To the Point
Discussion on the economy, by the Chief Economist
Cecilia Hermansson
Group Chief Economist
Economic Research Department
+46-8-5859 7720
cecilia.hermansson@swedbank.se
No. 2
2011 02 28
February 28, 2011
We need to accept the “slow fix”
Last year, panic often characterised financial markets’, as well as policymakers’,
reactions to euro zone developments. There was a search for the “quick fix” to
make things right again. However, economic problems in Greece, Ireland,
Portugal, and Spain tend to be more structural than cyclical, which means it´s
better to go for fundamental reforms, i.e., the “slow fix”, as long as there is any
“fix” at all and measures are taken.
Before the financial crisis, it was difficult to understand the magnitude of
imbalances by just analysing the growth and stability pact, since, for example,
Ireland and Spain had low public debt, budget surpluses, and high growth.
Instead, there were many microeconomic weaknesses, such as the functioning of
the labour market, the investment boom in the private sector, and financial sector
problems. This second 2011 version of To the Point analyses the structural
measures needed to restore competitiveness in Spain, a country that is still
contributing to uncertainties on the financial markets. Measures are needed now,
but the effects of these measures will most likely take years to become visible and
be appreciated – all the more important to start now!
What is the real problem with Spain?
Despite implementing a prudent macro-fiscal policy before the financial crisis and
the global recession, Spain built up imbalances in the private sector. Household
savings were satisfactory, but the main problem was overinvestment – especially in
residential construction, but also in the private business sector. The problems in the
financial sector affected the smaller savings banks more than large banks. So far,
the banking sector has proved resilient to the financial market turbulence and the
downturn on the domestic housing market, but, as the correction in construction
and housing is not yet over, the situation is still fragile and reforms are needed.
The overinvestment has contributed to large deficits in the current account. Spain
has not really lost market share in the last decade, although many other advanced
countries have seen losses as emerging markets have expanded their importance in
the world economy. Manufacturing, services, and other areas outside construction
have developed rather well, but not well enough to counteract the domestic
investment boom.
When the global crisis came, the private sector started to adjust, leading to a loss of
fiscal revenues. Because of this adjustment, along with some discretionary
measures, the fiscal surplus turned into large deficits, reaching more than 11% of
GDP in 2009, compared to a surplus of 2% of GDP in 2006. During the same
period, the public debt increased from 39.6% to 53.2% of GDP. This means that
Spain is experiencing a large transfer of private debt to public debt. How should
Spain manage this pileup of debt, and how will growth be affected?
Another way to understand the real problems in Spain´s economy is to study the
labour market. After great employment growth in the 1990s, which also absorbed a
large inflow of immigrants, unemployment has increased dramatically, more so
than in other European countries. The unemployment rate is again over 20% and
youth unemployment is over 40% (other countries with high youth unemployment
rates are Slovakia, Hungary, Greece, Italy, and Sweden). The large severance
payments made for permanent contracts have resulted in a dual labour market for
temporary and permanent workers.
To the Point (continued)
February 28, 2011

Chart 1: Unemployment rate, total and

among the population less than 25 years old Reforms can’t wait
The best way to manage the pileup of public debt is to improve the prospects for
45
growth. As problems are mainly microeconomic oriented, reforms must be carried
40 out to improve the functioning of markets, such as the labour market, the financial
sector, and the product markets. It seems as if a little nudging from the financial
35
Unemployment rate, markets has been important for the Spanish government. Not until the panic set in
30 less than 25 yrs old did the issue of reforms begin to be taken more seriously. The best way, however,
Percent

is to surprise financial markets by doing a little more than what is expected.

25
Thereby, interest spreads stay smaller.
20
Spain has many workers in the construction sector who need retraining. It is
15 important to strengthen areas other than construction and to transfer resources into
10 these sectors. Small and medium-sized companies will need to absorb a great
Unemployment rate,
total number of workers, but these sectors show inefficiencies and a lack of dynamism.
5
98 99 00 01 02 03 04 05 06 07 08 09 10 The labour market must be made more flexible at the firm level in order to reduce
Source: Reuters EcoWin
the duality of permanent and temporary workers discussed above. As long as there
are many temporary workers, productivity growth may be weakened. Later in
March, the government will introduce proposals on how to improve the labour
market. Education and vocational training will, we hope, be essential parts of these
proposals. Many young (and older) Spaniards do not speak English, and they do
not use computers. Immigrants must also be given tools to gain access into the
permanent labour market. The reform of the pension system is on its way, raising
Chart 2: Unit labour costs in Spain and the statutory retirement age from 65 to 67. Spain faces a dramatic increase in
Germany 1998-2010, Index 100=2000 aging-related public spending on both health and pensions. More action is therefore
needed to alleviate the effects on the budget.
135
The fiscal consolidation path includes reaching a deficit of 6% of GDP this year,
130
and driving it down to 3% of GDP in 2013. The balance between tax increases and
125
Spain expenditure cuts seems appropriate, and Spain may get the deficit down as long as
120 fiscal adjustment plans are followed and the economy grows. So far, construction
115 is reducing growth, while other sectors are holding up. Households will remain
Index

cautious, but their savings will help to support growth going forward. Regional
110
governments will also need to be reformed, and benchmarking is important to
105
identify the practices of those that are working well.
100

95 Germany A crisis is a terrible thing to waste

90
98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
Economic Research Department
SE-105 34 Stockholm, Sweden
Telephone +46-8-5859 1000
ek.sekr@swedbank.com
www.swedbank.com
Legally responsible publishers
Cecilia Hermansson
+46-8-5859 7720
We seem to overestimate the risks to Spain in the short run as budget consolidation
may work without support from the IMF or the euro zone, as long as interest
spreads don’t widen more; at the same time, we seem to underestimate the risks
over a longer time perspective. According to the IMF, Spain is overestimating its
growth prospects, and the country needs structural adjustment above what is
already planned for 2010-2013 (of some 3% of GDP): adjustment of some 5% of
GDP until 2020 is needed to stabilise public debt at 60% of GDP in 2030. Spain
has come a long way since it became a democracy, and last week marked the 30th
anniversary of the failed military coup attempt, which occurred on February 23,
1981. Not too long ago, but with many positive changes since then. Now, Spain
must continue to improve over the next 30 years. The recession can give its leaders
the momentum needed for change.
Cecilia Hermansson
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