Last year marked, but did not bring to an end, a decade of uninterrupted economic expansion, during which average incomes in Spain rose to 98.5% of the EU-25 average. Today, Spain’s GDP growth rate continues to be above 3% and employment is still buoyant.
This remarkable performance owes much to the continued implementation of reforms that opened up the economy, enhanced its flexibility, and improved the macroeconomic policy framework, and also to eurozone membership and related low interest rates. The Spanish government’s sustained fiscal consolidation resulted in 2003 in an overall budget surplus – impressive progress from the deficit of 6.6% of GDP in 1995, and one that marks a substantial reduction of public debt.
For all this good news, the global picture in Spain is not so positive. First, GDP growth figures are directly linked to exceptionally large immigration flows. With population growth rates close to 2% because of the country’s open immigration policy, per capita GDP is only growing at 1%, which currently means zero real convergence with the EU.
Second, the imbalances have deteriorated strongly since 2004. The external current account deficit widened to over 7.5% of GDP in 2005, making it the world’s second largest in absolute terms. Import penetration and the erosion of export market shares also intensified in 2004 and 2005. The widening external deficit reflects a deep decline in Spain's competitive position, and this was driven in turn by price pressures as inflation had climbed to 4.2% by the beginning of this year. More fundamentally, Spain is also suffering from lacklustre productivity growth.
According to the IMF and other national and international observers, the medium and long-term outlook in Spain is clouded by these imbalances and by competitiveness losses. There is, too, a risk of an abrupt slowdown if the boom in real estate prices is “corrected”, given the generally high levels of household indebtedness and the likelihood of a subsequent protracted period of balance-sheet adjustment, particularly in an environment of monetary tightening.
Macroeconomic policy in Spain therefore needs to be directed towards a moderating of domestic demand pressures, which in turn means the introduction of supply-side structural reforms. The Zapatero government, however, is doing the opposite.
When it comes to budgetary policy, Spain now desperately needs counter-cyclical fiscal restraint. But the current rates of growth in public expenditure are going in the opposite direction. These rates are too high; 9.3% in nominal terms, more than 6% in real terms, and spending plans for the following years outpace real GDP growth by a significant margin. This will mean higher inflation and higher taxation.
If Spanish productivity growth is not improved and its labour and product markets fail to become more flexible, regaining competitiveness within the eurozone would entail a protracted and costly process that would put a brake on both output and employment.
Not a few economic analysts now believe that the government should implement a broad plan of economic reforms, involving liberalising steps in the labour market together with competition-enhancing product and services market reforms. Long overdue pension and healthcare reforms should also be introduced.
Unfortunately, nothing of the sort figures on the government’s economic agenda. The only reform being promoted by it is tax reform. It is in any case limited in size and does not address the country’s economic imbalances; national saving is not to be fostered as a 20% increase in taxation of saving returns will apply, and a reduction in tax-exempt contributions to private pension plans will generally send a deterring signal. There remain a good many rigidities in the labour market that call for reform. In the area of employment protection, Spanish legislation remains among the most restrictive in the OECD.