Debt and indebtedness: The Spanish Economy

While the new Lib Tory (others prefer to call it Con Dem) government settles in and blames the outgoing government with ambiguous comparisons to Greece, I think I should draw attention to Spain.

Over the last few months living in Madrid, I’ve been in the thick of Spanish economic news and though I’m not an economist, I think I’ve managed to pick up a few things from my ex-girlfriend, who was.

Starting with the differences between Greece and Spain, it’s important to note that Greece was forging its figures for years and years acting totally recklessly. Spain, to the contrary, has had a fiscally responsible government since 2004. Some would contest this with the power of hindsight, but for a long time Europe’s 4th economy (I was also shocked to learn that)  was doing very well. It had comparatively low debt and was even running budget surpluses a few years ago, as you can see here.

The banking sector survived unscathed, in contrast to Britain’s bail-out, but problem in Spain has essentially been an over-reliance on the housing bubble, which burst violently, combined with spiralling unemployment reaching nearly 20%.

I’ve seen this unemployment for myself. There are 200,000 inhabitants of my city (Alcalá de Henares) and every morning as I leave the house I used to see a queue of a hundred or so people. Initially surprised that the Spanish could queue, I presumed bemusedly that it was to the bank at the end of the street. In fact, I discovered the queue turns around the corner at the bank, last another hundred years before veering into the jobcentre.

Spain has thus seen a sharp increase of pressure on the state, and has seen borrowing surge beyond 10% of GDP, seeing the sharpest deterioration of government debt compared to relatively low pre-crisis levels.

The President of the Government of Spain (aka Prime Minister) Zapatero, chairing the EU council, has seen the Commission set particularly ambitious consolidation targets for Spain due to the very high starting points for borrowing there.

Zapatero has shown considerable effort to advance, having already announcing a VAT hike for this year. Today he cancelled a trip to Brazil so he could help to push through some Labour Reform personally. The conservative party (El Partido Popular) has been in the town square all week, and I have collected no fewer than three “no VAT increase” leaflets. I duly explain my three points; I am foreign. I am socialist. I am in favour of the hike. The VAT hike for this year, from 16% to 18%, (and there could be the case for a further increase after that) might do less damage than increasing income taxes. The Populares did not share my point of view.

As Spain will is showing very slow signs of recovery I would not be surprised to see more tax hikes in the near future to offset spending. The low rates of income tax might be a good place to start.

There is also some room to reduce government spending given its high share in GDP. Hopefully if the necessary spending cuts can be achieved such an increase in income tax could either be avoided or at least softened significantly. However, the consumer sector here is so fragile, I am inclined to be sceptical.

In any case, I’m off on a trip to Lisbon tomorrow, then I’m leaving Spain for good on June 3rd. Hope you like the blog relaunch!