unemployed young people and immigrants – and as many insiders lost their jobs anyway and suddenly found themselves as outsiders, the Zapatero government responded by scaling back some of its employment protections for the insiders. For example, the government made it easier and less costly to lay off workers, and drastically reduced its generous severance pay. It’s cheaper to hire somebody, the government reasoned, if it’s also cheaper to fire them.

Leftist critics accused the socialist government of selling out yet it was hard to deny the downward trajectory of the economy which prompted the government’s interventions. One small business owner with eight employees told me he would have to pay about $14,000 in severance per employee to lay off two workers that he couldn’t afford any more because his sales were down 40 percent. “Please explain to me how my business is to survive,” he asked me, “under the weight of all those employees that I no longer can support. Most of my friends are business owners. The talk when we get together is that we are all struggling to find some way to survive.”
Other coping strategies were tried, including an increasing number of people willing to work under-the-table, allowing employers to skirt the law on severance pay and other labour protections. In fact, Professor Lopez-Santana says that many people claim that the unemployment rate actually is substantially lower than the official 26 percent because so many employees work in the grey economy and so don’t show up in official figures. Some estimates put the underground economy at 20 percent of overall GDP.
Out of the frying pan, into the fire
Labour unions responded to these interventions from the socialist government by calling for a series of strikes and demonstrations. The Indignados took over central plazas in many cities. The daggers were drawn among erstwhile allies. With frustration and outrage boiling over, in 2011 the electorate tossed out the Socialists in both national and many regional governments in favour of the conservative People’s Party, which then enacted even harsher austerity measures.
Spanish-style austerity has been a tough path to follow, but just recently the fragile signs of a recovery appeared. The government has announced a slew of good news: exports are up 8 percent – higher than Germany’s – which has resulted in a trade surplus of 2 percent; bond yields (the cost of government borrowing) are staying down and economic growth is up for the first time in three years. Prime Minister Mariano Rajoy told La Vanguardia the economic crisis “es historia”. Yet the recovery so far is a “by the numbers” one that most average people I talk to have failed to see any trickle down from.
Perhaps most importantly, however, the recovery may have begun the difficult process of moving the country away from over-dependency on housing/construction and tourism, and toward a more German-style economy driven by exports of everything from automobiles to hot tubs, pharmaceuticals, textiles, machinery and software. About 60,000 firms are now exporters, 9 percent more than last year. Most observers seem to agree that exports have been aided by the reduction in wages that has been wrung from workers, with Spain’s unit labour costs narrowing the gap with Germany by 5.5 percentDuring the boom years of the previous decade, Spanish wages had risen 40 percent relative to German levels, so this could make Spain’s exports more competitive.
Looking forward, Spain has many assets working for it, beyond its renewed focus on manufacturing and exports. Those include a highly educated and skilled workforce, and a burgeoning green tech industry that has made Spain a leader in solar and wind power. It also has an ideal climate and a gorgeous landscape that make it a tourist mecca, and outstanding infrastructure and mass transportation. As a Spanish-speaking nation, it benefits from a natural trade simpatico with the fast-developing economies in Latin America. If the Arab Spring survives and deepens, Spain’s geographic proximity (its coast is only 36 miles from the Moroccan coast) would allow it to benefit from relations with those developing economies as well.
And in many ways Spain remains remarkably resilient. Credit for this factor must go to various pillars of support, most notably strong families. José Ignacio Torreblanca, director of the Madrid office for the European Council on Foreign Relations, explained that involved families are motivated to help each other, especially parents and grandparents assisting their adult children by drawing upon savings. The unemployment rate for the “principal breadwinner” is about 14 percent lower than the overall rate, so this appears to be mitigating the pain.
For Spain, as well as for the rest of Europe, this economic crisis has been a wake-up call. The last few years has shown the limitations of their old economic model which, like in the United States, relied on speculative asset bubbles which led to unsustainable private debt. As Europe is slowly emerging from painful austerity, which hurt aggregate demand throughout the continent and increased inequality, even in better-off Germany, it is also trying to set course for a more sustainable economy driven by exports and steady growth rather than fragile bubbles. Finding the sweet spot with the right mix of business-friendly incentives, worker protections, a properly regulated banking sector, and a viable export strategy is a challenge that no nation on earth has yet mastered. As the recent wrangling over the US debt limit shows, Spain is not the only country sailing in uncharted waters.

Steven Hill is a political writer and columnist.