The Spanish Export Led Recovery - CORE
Undergraduate Economic ReviewVolume 11 Issue 1Article 12014The Spanish Export Led RecoveryDavid WagnerUniversity of Virginia, dcw8ch@virginia.eduRecommended CitationWagner, David (2015) "The Spanish Export Led Recovery," Undergraduate Economic Review: Vol. 11: Iss. 1, Article 1.Available at: http://digitalcommons.iwu.edu/uer/vol11/iss1/1This Article is brought to you for free and open access by The Ames Library, the Andrew W. Mellon Center for Curricular and FacultyDevelopment, the Office of the Provost and the Office of the President. It has been accepted for inclusion in Digital Commons @ IWU bythe faculty at Illinois Wesleyan University. For more information, please contact digitalcommons@iwu.edu. Copyright is owned by the author of this document.
The Spanish Export Led RecoveryAbstractI researched the export-led recovery currently taking place in Spain. My thesis revolved around Mariano Rajoyand the Popular Party coming into power in 2011 and instituting reforms in three distinct categories; financialmarket reforms, fiscal measures, and labor market reforms. These reforms have had a significant impact inrestoring credibility in Spain's capital markets and decreasing unit labor costs. In turn, Spain has shownimpressive export growth in the past two years, especially compared to its neighbors Italy and France.KeywordsExports, Reforms, SpainThis article is available in Undergraduate Economic Review: http://digitalcommons.iwu.edu/uer/vol11/iss1/1
Wagner: The Spanish Export Led RecoveryIn this thesis, I will give a background of the Spanish crisis, followed by adetailed account of the reforms the Spanish government instituted in response. I will thendescribe the effects of these reforms, especially as they relate to the exports of thecountry. Finally, I will predict the sustainability of these reforms and lay out risk factorsthat could affect the export led recovery in Spain.I Introduction2008 marked the 30th year of Spain’s constitutional monarchy, leaving behind a dark past.From 1939 to 1975 a dictator, Francisco Franco, ruled Spain. During these years, Francopropagated the message that Spain was the monarchy that defended Catholicism above allelse. Any anti-government, anti-Catholic, or anti-Spanish expression was suppressed,and las dos Españas evolved; one that held strong traditional, religious ties and one thathoped to break free from the oppression of the dictatorship.1In 1978, three years after the death of Franco, the Spanish people came together tocreate a constitutional monarchy. They named King Juan Carlos head of state andproclaimed themselves a secular nation with seventeen autonomous regions, rangingfrom Galicia in the northwest to Andalusia in the south. The government created by the1978 constitution remains in place today, and presides over a country of 46 millionpeople with a GDP of 1.3 trillion, making it the fourth largest economy in Europe.Today, Spanish culture is first and foremost distinguished by its seventeenautonomous regions. During the evolution of civilization in the Iberian Peninsula, citiessprang up along the coastlines with little interaction. The Pyrenees mountain rangeisolated Spain from France to the north, other mountain ranges made for a natural borderin the interior of Spain, and the sea served as a border from the exterior. Distinct culturesarose based on the various climates and inhabitants of the different cities, including aCatalán culture surrounding Barcelona in the northeast, a Gallego culture in thenorthwest, an Andaluciano culture to the south, and a Vasco culture in the north. Theoverarching cultural differences from hundreds of years ago persist today, as do tensionsbetween the cities. The regional differences that have developed over the years createfragmented political and economic systems that have caused local budgets to balloon andthe grasp of the central government weaker.2Another key cultural aspect of Spain today is the rise of immigration. Thepopulation of Spain grew from 40 million to 45 million from 2000 to 2008 while the birthrate of Spanish women was only 1.6, below the rate of 2.1 that is necessary to maintain apopulation. Further, from 1999 to 2007, the Spanish economy created a third of all newjobs in the European Union.The majority of the jobs were low-paying, and people began flooding in fromprimarily North Africa. Tensions arose as the North Africans were willing to work nt.Published by Digital Commons @ IWU, 20151
Undergraduate Economic Review, Vol. 11 [2015], Iss. 1, Art. 1less money than Spaniards, and set the stage for racial conflict when the economy took aturn for the worse in 2008. Immigration has changed the landscape of Spain, creating aneconomy with more low paying jobs and a larger base of low-income residents expectingsocial services.3According to Geert Hofstede, the most distinctive part of Spanish culture is itsuncertainty avoidance. For example, 75% of young people in Spain said they would liketo work in civil service, also defined as a job for life, compared to only 17% of youngpeople in the United States.4 This uncertainty avoidance has led to a society that looksharshly upon failure, and that lacks an entrepreneurial spirit. While many say thatentrepreneurship is currently on the rise in Spain,5 data would suggest otherwise. Thenumber of business starts has dropped steadily, from 410,975 in 2008 to 332,229 in 2012.Furthermore, the median capital investment to an entrepreneur was 18,000 in 2012,compared with 30,000 in 2011.6 Despite the hope that entrepreneurs will appear out ofmere necessity, Hofstede’s assertion that Spanish culture is defined by uncertaintyavoidance seems to be holding true, and it seems as if Spain will not be able to exit fromrecession through new business starts within the country.In 2007, Spain’s growth prospects looked promising as investment was pouringinto the real estate sector with house prices rising 250% in the previous 5 years.7Moreover, GDP was on an upward trend, growing by at least 3% in each of the past 5years. Yet, a combination of a housing bubble, various structural problems and theglobal financial crisis pushed Spain into its deepest recession since it became ademocracy.When Spain joined the Euro Zone in 2002, it was relatively less developed thanthe rest of the currency union. The lack of development meant higher yield projects wereavailable in Spain, and with easier mobility of capital and people, investments startedflowing into Spain, as its capital account surplus rose from 83 billion in 2005 to 155billion in 2008. Northern Europe, and specifically Germany, became an export machine,and invested some of its current account surplus in Spain. Consequently, Spaincontinuously ran a current account deficit, reaching 10% of GDP by e.N.p.,n.d.Web. http://geert- ‐hofstede.com/spain.html tartupEconomy."WSJ.N.p.,17Oct.2013.Web. http://blogs.wsj.com/tech- ‐europe/2013/10/17/spains- ‐financial- ‐crisis- ‐a- ‐boost- ‐to- ‐its- ‐startup- ‐economy/?KEYWORDS spain 6Nov.2013.Web. ualidad/1383766164 765200.html steriodeFomento,1Jan.2012.Web. http://www.fomento.gob.es/NR/rdonlyres/D02CD420- ‐9CF2- ‐4E91- ‐AB0B- ‐B37F66B94565/109402/adjspa real estate JAN2012.pdf b. ?page 1 .4http://digitalcommons.iwu.edu/uer/vol11/iss1/12
Wagner: The Spanish Export Led RecoveryMuch of the investment that came into Spain went into real estate. Housinginvestment in Spain sat at 9.5% of GDP in 2007,9 twice that of the European average.Further, in the year preceding the crisis, there were more housing starts in Spain(population 45 million) than in Germany, France, and Italy combined (population 204million).10Moreover, Spanish culture has an effect on the housing sector in the country. Thegeneral avoidance of uncertainty, as well as the availability of 40- and 50-yearmortgages, led to a homeownership rate of over 80% in 2011, compared to a rate of about65% in the UK and under 45% in Germany. In addition, the housing sector in Spain canbe characterized by the amount of secondary and vacation housing. In 2004, Spain had160 secondary houses per 1,000 habitants, compared with the EU average of 75.11The myth that real estate in Spain would never decrease in value was dispelled.The bubble hit a breaking point in the beginning of 2008. Since that time, housing priceshave fallen by 37%.12 Meantime, production of houses was halted. The constructionsector, which made up 17% of the economy in 2007,13 fell precipitously and income andwealth around the country dissipated. In the span of one year, a country dependent ondomestic demand lost two million jobs and fell into crisis.Moreover, non-financial corporations and households had increased debt in a timeof low-cost financing. With the introduction of the Euro, Spain’s interest rate convergedto that of Germany’s, from a 100 basis point spread in 1997 to virtually even in 2005,14but the risks were not properly priced. Further, non-financial companies held nearly220% of private debt to GDP, compared to 150% in France and 122% in Italy.15Suddenly, with the loss of wealth and incomes, the private sector of the country defaultedon many of its loans. The housing bubble popped, throwing Spain into a crisis with over25% unemployment, a depressed tax base, and increased government ,20Dec.2010.Web. /Ene/Files/art3e.pdf forSpain?.".N.p.,25Mar.2014.Web. http://www.williamchislett.com/2014/03/what- ‐does- ‐the- ‐economic- ‐future- ‐hold- ‐for- ‐spain/ urrentSituation.".BancodeEspaña,20Dec.2010.Web. /Ene/Files/art3e.pdf p.,13Sept.2013.Web. http://qz.com/124088/spanish- ‐real- ‐estate- ‐has- ‐lost- ‐more- ‐than- ‐a- ‐third- ‐of- ‐its- ‐value- ‐but- ‐its- ‐still- ‐overvalued/ pt.2011.Web. http://www2.euromemorandum.eu/uploads/ws1 etxezarreta et al. boom and deep crisis in the spanish economy the role of the eu in its evolution.pdf n.d.Web. http://www.tradingeconomics.com/spain/government- ‐bond- ‐yield .15"Privatedebtin%ofGDP."Eurostat.N.p.,n.d.Web. http://epp.eurostat.ec.europa.eu/tgm/table.do?tab table&plugin 1&language en&pcode tipspd10 .Published by Digital Commons @ IWU, 20153
Undergraduate Economic Review, Vol. 11 [2015], Iss. 1, Art. 1Much of Spain’s inability to cope with the housing crisis can be linked to thestructure of the Spanish economy. The labor market was rife with archaic laws andinflexibility. While the economy lost 2 million jobs between 2008 and 2009,compensation level per employee actually increased 6%.16 The collective bargainingagreements could not be negotiated and the labor unions demanded that their wages notbe lowered. The inability to change costs and prices only led companies to lay off moreemployees, and worsened the economic situation.Further, much of the banking system of Spain was largely unregulated andinefficient. Regional politicians ran and regulated 45 ‘cajas’, or savings banks. Thecajas held half of all banking assets in Spain and were not required to divulge a history ofrepayment, loan to value ratios, or collateral on loans to the central bank of Spain. In2009, the cajas, effectively a “shadow banking” system, held 56% of all mortgages inSpain. Additionally, the payments on the mortgage loans made up a significant portionof the cajas revenue, approaching a ratio of 20% of all assets.17 The combination of theavailability of cheap financing and the fact that the cajas did not have to disclose loaninformation to the government led to excessively risky, and unregulated, lending. As thebubble burst, almost 5% of all mortgages held by the cajas were underwater,18 andfinancial institutions across the country were unable to extend credit in Spain.Finally, the structure of the Euro Zone did not allow Spain to address thedownturn effectively. When Spain agreed to join the monetary union, it also agreed togive up its monetary policy and its influence over interest rates. Domestic demandplummeted in the aftermath of the housing bubble bursting, and Spain would havebenefited from devaluing its currency to make exports more attractive. Previously, intimes of low domestic demand, Spain had devalued the peseta, its previous currency, andincreased exports to spur growth. Yet now the Euro Zone, spearheaded by Germany, wasunwilling to depreciate the Euro.Further, because Spain could not devalue its currency, it was also unable to lowerits interest rates to free up credit and encourage companies to invest. With no monetarypolicy power, nor the ability to lower wages, Spain had very few tools to fight thedeclining state of the economy.Given all of the structural problems and the housing bubble, Spain fell into a deeprecession. The global financial crisis merely exacerbated its problem. On top ofdomestic demand declining and showing no signs of increasing, global demand forSpanish products decreased as well. Over 60% of all Spanish goods went to countries inthe European Union, the area hit hardest by the financial crisis.19 With the EuropeanUnion showing little signs of recovery, the Eurozone’s intransigence in its .,n.d.Web. http://stats.oecd.org/Index.aspx?queryname 430&querytype view sWoes.".N.p.,3June2010.Web. 04caja.html? r 2&sq spain%20cajas&st nyt&adxnnl 1&scp 1&pagewanted 1&adxnnlx 1397575120- ‐qk4bv5l9tZONhqjvyD9MCA . http://www.economist.com/node/14924481 l11/iss1/14
Wagner: The Spanish Export Led Recoverytowards the periphery, and the problems that existed inside Spain, internal structuralreforms were necessary.II ReformsBy 2008, the Spanish government was borrowing at a rate of nearly 5%,20 and businesseswere hard pressed to find financing at any rate. The future of Spain was uncertain asinvestors and business owners questioned whether Spain would stay in the Eurozone.Hiring and credit markets froze; unemployment rose to 20% in 2010 from 8% in 200821and loans over 1 million to companies dropped 25% from 2009 to 201022, as companiesawaited a response from the Spanish government. Yet, then Prime Minister José LuisRodríguez Zapatero was slow to institute any significant reforms. The socialist leaderhad political pressure from the left to uphold government services and labor-friendlylabor laws.Finally, in 2011, Mariano Rajoy was elected as a more conservative candidatefrom the People’s Party, as voters showed their frustration with Zapatero’s response tothe crisis. With an absolute majority in the legislature with 186 of 350 seats, Rajoyimmediately began implementing reforms to address the issues.23The reforms that the Rajoy government enacted in response to the crisis,highlighted in Table 1 at the bottom of the section, can be placed into three maincategories: financial market reforms, fiscal measures and labor market reforms. Eachreform was put into place to stabilize the macroeconomy of Spain and to allow for thereturn to capital markets for both the government and businesses. The Spanish economyneeded a renewed sense of credibility within global markets, and the reform effort wasaimed at reinstating this credibility to put Spain on the road to recovery.Financial Market ReformsTo restore confidence in the periphery: countries like Spain, Portugal, Ireland and Greeceoutside the core of Europe, on August 2, 2012 the European Central Bank’s presidentMario Draghi announced that the ECB was prepared to undertake Outright MonetaryTransactions (OMT) to aid ailing countries, and that Spain would be granted up to 100billion to salvage its banking system.24 The ECB recognized that the system that hadallowed for the origination of millions of mortgages in Spain, many of which were tosubprime borrowers with little equity to back up the loans, needed to be changed. Inexchange for the ECB’s pledge of support, Spain was required to administer certainreforms in its financial s,n.d.Web. http://www.tradingeconomics.com/spain/government- ‐bond- ‐yield eb. - ‐rate ralBank.N.p.,6Sept.2012.Web. r120906 1.en.html .Published by Digital Commons @ IWU, 20155
Undergraduate Economic Review, Vol. 11 [2015], Iss. 1, Art. 1First, on August 31, 2012, with the Spanish Royal Decree-Law 24/2012, theSpanish Government created SAREB (Sociedad de Gestión de Activos procedentes de laReestructuración Bancaria) that functioned as a typical ‘bad bank.’25 40 billion worthof assets were transferred from four of Spain’s previously nationalized financialinstitutions: BFA:Bankia, Catalunya Banc, NGC Banco-Banco Gallego and Banco deValencia. These assets consisted of bad loans from the mortgage crisis and allowed theoriginal institutions to focus on their business while a new entity could focus solely onthe restructuring and sale of the bad assets. The government branch, the Fund forOrderly Bank Restructuring, owns 45% of SAREB while private shareholders hold theother 55%. The bank has 15 years to dispose of the assets and aims to make a 15%cumulative profit.26The next task was to better capitalize Spain’s functioning banks. Many banks,with low amounts of capital in the first place, had yet to write off all of theunderperforming loans due to the housing crisis. In order to avoid another crisis of thesame scale, and instill confidence in the banking system, the European Union orderedbanks to raise their capital levels in line with the European Central Bank stress tests of6% of assets.27 Banks receiving state aid were required to shed their riskiest assets tocomply with risk-weighted capital requirements.Finally, Spain set out to rein in the largely unregulated ‘caja’ system that hadbeen in place for hundreds of years. Spain instituted a reform of the framework forregulation, allowing for a Single Supervisory Mechanism over the banking system andenhancing the Banco de España’s regulatory and supervisory powers, granting themsanctioning and licensing power. The reforms required that the cajas have formalshareholders with a system to distribute profits, and attempted to centralize the regulatoryauthorities in order to place the same requirements on all banks and reduce the risk ofshadow banking that helped lead to the housing bubble of 2008.28Each of these r
:!Walker&!Co.: . recession through new business starts within the country. . When Spain joined the Euro Zone in 2002, it was relatively less developed than the rest of the currency union. The lack of development meant higher yield projects were
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