Spain: Building a Flexible Economy to Face the Future

IMF News, April 3, 2018

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Two lessons from recent global crises:
- Maintain strong buffers (healthy fiscal buffers and robust capital levels in financial systems).
- Make institutions and markets flexible to ensure resilient and speedier recoveries.
Policy objective: create a framework that encourages innovation and economic dynamism by facilitating experimentation while ensuring skills, markets, and institutions can absorb creative destruction.

Remaining gaps identified:
- Need to create a unified capital market.
- Need to complete the banking union.
- Need to establish a central fiscal capacity (advocated rainy-day fund).
National responsibility: Strengthening euro-area architecture does not relieve national governments from addressing domestic vulnerabilities and promoting growth.

Causes of the crisis in Spain:
- Overheating of demand, an unsustainable real estate bubble, and rapidly rising private debt in the run-up to the Global Financial Crisis.
- Wage growth outstripping productivity led to a 30 percent faster increase in Spain’s unit labor costs compared with countries like Germany, making exports uncompetitive.
Crisis outcomes by 2012:
- Output plummeted and real estate prices fell.
- Construction industry collapsed.
- Unemployment was above 25 percent—higher for young people.
- Banks were failing and the government’s fiscal position eroded rapidly.
Constraints and external support:
- As a member of the European Monetary Union, Spain could not use exchange rate devaluation or loose monetary policy.
- ECB opened the money supply taps in 2012; ESM helped restore financial stability.

Measures taken:
- Tough fiscal measures and labor market reforms to support wage moderation and greater employer flexibility.
- Bank restructuring to reduce NPLs and shift lending to more productive purposes.
Use of buffers and creation of flexibility were central to improving external competitiveness.

Growth and income:
- Growth at more than 3 percent for the past three years.
- GDP above its pre-crisis level.
- Per capita GDP in PPP terms has reached an all-time high.
Exports and competitiveness:
- Exports relative to GDP are now 10 percentage points above 2007 levels.
- Costs of Spain’s exports relative to its trading partners reduced nearly 15 percent in real terms.
Employment:
- 1.8 million jobs have been created—about half of those lost in the crisis and about one-fourth of all Euro Area job creation in the past four years.
Remaining labor market weaknesses:
- Unemployment rate remains about 16½ percent and is more than twice that for the young.
- More than 40 percent of all unemployed have been without a job for more than a year.
- Nearly half of the new hires are temporary.

Macro and financial vulnerabilities:
- Public debt is still close to 100 percent of GDP—almost three times higher than at the eve of the crisis.
- Private sector balance sheets need further strengthening; removal of NPLs and distressed assets from bank books must continue.
External and cyclical risks:
- Current recovery has a strong cyclical component; likely medium-term scenario involves some slowdown.
- Global interest rates are headed higher and financial conditions tighter.
- Multilateral trade system faces new uncertainty amidst threats of trade actions.
- Downside risks are accumulating.

Fiscal policy:
- Rebuild fiscal reserves and reduce the debt burden.
- Future adjustments can be gradual but should be persistent and structural in nature.
- Sound fiscal policies are needed to free resources for education and training (investing in human capital).
Financial sector:
- Continue bank restructuring and removal of NPLs and distressed assets.
- Encourage weaker firms with high debt levels to strengthen their balance sheets.
Labor market and human capital:
- Complete labor market reforms to increase flexibility and make labor markets a new engine of growth.
- Implement active labor market policies to increase employment, especially for young people.
- Ease conditions for employers to rely less on fixed-term contracts to encourage investment in workers’ human capital.
Technology and competitiveness:
- Build policy foundations that embrace and enable change from new technologies and the digital economy.
- Invest in education, training, R&D, and policies that allow firms to combine capital, technology, and people in new ways.
European and global cooperation:
- Europe must continue to strengthen the architecture of integration to reduce the likelihood of sudden shocks.
- Global partners must avoid sudden shocks, including threats to world trade from protectionism.

If Spain preserves buffers and increases flexibility:
- It can sustain and build on recent gains, encourage innovation, and strengthen competitiveness and resilience.
If commitment to reform slackens:
- Higher growth may not be sustained in the long term; risks include lost competitiveness and a lost generation of young people.
Urgency:
- The time to act is now—“fix the roof while the sun is shining”—to prepare for possible cyclical slowdown and structural shifts from technology.

IMF First Deputy Managing Director David Lipton, Madrid, April 3, 2018.