Since late 2006, there has been a deceleration of the American economy that has particularly affected the real estate and construction sectors. This negative trend has been confirmed with GDP growth rates hovering around 2%, representing a much lower performance than in previous periods.

 

Adding to those troubles, the subprime mortgage financial crisis is greatly affecting financial markets as well as stock markets because their investment tools securitize enormous volumes of high-yield, high-risk debt sold to banking organizations and investment funds worldwide. When the mortgage default rate increases – no matter how small it may be, and fearing it becomes widespread – a vast sell-off pertaining these debt titles is triggered, causing that their value sink practically to nothing, and as a result, there is a drop in the valuation of similar assets creating a financial domino effect.

 

As a consequence of this situation, in the last three months, a greater aversion to risk and an apprehension toward accumulating positions in new assets have been perceived in international financial markets (as well as in Spain), making it difficult to place numerous bond emissions in the markets when they were being placed until very recently without any problems.

 

All these factors and, particularly, the feeling of unrest before an abrupt change in price expectations, have resulted in the development of an international financial crisis starting this summer that it is threatening to infect the real economy with a credit crisis and continued stock markets losses that might provoke a fall in consumption.

 

This situation can affect Spain, even though it does not hold positions in the subprime market. The aversion to risk actually supposes an increase in the price of money and a greater difficulty to attract capital. (Fig. 1)

 

Source: Markit.

 

*Crossover index: It tracks the credit cost of the 50 largest European issuers of debt. It is considered the investment barometer.  

 

When credit becomes expensive, it can be specially damaging to Spain because it is one of the world’s most heavily indebted countries in relation to its GDP.

 

The negative real interest rates going on for years have stimulated an increase in corporate and household indebtedness that, in the case of the latter, represented mainly investments in property. The Spanish economy has greatly benefited from low interest rates and has experienced continued growth, sustained by an increase in consumption and the construction sector. On the other hand, the increase in value of real estate assets has produced a wealth effect on the Spanish population that has stimulated consumption even more. (Fig. 2)

 

 

 

Source: Bank of Spain

 

In 2006, according to the OECD, the construction sector represented almost 10 percent of Spanish GDP, more than double the rate of any other European country. During several years, 40% of all new home construction in the Eurozone has taken place in Spain and the price of real estate has only gone up in spite that homeownership rate – in  other words, the number of families owing a housing unit – is the highest in Europe. 

 

 

Source: OECD

 

Facing a credit crunch – in other words, a drastic raise in the cost of mortgages along with the depletion of demand – it is foreseeable that supply would also decrease and the construction sector would be severely affected. The real estate sector will be the first to be hit as a consequence of the credit market situation, in particular due to the credit price increase to real estate developers who will not be able to place their building projects on the market without a drastic downward adjustment in house prices.

 

 

The greatest risk that the Spanish economy may face would probably not come as a result of the international situation, but due to the absolute inability of the present Socialist government to tackle an imminent cooling of the economy, and to take the right measures. 

 

In a frivolous and foolish way, and showing a lack of humility, Spanish citizens continue witnessing triumphant displays in which the Executive – behaving in a self-congratulatory way, so ridiculous as uncalled for – enhances the present economic situation while the financial advisers pray that positive economic growth will last until Election day.

 

The reality is that the problems of the Spanish economy are not limited to an

activity reduction in the construction sector. Spain has a serious problem with  competitiveness, proven by the fact that, since Spanish Prime Minister Jose Luis Rodriguez Zapatero took office, the Spanish current account deficit has tripled. (See fig. 4)

 

 

 

 

Source: Bank of Spain. Report on Performance

 

This is not the direct responsibility of Spanish authorities because they no longer have the devaluation tool, and, evidently, they cannot influence what Spaniards buy. However, it is their responsibility that, since the last term, Spain has not gone through deep reforms to give impulse to the economy. For example, in spite of the government’s promises, the labor market has not become more flexible and labor costs have increased 60 percent faster than in any other Eurozone country.

 

Economic productivity became the Socialist Party’s electoral motto. The Socialists pledge to improve it, and when in power, they even approved the so-called 100 measures to improve productivity, now all forgotten and useless. If one observes the diagram below, Spain cannot be satisfied with its productivity evolution (Fig. 5)

 

 

  

Source: OECD

 

 

In addition, the government of Spain has practiced an erratic budgetary policy. After Zapatero stated that he would never be president of a government with a surplus, the Socialist Party discovered that the economy was going better than they had hoped for and that, due to economic growth, tax collection had reached unprecedented levels. A principled government would have logically responded by not increasing expenditure and lowering taxes to reduce the high fiscal pressure exerted on Spanish citizens.

 

But we were not that lucky. Since its ascension to power, the Executive has added diverse budgetary burdens, marked not by investment, but by expenditure and long-term commitments: Statutes ensuring fixed investments in their own territories, more research scholarships, electioneering measures like the baby bonus, free dental care for children, free school books, apartments for all, etc. Naturally – and though they want to imply that – this will not be for free, and the so-called “social” commitments will be a burden for the Spanish economy.

 

Source: INE, Social Security - * projections

 

 

Spain faces a challenge to keep up economic growth in an international juncture that is much more difficult than previous ones. Unfortunately, it has a government unable to admit problems, much less to find solutions that sometimes must be unpopular when confronting difficult times.

 

If those solutions were found, those measures would move this government away from its main goal; stay in power at any price. It is no wonder that this Executive would not only delay all the necessary adjustments but, in addition, it practices a primitive electioneering tactic using taxpayer money.

 

New Model. New Reforms. New Government

The Spanish economic growth during recent years was based on two fundamental pillars: First, a series of economic deregulatory measures together with a fiscal reduction that constituted the axis of the so-called “Aznar-Rato economic model;” in addition, a persistence in low, negative interest rates in real terms (when compared to inflation) stimulated investment, consumption and internal demand.

 

The impulse of this economic model is being exhausted as consumption slowdown and the drop in construction activity are demonstrating... In the face of a fall in activity in that sector, and in order to keep the current growth rate, it is necessary to have a robust economy based on other sectors that could instantly replace the construction sector’s position.

 

In particular, it is a matter of special importance that the competitiveness of Spanish companies would increase and that the Spanish deficit would be drastically reduced to reach comparable levels to those of our European partners (See Fig. 7)

 

Source: Eurostat

 

 

The recipe for this economic situation is clear: In the first place, an appropriate taxation that, for example, reduces corporate tax rates –being at the moment, the second highest ones in Europe – all that would favor foreign investment and the creation of new businesses.

 

Secondly, a greater effort in research and new technologies. And in both cases, applied to companies. Our country’s main productivity profits cannot come reducing labor costs but increasing the value added to produced goods and services and with investments in technology generating important efficiency gains for them.

 

Moreover, it is necessary that the Executive have an anti-cyclical economic policy, a sustained fiscal surplus, a reduction in public expenditure, and now more than ever, a climate of public austerity in all administrations by improving management efficiency and analyzing the economic and social cost-effectiveness of each intervention. 

 

To sacrifice the present fiscal surplus in expenses related to an electoral cycle not only constitutes another proof of negligence and greed for power. It also demonstrates the need of a course change and a new Executive for Spain and its economy. 

 

 

©2007 Translated by Miryam Lindberg