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Spain Needs to Deliver on Reforms to Stabilize Economy

Shoppers in Cádiz, Spain: the government needs to reduce the deficit and boost growth, according to the IMF (photo: Saez Pascal/SIPA)

SPAIN'S ECONOMY

Spain Needs to Deliver on Reforms to Stabilize Economy

IMF Survey online

July 27, 2012

  • Key goals: make the economy more competitive to boost growth, clean up the financial sector, put public finances on a sustainable footing
  • Labor reforms should aim to put more people back to work
  • IMF will monitor financial assistance to Spain's banks

The Spanish government has passed a number of reforms to help the economy and financial system as the ongoing crisis in Europe means higher borrowing costs for the country.

On the heels of the IMF’s latest annual check-up of Spain’s economy, James Daniel, IMF mission chief for Spain, sits down for an interview with IMF Survey online to discuss the challenges of reforming the country’s economy and explain the IMF’s policy recommendations.

IMF Survey online: What is the best way for Spain to balance austerity measures and increase economic growth?

Daniel: The government seeks to strike a balance between the need to cut back the deficit and boost economic growth in three ways.

First, by making sure the measures to reduce the fiscal deficit are as growth-friendly as possible. One example of such measures would be increasing the revenue derived from the value-added tax, rather than cutting productive spending. Raising the value-added tax has a less negative effect on growth than cutting spending; especially spending that has the potential to help growth. When compared to other countries in Europe, Spain raises less from the value added tax.

Second, the government is implementing reforms to make the economy more competitive, which will have a positive effect on growth. It should do more in this area.

And third, by making the financial system work better. For example, the European loan will help clean up banks so they can lend more to healthy businesses rather than being stuck with loans to defunct real estate projects.

IMF Survey online: Why is unemployment so high in Spain, especially among young people, and what reforms are needed to address this problem?

Daniel: This is a big issue for a number of reasons. First and foremost, it’s bad for human dignity and a large strain for families. It also has adverse economic implications: it’s bad for government revenues, it can lower potential growth going forward, and it’s bad for the banks because people out of work can’t afford to pay back their loans.

First, let me say that unemployment is unacceptably high in Spain, much higher than in other countries, especially for young people. Unemployment has risen to almost 25 percent and for young people it is now over 50 percent, which is terrible. Part of the reason is the bursting of the housing bubble, but that’s only part of the story. Spain has always had high unemployment and there are other countries that have had housing bubbles burst that have not had such high unemployment, such as the United States, Ireland, and the United Kingdom.

As we have pointed out for many years, there are big problems in the way the Spanish labor market works or, rather, doesn’t work. Especially the big divide between those with permanent and protected jobs and those, who are often young, with temporary jobs. This structure of the labor market means that when bad economic times hit, firms have to adjust by sacking temporary workers rather than by changing working conditions, including wages. This way of doing things disproportionately affects young workers. In the rest of the world they do a bit of both, hiring and firing, but also changing working conditions and adjusting wages.

For example, temporary employment has fallen by a third since the beginning of the crisis, whereas permanent employment has only dropped by 6 percent.

Fixing this requires making the labor market more inclusive. So the IMF is recommending two things for Spain: make sure more people are working; and give firms the confidence to hire, even if it means some people are working in a different way, under more flexible conditions, or for less pay. We would like to see a more inclusive labor market rather than one divided between protected and unprotected workers; one that helps firms adjust to difficult times without having to let workers go.

In other countries wages go up and down, and employment doesn’t move so much. Spain is the outlier. We want firms to be able to agree with their workers about working conditions that reflect economic conditions, and not having to respond just by sacking people.

The labor market reforms adopted by this government in February of this year and by previous governments go in this direction. Of course, these are very sensitive issues that affect society at large and are difficult to change. Indeed, we suggest it might be helpful to have a more cooperative approach that involves the government, the labor unions, and the employers whereby regaining competitiveness should be the overarching objective.

IMF Survey online: Financial markets don’t appear convinced by the reforms already taken by the governmentwhat more can they do to restore investor and market confidence?

Daniel: Spain’s plans are good, it now needs to deliver. The country has passed many reforms and made many commitments, and now the government needs to deliver on them so the results can be seen. For example, it’s not enough to announce ambitious fiscal deficit targets, especially as in the past these targets were missed. The government now needs to hit these targets. Actually, it should be trying to surpass these targets, to generate good, not bad, surprises.

The recent package of measures, which includes raising the value-added tax from 18 to 21 percent and the removal of the mortgage income tax deduction, is encouraging in this regard. These are measures well designed to minimize the drag on growth.

But the problems that Spain faces in the financial markets go beyond the country’s borders, and speak to the design flaws in the eurozone. European leaders need to complete the reforms they have announced and fix the flaws in the monetary union. Most immediately, for example, Europe could draw up a roadmap for transforming the European loan to the government into a direct recapitalization of banks by Europe’s rescue fund, the European Stability Mechanism. Spain’s role would be to demonstrate to its eurozone partners that the country is putting its own house in order.

Many of the reforms will take some time to bear fruit. Take the example of labor market reform; in the current difficult environment it’s hard to see that employment will be created quickly, but we should be able to see the signs of it working. We would like to see evidence that firms are now using the new law, for example, to have more firm-level agreements, and to change working conditions so that they don’t have to cut jobs. There are some tentative signs this could be happening.

IMF Survey online: What role will the IMF play in monitoring the European financial assistance for Spain’s banks?

Daniel: We published our Terms of Reference for this monitoring on our website on July 20. Our contribution will take the form of technical assistance, and our goal is to provide our independent advice and views on what we find. This will involve monitoring Spain’s financial sector regularly, including the progress on the financial sector reforms the government has committed to when it agreed the loan with its European partners. We expect to deliver updates every few months or so detailing the progress made in restoring Spain’s banking sector to health. We will provide these regular reports to our Spanish and European counterparts, and the firm expectation is that they will be published promptly.

During this process, we will of course be coordinating closely with our Spanish and European counterparts. At the same time, we are an independent institution, not party to the loan, and will report our views accordingly.


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