## _cr15233

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### Nominal and real wage dynamics; reform timeline and aggregate context
- Reform chronology (selected measures; dates preserved exactly):
  - Feb-12: Increased flexibility in wage bargaining by prioritizing firm-level (from sector-region level) agreements, eased opt-outs, reduced ultra-activity period.
  - Feb-12: Reduced dismissal cost for unfair dismissals of permanent workers to 33 days' wages/year of seniority up to 24 months (down from 45 days/year up to 42 months).
  - Feb-12: Extended the use of fair dismissals to objective business criteria and facilitated firm-level agreements on dismissals.
  - Feb-12, revised Aug-13: Eliminated requirement of administrative authorisation for collective dismissals, introduced training requirement for dismissed workers and tax to employer if business is profitable.
  - Feb-12: Special contract for small firms (contrato emprendedores) introduced.
  - Feb-12: Re-instated the 2 year limit for extension of temporary contracts.
  - Nov-12: Introduction of the training and apprenticeship contract.
  - Feb-13: Hiring subsidies for young workers (<30 years) in form of reduced ESSC.
  - Dec-13: Reform of part-time contracts.
  - Feb-14, expired Feb-15: Flat rate (payroll) tax of 100 Eur for all permanent hires for 2 years.
  - Oct-14: Implementation of the National Youth Guarantee Plan.
  - Feb-15: Flat rate tax replaced by ESSC exemption of first 500 Eur for all new permanent hires.
  - Jul-2012 to Mar-15: New activation program for the long-term unemployed and reformed training program for the employed.
- Aggregate macro context:
  - Sovereign funding costs were brought down from peak levels around mid-2012, reducing borrowing costs for corporates and households and improving firms’ hiring conditions.
  - Employment started to grow in 2014Q2 despite still relatively low growth of GDP.
- Key aggregate wage facts:
  - Nominal year-on-year wage growth decreased from an average of 2.7 percent in 2009–11 to 0.2 percent in 2012–14.
  - Wage moderation coincided with a slowdown in employment losses and a return to positive employment gains in 2014Q2.

### Sectoral and regional wage cyclicality; regression evidence and interpretation
- Sector-level regression setup:
  - Regress nominal and real wage growth on sector-level lagged employment growth with sector fixed effects; 18 sectors, quarterly data; Observations: 414.
- Selected sectoral coefficients and statistics (preserved exactly as reported):
  - Table 2a (selected):
    - Column (1) employment growth (t-1): -0.050
    - Column (2) employment growth (t-1): 0.495***
    - Column (2) neg. employment growth (t-1): -0.742***
    - Column (3) employment growth (t-1): -0.046
    - Column (4) employment growth (t-1): 0.384**
    - Column (4) neg. employment growth (t-1): -0.585***
    - Observations: 414; Number of secnum: 18; R-squared examples: 0.003, 0.064, 0.004, 0.054, 0.020, 0.620, 0.262.
  - Table 2b (pre- vs post-reform interactions; selected):
    - employment growth (t-1): 0.522*** (column 1); 0.409*** (column 2)
    - neg. employment growth (t-1): -0.813*** (column 1); -0.599*** (column 2)
    - employment growth (t-1)*Post-Reform: -0.258 (column 1); -0.261 (column 2)
    - neg. employment growth (t-1)*Post-Reform: 0.553** (column 1); 0.386* (column 2)
    - Post-Reform: 0.000 (col 1); -0.012** (col 2); -0.009** (col 3); -0.010*** (col 4)
    - Observations: 414; Number of secnum: 18; R-squared examples: 0.117, 0.129, 0.081, 0.081, 0.620, 0.495.
- Key interpretations:
  - Pre-reform: evidence of downward wage rigidity—wages rose in expansions and also rose (though by less) during downturns.
  - Post-reform: macro-flexibility increased—the countercyclical hourly wage behavior observed pre-reform weakened post-reform; the pre- vs post-reform difference is statistically significant.
  - A one standard deviation decrease in lagged sectoral employment (about -8 percent employment growth) is associated with a sizeable change in wage response tied to regression results.
- Micro-flexibility and robustness:
  - Little evidence that wages systematically respond to sector-specific variation; columns controlling for time fixed effects render estimates insignificant.
  - Tests using aggregate employment growth instead of time fixed effects yield similar results (Appendix Table A1).
  - Conclusion: more evidence of improving macro-flexibility than of changes in micro-flexibility needed for sectoral reallocation and productivity growth.

### Regional evidence and simulated employment resilience gains
- Regional findings:
  - Within-region nominal wage growth is procyclical in expansions and only weakly procyclical or acyclical in downturns; downward rigidity driven by pre-reform period.
  - A one standard deviation decrease in regional employment (equivalent to -4.2 percent employment growth) led to no change in nominal wage growth before the reform, and a 1.1 percent nominal wage decline after the reform.
  - The 1.1 percent nominal wage decline corresponds to half the standard deviation in wage growth across all regions and years.
- SUR simulation of a one-time negative 1 percent employment growth shock (median historical negative shock):
  - Post-reform dynamics could reduce long-term job losses by 20 percent compared to the pre-reform regime.
  - Specifically, the loss in net employment after a one percent drop in labor demand would be 5.7 instead of 7.2 percent relative to the pre-shock level.
  - Translating to jobs: saving of around 200.000 jobs overall (based on 14.3 million employed in 2014).
- Caveats:
  - Improved wage flexibility may partly reflect changes in reservation wages due to very high unemployment or composition effects.
  - Estimates become insignificant once time fixed effects are included, indicating aggregate forces drive much variation.

### Duality, temporary contracts, and margins of adjustment
- Stylized facts:
  - Spain has one of the highest degrees of duality between permanent and temporary workers among advanced economies.
  - Temporary workers carried most of the burden of adjustment during the recession and led most of the employment gains in the early recovery.
  - Share of temporary employment remains at 25 percent, broadly at the same level as at the onset of the crisis.
  - The share of newly issued temporary contracts and rollover of existing ones still makes up more than 90 percent of all new contracts.
- Regression on share of temporary workers (private sector) (Table 4; preserved exactly):
  - tempshr (t-1) 0.762***
  - Reform Dummy -0.011***
  - Emp. Growth 0.235***
  - Emp. Growth*Reform Dummy -0.203**
  - Constant 0.069***
  - Observations 49
  - R-squared 0.973
- Interpreted magnitudes:
  - A one standard deviation change in employment growth is associated with a change in the share of temporary workers of 0.2 percentage points in the same quarter instead of 1.1 percentage points before the reform.
  - The difference in sensitivity of the share of temporary workers to growth increases to 4 percentage points in the long run accounting for model dynamics.
  - Reform effects on permanent hires: hiring into permanent contracts increased by 13 percent but remains below pre-crisis rates; effects concentrated on newly unemployed (less than 6 months) and small firms.

### Policy measures and recommendations on duality and matching
- Measures in place and design notes:
  - Hiring incentives: contrato emprendedores; ESSC exemptions; payroll tax measures with anti-substitution provisions (Royal Decree law 1/2015, article II.8).
  - Effective compliance with net employment gain provisions remains to be assessed; past attempts to avoid substitution have not been successful.
- Policy recommendations:
  - Achieve more convergence in employment protection between contract types; align dismissal cost between permanent and temporary contracts, starting from a common level and increasing with tenure.
  - Further decentralized wage-setting and collective agreement opt-outs to provide temporary flexibility.
  - Use hiring incentives while monitoring and enforcing anti-substitution provisions.
  - Product market reforms (Market Unity law, reform of regulatory barriers) to reduce barriers and uncertainties for firms to invest and grow.
  - Continue and fine-tune active labor market policies; make data on take-up and effectiveness at the regional level public.

### Firm structure, SME financing, and productivity—stylized facts
- Firm-size distribution and productivity:
  - Firms with less than 20 employees comprise 95 percent of non-financial firms in Spain.
  - Micro firms with less than 9 employees represent 90 of all firms and their share increased after the crisis.
  - Micro and small firms employ nearly two thirds of the labor force and generate about half of value added; micro firms typically have lower productivity and profitability compared to larger companies.
- Losses and sectoral concentration:
  - About a third of all firms in the database are suffering losses, with micro enterprises comprising the bulk of the loss-makers.
  - Loss-makers concentrated in construction, trade and market services; regional concentration notable in Catalonia and Andalucía.
- Access to finance and borrowing costs:
  - Borrowing costs for Spanish SMEs have come down by nearly 300 basis points on average from the 2008 peak.
  - They are still about 170 basis points higher than those on larger loans to non-financial corporates.
  - Non-financial corporates in Spain continue to pay about 90–100 basis points more than those in Germany and France.
  - According to ORBIS data nearly 30 percent of Spanish SMEs are still liquidity constrained, with less than 100 percent coverage of liabilities coming due in one year.
- Public/private SME finance initiatives (selected figures preserved):
  - ICO balance sheet comprised of €102 billion in loan assets, funded mainly by €93 billion of market debt.
  - SME securitization in Spain is relatively small, amounting to €30 billion; broader securitization universe nearly €180 billion.
  - Launch of FOND-ICO Global, a €1.2 billion fund of funds.

### Determinants of TFP, firm-level productivity differentials, and benchmarking scenarios
- Empirical findings (2006–13 ORBIS data):
  - Firm size strongly positively correlated with TFP; micro firms are about a third less productive compared to large firms.
  - Sector fixed effects significant: utility and energy, and manufacturing relatively more productive than services and trade; services productivity about a half of energy and utility sectors.
  - Regional fixed effects significant; productivity gap between least and most productive region about 50 percent.
- Benchmarking scenarios (preserved exactly):
  - Scenario 1 (adjust employment shares to Germany’s weights): average TFP would increase by about 7 percent relative to baseline.
  - Scenario 2 (Scenario 1 plus narrowing the micro-to-large TFP gap to Germany’s): average TFP would be 9 percent above the baseline (i.e., an additional 2 percent above Scenario 1).
- Policy implications:
  - Review and eliminate regional and local regulatory barriers that impede entry and competition.
  - Accelerate liberalization of professional services.
  - Enhance competition, encourage innovation, and foster internationalization to realize potential TFP gains.

### Insolvency reform (“fresh start”) design, estimated impacts, and recommendations
- Fresh start design (Royal Decree Law 1/2015; procedures and thresholds preserved exactly):
  - OCAP applies to individual debtors with an estimated debt below 5 million euro; mediator drafts plan; opening OCAP limits debtor’s legal acts; public creditors are not affected by OCAP.
  - In-court insolvency stage follows failed OCAP; only good faith debtors may obtain discharge; provisional discharge affects (i) all outstanding unsecured and subordinated claims, except public claims and alimonies; and (ii) part of secured claims unpaid after execution of collateral.
  - Payment plans can last up to 5 years.
  - June 2015 parliamentary amendments: discharge can be revoked during payment plan period upon fortuitous gains; guarantor gets no recourse action against discharged debtor (provided it is not revoked); threshold reduced from 50% to 25% for those debtors subject to the Code of Good Practices.
- Key statutory thresholds and procedural changes (preserved exactly):
  - Plan content (in court): no limit to write downs and reschedulings can be up to 10 years.
  - Class voting: majority of 50% or 65% of ordinary creditors required to approve the plan; privileged creditors included in those percentages when they vote in favor.
  - To bind all privileged creditors within a class:
    - (a) creditors holding 60% of the total value of the claims if the plan includes write downs of less than 50% and reschedulings of up to 5 years; or
    - (b) creditors holding 75% of the total value of the claims if the plan includes higher write-downs and longer reschedulings (with a cap of 10 years).
  - Out of Court Agreements (OCAP) majorities: 60% for plans with write-downs up to 25% or rescheduling <5 years; 75% for higher write-downs/reschedulings (cap 10 years). Secured creditors may be bound if 65% or 80% vote in favor depending on extent.
  - Sección de Calificación: no “sección” opened if plan envisages write off of less than 1/3 or stay shorter than 3 years; paying 67% of claims to one class avoids mandatory investigation.
  - Judicial discretion: judge may authorize transfer to bidder that better secures job preservation even if bid is lower by as much as 15%.
- Estimated quantitative impacts (preserved values):
  - Estimated reduction in private sector liabilities if entire stock of banks’ NPLs were liquidated: €30–44 billion.
  - Estimated public claims potentially affected by discharge: €7–9 billion cumulatively (3–4 percent of annual tax revenues).
  - Debt relief split estimates:
    - Consumers: €22–28 billion (about 3–4 percent of current total household debt and between 35–50 percent of the flow of new credit to households during 2014).
    - Individual entrepreneurs: €9–18 billion (about 1–2 percent of the current level of corporate debt and between 35–65 percent of the flow of new credit to firms for loan sizes below €1 million during 2014).
  - Estimated aggregate macro effects (spread over 5 years or more depending on liquidation pace):
    - Pickup in annual consumption: 0.9–1.3 percent.
    - Pickup in annual investment: 0.4–0.9 percent.
  - Aggregate estimated pickup in credit demand from insolvency reform alone: approximately 0.5 to 1.0 percent over several years.
- Estimated banking impacts (selected bank-level and system figures preserved exactly):
  - Aggregate debtor relief attributable to cancellation of banks’ remaining claims after liquidation: €30–44 billion.
  - Estimated effect on banks’ earnings: about 1–2 percent per year at current pace of liquidation.
  - Estimated effect on banks’ overall capital: less than 1 percent versus what it might have been at the end of a 3-year period.
  - Top 5 banks aggregate: Proportion 73 percent; Domestic loans 670 bn eur; Domestic deposits 702 bn eur; Projected Available Credit Supply -2 to -3; Estimated Earnings Impact -2 to -1; Estimated Capital Impact -1 to -0.5.
  - System: Proportion 13 percent; Domestic loans 1,319 bn eur; Domestic deposits 972 bn eur; Projected Available Credit Supply -2 to -3; Estimated Earnings Impact -2 to -1; Estimated Capital Impact -1 to -0.5.
- Implementation and policy recommendations:
  - Include public claims in discharge at least to extent ranked as ordinary or subordinated; second-best: include public claims in payment plan and stay enforcement during plan.
  - Introduce a “cram-down” mechanism or specify conditions to bind dissenting impaired creditor classes.
  - Reassess successor liability and the 15% judicial preference rule for job preservation in going-concern sales.
  - Clarify bases for revocation and improve statistical monitoring of fresh start take-up and effectiveness.
  - Improve judicial resources, IT capacity, standard forms, and monitoring to maximize effectiveness while minimizing misuse.

### Potential growth, output gaps, and labor trends
- Potential growth estimates and recent declines (preserved exactly):
  - Spain: potential growth declined by 2.3 percentage points relative to 1993–2007.
  - For 2008–2014: Spain estimated potential output growth around 0.7 percent (average of methods); with judgment MVFRES (Judgment) gives 0.8 percent.
  - Output gap in 2014 for Spain: -5.4 percent.
  - Baseline medium-term projection: potential output expected to grow at around 1.2 percent over 2015–20 on average for Spain.
- Components and drivers:
  - Capital: sharp fall in investment in Spain; real estate prices declined by 40 percent from pre-crisis peak.
  - Labor: unemployment rose rapidly, increasing long-term and structural unemployment; NAIRU increased substantially and expected to remain in double digits in the medium term.
  - TFP: secular decline pre-crisis; some improvement post-crisis largely reflecting exit of less-productive firms and labor shedding.
- Labor trends (country comparisons):
  - Spain: rapid labor input expansion in 1995–2007 driven by working-age population and participation; since crisis potential employment contribution turned negative, population growth slowed and turned negative in 2012; high volatility in unemployment with Okun’s coefficient more than twice OECD average during 1990–2011.
- Policy implication summary:
  - Substantial scope for raising potential GDP through structural reforms addressing low TFP, high duality, small firm dominance, and skill mismatches.
  - Recommended reforms include product market liberalization, labor market measures to reduce duality, and measures to raise firm size and innovation.

### External position, NIIP, and trade dynamics
- External vulnerability and NIIP:
  - Spain’s NIIP liabilities: 234 percent of GDP at end 2014.
  - Target2 balances: -€429bn in August 2012; -€188bn as of February 2015.
  - Liability equity component: 62 percent of GDP; debt instruments related to direct investments: 20 percent of GDP; Target2 liabilities around 18 percent of GDP.
- External debt projections and stress scenarios:
  - Baseline: external debt falls from around 160 percent of GDP at end 2014 to 132 percent in 2020.
  - Adverse historical-properties scenario: leads to external debt of 168 percent of GDP in 2020.
  - Combined shock: external debt 144 percent of GDP in 2020.
- Growth threshold for no deterioration in CA/GDP:
  - Quarterly OLS estimated real GDP growth threshold: 2.5 percent (shorter sample 2.3 percent).
  - Domestic demand threshold: 2.6 percent (2.3 percent for shorter sample).
- Export/import elasticities and trade simulations:
  - Domestic demand elasticity to imports estimated around 1.5 (rolling evidence rebounded in 2014 to values above 2).
  - Export elasticity to foreign demand estimated over 1.5.
  - Upside trade simulation: gradual 5 percent increase in global export market share and reduction in import elasticity to around 1 → simulated trade balance surplus increases by around 2 percent of GDP.
- Policy recommendations to improve external sustainability:
  - Foster export market share gains and lower import demand elasticity via structural reforms that raise firm size, productivity, and export capacity.
  - Address barriers to firm growth (tax thresholds, regional regulatory barriers, limited financing access, labor market duality).

### Fiscal coordination, subnational fiscal framework, and reform options
- Progress and gaps:
  - Fiscal coordination improved post-crisis with more synchronized policies between CGs and SNGs; fiscal governance strengthened (2012 BSL, AIReF creation).
  - Gaps: weak timely application of monitoring and enforcement mechanisms; regions’ targets often set equal to group target regardless of capacity; non-compliance warnings not issued timely; corrective measures slow.
  - Vertical fiscal imbalances and payment system design: advanced transfers and delayed settlement reduce incentives to adjust; multi-fund allocation under common system may weaken equalization.
- Regional liquidity mechanisms (RLMs):
  - FLA and FFPP used; ACFF introduced; about €60 billion disbursed via FLA during 2011–14; estimated savings about €22.6 billion.
  - Moral hazard risks: reduced financing costs for non-compliant regions, possible decoupling of lending from fiscal fundamentals.
- Three reform options considered (preserved exactly):
  - Option 1: Deepen the existent centralized framework by strengthening center-based budget constraints and oversight, further reducing subnational fiscal autonomy.
  - Option 2: Dismantle the centralized framework and move towards a fully decentralized, strictly market-based framework.
  - Option 3: Move towards a more coherent intermediate system combining elements of centralized, cooperative, and market-based frameworks.
- Preferred route and recommended actions (intermediate system emphasis):
  - Strengthen monitoring and enforcement under the BSL with gradual and predictable application, monthly and quarterly monitoring, and use of “yellow cards” prior to coercive measures.
  - Ensure AIReF has sufficient resources and access to information; implement more differentiated, rules-based allocation of regional fiscal targets to enhance ownership.
  - Enhance subnational fiscal autonomy carefully: expand regions’ regulatory power over devolved tax bases and reform regional finance payment systems (adaptive partial payments).
  - Improve fiscal resilience: condition RLM access on adjustment plans and intra-year targets; consider rainy-day funds with simple, transparent rules to mitigate moral hazard.

*Source: _cr15233 — IMF staff analysis and cited study excerpts as presented in the chapter.*

### 1. Nominal Wage Growth Before and After the Reforms  __________________________________ 8

### _cr15233 - 1. Nominal Wage Growth Before and After the Reforms

### Reform context and aggregate stylized facts
- The 2012 labor market reforms are making a difference: wage moderation is contributing to a visible recovery in headline employment growth, and the reforms have made the labor market more resilient to shocks.
- Key descriptive facts:
  - Spain has one of the highest degrees of duality between permanent and temporary workers among advanced economies.
  - Temporary workers carried most of the burden of adjustment during the recession and led most of the employment gains in the early recovery.
- Summary of major reform measures (as listed in Table 1):
  - Feb-12: Increased flexibility in wage bargaining by prioritizing firm-level (from sector-region level) agreements, eased opt-outs, reduced ultra-activity period.
  - Feb-12: Reduced dismissal cost for unfair dismissals of permanent workers to 33 days' wages/year of seniority up to 24 months (down from 45 days/year up to 42 months).
  - Feb-12: Extended the use of fair dismissals to objective business criteria and facilitated firm-level agreements on dismissals.
  - Feb-12, revised Aug-13: Eliminated requirement of administrative authorisation for collective dismissals, introduced training requirement for dismissed workers and tax to employer if business is profitable.
  - Feb-12: Special contract for small firms (contrato emprendedores) introduced to incentivize hiring of permanent workers, particularly of unemployed youth.
  - Feb-12: Re-instated the 2 year limit for extension of temporary contracts.
  - Nov-12: Introduction of the training and apprenticeship contract, providing firms with incentives to train and retain uneducated youth.
  - Feb-13: Hiring subsidies for young workers (<30 years) in form of reduced ESSC.
  - Dec-13: Reform of part-time contracts.
  - Feb-14, expired Feb-15: Flat rate (payroll) tax of 100 Eur for all permanent hires for 2 years.
  - Oct-14: Implementation of the National Youth Guarantee Plan.
  - Feb-15: Flat rate tax replaced by ESSC exemption of first 500 Eur for all new permanent hires.
  - Jul-2012 to Mar-15: New activation program for the long-term unemployed and reformed training program for the employed.
- Aggregate macro context:
  - Sovereign funding costs were brought down from peak levels around mid-2012, reducing borrowing costs for corporates and households and improving firms’ hiring conditions.
  - Employment started to grow in 2014Q2 despite still relatively low growth of GDP.

### Key empirical findings on nominal and real wage dynamics
- Aggregate change in nominal wages:
  - Nominal year-on-year wage growth decreased from an average of 2.7 percent in 2009–11 to 0.2 percent in 2012–14.
- Evidence on hiring and transition to permanent jobs:
  - OECD (2013) regression discontinuity results: the reforms likely increased the hiring rate from unemployment into permanent contracts; the hiring rate increased by one-tenth from very low levels.
  - The reform’s impact on the rate of permanent hires is estimated to be positive but small: hiring into permanent contracts increased by 13 percent, and remains below pre-crisis rates.
  - Effects concentrated on: newly unemployed (less than 6 months unemployment duration) and small firms (likely due to “contrato emprendedores” targeting firms with less than 50 workers).
- Interpreting wage moderation and employment:
  - Wage moderation coincided with a slowdown in employment losses and a return to positive employment gains in 2014Q2, possibly indicating more job-rich growth.
  - Composition effects (loss of lower-skill, lower-seniority workers) can raise average wages, but micro evidence (Font et al., 2015) controlling for composition still documents downward wage rigidity concentrated among protected workers with long tenure and permanent contracts.

### Sector-level wage cyclicality and changes after reforms (regression evidence)
- Method: regress nominal and real wage growth on sector-level lagged employment growth (proxy for labor demand) with sector fixed effects, covering 18 sectors and quarterly data.
- Main qualitative result: macro-flexibility increased after the reform—countercyclical hourly wage behavior observed pre-reform weakened post-reform; little evidence of systematic response of wages to sector-specific variation persists (micro-flexibility still limited).
- Selected numeric estimates from Table 2a and Table 2b (sector-level regressions; all numeric values preserved exactly as reported):
  - Table 2a (selected coefficients and statistics):
    - Column (1) employment growth (t-1): -0.050
    - Column (2) employment growth (t-1): 0.495***
    - Column (2) neg. employment growth (t-1): -0.742***
    - Column (3) employment growth (t-1): -0.046
    - Column (4) employment growth (t-1): 0.384**
    - Column (4) neg. employment growth (t-1): -0.585***
    - Observations: 414; Number of secnum: 18; R-squared values vary by column (e.g., 0.003, 0.064, 0.004, 0.054, 0.020, 0.620, 0.262).
  - Table 2b (pre- vs post-reform interaction estimates; selected coefficients):
    - employment growth (t-1): 0.522*** (column 1)
    - employment growth (t-1): 0.409*** (column 2)
    - neg. employment growth (t-1): -0.813*** (column 1)
    - neg. employment growth (t-1): -0.599*** (column 2)
    - employment growth (t-1)*Post-Reform: -0.258 (column 1), -0.261 (column 2)
    - neg. employment growth (t-1)*Post-Reform: 0.553** (column 1), 0.386* (column 2)
    - Post-Reform: 0.000 (col 1), -0.012** (col 2), -0.009** (col 3), -0.010*** (col 4)
    - Observations: 414; Number of secnum: 18; R-squared (examples): 0.117, 0.129, 0.081, 0.081, 0.620, 0.495.
- Interpretation of coefficients and asymmetry:
  - Pre-reform: wages increased in expansions and also rose (though by less) during downturns—evidence of downward wage rigidity.
  - Post-reform: the countercyclical behavior of hourly wages is largely driven by pre-reform dynamics; the difference in wage responses between pre- and post-reform periods is statistically significant.
  - A one standard deviation decrease in lagged sectoral employment (about -8 percent employment growth) is associated with a sizeable change in wage response (explicit magnitude reported in the text as tied to regression results).

### Mechanisms and margins of adjustment
- Downward wage rigidity and intensive margin:
  - The asymmetry in wage responses persists for nominal wages, ruling out the zero lower bound as sole explanation.
  - Likely mechanism: in downturns, hours worked per worker are reduced while compensation per worker is not reduced proportionately due to previous collective agreements—i.e., limited effective intensive margin adjustment.
- Micro-flexibility:
  - Little evidence that wages respond systematically to sector-specific variation in economic conditions, indicating persistent lack of micro-level flexibility in wage setting.

### Early evidence on employment composition and temporary vs permanent contracts
- Temporary workers bore most adjustment during the recession and led early recovery employment gains; tentative evidence suggests:
  - Some increased hiring to permanent contracts and faster transitions from unemployment to permanent jobs, but magnitudes are small and concentrated in certain segments.
  - Reform effects on permanent hires are modest: hiring into permanent contracts increased by 13 percent but remains below pre-crisis levels.
- Policy-targeted measures (e.g., contrato emprendedores, hiring subsidies, ESSC exemptions) appear to have concentrated effects on small firms and youth.

*Source: _cr15233 - 1. Nominal Wage Growth Before and After the Reforms (July 10, 2015), IMF staff calculations and cited studies as presented in the chapter.*

### 2.3 percentage point increase in sectoral real wage growth before the reforms (or ½ of the

### _cr15233 - 2.3 percentage point increase in sectoral real wage growth before the reforms (or ½ of the

### Sectoral wage dynamics and micro-flexibility
- Pre-reform: a 2.3 percentage point increase in sectoral real wage growth before the reforms (or ½ of the standard deviation in real wage growth).
- Post-reform: virtually zero wage growth after the reform.
- Similar results obtained using nominal hourly wages (column 2).
- Wages at the extensive margin (column 4) display qualitatively similar, but quantitatively smaller shifts pre and post-reform, and they are less precisely estimated.
- Despite absence of a countercyclical wage response after the reform, wages remain downward rigid and on average do not decline in the face of negative employment growth.
- Lack of micro-flexibility:
  - Column 7 and 8 of Table 2a and column 5 and 6 of Table 2b control for time (quarterly) fixed effects, rendering the estimates insignificant in both cases.
  - Regressions that use aggregate employment growth instead of time fixed effects yield similar results (Appendix Table A1).
  - Interpretation: relative wages did not respond to sector-specific employment growth in a way that would facilitate reallocation (expanding sectors did not see faster relative wage growth and vice versa).
  - Possible caveats: short sample period and large shortfall in aggregate demand during the Great Recession could mask inter-sectoral wage dynamics.
  - Conclusion: more evidence of improving macro-flexibility than of changes in micro-flexibility needed for sectoral reallocation and productivity growth.

### Regional evidence of wage moderation and rigidity
- Structural shift toward wage moderation inferred from regional data; longer regional time series yield more precise estimates (Table 3a).
- Main regional results:
  - Downward wage rigidity: within-region nominal wage growth is procyclical in expansions and only weakly procyclical or acyclical in downturns.
  - Pre- vs post-reform: downward rigidity driven by the pre-reform period; post-reform period associated with statistically significantly higher wage flexibility.
  - Region-specific wages do not move to reflect region-specific employment conditions and thus are not conducive to inter-regional reallocation.
- Quantitative regional example:
  - A one standard deviation decrease in regional employment (equivalent to -4.2 percent employment growth) led to no change in nominal wage growth before the reform, and a 1.1 percent nominal wage decline after the reform.
  - This 1.1 percent nominal wage decline corresponds to half the standard deviation in wage growth across all regions and years.
- Lack of regional micro-flexibility:
  - Estimates become insignificant once time fixed effects are included, suggesting much variation in regional employment growth is driven by aggregate forces.
  - The standard deviation of regional employment growth relative to the national average is only half the standard deviation of overall employment growth.
  - Variance decomposition (Figure 3) shows a significant share of regional employment variation remains unexplained by aggregate forces, implying spatial adjustment should be triggered, yet wages did not respond accordingly.
  - Replacing time fixed effects with aggregate lagged employment growth produces similar findings (Table 3b): post-reform wage moderation primarily driven by enhanced macro flexibility, with little improvement in wage responsiveness to regional labor demand disparities.
- Robustness checks:
  - Allowing for a lagged dependent variable reduces short-term wage response but long-run response remains similar.
  - Controlling for region-specific trends does not affect results.
  - Weighting regions by average employment share (column 5 of Table 3a) shows dynamics are not driven by any outlier region.
  - Using wage and employment growth in deviation from national averages also yields lack of region-specific micro-flexibility (Table 3b).
- Survey corroboration: less than 7 percent of (mostly large) firms have used options introduced in the labor market reform to deviate from collectively bargained wage levels (Encuesta Anual Laboral, 2013).

### Impact of wage moderation on employment resilience
- Estimation approach:
  - A 2-variable Seemingly Unrelated Regression (SUR) system on region-quarterly panel with region fixed effects.
  - Wage response to lagged employment growth allowed to vary between positive and negative labor demand quarters, and for negative quarters between before and after the reform year.
  - Wage growth expressed in real terms (deflated by national CPI).
- Simulation of response to a one-time negative 1 percent employment growth shock (median negative shock historically):
  - Figure 6 shows employment response over 20 quarters (cum. IRF for employment growth from a 2-variable SUR).
- Key quantitative result:
  - Post-reform dynamics could reduce long-term job losses by 20 percent compared to the pre-reform regime.
  - Specifically, the loss in net employment after a one percent drop in labor demand would be 5.7 instead of 7.2 percent relative to the pre-shock level.
  - Translating to jobs: saving of around 200.000 jobs overall (based on 14.3 million employed in 2014).
  - The improvement in resilience depends on wage responsiveness remaining a sustained long-term policy impact rather than a temporary effect from massive economic slack.
- Caveats: improved wage flexibility may partly reflect changes in reservation wages due to very high unemployment or composition effects.

### Duality, temporary workers, and labor adjustment margins
- Pre-reform pattern: firms hire disproportionately more temporary workers in upswings and dismiss them more in downturns due to a wide wedge between the cost of permanent and temporary workers.
- Regression testing share of temporary workers (private sector) on lagged share, contemporaneous year-on-year employment growth, allowing slope to vary before and after reform (Table 4):
  - tempshr (t-1) 0.762***
  - Reform Dummy -0.011***
  - Emp. Growth 0.235***
  - Emp. Growth*Reform Dummy -0.203**
  - Constant 0.069***
  - Observations 49
  - R-squared 0.973
  - Robust standard errors in parentheses; significance: *** p<0.01, ** p<0.05, * p<0.1
- Interpretation:
  - A one standard deviation change in employment growth is associated with a change in the share of temporary workers of 0.2 percentage points in the same quarter instead of 1.1 percentage points before the reform.
  - The difference in sensitivity of the share of temporary workers to growth increases to 4 percentage points in the long run accounting for model dynamics.
  - Given continued contraction, proportionately less of the contraction post-reform has been borne by temporary workers relative to before the reform.
  - The difference is statistically significant at the 5 percent level but the magnitude is small considering the share of temporary workers in private employment has been largely stable.
- Stocks and flows:
  - Share of temporary employment remains at 25 percent, broadly at the same level as at the onset of the crisis.
  - The share of newly issued temporary contracts and rollover of existing ones still makes up more than 90 percent of all new contracts.
  - To reduce the high share of temporary employment, growth in permanent jobs must increase substantially and surpass temporary ones for a sustained period.
  - Labor shedding during the height of the crisis was overwhelmingly at the expense of temporary workers; starting mid-2013 job destruction shifted toward permanent jobs; early recovery net employment growth mostly driven by temporary hiring, but more recently composition shifted toward permanent hiring, possibly due to hiring subsidies or composition of remaining temporary workers.

### Caveats and identification issues
- The estimated structural break in wage responsiveness occurs around the reforms but may be partially due to other factors:
  - Staggered sequencing of reform elements and possibly long lags in propagation complicate causal attribution.
  - Unprecedented severity of the preceding crisis and very high unemployment may have altered reservation wages.
  - Composition effects may impact results.

*Source: IMF staff analysis (regional and sectoral regressions, Table 2, Table 3a, Table 3b, Table 4, Figures 2–7).*

### 21.      Although the share of temporary workers may come down further if the economy and

### _cr15233 - 21.      Although the share of temporary workers may come down further if the economy and

### Temporary employment, duality, and policy measures
- The share of temporary workers may decline if the economy and labor demand continue to recover and businesses face less uncertainty, but the overall impact may be limited due to substitution across subsidized and non-subsidized contracts.
- Recent reform measures targeting duality include:
  - Hiring incentives through the “contrato emprendedores”.
  - A broader payroll tax exemption with provisions that attempt to avoid substitution by requiring firms to demonstrate a net employment gain over a certain period after the subsidized permanent hire (see Royal Decree law 1/2015, article II.8).
- Effective compliance with the net employment gain provision remains to be assessed.
- Past attempts at avoiding substitution have not been successful (see Jaumotte, 2011; IMF, 2014).

### Labor market outlook and key labor statistics (Looking Forward)
- Unemployment remains high despite recovery; hiring has strengthened considerably and there are signs the unemployment rate might have turned, but the level remains painfully high.
- Key statistics and indicators:
  - Unemployment rate remains close to 25 percent.
  - Over 60 percent of the unemployed are long-term (i.e., one year or longer).
  - Most unemployed have been looking for a job for more than a year.
  - There are signs of underemployment: many employed part time are looking for additional work.
  - No evidence yet of improvement in matching efficiency between vacancy and the unemployed; the degree of skill mismatch has continued to widen (cf. European Commission, 2014).

### Policy recommendations to reduce duality and improve matching
- Reduce duality by:
  - Achieving more convergence in employment protection between contract types.
  - Further decentralized wage-setting.
  - Product market reforms that reduce barriers and uncertainties for firms to invest and grow.
- Specific measures suggested:
  - Align dismissal cost between permanent and temporary contracts, starting from a common level and increasing with tenure, to encourage hiring on permanent contracts more efficiently.
  - Use hiring incentives to address distortions in firms' adjustment processes to business conditions, while monitoring and enforcing anti-substitution provisions.
  - Progress in product market reforms—implementation of Market Unity law and reform of regulatory barriers that limit firm size—would support profitability and opportunities for expansion, which drive job creation and quality.
  - During the transition, allow further decentralized wage-setting and collective agreement opt-outs to provide flexibility for firms and workers to adjust to temporary shocks.

### Active labor market policies and Youth Guarantee Scheme
- The package of active labor market policies and the Youth Guarantee Scheme aims to:
  - Improve skills of the unemployed.
  - Improve education of youth.
  - Improve productivity of the employed.
- Recommended follow-up:
  - Continue the reform agenda and fine-tune existing measures to ensure overall effectiveness.
  - Make data on take-up and effectiveness of various initiatives at the regional level public.
  - Leverage the economic recovery, as structural reforms deliver their strongest impact when cyclical conditions are favorable (see Decressin and others, forthcoming; Barkbu and others, 2012).

### Appendix finding: Aggregate versus sector-level labor demand and wage dynamics
- Controlling for aggregate labor demand diminishes the statistical significance of the reform effect of wage moderation.
- Allowing responsiveness to aggregate forces to differ before and after 2012 captures wage moderation through differential responsiveness to aggregate forces; additional variation in sectoral labor demand is not reflected in sectoral wage dynamics.
- Regression results summary (Table A1):
  - Observations: 414
  - Number of secnum: 18
  - R-squared by column: 0.182, 0.179, 0.139, 0.011
  - Coefficients of interest (examples reported exactly as in table):
    - employment growth (t-1): 0.405*** (0.133)
    - aggr. Employment growth (t-1): 1.485*** (0.411)
    - neg. aggr. Emp growth: -2.031*** -0.527*** -0.353** (0.477) (0.170) (0.143)
    - Ref Dummy*neg. aggr. Emp. Growth: 0.745*** 0.634*** (0.228) (0.184)
- Footnote: The standard deviation of relative employment growth and absolute employment growth are similar (around 8 percent), hence the lack of correlation is not due to lack of variation in relative employment dynamics.

### Obstacles to firm growth and stylized facts on firm size and productivity
- Long-run productivity trends:
  - Spanish labor productivity growth and the level of total factor productivity (TFP) have been falling since the 1980s and continued in the 1990s and 2000s despite capital deepening in the pre-crisis period.
  - The gap between Spain and the most advanced economies has widened significantly; recent improvements mostly linked to exit of low-productivity firms and drastic labor shedding during the 2008–09 crisis.
- Contributing factors to weak productivity:
  - Credit and construction boom pre-crisis shifted resources away from more productive tradables sectors.
  - Structural factors: labor market duality (low skill-building incentives in temporary work), low R&D, and regulatory/legal framework elements that constrain firm growth.
- Firm-size distribution and productivity:
  - Firms with less than 20 employees comprise 95 percent of non-financial firms in Spain.
  - Micro firms with less than 9 employees represent 90 of all firms and their share increased after the crisis.
  - Micro and small firms employ nearly two thirds of the labor force and generate about half of value added, but their productivity is typically lower compared to larger companies.
  - Micro firms, particularly in construction, trade and services, tend to be the least productive and least profitable.
  - Labor productivity and profitability of micro and small firms deteriorated significantly post 2008–09 crisis compared to medium-sized and large companies.
  - Firms in less competitive sectors (e.g., services) have lower productivity than others (such as manufacturing).
  - Dispersion around median productivity and profitability is greater for energy, services, and the “others” category (including agriculture, mining and quarrying, and otherwise unspecified sectors).
  - There are sizeable regional disparities in labor productivity and profitability.
- Data and methods:
  - The analysis uses the ORBIS dataset covering about 700,000 Spanish firms between 2006–13; the dataset excludes companies with zero employees and focuses on active companies reporting number of employees.
  - Coverage accounts for about a half of corporate total gross value added and 2 ⁄ 3 of total cost of employees; micro firms are somewhat underrepresented compared to National Statistical Institute data.

*Source: _cr15233*

### 10.      The data also suggests that micro and small firms are also among the firms most

### 10.      The data also suggests that micro and small firms are also among the firms most under economic pressure

### Losses, distribution, and sectoral concentration
- About a third of all firms in the database are suffering losses, with micro enterprises comprising the bulk of the loss-makers.
- Significant regional variation in the distribution of loss-makers, with particularly high numbers of loss-makers in Catalonia and Andalucía.
- Across sectors, loss-makers are concentrated in construction, trade and market services.
- Loss-making firms are defined as firms with negative EBIT or net operating income, with similar results for both definitions.

### Firm size and the role of institutional factors
- Burdensome regulations on entrepreneurial activity tend to hamper market entry and growth of small firms (Scarpetta and others, 2002).
- Indications that in Spain, despite recent progress, barriers to entrepreneurship, barriers to entry in the service sector, and relatively more cumbersome license and permit systems remain an obstacle to firm growth (Figure 2 and OECD, 2014).

### Size-related taxation thresholds and incentives
- Historically, the corporate tax system allowed for lower corporate standard tax rates for SMEs with an annual turnover below €10 million, and even lower rate for those under € 5 million and with fewer than 25 employees, combined with generous deductions for larger firms (OECD, 2014).
- The result was an effective tax rate that increases with firm size, discouraging firm growth.
- The 2015 tax reduced some disincentives to firm growth by eliminating the reduced rate for SMEs while reducing the deductions and tax benefits for big companies, to lower the tax gap between the actual and the effective rate.
- Effective Corporate Income Tax, 2012 (Percent) — categories shown in source: No employees, Micro business, Small, Medium, Large (chart referenced).

### Size-related regulatory and reporting thresholds
- Size-related labor legislation requires a compulsory workers’ committee for firms with more than 49 employees, which could discourage firm growth (Bank of Spain, 2015).
- Substantial bunching of firms just below the “large tax-payer” threshold—firms with operating revenue of more than €6 million are monitored by the Large Tax Payers Unit.
- Requirement for external audit if the firm’s size exceeds two of the following thresholds for two consecutive years:
  - (i) €4.75 million in operating revenues; (ii) €2.4 million of total assets; and (iii) 50 employees on average over the year.
  - Since 2007 the first two of these thresholds have been increased to €5.7 and €2.85 million, respectively.
- These criteria also determine if a firm can use an abbreviated form of corporate income tax return and create compliance costs.

### Regional aspects and government quality
- Regional GDP per capita correlates with measures of firm labor productivity (e.g., real value added per employee).
- Differences in firm productivity across regions with similar sectoral or firm-size structure could suggest differences in local or regional regulatory practices or the quality of regional or local governments.
- Regional variations in the share of small firms seem to be negatively correlated with the survey based index of regional government quality developed by the European Commission (2010).

### Access to finance, investment, and balance sheets
- Following years of strong investment during the pre-crisis boom, investment fell sharply across all sectors and geographical regions.
- High corporate debt levels and debt overhang amplified the impact of the sharp fall in demand on investment.
- Evidence from a sample of 500,000 Spanish firms over 2006–13 finds a significant negative impact of firm leverage and debt overhang on firm investment, after accounting for:
  - sales growth (proxing investment opportunities),
  - return on assets (proxing firm profitability),
  - cash-to-assets ratio (captures role of liquidity constraints),
  - year fixed effects, and
  - firm-level fixed effects.
- Investment is highly sensitive to the availability of liquid assets and the financial position plays a particularly large role for micro and small firms.

### Creditworthiness and SME financing conditions
- The creditworthiness of Spain’s smaller firms improved by end-2014, aided by the domestic recovery; corporate deleveraging returned the debt equity ratio to its 2006 level and profitability picked up from very low levels.
- Access to finance remains constrained for a large fraction of SMEs:
  - The mid-2014 ECB survey finds the proportion of SMEs reporting access to finance as their most pressing problem fell to 20 percent of total respondents from 35 percent at the peak.
  - A larger fraction of SMEs are concerned about access to finance in Spain than in Germany, France or Italy.
- Borrowing costs:
  - Borrowing costs for Spanish SMEs have come down by nearly 300 basis points on average from the 2008 peak.
  - They are still about 170 basis points higher than those on larger loans to non-financial corporates (compares to long-term historical spread closer to 150 bps).
  - Non-financial corporates in Spain continue to pay about 90–100 basis points more than those in Germany and France (historically this spread averaged 40–50 basis points).
- Liquidity and constraints:
  - According to ORBIS data nearly 30 percent of Spanish SMEs are still liquidity constrained, with less than 100 percent coverage of liabilities coming due in one year.

### Banking practices, reforms, and non-bank finance measures
- During the crisis banks shifted credit underwriting focus from collateral recovery value to free cash flow (liquidity).
- Policy measures that supported banks’ ability to lend:
  - Financial sector reform under the ESM program strengthened capital buffers; problem assets were transferred out; local savings banks were consolidated.
  - ECB measures: LTROs, a purchase program for securitized products, TLTROs, and QE.
- April 2015 securitization law allows:
  - greater flexibility for issuers concerning liabilities of securitization structures;
  - active management of underlying collateral assets;
  - a diversified asset pool comprised of different types of assets;
  - a securitization structure to receive external guarantees;
  - the use of third-party custody and administration of pool assets by originators.
- SME securitization in Spain is relatively small, amounting to €30 billion, while the law affects a broader securitization universe of nearly €180 billion in Spain.
- Insolvency framework reforms: strengthened mechanisms to encourage distressed borrowers to reach out-of-court debt restructuring agreements with creditors, including banks.

### Public and private initiatives to promote SME finance
- Direct debt and equity financing mainly via:
  - Instituto de Crédito Oficial (ICO) — state-owned bank; ICO balance sheet comprised of €102 billion in loan assets, funded mainly by €93 billion of market debt.
  - Empresa Nacional de Innovación (ENISA) — focuses on innovative, manufacturing and technology-related firms.
- Alternative public capital platforms:
  - Mercado Alternativo Bursátil (MAB) — equity market platform for SMEs (operational 2009).
  - Mercado Alternativo de Renta Fija (MARF) — bond market (operational 2013).
  - These platforms have easier listing and reporting requirements for SMEs but suffer from limited liquidity partly on account of reduced transparency.
- Private equity and debt market initiatives:
  - Launch of FOND-ICO Global, a €1.2 billion fund of funds aimed at promoting early-stage private financing.
  - Revamped legal framework for venture capital (Law 22/2014).
  - Legal amendments relating to crowdfunding and securitization (Law 5/2015).

### Policy recommendations to improve SME financing
- Continue implementation of initiatives to improve access to financing for small firms.
- Strengthen transparency of SME financials, including by:
  - requiring recognized audits,
  - regular timely reporting of consolidated financials in the centralized database of SME data.
- Consider reducing the tax advantage of debt over equity financing for firms.

### Determinants of Total Factor Productivity (TFP) — econometric approach
- Orbis data for 2006–13 used to investigate how firm characteristics (size, main activity, location) affect firm TFP.
- Estimation approach:
  - Regress logarithm of real gross value added on logarithms of labor and capital.
  - Coefficients for labor and capital interpreted as shares in a Cobb-Douglas production function.
  - Constant term represents average TFP across firms and time.
  - Time fixed effects included to capture macro conditions.
  - Additional fixed effects for firm size, sector, and regional location to assess productivity differentials.
- Model estimated (notation preserved):
  - LGVA_{i,t} = μ + α LN_{i,t} + β LK_{i,t} + τ YR_t + η SZ_i + κ SECT_i + λ RGN_i + u_i + ε_{i,t}
- Panel unit root tests confirm stationarity of variables, allowing estimation of equation (1) in levels.
- Estimated size fixed effects and productivity indicate differences in logTFP controlling for time effects across size bins (chart referenced: 1-9,10-19,20-49,50-249,>=250).

*Source: _cr15233 - 10.      The data also suggests that micro and small firms are also among the firms most (PDF chapter/section).*

### 27.      The results confirm that there are

### _cr15233 - 27.      The results confirm that there are

### Productivity differences by firm size
- Firm size is strongly positively correlated with TFP.  
- Micro firms are about a third less productive compared to large firms.  
- Empirical analysis uses firm-level data over 2006–13.  
- Estimation approaches: benchmark production-function model with time and firm-size fixed effects; robustness checks using stochastic frontier analysis and system GMM produce broadly similar results, suggesting endogeneity bias may not be particularly strong in the sample.

### Productivity differences across sectors
- Sector fixed effects are highly significant.  
- Sectors such as utility and energy, and manufacturing are relatively more productive (in TFP terms) than services and trade.  
- The productivity gap between the least productive and the most productive sectors amounts to about a third.  
- Services productivity is about a half of that of the energy and utility sectors.  
- The gap between micro and larger firms is larger in sectors where productivity is relatively higher, especially in manufacturing and utilities.

### Productivity differences across regions
- Regional fixed effects are significant even after accounting for time, firm size, and sector composition.  
- The productivity gap between firms in the least productive and in the most productive region is about 50 percent.  
- Estimated regional TFP fixed effects are positively correlated with the quality of regional government index (survey-based measure developed by the European Commission).  
- Evidence indicates that more stringent regional regulation is associated with lower productivity of the sector, while less stringent regional regulation is associated with higher firm productivity (retail sector evidence cited).

### Micro firms — regional and sectoral heterogeneity
- Interaction models (benchmark with regional and sector fixed effects and interactions with micro-firm dummy) show all fixed effects, including regional effects for micro firms, are highly significant.  
- Findings:
  - There are significant productivity differences between micro and larger firms across regions.
  - With a few exceptions, regional differences in small-firm TFP mirror differences in the entire population.
  - The productivity gap between micro and other firms is larger in regions with average and higher productivity and smaller in regions with relatively low or high productivity.

### Sampling bias and weighting
- ORBIS data tend to under-represent micro firms.  
- Baseline model re-estimated using population weights aligned with OECD (2014); this gives higher weights to micro and small companies relative to medium and large companies.  
- The weights applied (per OECD (2013) derivation): micro companies weight 2.4; companies with 10–19 employees weight 1.7; companies with 20–49 employees weight 1.5; medium companies weight 1.4; large companies weight 1.2.  
- Maximum-likelihood random effects (MLE) estimates with these weights show results remain qualitatively similar.

### Benchmarking scenarios and potential aggregate TFP gains
- Method: compute average firm-level TFP as the average TFP of five firm-size categories weighted by their relative employment shares based on model (1d) in Table A.1; then counterfactually “grow” Spain’s firms to match the employment share by firm size observed in Germany; and in a second step, also narrow the micro-to-large TFP gap to Germany’s level.  
- Scenario results:
  - Scenario 1 (adjust employment shares to Germany’s weights): average TFP would increase by about 7 percent relative to baseline.  
  - Scenario 2 (Scenario 1 plus narrowing the micro-to-large TFP gap to Germany’s): average TFP would be 9 percent above the baseline (i.e., an additional 2 percent above Scenario 1).  
- Rationale: Germany’s firm distribution favors relatively larger firms and its smaller-firm productivity gap tends to be smaller than Spain’s.

### Conclusions and policy implications
- Low aggregate productivity in Spain is partly explained by the dominance of small and low-productive firms; the average firm size in Spain is smaller compared to other developed countries and small firms comprise a larger share of employment and output.  
- Small firms face greater difficulties exporting, innovating, and realizing economies of scale.  
- Size-dependent regulatory thresholds (reporting, auditing, labor-related regulation) and taxation can act as disincentives to firm growth, though the 2015 tax reform has reduced some disincentives.  
- Regional and sectoral variations suggest removal of obstacles that inhibit firm growth could raise productivity. Examples of such obstacles: excessive strictness of regional regulatory requirements and practices (permits, licensing, standards) that act as barriers to entry and reduce competition.  
- Policy recommendations highlighted:
  - Review and eliminate regional and local regulatory barriers that impede entry and competition.
  - Accelerate liberalization of professional services to foster competition in the services sector.
  - Implement reforms that enhance competition, encourage innovation, and foster internationalization to realize potential TFP gains from firm growth and improved small-firm productivity.

*IMF staff summary based on the provided chapter content.*

### References

### References

### Bibliographic entries
- Bank of Spain, 2015, Annual Report 2014 (Madrid, June).  
- Barkbu, B., S. Pelin Berkmen, P. Lukyantsau, S. Saksonovs, and H. Schoelermann, 2015, “Investment in the Euro Area: Why Has it Been Weak,” IMF Working Paper No. 15/32 (Washington: International Monetary Fund).  
- Cecchetti, S.G., M.S. Mohanty, and F. Zampolli, 2011, “The Real Effects of Debt.” BIS Working Papers 352 (Basel: Bank for International Settlements).  
- Claessens, S., H. Tong, and S.-J. Wei. 2012, “From the Financial Crisis to the R eal Economy: Using Firm-L evel Data to Identify Transmission Channels,” Journal of International Economics, Vol. 88(2012): 375-387.  
- Doing Business 2015, Going Beyond Efficiency, Economy profile 2015, Spain.  
- Charron, L. and Dijkstra, 2012, “Regional Governance Matters: A Study on Regional Variation in Quality of Government within the EU”, European Commission WP 01/2012 (Brussels).  
- European Central Bank, 2014, “Deleveraging Patterns in the Euro Area Corporate Sector,” ECB Monthly Bulletin, February 2014.  
- European Commission, 2014, “A Partial and Fragile Recovery—Annual Report on European SMEs 2013/20014.” July 2014 (Brussels).  
- ———, 2014, “Reindustrializing Europe,” Member States Competitiveness Report (Brussels).  
- European Union, 2013, 2013 SMEs’ Access to Finance Survey.  
- Fazzari, Steven, Glenn Hubbard and Bruce Petersen. 1988. “Financing Constraints and Corporate Investment.” Brookings Papers on Economic Activity 1(1988): 141-95.  
- Gal, Peter (2013), “Measuring Total Factor Productivity at the Firm Level Using OECD-ORBIS”, Economics Department Working Papers No. 1049, ECO/WKP(2013)41.  
- Goretti, Manuela and Marcos Souto. 2013. “Macro-Financial Implications of Corporate (De)Leveraging in the Euro Area Periphery.” IMF Working Paper WP/13/154.  
- Hospido and Moreno-Galbis, The Spanish Productivity Puzzle in the Great Recession, Bank of Spain, Working paper 1501, 2015.  
- International Monetary Fund (IMF), 2015, World Economic Outlook, Chapter 4 (Washington, April).  
- International Monetary Fund (2014), “SME Financing in the Netherlands”, Selected Issues, Article IV Consultation with the Kingdom of the Netherlands – Netherlands, forthcoming.  
- Jimenez, Ongena, Peydro and Salas, 2014, “'Credit Demand Forever?' On the Strengths of Bank and Firm Balance-Sheet Channels in Good and Crisis Times,” Bank of Spain, 2014.  
- Klein, N., 2015, “The Internationalization of Small and Medium Sized Enterprises in Hungary: Determinants and the Link to Growth,” Hungary, Selected Issues, mimeo.  
- Mora Sanguinetti, J. S. and A. Fuentes, 2012, “An Analysis of Productivity Performance in Spain Before and During the Crisis: Exploring the Role of Institutions,” OECD Economics Department Working Papers No. 973683 (Paris: Organization for Economic Co-operation and Development).  
- Organization for Economic Cooperation and Development (OECD), 2014, “Chapter 2: Moving Towards a More Dynamic Sector in Spain,” in Spain Economic Studies, September, 2014.  
- Ribeiro, Samuel Pinto, S. Menghinello, K. De Backer, 2010, “The OECD ORBIS Datatbase. Responding to the Need for Firm-level Micro-data in the OECD.”  
- Syverson, Chad, 2011, “What Determines Productivity?”Journal of Economic Literature, Vol. 49:2, pp. 326–365.  
- Van Biesebroeck, Johannes. 2008, “The Sensitivity of Productivity Estimates: Revisiting Three Important Debates.” Journal of Business and Economic Statistics, 26(3): 311–28

*Source: _cr15233 - References (IMF PDF).*

### 11.      There is little variation in estimated potential growth across estimation techniques on

### _cr15233 - 11.      There is little variation in estimated potential growth across estimation techniques on

### Variation across estimation techniques
- Average over 1993–2014: little variation in estimated potential growth across HP, ECPF, and MVFRES.
- Largest discrepancy: occurs between the ECPF and other approaches for Spain, possibly reflecting difficulties estimating potential output in the context of large financial cycles (Table 2, Box 2).

### Recent declines in potential output (summary)
- Potential output growth declined markedly in France and Spain since the global financial crisis (Table 2, Figure 1).
- Decline relative to 1993–2007, averaged across three methodologies:
  - Spain: declined by 2.3 percentage points.
  - France: declined by 1 percentage point.
- Germany slowdown was more contained:
  - Decline of 0.4 percentage points relative to 1993–2000, and only 0.2 percentage points relative to 2001–07.

### Tabulated potential GDP growth (1993–2014) — methodologies and averages (as reported)
- Columns: (1) HP, (2) ECPF, (3) MVFRES (Raw), Average of (1),(2),(3), (4) MVFRES (Judgment)
- France
  - 1993–2000: 2.2, 2.0, 2.2, 2.1, 2.2
  - 2001–2007: 1.7, 1.8, 1.8, 1.8, 1.8
  - 2008–2014: 0.9, 1.1, 0.9, 1.0, 1.0
- Germany
  - 1993–2000: 1.7, 1.8, 1.8, 1.7, 1.8
  - 2001–2007: 1.2, 1.3, 1.2, 1.3, 1.2
  - 2008–2014: 1.1, 1.1, 1.1, 1.1, 1.1
- Spain
  - 1993–2000: 3.5, 2.6, 2.8, 3.0, 2.8
  - 2001–2007: 2.8, 3.6, 3.0, 3.1, 3.0
  - 2008–2014: 0.7, 0.6, 0.9, 0.7, 0.8
- Source: IMF Staff estimates.
- Note on MVFRES (Judgment): MVFRES augmented with additional information outside the filter to improve plausibility (see paragraphs 14 and 15).

### Baseline approach and role of judgment
- Baseline estimates based on MVFRES, including judgment (Table 2; Figures 1 and 2).
- Multivariate filters (MVFRES) extract cycle information from unemployment, inflation, growth and inflation expectations, and generally are more robust to new information than HP.
- Limitations: MVFRES may miss factors such as large swings in GDP linked to financial cycles or natural disasters.
- End-point problem: less severe for multivariate filters than HP, but remains an issue; raw MVFRES can be augmented with judgment to improve plausibility and robustness.

### Detailed results for 2008–14 (paragraph 14)
- France
  - Estimated potential growth: around 1 percent on average over 2008–14.
  - Estimated output gap in 2014: -2.5 percent.
  - Raw MVFRES: potential growth 0.9 percent on average during 2008–14; output gap of -0.7 percent in 2014.
  - Judgmental assessment: output gap in 2015 is -2.5 percent.
  - With adjustment: model delivers average potential growth of 1.2 percent (and average TFP growth of 0.5 percent) over 2015–20.
  - Output and unemployment gap close by 2020 at estimated NAIRU of 9.1 percent.
- Germany
  - Estimated potential growth: around 1.1 percent on average over 2008–14.
  - Estimated output gap in 2014: -0.3 percent.
  - Raw MVFRES: same potential growth; output gap -0.2 percent in 2014; small increase in TFP growth after 2015.
  - Judgment: potential GDP growth adjusted slightly upward to 1.3 percent on average over 2015–20 to keep average TFP growth in line with 2011–14 average of 0.7 percent.
- Spain
  - Estimated potential output growth: around ¾ percent on average over 2008–14.
  - Output gap in 2014: -5.4 percent.
  - Raw MVFRES: broadly similar potential growth estimates for 2008–14; exception 2009 raw MVFRES yields potential growth 1.6 percent (implausibly high).
  - MVFEUR (with financial variables) suggests larger output gap than raw MVFRES and yields lower 2009 potential growth than raw MVFRES.
  - Judgmental adjustments used:
    - (i) lower the 2009 potential growth to 1 percent;
    - (ii) set the 2014 output gap to -5.4 percent;
    - (iii) ensure projected output gap closes slightly more slowly (in 2018 instead of 2017), consistent with MVFEUR.

### Medium-term projections and expected paths (paragraph 15)
- Without additional reforms, potential growth expected to remain low in the medium term in all three economies.
- Under current policies, potential output expected to grow at around 1.2 percent over 2015–20 on average across countries, up from 0.9 percent during 2008–14.
- Compared to 2001–07:
  - Spain: potential growth projected to remain significantly lower by 1.8 percentage points, to 1.2 percent.
  - France: moderately lower by about ½ percentage point, to 1.2 percent.
  - Germany: potential output has rebounded and is expected to continue close to its 2014 level during the next few years.

### Country-specific drivers and projections
- Germany
  - Past: potential growth declined moderately between the 1990s and pre-crisis period; held up during crisis and post-crisis years.
  - Drivers: slowdown in TFP and capital accumulation explains decline in 2001–07 vs 1993–2000; during 2008–14, TFP decreased further by about 0.1 percentage points; slowdown in capital accumulation by almost 0.2 percentage points; labor contribution improved due to lower unemployment and higher participation.
  - Projection: potential growth projected around 1.3 percent over 2015–20 on improved investment prospects; TFP expected to grow at 0.7 percent; labor contribution broadly unchanged.
  - Demographics: strong immigration offsets adverse effects of aging on working-age population in short-to-medium term; adverse effects of aging become increasingly visible only at end of decade.
- France
  - Historical decline: from 2.2 percent in 1990s to 1.8 percent over 2001–07, and down to 1 percent throughout the crisis.
  - Drivers: sustained decline in TFP initially; during crisis, half of decline came from flagging employment (rising NAIRU and falling labor force participation); TFP and slowdown in investment contributed about evenly to remainder.
  - Projection: potential output set to grow at average rate of 1.2 percent over medium term as investment recovers; TFP expected to accelerate to 0.5 percent by 2020 (vs. 0.8 percent on average over 1993–2007); labor contribution stable at 0.3 percent.
  - Reforms: estimates take into account recent and planned structural reforms, estimated to raise real GDP growth by an average of ½ percent over next five years.
- Spain
  - Decline: potential output growth fallen from about 3 percent in 1993–2007 to around ¾ percent on average since 2008.
  - Crisis effects: sharp fall in investment; real estate prices declined by 40 percent from pre-crisis peak; financial frictions and debt overhang significantly reduced corporate investment.
  - Labor: unemployment rose rapidly, increasing long-term and structural unemployment and aggravating skill deficits.
  - TFP: empirical estimates show some improvement post-crisis, largely reflecting exit of less-productive firms and labor shedding of lower-skilled temporary workers.
  - Projection: potential growth estimated at 1.2 percent per year on average over 2015–20, constrained by (i) low productivity growth; (ii) relatively tepid investment; (iii) modest labor contribution due to adverse population dynamics and still very high NAIRU.
  - NAIRU: recent evidence suggests NAIRU increased substantially during crisis and expected to remain in double digits in the medium term.

### Modeling choices and assumptions
- MVFRES framework requires key assumptions on:
  - (i) smoothness properties of potential output;
  - (ii) impact of existing policies on potential output.
- Smoothness calibration:
  - Assumes relative incidence of supply and demand shocks of about 1 to 4.
  - Footnote: The variance of the shock term to potential output is one fourth of the variance of the shock term to the output gap.
- Reforms and policy incorporation:
  - MVFRES uses real GDP projections up to 2020 as input; extent to which projections reflect ongoing policy depends on assumptions in those projections.
  - France: estimates incorporate recent and planned structural reforms estimated to raise real GDP growth by an average of ½ percent over next five years.
  - Germany: baseline incorporates current and announced policies, including lowering of retirement age for some categories of workers and planned increase in public investment.
  - Spain: current growth rebound partly reflects past reforms, including labor market reforms, captured in baseline projections.

### Box 2 — Estimating potential/sustainable output with financial cycles
- Multivariate filter augmented with financial variables (MVFEUR) helps identify episodes of high/low GDP growth unlikely to last (“sustainable” output).
- Financial variables used: deviations of credit, house and stock prices from their longer-term trends.
- Approaches including financial variables are less likely to interpret credit-driven temporary GDP changes as lasting changes in sustainable output.
- Spain example:
  - Conventional output-and-prices-focused estimates would have suggested a much smaller output gap during 2000–07 housing and credit boom than MVFEUR.
  - MVFEUR implies larger output gaps during crisis period after 2007.
- Practical use: comparing conventional and financial-augmented estimates informs judgment; where financial variables deviate strongly from trends and models differ widely, conventional estimates may give incomplete picture. This informed adjustments to raw MVFRES for Spain.

### Components of potential growth — capital and potential employment
- Capital contribution:
  - Relatively dynamic until the crisis.
  - France in 2000s: business investment dominated by accelerator effects, equity leverage, low borrowing costs.
  - Spain in 2000s: investment increased during strong credit and housing boom, reflecting fall in interest rates and relatively high wage growth.
  - Germany in 1990s: robust capital contribution reflected construction boom after reunification and later ICT capital investment; early 2000s decline due to Neuer Markt collapse and competitiveness issues.
- Crisis impact:
  - Fall in investment across all three countries; most pronounced in Spain where real estate prices declined by 40 percent from pre-crisis peak.
  - Financial frictions amplified investment decline; debt overhang significantly and negatively affected corporate investment, especially in Spain.

*Source: IMF Staff estimates (excerpts from the provided IMF chapter).*

### 20.      Trend labor developments display significant heterogeneity across countries (Figure 3). In

### _cr15233 - 20.      Trend labor developments display significant heterogeneity across countries (Figure 3). In

### Labor developments: France, Germany, Spain
- France
  - Trend labor developments are dominated by working age population dynamics.
  - Drivers: steady immigration (especially from former colonies in North Africa) and high fertility rates.
  - Working-age population increased by 0.5 percent on average over 1995–07 (0.34 percent during 2008–14 as baby boom effects waned).
  - Labor participation and the NAIRU contributed only modestly to changes in potential growth.
  - Structural unemployment ranged between 7.3 in 1980 and 10 percent in 1996) and displayed significant persistence (e.g. NAIRU only started to decline in the late 1990s).
  - Institutional rigidities listed as keeping structural unemployment high: high minimum wage, limited enterprise-level flexibility, unemployment and social benefits with insufficient job search incentives.
  - Recent reforms have reduced the labor tax wedge but some fundamental issues remain to be fully addressed.

- Germany
  - Labor’s contribution to potential GDP growth was negative throughout the 1990s, driven by a continuous reduction in average hours worked per employed person and a steady increase in the natural unemployment rate.
  - Secular trend toward shorter work week and more annual leave continued in early 1990s; share of part-time jobs then began to increase.
  - Hartz reforms in the mid-2000s and wage moderation helped address unemployment; structural unemployment has been on a steady decline since then.
  - German labor market weathered the crisis particularly well; the employment rate (measured in hours) contributed positively to growth on average during the most recent period.
  - Contribution of working age population has been small or negative since the mid-1990s; labor force participation rate contribution has been positive, reflecting increasing participation of women and older workers—especially after the increase in the mandatory retirement age from 2007.

- Spain
  - Labor input expanded rapidly in 1995–2007 driven by fast growing working age population (partly reflecting large migration inflows) and a rise in the labor force participation rate.
  - Rise in migration partially driven by the housing boom—almost ¼ of all new jobs were created in the construction/real estate sectors.
  - Since the crisis, the contribution from potential employment turned negative: population growth slowed and turned negative in 2012; NAIRU increased substantially.
  - Unemployment has been among the highest and most volatile, with an estimated Okun’s coefficient more than twice the OECD average during 1990–2011.
  - Volatility attributed to wage rigidity, insufficient flexibility of working conditions, and high labor market duality.
  - Steep increase in NAIRU during the crisis linked to temporary but persistent skill mismatch during sectoral reallocation (e.g., labor moving from construction to other sectors).

### Total Factor Productivity (TFP): differences and drivers
- Cross-country differences
  - Average TFP growth rates differ significantly: Germany leads in TFP growth; France is higher than Spain but lower than Germany; Spain experienced negative TFP growth prior to the crisis with some recent improvement attributed to increased unemployment and exit of low-productivity firms.
  - Factors potentially explaining differences: (i) innovation capacity; (ii) structural characteristics (firm size, public efficiency, quality of governance).

- Innovation capacity
  - Germany: EU innovation leader per 2015 EU Innovation Scoreboard; best performer on the European Innovation Output Indicator; achieved R&D expenditure target of 3 percent of GDP; weakness in venture capital investments noted.
  - France: just above average innovation performance; relative weaknesses include poor non-R&D innovation expenditure in the business sector, few EU-wide trademarks, and inadequate innovation capacity of SMEs.
  - Spain: performance below average; suffers from funding shortages and very low innovation capacity of SMEs; license and patent revenues from abroad particularly weak.

- Structural characteristics affecting TFP
  - Firm size: smaller firms, more prevalent in France and Spain relative to Germany, are less productive than larger ones.
  - Spain: low TFP also reflects labor market duality, lowering incentives to invest in workers’ skills.
  - Regulatory and institutional quality (public efficiency, governance) correlate with productivity and firm-size dynamics.

### TFP dynamics and hypotheses for slowdown
- Overview
  - A secular TFP slowdown observed to some extent in all three countries prior to the crisis; evidence points to a significant slowdown in ICT diffusion and adoption in the services sector, likely linked to regulatory and institutional frameworks that discourage innovation and absorption.

- Hypothesis 1 — Reallocation from manufacturing to services
  - Limited support: allocation toward lower-than-average productivity sectors contributed somewhat negatively to TFP over 1980–2007 (Germany -0.2 percent; France -0.1 percent; Spain -0.1 percent).
  - More important is the decline in productivity growth within services sectors themselves, which comprise the bulk of employment and activity.
  - Business services TFP declined in all three countries; distribution services TFP picked up in Germany but slowed in France and Spain during 2001–07; average TFP growth became negative in Spain during that period.

- Hypothesis 2 — ICT revolution loses steam
  - Two dimensions: (i) direct effects in ICT goods & services producers (ICTGS); (ii) indirect effects in ICT-using sectors.
  - (i) Little evidence that ICTGS productivity slowdown explains wider TFP slowdown; TFP growth in ICTGS was higher in 2000–07 than in 1990–99 in all three countries.
  - (ii) More evidence for indirect effects: slowdown in ICT diffusion/adoption in services can account for some of the TFP slowdown; ICT as a general-purpose technology fosters complementary innovations, and reduced diffusion limits broad-based gains.

- Hypothesis 3 — Innovation fatigue / catching-up limits
  - Evidence does not support this as the main explanation: the gap between Germany and France/Spain has increased over time rather than decreased, so catching-up fatigue cannot account for the slowdown.

- Hypothesis 4 — Regulatory and institutional constraints on innovation creation/absorption
  - Market regulation and ICT investment: negative correlation observed between product market regulation and ICT use in services; lower initial regulation associated with higher subsequent TFP growth; combined labor and product market deregulation may have larger effects.
  - Firms’ size, economies of scale, innovation capacity:
    - France: heavy labor-related regulations and legal requirements (accounting, tax, profit sharing) limit firm growth and economies of scale; threshold at 50 employees estimated to cost at least 0.5 percent of GDP in foregone employment and productivity.
    - Spain: firms are smaller, less productive, innovative, and export-oriented; productivity gap between small and large firms is wider than in many peers; obstacles include size-dependent regulatory thresholds, limited financing access, and market fragmentation from regional/local regulatory proliferation.

### Conclusions and policy implications
- Potential output and recent trends
  - Potential output growth has declined significantly in France and Spain since the Great Recession and is expected to remain below pre-crisis levels in the medium term without additional reforms.
  - In Germany, potential growth is expected to remain at pre-crisis levels, though aging will exert pressure on potential growth in the longer term.

- Sources of potential growth (summary)
  - Capital: strong pre-crisis in Spain but large drop in investment during the crisis; Germany’s capital contribution had declined pre-crisis and remained low; France’s capital contribution resilient.
  - Potential employment: robust pre-crisis in France and Spain (fast growing working age population and rising participation in Spain); trend reversed during crisis due to increasing structural unemployment and adverse population dynamics (Spain). In Germany, trend employment contribution has picked up recently due to higher labor force participation (women, older workers) and declining structural unemployment.
  - TFP: secular decline in Spain; decline since 2000s in France prior to crisis; improvement in Spain post-crisis mostly due to labor shedding; Germany’s TFP has remained the main engine of potential growth.

- Structural constraints and reform priorities
  - Germany: population projected to age fast despite net immigration mitigating near-term pressures.
  - France: structural unemployment expected to remain high without reforms.
  - Spain: potential growth constrained by adverse population dynamics, high structural unemployment, low TFP growth, dominance of small firms, and labor market duality that lowers incentives to invest in workers’ skills.
  - Significant potential exists for lifting TFP and reducing high structural unemployment in France and Spain.

- Staff analysis on reform scope
  - Substantial scope for raising potential GDP through structural reform; precise gains depend on starting position, ambition, implementation speed, and time to take effect.
  - Recommended reform emphases (as discussed in 2015 Staff Reports for Article IV Consultations):
    - France: reduce structural unemployment and high level of spending and taxes.
    - Germany: reduce disincentives for women to work full time.
    - Spain: address relatively low productivity, high duality, and skill deficiencies.
  - Reforms along these lines would provide a well needed boost to potential output.

*Source: _cr15233 - 20.*

### References

### _cr15233 - References

### Summary of Spain's insolvency reforms (2014 and 2015)
- Spain introduced reforms via Royal Decree Laws issued in September 2014 and February 2015 to:
  - facilitate enterprises reaching restructuring agreements in court;
  - encourage the sale of businesses as going concerns in insolvency liquidation;
  - improve the mediated out-of-court restructuring process for SMEs and extend it to include consumers;
  - provide a “fresh start” for consumers and individual entrepreneurs after liquidation of personal assets in bankruptcy.
- The “fresh start” allows financially distressed entrepreneurs and consumers to be discharged of unsustainable debt after liquidation of personal assets and is expected to incentivize future entrepreneurial behavior and consumption, supporting continued economic growth and social cohesion.

### Assessment of reform design and expected effects
- Positive advances:
  - Expansion of restructuring tools and removal of previous limits on write-downs and reschedulings in in-court plans (see thresholds below).
  - Introduction of rules permitting automatic assignment of executory contracts and licenses and negotiated direct sales of businesses as going concerns without an auction.
  - Extension and streamlining of the out-of-court payment agreement procedure (OCAP) to consumers and entrepreneurs, with mediation and simplified processes via Commercial Registry, notaries, and chambers of commerce.
- Limitations and potential inefficiencies:
  - Public creditors remain excluded from out-of-court restructuring processes and are not subject to discharge after liquidation, which:
    - disincentivizes other creditors from voluntarily restructuring; and
    - incentivizes debtors to pay public debts at the expense of other creditors.
  - No “cram-down” mechanism is provided to bind dissenting impaired creditor classes, which may reduce the efficiency and feasibility of restructuring plans when multiple affected classes must approve.
  - The new class voting system can include up to nine distinct affected voting classes, which may be too involved to be workable in practice and mixes creditors with different economic incentives within single voting classes.
  - Successor liability for residual social security and labor liabilities protects social creditors but discourages potential buyers and can distort value allocation among creditors.
  - Judicial discretion allowing transfer to a bidder that better secures job preservation even if its bid is lower by as much as 15% can distort market-efficient outcomes.

### Policy recommendations and areas for improvement (as indicated by the text)
- Consider clarifying and potentially expanding the inclusion or treatment of public creditors in restructuring processes to enhance effectiveness, particularly where entrepreneurs have tax arrears.
- Clarify the “fresh start” legislation to facilitate wide and uniform application while minimizing misuse.
- Reconsider the absence of a cram-down mechanism or specify conditions under which dissent by impaired creditor classes can be overridden to improve restructuring feasibility and prevent holdouts.
- Reassess successor liability and the 15% judicial preference rule for job preservation in going-concern sales to better balance worker protection with value maximization for creditors and market efficiency.

### Key statutory thresholds and procedural changes (preserved exactly as in source)
- Plan content (in court): no limit to write downs and reschedulings can be up to 10 years.
- Class voting: majority of 50% or 65% of ordinary creditors required to approve the plan; privileged creditors included in those percentages when they vote in favor.
- To bind all privileged creditors within a class:
  - (a) creditors holding 60% of the total value of the claims if the plan includes write downs of less than 50% and reschedulings of up to 5 years; or
  - (b) creditors holding 75% of the total value of the claims if the plan includes higher write-downs and longer reschedulings (with a cap of 10 years).
- Out of Court Agreements (OCAP):
  - Majorities: 60% of the value of the claims for plans including write-downs of up to 25% or rescheduling of less than 5 years; 75% necessary to pass a plan with higher write-downs and reschedulings (with a cap of 10 years).
  - Secured creditors may be bound by the plan (for the amount covered by the collateral) as long as 65% or 80% vote in favor of the agreement, depending on the extent of the write downs/rescheduling.
- Sección de Calificación: no “sección” on liability and disqualification of directors will be opened if an insolvency plan is passed that envisages a write off of less than 1/3 of the claims or a stay shorter than 3 years, either for all creditors or for the creditors of one or more classes; it will suffice to pay 67% of the claims to only one of the classes of creditors to avoid the mandatory investigation into the behavior of directors.
- Judicial discretion in going-concern transfers: judge may authorize transfer to the bidder that better secures continuation of the business and preservation of jobs even if the bid is lower than other bids by as much as 15%.

*Source: _cr15233 - References*

### 7.      The most noteworthy achievement is the introduction of a fresh start for individual

### 7.      The most noteworthy achievement is the introduction of a fresh start for individual

### The “Fresh Start” Reform: structure and process (Box 2)
- Royal Decree Law 1/2015 introduced a specific system to deal with the insolvency of individuals covering both consumers and individual entrepreneurs.
- Two mandatory, consecutive stages:
  - Out of Court Stage (OCAP)
    - Applies to individual debtors with an estimated debt below 5 million euro; a prior “OCAP” procedure must be attempted.
    - Individual professionals (empresarios according to Social Security rules and autonomos) are regarded as entrepreneurs.
    - Debtors convicted of certain economic and social crimes and those who had reached an OCAP, concluded a refinancing agreement or who have undergone insolvency proceedings in the previous 5 years may not access the proceedings.
    - Procedure varies by debtor type: entrepreneurs petition through the Commercial Registry or a Chamber of Commerce; consumers petition to a public notary. Templates designed by the Ministry of Justice must be used.
    - The mediator is a private professional who analyzes documents; summons creditors to a meeting; drafts the plan (including a payment plan referencing resources needed); and must supervise implementation of the plan.
    - Opening of the OCAP limits the debtor’s ability to carry out legal acts outside ordinary administration; generally, executions are stayed, and the accrual of interest is suspended during negotiation.
    - Creditors must express their opinion on the plan or their claim will be subordinated. Public creditors are not affected by the OCAP.
  - In-Court Insolvency Stage (following a failed OCAP)
    - Proceedings are abridged, formal insolvency proceedings; for consumers, proceedings will necessarily be liquidation proceedings.
    - The debtor must have previously tried an OCAP (unless not legally allowed).
    - Only good faith debtors may obtain a discharge. Good faith is deemed to exist when:
      - (a) the procedure has not been classified as “guilty” (culpable);
      - (b) the debtor has not been convicted for criminal offences in the 10 years prior to the opening of insolvency;
      - (c) the debtor has paid all administration claims, all privileged claims and 25% of unsecured claims; or alternatively, if such payment has not happened:
        - (d) the debtor has not breached the duty to collaborate during insolvency proceedings;
        - (e) has not obtained a discharge in the previous 10 years;
        - (f) has not unjustifiably rejected a job offer in the previous 4 years;
        - (g) accepts to be included in the public insolvency register for 5 years; and
        - (g) accepts to be subject to a post-liquidation payment plan.
    - The immediate yet provisional discharge will only affect:
      - (i) all outstanding unsecured and subordinated claims, with the exception of public claims and alimonies; and
      - (ii) the part of secured claims that remains unpaid following execution of the collateral (if it is classified as unsecured).
    - Dischargeable claims are provisionally discharged upon liquidation. All other claims (except public claims) are subject to a payment plan that can last up to 5 years.
    - A final discharge will be granted upon compliance with the payment plan unless any of the following occur:
      - debtor incurs causes that would have prevented provisional discharge (see “good faith”);
      - debtor enjoys certain fortuitous gains (inheritance or lottery) such that he or she is able to satisfy all discharged claims and alimonies;
      - undeclared assets or revenues are discovered;
      - the payment plan is not complied with.
    - Despite having breached the payment plan, the judge may confirm the discharge if, given the circumstances and having heard creditors, the debtor has devoted 50% of her non-exempt income to the satisfaction of the plan.
- June 2015 parliamentary amendments to RDL 1/2015 clarified that:
  - discharge can be revoked during the payment plan period upon fortuitous gains such as lottery or inheritance (and not other economic success);
  - guarantor gets no recourse action against the discharged debtor (provided it is not revoked);
  - threshold reduced from 50% to 25% for those debtors subject to the Code of Good Practices;
  - grounds for revocation shall occur during the term of the payment plan (except revocation based on discovery of undisclosed assets or revenues, which can occur any time within the five-year period).
- The amended version is still subject to confirmation by the Senate (as stated in the source).

### Rationale and expected economic and social effects
- The reform is intended to encourage individuals to engage in productive economic activity in the formal sector by lowering the personal cost of business failure.
- A “fresh start” regime incentivizes starting new businesses and risk-taking, deters grey market activity, and recognizes economic failure as a temporary setback rather than a life sentence.
- Spain’s regime balances quick deleveraging with minimizing moral hazard by combining features of U.S. Chapter 7 immediate discharge and European post-liquidation “good faith” commitment periods.
- The system could maximize benefits by increasing post-discharge certainty, remedying lack of clarity on the post-liquidation payment plan and revocation of discharge, and careful monitoring to detect misuse.

### Main concerns: exclusion of public creditors and incentive effects
- The unusually broad exclusion of public claims is a notable feature and potential drawback.
- Residual Debt:
  - After bankruptcy liquidation, residual debt owed to public creditors (even to those public law debts that enjoy no privilege in the insolvency law) will not be extinguished or included in the post-discharge payment plan.
  - Individuals, particularly entrepreneurs, may remain saddled with sizeable public debt after liquidation, reducing resources to start and grow businesses and likely negatively impacting tax revenues in the longer term.
  - Public creditors may enforce arrears administratively (including garnishing wages), which may obstruct the debtor from complying with the payment plan and thus prevent final discharge.
- Unintended Incentive Effects:
  - Broad exclusion of public creditors may incentivize debtors in distress to pay public creditors preferentially and default strategically on other liabilities before petitioning for mediation and bankruptcy.
  - This may harm payment culture and reduce recoveries for financial and trade creditors of entrepreneurs.

### Cross-country design comparisons (Box 3): Immediate discharge v. commitment period and scope of dischargeable claims
- Germany:
  - Discharge granted only after a commitment period that generally lasts 6 years (reduced to 5 years upon payment of all costs of proceedings and 3 years if there is 35 percent recovery for creditors).
  - During the commitment period the debtor assigns/transfers all nonexempt income to a trustee for ratable payment of unpaid claims.
  - Public law claims are included in the discharge, including VAT, except taxes or social security contributions criminally evaded or withheld (non-dischargeable only after final criminal verdict).
- Italy:
  - Multiple procedures (creditors agreement, consumers’ insolvency plan, bankruptcy liquidation).
  - After bankruptcy liquidation, discharge can be granted four years after initiation of insolvency procedures, subject to good conduct.
  - Discharge does not cover debts for alimony, tort debts, pecuniary sanctions and tax liabilities for acts preceding the insolvency process but assessed after its commencement. All other tax claims are dischargeable.
- United Kingdom:
  - Bankruptcy liquidation generally leads to discharge one year after opening (moratorium period); debtor may pay excess income for up to three years.
  - Restrictions during moratorium; some can continue up to 15 years if debtor was reckless or culpable.
  - No special priority for public claims; they are subject to discharge after the one year moratorium.
- United States:
  - Chapter 7 provides immediate discharge (in practice about 4 months after closing of liquidation); Chapter 13 involves min. three year plan, extendable to five years.
  - Discharge excludes priority tax claims (non-priority tax claims are discharged), claims incurred by fraud, domestic support obligations, willful or malicious injury, fines and penalties, educational benefits and loans, and certain intentional personal injury claims.

### Maximizing effectiveness: resources, clarity, and monitoring
- Implementation needs sufficient judicial resources and active monitoring:
  - Strengthen IT capacity, improve case management by digitalization of files, develop standard forms and templates, invest in dissemination and capacity building for stakeholders.
  - Gather relevant statistics to monitor use of the regime, especially the fresh start mechanism, allowing informed adjustments.
- Urgent legal clarifications needed to create maximum certainty for debtors and markets:
  - Clarify bases for revocation and ensure they are minimal and explicitly clear.
  - Address widely-held misunderstandings regarding:
    - which non-discharged liabilities are included in the payment plan and whether such liabilities are forgiven after successful completion or dedication of 50% of income;
    - the length of the payment plan (whether up to or fixed at five years);
    - circumstances in which discharge can be revoked;
    - circumstances under which a judge would choose not to revoke discharge when debtor used 50% of disposable income for plan compliance.
  - Strict and broad interpretation of ex-ante good faith requirement so listed criteria are illustrative and not exclusive.

### Policy recommendations and potential further improvements
- Inclusion of public claims:
  - Public claims should be included in bankruptcy discharge, at least to the extent they are ranked as ordinary or subordinated claims.
  - Second-best: include public claims in the payment plan, stay their enforcement during the plan period, stop accrual of interest and penalties, and eventually discharge them like other claims included in the plan.
- In-court and out-of-court procedural improvements:
  - Include public creditors in the OCAP procedure and in refinancing agreements.
  - Introduce a “cram-down” mechanism to disregard majority dissent of one or several classes provided they receive fair value under the plan (minimum: net present value of liquidation payout).
  - Successor liabilities: social security and labor liabilities should not be transferred to acquirer in going-concern sales; such liabilities should be included in the restructuring plan. Consider disclosure/control of sales to insiders and public auction requirement for such sales. Reconsider the rule allowing judge to authorize a going-concern transfer to preserve business and jobs even if bid is up to 15 percent lower.
  - Pending bilateral contracts: classify claims of counterparties of rejected terminated executory bilateral contracts as ordinary insolvency claims (not claims against the estate).
- Fresh start-specific measures:
  - Revocation alternative: rather than revocation for fortuitous gains, distribute substantial fortuitous gains ratably to pre-insolvency creditors based on final list of bankruptcy claims.
  - Preventing misuse: consider expanding bases for revocation to other kinds of post-insolvency fraud and state that certain liabilities are never dischargeable if abuse evidence emerges.
  - Co-debtor joint case management: consider enabling joint case administration for debtor and household co-debtors for coherent resolution of household debt.

*International Monetary Fund — Spain: discussion of the fresh start reform and related insolvency-policy recommendations as presented in the source content.*

### 14.      The analysis below attempts to estimate the impact of post-liquidation discharge on

### _cr15233 - 14.      The analysis below attempts to estimate the impact of post-liquidation discharge on

### Overview
- Purpose: Estimate impact of post-liquidation discharge on debtors, banks, and the government, subject to uncertainty from legal interpretation and data limits.
- Core assumption: Reform is effective in promoting discharge of debtors and recommendations are followed; behavioral changes of borrowers or lenders are not modelled.
- Key methodological note: Details of methodology and assumptions appear in the annexes.

### Estimated impact on debtors (aggregate private sector)
- Estimated reduction in private sector liabilities if the entire stock of banks’ NPLs were liquidated: €30–44 billion.
- Debtors affected are assumed to include consumers and “individual entrepreneurs” (more specifically: sole proprietors of unincorporated businesses, consumers, individual general partners of partnerships, and individuals who gave personal guarantees, or provided collateral, for debt of another).
- Assumed average recovery from liquidation:
  - Between 45–55 percent on loans of consumers (mortgage and auto loans, credit card debt and other personal loans).
  - A similar recovery rate on loans to individual entrepreneurs.
- Key data uncertainty: Size of debt of individual entrepreneurs estimated via (i) ORBIS small enterprise liability data and (ii) BdE aggregate NPLs in industries where individual entrepreneurs are active.

### Estimated Impact on Banks
- Aggregate debtor relief attributable to cancellation of banks’ remaining claims after liquidation: €30–44 billion.
- Estimated effect on banks’ earnings: about 1–2 percent per year at the current pace of liquidation.
- Estimated effect on banks’ overall capital: less than 1 percent versus what it might have been at the end of a 3-year period.
- Rationale: Banks already hold provisions at 55 percent of NPLs and would realize other benefits from cancellation (for example, lower carrying costs of NPLs). Even before reform banks could collect only a small portion of residual amounts after liquidation.
- Estimation approach:
  - Bottom-up projection using 10 years of annual filings for Spain’s largest 5 banks by consolidated assets to project balance sheets, earnings, and capital over a three-year period.
  - Iterative procedure maximizes loan growth subject to capital and funding constraints.
  - Capital constraint: reinvested earnings and equity issuance must equal or exceed market expectations of target capital requirements over 2015–17.
  - Funding constraint: funding raised (deposits, interbank, debt issuance, ECB facilities) must equal or exceed funding needs for projected loan growth.

- Bank-level estimated impacts from Table 2 (percent of pre-reform earnings and capital; loan supply projections preserved as presented):
  - Santander: Proportion of loan book in Spain 20 percent; Domestic loans at end-2014 661 bn eur; Domestic deposits at end-2014 753 bn eur; Projected Available Credit Supply (percent yoy) -4 to -1; Estimated Earnings Impact (percent of pre-reform) -1 to -0.5; Estimated Capital Impact (percent of pre-reform) -0.5 to 0.
  - BBVA: Proportion 50 percent; Domestic loans 661 bn eur; Domestic deposits 394 bn eur; Projected Available Credit Supply -5 to -1; Estimated Earnings Impact -0.5 to 0; Estimated Capital Impact -0.5 to 0.
  - Caixa: Proportion 100 percent; Domestic loans 189 bn eur; Domestic deposits 182 bn eur; Projected Available Credit Supply -4 to -5; Estimated Earnings Impact -2.5 to -2; Estimated Capital Impact -1 to -0.5.
  - Bankia: Proportion 100 percent; Domestic loans 113 bn eur; Domestic deposits 107 bn eur; Projected Available Credit Supply -1 to 0; Estimated Earnings Impact -2.5 to -2; Estimated Capital Impact -2 to -1.
  - Sabadell: Proportion 90 percent; Domestic loans 102 bn eur; Domestic deposits 98 bn eur; Projected Available Credit Supply -1 to 0; Estimated Earnings Impact -1.5 to -1; Estimated Capital Impact -1 to -0.5.
  - Top 5 banks aggregate: Proportion 73 percent; Domestic loans 670 bn eur; Domestic deposits 702 bn eur; Projected Available Credit Supply -2 to -3; Estimated Earnings Impact -2 to -1; Estimated Capital Impact -1 to -0.5.
  - System: Proportion 13 percent; Domestic loans 1,319 bn eur; Domestic deposits 972 bn eur; Projected Available Credit Supply -2 to -3; Estimated Earnings Impact -2 to -1; Estimated Capital Impact -1 to -0.5.
- Sources used: BdE, Haver Analytics, ORBIS, IMF staff estimates (June 2015) and bank statements, IMF staff estimates (May 2015).

### Credit Supply
- Base scenario conclusion: Law is unlikely to be a significant impediment to credit supply because:
  - Estimated balance sheet impact is relatively small.
  - Largest banks appear to have adequate capital and provisioning buffers and ample funding.
  - Continued availability of ECB liquidity, including TLTROs, is assumed.
  - Estimates assume discharge is not revoked within the five-year period after being granted.

### Estimated Impact on the Government
- Estimated public claims potentially affected by discharge: €7–9 billion cumulatively.
- This amount corresponds to 3–4 percent of annual tax revenues.
- Timing: Likely spread over several years depending on pace of liquidation.
- Estimation basis: Assumes net earnings of distressed consumers and entrepreneurs are at most similar in magnitude to their debt servicing costs; then applying estimated average income tax and social security contribution rates.
- Caveat: Potential loss could be partially or wholly compensated by higher tax revenue from firms entering the formal economy (not included in this analysis). Much of these public claims are noted as uncollectible.

### Estimation Uncertainty (major sources)
- Scope of the reform:
  - Uncertainty in size of debt of individual proprietorships affected by discharge and extent of recovery on consumers’ and entrepreneurs’ debt.
  - Example sensitivities:
    - If banks’ NPLs due to entrepreneurs were cut by half (e.g., via OCAP or refinancing), private sector debt relief related to discharge would fall by nearly 20 percent.
    - If recovery rate on distressed debt were 10 percent higher, discharge from debt relief would be 20 percent lower.
- Banks’ capital and funding buffers:
  - Capital requirements in calculations set at fully-loaded Basel III CET1 capital ratios of 11, 11.5, and 12 percent over 2015–17 for SIFIs and 2 percentage points lower each year for non-SIFIs.
  - Future regulatory developments on DTAs or TLAC could raise capital needs above assumed targets.
  - Funding assumption: banks take full advantage of ECB facilities, including TLTROs, and deposits remain stable.

### Credit Demand and Macroeconomic Effects
- “Fresh start” effect: Allowing discharge is likely to increase credit demand over time as discharged debtors re-integrate into the formal economy and seek new credit.
- Quantified estimates:
  - Debt relief split estimates:
    - Consumers: €22–28 billion (about 3–4 percent of current total household debt and between 35–50 percent of the flow of new credit to households during 2014).
    - Individual entrepreneurs: €9–18 billion (about 1–2 percent of the current level of corporate debt and between 35–65 percent of the flow of new credit to firms for loan sizes below €1 million during 2014).
  - Expected macro effects (spread out over 5 years or more, depending on pace of liquidation):
    - Pickup in annual consumption: 0.9–1.3 percent.
    - Pickup in annual investment: 0.4–0.9 percent.
  - Implied increase in credit demand from insolvency reform alone if consumption/investment only partially financed by borrowing: 0.3–0.6 percent over this period.
  - Aggregated estimate of insolvency reform impact on credit demand from household and corporate borrowers: approximately 0.5 to 1.0 percent, spread over a number of years based on pace of liquidation.
- Data note: BdE data on the flow of new credit available only since March 2014; 2014 flows do not capture full year.

### Annex I — Estimation of Banking Sector Impact: methodology and key assumptions
- Objective: Determine impact of February 2015 insolvency reform (cancelation of residual debt after liquidation for some borrowers) on banks’ asset quality, earnings, capital and credit supply over a three-year period.
- Data:
  - Balance sheet and earnings data from 10 years of annual filings through 2014 and 2015 Q1 for top 5 banks (SNL, Bankscope).
  - Top 5 banks represent close to 60 percent of domestic assets; top 2 SIFIs have 23 percent and 50 percent of consolidated assets in the domestic market respectively.
  - Corporate sector data from ORBIS; household data from OECD and Haver.
- Approach:
  - Estimate potential credit supply from each top-5 bank independently of credit demand, based on capital and funding constraints.
  - Two scenarios: (i) before reform and (ii) after reform (reduced recovery amounts on NPLs from consumers and individual entrepreneurs).
- Key assumptions:
  - Capital: Fully-loaded Basel III CET1 capital ratios of 11, 11.5 and 12.0 percent over 2015-2017 for SIFIs; 2 percentage points lower each year for non-SIFIs. Market issuance of CET1 includes only equity (CoCos excluded). Equity issuance already announced is included.
  - Funding: Annual deposit growth matches past year; debt issuance only rollover; banks take full advantage of ECB TLTROs if eligible per ECB circular.
  - Earnings: For 2015-2017, net interest margin (NIM), fee income, expenses, tax-rate, provisioning ratio versus NPLs remain constant at 2015 Q1 levels. Dividend policy remains constant unless announced otherwise.
  - Assets: Fixed assets unchanged; refinancing does not count towards credit growth; liquidated NPLs reduce risk-weighted assets.
  - Asset impairment assumptions:
    - Recovery rate on secured NPLs (mainly mortgages) estimated at 50 percent (based on pre-crisis LTV of 80 at origination, a 60 percent haircut to foreclosure value: 40 percentage points from real estate price decline and 20 percentage points transaction costs).
    - Recovery rate on unsecured NPLs set to 15 percent of par amount (matching average level for top 5 banks).
  - Insolvency reform scope: Affects only banks’ NPLs from consumers and individual entrepreneurs; residual debt after liquidation includes secured and unsecured loans; discharge is not revoked.
- Estimation steps:
  - Estimate NPLs of individual entrepreneurs using BdE industry breakdown (industries where proprietorships dominate) as one approach; alternative ORBIS size-based approach noted.
  - Estimate overall debt of affected borrowers by applying banks’ financing share to banks’ NPLs for consumers and individual entrepreneurs.
  - Calculate liquidation recoveries (50 percent for secured mortgages; 15 percent for unsecured).
  - Residual debt after liquidation = total debt − estimated recoveries. Banks’ portion of residual debt proportional to banks’ financing share.
  - Before reform, banks may have collected perhaps 10–15 percent of residual debt after liquidation; after reform banks may not collect that portion.

*Source: IMF staff estimates and analysis as presented in the content unit.*

### Annex II. Estimation of Impact on Credit Demand of Recent

### Annex II. Estimation of Impact on Credit Demand of Recent Insolvency Reform

### A. Introduction
- Outlines methodologies to estimate the impact of recent insolvency reform concerning post-liquidation discharge on overall credit demand from consumers and firms.
- Approaches were developed by other authors and the results are adapted and used here.

### B. Data
- Consumer demand estimation uses cross-country data from BIS over 2000–14 on consumer leverage and credit.
- Firm demand estimation relies on Banco de España’s confidential data over 2002-2010 for loan applications received by banks and the characteristics of the lending institutions which approved or denied those applications.

### C. Consumer Demand
- Method: least-squares linear fit of the inverse relationship between real consumer credit and the level of their debt to GDP.
- Key quantitative findings:
  - Elasticity of -0.47 with a standard error of 0.14.
  - A decline in overall consumer leverage by about 1.5 to 3 percentage points resulting from discharge would lead to an increase in overall credit demand by 0.7–1.5 percent over a period of time corresponding to the liquidation of banks’ end-2014 NPLs that would be covered by the law.

### D. Demand from Firms
- Method: model linking loan-application approvals to firm fundamentals and lending-institution characteristics (Jimenez et al.). Success of application coded 1 (granted) or 0 (not granted); least-squares linear fit versus firm and bank variables.
- Time periods defined:
  - Good times: 2002–(July) 2007.
  - Crisis period: (August) 2007–2010.
- Observed acceptance rates:
  - Good times average acceptance rate: 39 percent.
  - Crisis period acceptance rate: 30 percent.
- Firm-specific variables emphasized: firms’ capital ratio (natural log of ratio of firms’ own funds to assets) and past history of delinquency (number of firms applying while having other delinquent loans).
- Observed firm capital ratios:
  - In good times, firms granted credit had on average 13 percent of own funds relative to assets.
  - In crisis period, banks required on average 17 percent of own funds.
- Assumptions and estimated impacts:
  - Assume a 1–2 percent decrease in firms’ debt due to the law translates to a proportionate increase in firms’ own funds relative to assets.
  - This leads to an increase in loan approvals by 0.3–0.5 percentage points relative to the assumed baseline of 39 percent for good times.
- Additional scenarios related to delinquent (“subprime”) firms:
  - A decrease in subprime firms by half would raise loan approval by 0.9 percentage points.
  - Complete resolution of all subprime firms’ NPLs (no history of delinquency) would increase loan acceptance by nearly 2 percentage points; this impact would be spread out over time.

### E. Caveats
- Consumer-demand methodology caveats:
  - Use of cross-country data with banking systems in different states of development and wide variation in macro conditions limits precision.
- Firm-demand methodology caveats:
  - Structural change in the Spanish banking system after the financial crisis (consolidation of many savings banks and loss of banking relationships) likely altered elasticities of loan approvals and banking-sector variables.
  - The firm-demand sensitivity estimates analyze effects in isolation; debt discharge would also likely reduce numbers of firms with delinquent NPLs, an effect hard to model without data on affected firms.

### F. Results (Aggregate)
- Aggregating consumer and (individual entrepreneur) firm estimates suggests a pickup in credit demand of 0.5-1.0 percentage points over a period of several years depending on the pace of liquidation.

*Prepared by Mustafa Saiyid (MCM).*

### 16.      Spain’s Target2 flows have substantially improved since the crisis. Target2 balances are

### _cr15233 - 16.      Spain’s Target2 flows have substantially improved since the crisis. Target2 balances are

### Target2 flows and short-term dynamics
- Target2 balances for Spain declined significantly during the crisis, reaching -€429bn in August 2012.
- Target2 balances rebounded to -€188bn as of February 2015.
- The decline in Target2 balances was reflected in a sharp widening of the Bank of Spain net debt liabilities in the NIIP and an increase in other investments (Bank of Spain) in the financial account.
- From a cross-country perspective, Spain’s experience was mirrored in other Euro area countries with sizable negative Target2 balances that eventually rebounded from 2013.

### Composition of Spain’s IIP liabilities and mitigating factors
- Spain’s IIP liabilities: 234 percent of GDP at end 2014.
- Liability equity component (direct and portfolio investments): 62 percent of GDP.
- Debt instruments related to direct investments (typically intra-company loans): 20 percent of GDP.
- Target2 liabilities: around 18 percent of GDP.
- Interpretation: The sizable equity nature of IIP liabilities mitigates sudden withdrawal risks relative to pure fixed-income liabilities.

### Geographic diversification of bank exposures
- Spanish banks increased exposure to Latin America, the US and the UK since the crisis.
- Largest Spanish bank exposure: UK with 27 percent of Spain’s GDP (stable through the crisis).
- US exposure: 17 percent of Spain’s GDP (a sharp increase compared to 2007).
- Brazil and Mexico exposures are close behind the US.
- Combined claims of French, German, UK and Dutch banks on Spain: 24 percent of Spain’s GDP in 2014 (down from 51 percent in 2007).
- Note: BIS bank exposure data are not strictly comparable to the NIIP data.

### Cost of debt and maturity structure
- Spain’s cost of sovereign debt outstanding has continuously declined since 2012; cost at issuance reached historical lows.
- 91 percent of portfolio investment debt liabilities have a long-term maturity.
- The average maturity of sovereign debt outstanding increased to 6.5 years.
- Non-resident share of Spain’s sovereign debt holdings: around 50 percent.
- ECB measures such as QE or OMT are noted as limiting the risk from large-scale capital outflows.

### Overall external vulnerability assessment
- Spain’s negative NIIP is very high by cross-country and historical standards.
- Despite a remarkable CA adjustment since the crisis, the current account (CA) balance remains very sensitive to changes in domestic demand and its impact on imports.
- Mitigating factors: low cost of debt, favorable maturity structure, export and bank exposure diversification, sizable equity IIP liability component, and moderate competitiveness gains since the crisis.
- Conclusion: These vulnerabilities still outweigh the mitigating factors and leave significant external concerns.

### EBA assessment and REER/current account gaps
- EBA assessment: Spain’s external position in 2014, though slightly improving from 2013, remains substantially weaker than consistent with medium-term fundamentals and desirable policies.
- Staff baseline projection: 3–4 percent annual NIIP/GDP improvement in the medium term.
- EBA cyclically-adjusted CA gap: ½ to 2 ½ percent of GDP weaker than desired for 2014.
- EBA REER regression models suggest a REER overvaluation of between 10–13 percent for 2014.
- Staff assesses an overall REER gap of around 5 to 10 percent above the desired level, taking into consideration NIIP sustainability.
- Achieving significantly lower unemployment rates closer to international peers in the medium term would likely imply a larger REER and CA gap.

### External DSA: baseline, scenarios, and risks
- Baseline: External debt falls from around 160 percent of GDP at end 2014 to 132 percent in 2020 (staff projection based on continued recovery and increasing trade balance and CA surplus).
- External debt-to-exports ratio is projected to narrow by over 1 50 percent of GDP during 2015–20 (text as presented).
- Gross external financing needs remain high but decline over the projection period to around 58 percent of GDP by 2020.
- Adverse historical-properties scenario: real GDP growth of 0.7 percent and a one percent higher nominal external interest rate lead to external debt of 168 percent of GDP in 2020 (over 35 percent of GDP higher in 2020 relative to baseline).
- Alternative stress scenarios:
  - Benign interest rate shock (from 2.6 in the baseline to 3.1 percent) leads to only a slight increase in external debt.
  - 30 percent real depreciation shock: similar modest increase.
  - Growth shock (average growth rate of 0.8 percent vs 2.1 percent baseline): external debt around 142 percent of GDP in 2020 (about 10 percent of GDP higher than baseline).
  - Combined shock (¼ standard deviation shocks to real interest rate, growth rate, and current account): external debt 144 percent of GDP in 2020 (12 percent higher than baseline).
- Overall DSA conclusion: External debt levels are projected to decline under the baseline but remain vulnerable to adverse macroeconomic shocks; stabilization fails under a return to historical macro variables.

### Export and import elasticities; implications for trade balance
- Domestic demand elasticity to imports: stylized regression models suggest around 1.5 (a one percent increase in domestic demand results in a 1.5 percent rise in imports of goods).
- Demand elasticity declined through the crisis but rebounded in 2014 to values above 2 (rolling regression evidence).
- Exports-to-imports linkage: estimated elasticity of export changes to import growth is 0.9, indicating strong import content of Spanish exports.
- Exports are highly elastic to foreign domestic demand with estimated elasticities over 1.5.
- REER changes (price competitiveness) are a highly significant factor for export performance; oil prices play a minor role.

### Trade-balance simulation scenarios
- Upside scenario assumptions:
  - Gradual 5 percent increase in Spain’s global export of goods market share (from around 1.7 percent value-based to 1.78 percent).
  - Gradual reduction in Spain’s demand import elasticity to around 1 (as observed during the crisis period).
- Upside simulation result: Simulated trade balance surplus increases significantly from the baseline by around 2 percent of GDP; exports-to-GDP ratio would improve toward best performers.
- Downside scenario assumptions:
  - Gradual 2.5 percent decline in export market share.
  - Increase of demand elasticity to 2.5 from 1.5.
- Downside simulation result: Sizable deterioration of the trade balance over the medium term.
- Methodology note: Simulations are based on quarterly data with WEO projections; estimated elasticities from export and import regressions are used.

*Sources: ECB; Bank of Spain; WEO; and IMF staff calculations.*

### 32.      As a complement, we estimate the growth threshold in Spain that would be consistent

### _cr15233 - 32.      As a complement, we estimate the growth threshold in Spain that would be consistent

### Growth threshold for no deterioration in the CA/GDP ratio
- Finding: Growth rates higher than about 2 ½ percent are associated with a weakening of the CA/ GDP ratio.  
- Robustness: Quarterly OLS regressions produce an estimated real GDP growth threshold of 2.5 percent; using a shorter sample period (2000Q1-2014Q4) the threshold slightly declines to 2.3 percent.  
- Domestic demand threshold: A domestic demand growth rate of 2.6 percent (2.3 percent for the shorter sample period) would not lead to a deterioration of the CA/ GDP ratio.  
- Cross-country comparison: Spain’s estimated growth threshold in the annual OLS cross-country comparison is 2.3 percent and is fully consistent with the quarterly-model result (2.5).  
- Interpretation and caveats:
  - The growth “speed limit” is estimated by –c(0)/c(1), where c(0) is the estimated constant and c(1) the estimated coefficient on real GDP growth, ceteris paribus.
  - The approach is a simplified regression framework that does not capture the impact of structural reforms and is not a general equilibrium analysis.
  - The finding should be taken with caution given the simplicity of the empirical approach.

### External balance context and drivers
- Recent constraint: High import growth triggered by strong domestic demand has recently been a constraint on the trade and CA balance despite favorable tailwinds from lower oil prices and the euro depreciation.
- Elasticities and short-term estimates:
  - Average demand import elasticity of around 1.5 is estimated (sum of contemporaneous and one-quarter lagged domestic demand coefficients; second quarter lag not significant).
  - Rolling regressions complement OLS to estimate time-varying domestic demand elasticity to imports.
- CA regressions (stylized OLS, quarterly sample 1995Q1–2014Q4):
  - A 1 percent increase in the real GDP growth rate is, ceteris paribus, associated with a 0.6 percent decline in the CA/ GDP ratio (column 1).  
  - For domestic demand growth, the CA would decline by 0.4 percent (column 2).  
  - Oil price and REER are less important determinants of the CA/ GDP ratio, while foreign demand growth matters (column 6).
- Selected regression outputs and elasticities (export/import equations, estimation period 2000Q1-2014Q4):
  - Export equations (no. of observations 56): Δ Foreign Demand 1.77***; Δ Foreign Demand (-1) 0.73**; Δ Foreign Demand (-2) 0.68; Δ REER (-3) -0.87**; Δ Oil Price (-2) -0.06**.
  - Export of Services: Δ Foreign Demand 0.85***; Δ REER (-3) -0.41**.
  - Import equations (no. of observations 57): Δ Domestic Demand 2.66***; Δ Domestic Demand (-1) -1.15***; Δ Domestic Demand (-2) -0.29; Δ Export of Goods 0.89***; Δ Export of Goods (-1) 0.15.
  - Import of Services: Δ Domestic Demand 1.26***; Δ Export of Goods 0.17*.
  - Note: ***, **, * significant p-value at 0, 5, and 10 percent, respectively.

### Spain vis‑à‑vis peers: growth thresholds and exports
- Cross-country thresholds higher than Spain include:
  - Germany 3.1 percent
  - Netherlands 3.2
  - Ireland 6
  - Korea 7.6
  - Poland 4.1
- These countries tend to have higher export/GDP shares than Spain.
- Implication: Spain’s growth threshold for external stability could be lower than many peers; sizable scope exists to improve the level of domestic growth compatible with external balance by raising export competitiveness and/or lowering import demand elasticity.

### Structure of exports, firm size, and competitiveness
- Export composition and characteristics:
  - The majority of Spanish exports are in intermediate, equipment, motor vehicles and food products, which tend to be more price sensitive and exhibit a high import content (except food products).
  - Low share of high technological content and lower quality of exports relative to other advanced economies could explain limited integration in global value chains (EC, 2015).
- Firm-size role and extensive margin:
  - The extensive margin (lack of exporting firms) is a key weakness for Spain’s export capacity.
  - Between 2007-2013 there were 50 percent more Spanish exporters, but 70 percent of exporters are not regulars, and over 85 percent of exporting activity is undertaken by the largest 5000 companies (EC, 2015).
  - Correa-Lopez and Domenech (2012) estimate that increasing the median firm size from 50 to 60 employees would yield a 1.7 percent higher likelihood of export probability.
  - Larger firms exhibit higher productivity, lower employment volatility, higher share of permanent employment, better human capital, innovative capacity, and easier access to external finance. Spanish affiliates of foreign firms are larger, more export-oriented and more productive than domestic firms (Tello and Rodriguez, 2015).
- Constraints and policy-relevant frictions:
  - Obstacles to firm growth include size-thresholds in taxation, regulatory barriers to entry at the regional level, limited financing access, and post-crisis deleveraging needs for small firms.
  - Structural labor market reforms (decentralization of wage-setting, policies that lower duality) and reforms on regulation and the business climate would help SMEs and encourage firm growth.

### Policy implications and recommendations
- To improve external balance and raise the growth threshold consistent with CA stability:
  - Foster moderate gains in global export market share and lower the demand elasticity of imports to significantly boost the trade balance over the medium term.
  - Implement structural reforms that increase firm size, raise labor productivity, and shift export composition toward higher value-added goods.
  - Address barriers to firm growth: taxation size-thresholds, regional regulatory barriers, limited financing access, and labor market duality.
  - Reforms that increase the share of permanent workers and create incentives for firm growth would raise skills, encourage exports, and facilitate competitiveness.
- Institutional note: The simplified empirical framework does not capture structural reform effects; policy actions that change competitiveness or import elasticities could raise the GDP growth threshold consistent with no CA deterioration.

### Conclusion
- Spain’s external position remains vulnerable: very high NIIP and external debt levels, and high import demand elasticity can constrain the CA during the recovery.
- Offsetting factors: cost of external debt at historical lows, improved competitiveness, more favorable debt maturity structure, and geographic diversification of exports supporting relatively stable export market shares.
- There is sizable scope to improve export competitiveness and CA performance through firm-level and structural reforms, which would also help move the highly negative NIIP to more sustainable levels.

*Source: IMF staff estimates and analysis as presented in the supplied content.*

### 7. The rest of the note will take stock of the progress in improving fiscal coordination

### _cr15233 - 7. The rest of the note will take stock of the progress in improving fiscal coordination

### B. Assessing Progress in Coordination
- Fiscal policy responses have become more synchronized following the crisis:
  - Fiscal policy synchronicity between CGs and SNGs greatly improved among OECD countries following the crisis (Lledó and Pereira, forthcoming).
  - In Spain, SNGs fiscal position in the pre-crisis boom years was mainly expansionary, while CGs presented some consolidation episodes.
  - Expansionary policies were adopted by both central and subnational governments in the immediate aftermath of the global financial crisis (2008–09).
  - Fiscal consolidation started in 2010, led initially by CGs, with growing SNG involvement after that.
- Greater post-crisis synchronization reflects, in part, greater policy coordination efforts:
  - Fiscal measures proposed in fiscal consolidation plans at the general government (GG) level cut across government levels with a strong contribution by regions, particularly after 2012 (Kingdom of Spain, 2011–14).
  - Fiscal targets have been broadly discussed among CGs and SNGs prior to approval within intergovernmental fiscal bodies (Consejo de Política Fiscal y Financiera—CPFF for regions; Comisión Nacional de Administración Local—CNAL for local governments).
  - Specific measures, particularly on the expenditure side, were agreed by working groups with representation by both CGs and SNGs.
  - The larger frequency of meetings at multilateral intergovernmental fiscal bodies vis a vis bilateral meetings between the CG and individual SNGs following the crisis indicates increasing efforts to improve fiscal coordination across and within government levels (Aja and Colino, 2014).
- Enhancements in fiscal coordination have been underpinned by reforms in the fiscal framework:
  - SNG capacity and incentives to adopt fiscally sustainable policies are more likely when locked in by institutional arrangements that are well monitored and enforced, supported by sound budgeting procedures, and that result in a functional fiscal decentralization framework (Box 1).
  - In Spain, regions’ capacity and incentives to adjust have been partially attributed to fiscal decentralization reforms and refinements in the fiscal governance framework.

### Box 1. Institutional Arrangements for Fiscal Coordination
- Core principle:
  - Fiscal coordination requires reinforcing SNGs’ fiscal capacity and incentives by balancing fiscal autonomy and responsibility.
  - CGs, under their mandate to safeguard fiscal sustainability, are expected to take the lead in implementing fiscal consolidations following a common nationwide fiscal shock.
  - Granting SNGs more fiscal autonomy without hardening their budget constraints would intensify SNGs deficit bias, weaken fiscal responsibility, and undermine incentives to adjust.
- Institutional arrangements spectrum (as described):
  - Direct (administrative) controls by the center: lowest degree of fiscal autonomy, tightest budget constraints.
  - Rules-based fiscal frameworks (including explicit numerical targets): intermediate, allow cyclical adjustments or escape clauses for large macroeconomic shocks, emergency situations, and natural disasters.
  - Intergovernmental fiscal policy bodies: highest degree of fiscal autonomy, allow SNGs to renegotiate fiscal targets regularly.
  - Fiscal responsibility imposed by creditors: SNGs free to set their own targets provided market confidence is not impaired.
- Monitoring and enforcement mechanisms:
  - Preventive mechanisms: guidelines on frequency of monitoring fiscal targets and criteria for assessing breach likelihood.
  - Corrective mechanisms: pre-assigned paths to restore SNG finances, may imply temporary loss of fiscal autonomy; e.g., requirement to prepare a one-year Economic and Financial Plan (PEF) monitored quarterly (BSL, Article 21).
  - Coercive mechanisms: pre-established sanctions and financial penalties if corrective actions are not taken; e.g., triggering coercive measures if PEF not implemented for two consecutive quarters (BSL, Article 24).
  - Oversight often assigned to fiscal councils (agencies with expertise and autonomy to issue public assessments independently).
- Public financial management (PFM) arrangements that support fiscal coordination include:
  - Shared medium- and long-term fiscal objectives to guide budget formulation and fiscal targets.
  - Shared macroeconomic assumptions for consistent budgetary projections across government levels.
  - Timely and frequent in-year fiscal reports, annual accounts, and financial statements at each government level followed by independent external auditing.
  - Common budget classification and accounting standards.
- Limits of PFM and the importance of fiscal decentralization framework:
  - Sound subnational constraints and budget practices help when coordination failures stem from lack of information, instruments, or procedures.
  - They are less effective if inherent flaws in the fiscal decentralization framework persist (ill-designed transfer systems, mismatch between revenue and spending responsibilities, unfunded spending mandates).
- Vertical fiscal imbalances (VFIs):
  - Fiscal decentralization reforms in OECD countries, including Spain, have often featured an asymmetry between expenditure and revenue decentralization (Blochliger and Vammalle, 2012).
  - Devolution of spending frequently outpaced devolution of revenues, creating a gap between own revenue and spending (VFI), financed by transfers and subnational borrowing.
  - Transfers can promote risk-sharing and redistribution, and support fiscal consolidations, but large VFIs undermine incentives to adjust by intensifying transfer dependency, common-pool financing, bailout expectations, and moral hazard (von Hagen and Eichengreen, 1996; Rodden 2002).
  - Granting SNGs additional tax autonomy can promote fiscal responsibility and may be as or more important than strict subnational fiscal rules when VFIs are initially very large (Plekanov and Singh, 2006; Foremny, 2014).

### Fiscal decentralization
- Historical evolution:
  - Pre-crisis period:
    - Over the four decades prior to the crisis, Spain underwent a deep process of fiscal decentralization.
    - SNG share in total spending increased from just under ⅓ in 1995 to about half of total public spending in 2007.
    - SNG share of own revenues to total revenues doubled to near a quarter between 1995 and 2007.
    - Two reforms in the regional finance system in 1997 and 2002 drove large increases in tax autonomy through increases in both own taxes and shared revenues; the increase in revenue decentralization was particularly pronounced immediately after these reforms.
  - Crisis period:
    - Revenue decentralization in Spain was not interrupted by the crisis (Eyraud and Moreno Badia, 2013).
    - A 2009 reform devolved additional tax revenues and mandates to the regions.
    - Expenditure decentralization slowed, due to CG’s relatively larger spending increases and subsequently smaller spending cuts than those carried by SNGs in the post-2007 crisis period, rather than a systematic reversal of devolution of spending responsibilities to SNGs (Figure 4).
- Box 2 summary (Regional Finances and Tax Autonomy in Spain):
  - Dual system of regional finances: foral system (Basque Country and Navarra) and common system (remaining fifteen regions).
  - Foral system: regions responsible for design, administration, collection, and inspection of all taxes in their territory except customs tariffs; no revenue sharing with other regions or CG except a Cupo/Aportacion transfer covering CG non-devolved spending responsibilities set by formula.
  - Common system: regions finance spending through combination of own revenues, shared revenues, and intergovernmental transfers; less regulatory power over taxes than foral regions.
  - Revisions to common system increased tax autonomy since 1997:
    - 1997: regions benefited from 30 percent of personal income taxes (PIT).
    - 2002: revenue sharing broadened to include value-added taxes (VAT) with revenue sharing rates increased to 33 percent.
    - 2009: increased region’s share of PIT and VAT revenues to 50 percent and devolved 58 percent of revenues from excise duties and special taxes on alcohol, tobacco and hydrocarbons back to the regions where collected.
  - Regional Finance System - Shared Tax Bases (percent of shared revenues): Personal Income Tax 33 50; Value-Added Tax 35 50; Excise duties and special 40 58 (1/ Levied on alcoholic beverages, hydrocarbons, and tobacco).

### Vertical fiscal imbalances and crisis dynamics
- VFIs trajectory:
  - VFIs declined in most of the pre-crisis period, especially following reforms in regional finance.
  - VFIs temporarily increased during the crisis due to a significant drop in SNG own revenues and increased SNG net borrowing to support the 2008–09 fiscal stimulus.
  - VFI increases started to revert as SNG net borrowing slowed and eventually declined to support ensuing fiscal consolidation.
  - Trend decline in transfer dependency was disrupted in the crisis aftermath, mainly due to swings after the 2009 regional finance reform stemming from the way transfers to regions are advanced and settled.
- Definitions (as used in figures):
  - Expenditure (revenue) decentralization ratio = ratio of SNG own expenditure (revenue) to general government spending (revenue).
  - Vertical fiscal Imbalances = ratio of the sum of net transfers and net SNG borrowing to own expenditure.

### SNG policy actions during and after the crisis
- Use of fiscal autonomy:
  - SNGs actively used their enhanced tax and spending mandates to support post-crisis general government consolidation by relying on both tax and spending instruments.
  - Initial consolidation observed in 2010 driven by increases in VAT and personal income taxes at the CG level.
  - Fiscal consolidation after 2010 also driven by SNGs through increases in regional taxes and fees (Kingdom of Spain, 2014).
  - Regions established new environmental taxes and increased tax rates on property transactions, personal income tax, and excises for some products.
  - Regional governments reinforced information sharing to reduce tax evasion.

### Fiscal governance
- Reforms raised regions’ non-compliance costs:
  - Reforms strengthened subnational fiscal rules and addressed challenges to monitoring and implementation, leading to de-jure very strict rules and raising ex-ante non-compliance costs.
- Timeline and measures:
  - Pre-crisis:
    - Constraints on SNG borrowing and deficits date back at least two decades with adoption of Spain’s Convergence Program (Hernandez de Cos and Peres, 2013).
    - Balanced budget rules at the regional level introduced in the 2001 BSL with envisaged sanctions for non-compliance; amended in 2006 to target fiscal balance over the cycle and extended to local governments with a non-bail out clause.
  - Crisis period:
    - Subnational rules refined to comply with EU-wide fiscal governance (Six-Pack, Fiscal Compact, Two-Pack).
    - Constitutional reform approved in 2011 enshrined the rules-based framework in the Constitution.
    - New BSL approved in 2012 introduced structural budget balance, expenditure, and debt rules at the regional level.
    - 2012 BSL strengthened monitoring and enforcement through mechanisms to prevent, correct, and penalize deviations from fiscal rules and targets.
    - Monitoring and enforcement reinforced via improved quality, coverage, and frequency of intra-year regional and local budget figures and the creation in 2013 of Spain’s independent fiscal council—Autoridad Independiente de Responsabiliad Fiscal (AIReF).
- Example of enforcement mechanisms (BSL references):
  - Preventive mechanism: a non-compliance warning can be issued at any time and corrective measures implemented within a month of the warning (BSL, Article 19).
  - Corrective mechanism: fiscally non-compliant regions prepare a one-year Economic and Financial Plan (PEF) with corrective measures (BSL, Article 21) monitored quarterly.
  - Coercive mechanism: if corrective measures not implemented for two consecutive quarters, coercive measures may be triggered (BSL, Article 24).
- Indicator evidence:
  - Balanced budget rules became stricter in Spain following the crisis (strictness index charts referenced).

*Source: _cr15233 - 7. The rest of the note will take stock of the progress in improving fiscal coordination*

### 15. Despite the strengthening of regional fiscal autonomy and governance, fiscal non-

### _cr15233 - 15. Despite the strengthening of regional fiscal autonomy and governance, fiscal non-

### Fiscal non-compliance: current status and trends
- Short period after the 2012 BSL has seen some improvements in fiscal compliance, particularly by municipalities and the social security administration.
- Non-compliance margins at the regional level have declined, but "more than 2 5  of regions have continued not to meet their targets since then."
- The overall regional target has been systematically missed every year since 2010, accounting for the bulk of deviations accumulated during this period.
- Fiscal Deficit Deviations by Sector (percent of GDP) shown include Social Security, Municipalities, Regions, Central Government (note: positive deviations = under-compliance; negative deviations = over-compliance).

### Fiscal governance: design and implementation gaps
- Key governance gaps identified:
  - Weak application under the BSL and related legislation of (i) monitoring and enforcement mechanisms; (ii) the horizontal allocation of fiscal targets; and (iii) budget practices.
- Monitoring and enforcement weaknesses:
  - Non-compliance warnings have not been issued in time and often remained unaddressed (IMF, 2013; EC, 2015).
  - Adoption of corrective measures has been slow and implemented through adjustment plans with a lag of more than one year.
  - No formal warnings or financial sanctions were issued since the BSL inception despite repeat non-compliance by a number of regions.
  - Monitoring and enforcement largely tied to extraordinary liquidity mechanisms in an environment of tight financing conditions and stronger political cohesion than pre-crisis.
  - Delays in AIReF’s set up reduced opportunity to reinforce monitoring earlier.
  - Absence of procedures capable of activating prevention, correction, and coercive mechanisms in a gradual and predictive way.
  - Under the preventive mechanism there are no specific provisions on frequency of warnings, definition of non-compliance risk, or acceptable preventive measures.
- Procedures for establishing regions’ deficit targets:
  - BSL does not specify criteria for determining fiscal deficit targets for individual regions other than that "they should add up to the deficit target for regions as a group set as percent of GDP."
  - BSL delegates to the Ministry of Finance the task of making annual proposals—following a recommendation by AIReF—and subject to CPFF appreciation and Council of Ministers approval (BSL, Articles 15 and 16).
  - In practice, fiscal targets for individual regions have mostly been set equal to the group target regardless of regional differences in adjustment needs and capacity.
  - The de-facto majority of the Ministry of Finance at the CPFF has fueled perceptions of lack of evenhandedness, negatively affecting regions’ ownership and credibility of fiscal adjustment.
- Budgetary practices at regional level needing improvement:
  - Several regions have yet to fully observe public financial management and fiscal transparency practices mandated by the Budget Stability Law, including submission of multiannual budget plans with sufficient specification to verify compliance with the expenditure rule and public debt targets (AIReF, 2014 a).
  - Divergent regional budgetary accounting practices, including economic classification of revenue and expenditure (AIReF, 2014 a and b).

### Regional finances: autonomy, revenue structure, and system design drawbacks
- Tax autonomy and regulatory power:
  - Regions collect about ⅓ of tax revenues and social security contributions, but their regulatory power extends to just over half of these revenues (Tax reform expert committee, 2014).
  - This corresponds to an intermediate level of tax autonomy comparable to that in Australia and Germany.
  - Most taxes are levied on immobile bases; Spanish property taxes are prone to large fluctuations and are distortionary given their transaction-base, non-recurrent nature.
  - Regions can establish their own taxes, fees, and charges subject to restrictions; full legal control over tax bases and rate structure is the exception.
  - Regulatory power over fees, charges, and copayments for public services is limited; regulatory power over excise and other indirect taxes, including VAT, is constrained by EU regulations.
- Drawbacks in regional finance system limiting capacity and incentives to adjust:
  - The current multi-fund structure used to allocate resources under the common system of regional finances is believed to compromise equalization objectives and may undermine capacity and incentives to adjust for regions with below-average fiscal capacity after distribution.
  - Payment system design delays regions’ adjustment:
    - Bulk of resources transferred by central government are paid in advance based on budget appropriation; settlement takes place two fiscal years later with regions reimbursing or receiving settlements depending on actual collection.
    - This reduces incentives to adjust, particularly at turning points when revenues and transfers are prone to overestimation.
    - Example: unanticipated economic slowdown led resources transferred in 2010 to be overestimated and delayed adjustment until 2012 when settlement occurred.
    - Settlement procedures constrained regions’ capacity to comply with fiscal targets; 2014 non-compliance largely explained by declines in advanced transfers in 2014 based on forecasts that did not incorporate recent recovery.
- Regulatory power table (selected entries preserved as in source):
  - Wealth 100 schedules, minimum income limits, deductions and credits
  - Estate and Gift 100 schedules, deduction and credit, management
  - Property Transfers, Legal Acts 1 100 schedules, deduction and credit, and management
  - Gambling 100 exemptions, base, rate, charges, credit, and accrual
  - Vehicle registration 100 rates
  - Electricity 100 no power
  - Hydrocarbons 58 rate of region share
  - Excises 2 58 no power
  - Personal Income (PIT) 50 schedules, allowances, certain credits
  - Value-Added (VAT) 50 no power
  - Source: Tax reform expert committee, 2014
  - 1/ ITP-AJD: Includes real estate, administrative concessions, personal property, notary public documents
  - 2/ Includes alcoholic beverages, tobacco, other intermediate manufacturing products

### Regional liquidity mechanisms (RLMs): use, benefits, and moral hazard risks
- RLMs deployed to provide liquidity to fiscally stressed regions during crisis and later broadened to all regions.
- Key RLMs and features:
  - FFPP (Fondo para la Financiación del Pago a Proveedores) and FLA (Fondo de Liquidez Autonómico) financed by issuance of Treasury bonds; resources channeled to regions through loan agreements guaranteed by regions’ financing system resources.
  - Regions joining the FLA are subject to fiscal conditionality implemented through an adjustment plan monitored monthly by the Ministry of Finance.
  - Financial prudence rules: all non-RLM loans subject to prior approval by the Treasury and the Ministry of Finance.
  - December 2014 modification (Royal Law-Decree 17/2014) created the Autonomous Communities Financing Fund (ACFF), broadening access through different facilities and making facilities permanent.
  - ACFF preserved FLA and introduced the Facilidad Financeira (FF) available to regions meeting ex-ante assessment of compliance with fiscal targets under the BSL; FF recipients are subject to financial prudence rules but, unlike the FLA, access to FF is not conditional on adjustment measures. FF regions failing to comply are expected to be transferred to the FLA.
  - Subsidy under new facilities increased: Treasury will on-lend at no interest through the FLA in 2015 and under the FF during 2015–17.
- Utilization and savings:
  - Nine out of the seventeen regions benefitted from about €60 billion disbursed during 2011–14 via the FLA.
  - Savings from the FLA and other facilities are estimated at about €22.6 billion during the life of these loans.
- Risks and consequences:
  - RLMs reduced regional financing costs and helped avert major fiscal crises among vulnerable regions, especially when market financing was costly or unavailable.
  - Growing reliance on RLMs has increased moral hazard risks:
    - Bond yields of fiscally non-compliant regions benefitting from RLMs have started to converge to those of fiscally prudent regions that opted out.
    - Signs that public debt among RLM beneficiaries has risen faster than among non-beneficiaries.
    - Evidence that lower financing costs from RLMs increased sovereign risk premium (Jenkner and Lu, 2014).
    - Lending appears decoupled from fiscal fundamentals: interest premium of fiscally non-compliant regions declining and those of fiscally compliant regions increasing.
    - Central government has become the largest lender to regions, particularly those with less fiscally responsible track record.

### Prospects: balancing autonomy, governance, and resilience
- The balance between autonomy, governance, and resilience in the regional fiscal framework requires attention; multiple frameworks internationally illustrate trade-offs:
  - High subnational fiscal autonomy models with credible "no bailout" clauses, self-imposed budget constraints, and strong market discipline (examples: U.S., Canada).
  - Center-based budget constraints with bailouts and stronger oversight and less sub-national autonomy (examples: Germany, Brazil).
  - Intermediary frameworks relying on dialogue and cooperation via intergovernmental fiscal policy bodies (examples: Australia, Belgium).
- Spain’s trajectory:
  - Following the crisis and in line with the general EU approach, Spain moved from a cooperative pre-crisis framework toward a more centralized framework.
  - Regions’ spending and borrowing autonomy acquired before the crisis have been increasingly subdued by rules and constraints imposed by the center, with a lesser role for market discipline.

*Source: IMF staff estimates and Ministry of Finance material as presented in the provided content.*

### 24. Three options could be considered:

### 24. Three options could be considered:

### Options for reforming the subnational fiscal framework
- Option 1: Deepen the existent centralized framework by strengthening center-based budget constraints and oversight, further reducing subnational fiscal autonomy, and relying less on market price signals to orient SNG fiscal behaviour. Note: this approach runs against the recent trend of increasing fiscal and political decentralization.  
- Option 2: Dismantle the centralized framework and move towards a fully decentralized, strictly market-based framework. This would foster fiscal discipline through the power of markets and outside often complex rules-based framework. It would not exclude some centralized borrowing or vertical transfers, and a minimum of fiscal risk sharing is usually required to ensure no-bailout clauses are credible (Allard and others, 2013). Transitioning would take time and might bring back market-induced fiscal stress given high existing debt levels, uneven and insufficient subnational tax autonomy, and the absence of a well established subnational insolvency framework to allow orderly debt restructuring in the event of a subnational default.  
- Option 3: Move towards a more coherent intermediate system combining elements of centralized, cooperative, and market-based frameworks. One approach: bring back cooperative practices in determining subnational fiscal targets and other budget constraints initially underpinned by smart rules and strong oversight imposed by the center and eventually supported by market discipline.

### Rationale for preferring an intermediate system
- Adoption of an intermediate system that balances autonomy, governance, and resilience will directly help address identified gaps in the current framework. Three areas deserve particular attention: fiscal governance, fiscal autonomy, and fiscal resilience.

### Fiscal governance — recommended actions and mechanisms
- Ensure the BSL is monitored and enforced on a timely basis, especially at the regional level. Effective monitoring and enforcement will largely depend on:
  - (i) making the application of mechanisms envisaged under the BSL gradual and predictable;
  - (ii) further improvements in budget accounts and practices so fiscal rules and targets can be comprehensively, accurately, frequently, and expediently evaluated;
  - (iii) establishing AIReF’s as a respected referee; and
  - (iv) more collegial procedures and a differentiated treatment when setting region’s fiscal targets.
- Gradual and predictable monitoring and enforcement mechanisms:
  - Monitoring and enforcement could be made more gradual and predictable if done both monthly and quarterly based on pre-established targets and preventive or corrective measures in the event intra-year targets were missed.7
  - Under this scheme, the issuance of warnings (if the region is fiscally compliant) or the application of coercive measures (if the region is non-fiscally compliant and under a PEF) would only take place after two consecutive quarterly targets were missed, with “yellow cards” issued prior to that.
- Sound regional budgeting:
  - Ensure all regions deliver multiannual budget plans with well-specified revenue and expenditure measures to benchmark design and implementation of fiscal consolidation across government levels.
  - Encourage greater convergence of budgetary practices among regional governments, particularly regarding economic classification of expenditure and revenue items, to ensure comparable assessment of fiscal rules and targets across regions.
- AIReF as an effective referee:
  - Ensure AIReF has sufficient resources and access to all relevant information in accordance to legal timelines to fully exercise its mandate to help the Ministry of Finance monitor and enforce the BSL frequently, timely, gradually, and predictably as proposed.
  - Sufficient resources, including staffing, and timely access to relevant information are critical to properly monitor fiscal compliance at the subnational level.
  - Sustain on-going efforts to ensure the “comply and explain” principle regarding AIReF’s recommendations is consistently and transparently implemented by all public entities subject to such recommendations.8
- A more differentiated treatment of fiscal targets:
  - Enhance regions’ ownership of fiscal consolidation by allowing individual fiscal deficit or debt targets to vary in a rules-based and transparent fashion, taking into account structural differences in adjustment needs and capacity and consistent with overall fiscal targets at both the regional and general government level.
  - Asymmetric fiscal targets imply regions with targets above the overall regional target will need to be matched by regions with targets below this average. Consensus is not straightforward, reinforcing the need for a transparent rule-based allocation of fiscal targets.
  - AIReF’s role in providing an objective assessment of the design and implementation of these rules would be important. Allowing for a more collegial discussion of these targets in the CPFF may also be warranted.

### Fiscal autonomy — reforms to consider
- Enhance subnational fiscal autonomy through reforms to:
  - (i) increase region’s regulatory power over devolved tax bases; and
  - (ii) address design gaps in the regional financing system.
- Enhancing regions’ tax autonomy:
  - Regions’ remit to establish co-payment for public services and other fees and charges could be extended.
  - Additional regulatory power over excise and other indirect taxes could be considered, preserving market unity by ensuring any changes are uniformly and simultaneously implemented across regions.
  - The CPFF could be further empowered to promote coordination over these and other devolved taxes.
- Reforming regional finances:
  - Intergovernmental transfers should aim at promoting fiscal equalization in a comprehensive and transparent way.
  - Consider merging all existing funds into just one fund that follows the same criteria of the current Guarantee Fund.
  - Reform the regional finance payment system through an adaptive mechanism in which income forecasts are updated over the course of the year and affect partial payments, along the lines proposed by Hernández de Cos and Pérez (2015).

### Fiscal resilience — risk-sharing, governance, and liquidity mechanisms
- International experience shows stronger risk-sharing and stronger governance typically go hand in hand (Allard and others, 2013).
- Increasing reliance on central government debt issuance to finance regions through RLMs suggests a heightened need for fiscal governance in the form of an appropriately monitored and enforced BSL to increase fiscal resilience while minimizing moral hazard risks.
- Possible measures:
  - Make access to resources obtained through RLMs for both fiscally and non-fiscally compliant regions conditional on the approval and implementation of an adjustment plan, with disbursements under this plan conditional to intra-year fiscal targets.
  - Adopt ex-ante minimum risk-sharing mechanisms such as rainy-day funds to complement reinforced liquidity financing schemes. Such a fund would collect revenues from regions at all times and make transfers to those that experience negative shocks.9
  - Rainy-day funds share advantages and challenges:
    - Advantages: reduce fiscal pro-cyclicality by providing region-wide automatic mechanism to save in times of common positive shocks; associated with better credit ratings and lower financing costs in some contexts.
    - Challenges: correctly detect events warranting activation and transfer payments; moral hazard risks if the scheme delivers more transfers than warranted leading regions to build insufficient fiscal buffers or avoid adjustment measures.
  - Design of any insurance scheme should favor simple and transparent rules to mitigate moral hazard.

*Source: _cr15233 - 24. Three options could be considered:*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15233.pdf_