The Spanish stability test

After the bursting of the Spanish property bubble, the country's economy collapsed and unemployment reached record levels in the EU. Will Mario Rajoy's government, which recently completed its first 100 days in office, be able to implement much-needed structural reforms in the labor market?

Kiril Mirchev

As expected, 2012 is proving to be an extremely difficult year for Spain. The 100-day-old government of the Popular Party led by Mariano Rajoy continues to experience serious difficulties in finding the right path for the country's economy.

Reforms are slow and hesitant

Exactly two decades ago, Spaniards took rising prosperity for granted—sustainable growth, rising living standards, sharply falling unemployment. Zapatero was careful not to spoil the picture with reckless budget spending, but he also failed to introduce the structural labor market reforms needed to restore the country’s competitiveness. Instead, he focused his efforts on social and cultural wars against Spain’s conservatives and appeasing regions seeking greater autonomy, such as Catalonia and the Basque Country.

Caught in the eye of the storm called the global economic crisis, the Socialists wanted to show that the country was not in the same group as the bailed-out Greece, Ireland and Portugal and took up the cause of fiscal austerity and deep reforms. The latter, however, were slow and timid, and today the task of the new government is to make up for lost time. It was the leader of the Popular Party, Mario Rajoy, who accused the Socialists of being to blame for the biggest economic downturn Spain has experienced in decades. In the last parliamentary elections, Rajoy received an absolute majority in parliament, currently controlling 11 of the 17 provinces with partial autonomy. By this indicator, Rajoy becomes the most powerful prime minister since the death of dictator Franco in 1975.

The question remains, however, whether the current fiscal picture looks set to be corrected. Following a constitutional change, the country has a strict deficit ceiling that must fall below 3.5% of GDP over the next two years, and the debt level is still below the Eurozone average, but unfortunately, it is not stopping growing. Rajoy is trying to restore confidence in Spain by pushing through unpopular and painful measures for society:

• Cutting 27 billion euros in budget spending this year with the aim of reducing the deficit from 8.5 to 5.3 percent of GDP;
• Reducing the budgets of ministries and freezing the salaries of civil servants;
• Fiscal regulation of large enterprises and increasing their taxes, without raising VAT, so as not to harm consumption

However, the lack of obvious sources of growth since the country's property bubble burst remains worrisome. Spain's productivity growth remains below inflation, unemployment is the highest in Europe at 23%, and youth unemployment is running at a chilling 50%, although it is inflated by the informal sector.

The provinces, which are responsible for 1/3 of public spending and have a total debt of 120 billion euros, continue to pose a serious threat. Since the beginning of the crisis, the autonomous communities have barely managed to reduce spending by 2%, while at the same time their revenues have fallen by 10%. These figures are eloquent in showing that regional governments are not only unable to meet deficit reduction targets, but are also having difficulty correcting their budget imbalances. It is the tax system that fills the coffers of regional authorities that is closely linked to the development of the housing market. According to calculations by Fedea (a Spanish non-governmental research center dedicated to the country's problems), the collapse in the housing market has sharply reduced tax revenues by more than 4 percentage points of GDP. All this also affected the revenues from Property Transfer Taxes and Stamp Duty, which tax the preparation of certain notarial, commercial and administrative documents valid in Spain.

The nightmare of the labor market

Probably after the Greeks, the Spanish are in second place in the ranking for an absolutely broken labor market. Compared to other countries in Europe, the collective bargaining system is quite centralized, i.e. it is not carried out at the enterprise or company level, but at the industry and provincial level, with agreements simply having the force of law and it is very difficult to dismiss employees with permanent employment contracts. In reality, the entire burden is borne by people on temporary contracts, because they are dismissed and their salaries are reduced. One third of all workers are on temporary contracts, and such a system with double standards - one for those inside and another for those outside - leads to opposition, to the encapsulation of the former, undermines the jobs of the latter and hinders the flexibility of the labor market in troubled times. The whole system is designed in such a way that it goes against growth and competitiveness.

However, some of the main aspects of the reform of labor relations between workers and employers announced by the government a few days ago bring some light in the tunnel:

• lower compensations have been approved for layoffs;
• collective layoffs of employees in the public sector are facilitated under the same conditions as in the private sector
• if losses are reported for 9 consecutive months, the employer may undertake collective layoffs of personnel;
• the omnipotent power of collective labor agreements is being revised - the reform limits their effect by eliminating their automatic renewal, and the agreements will have to be renegotiated every 2 years;
• promoting the development of small and medium-sized businesses - when hiring an unemployed person up to the age of 30, the employer receives a reduction in his taxable income in the amount of 3 thousand euros for each new employee hired;
• capitalization of unemployment benefits - when starting a business as self-employed, young people under 30 and women under 35 will receive 100% of unemployment benefits to start their own business. The previous threshold was up to 80%;
• tax breaks for hiring the unemployed on a permanent employment contract to tackle youth unemployment - when calculating the employer's profit tax, 3,300 euros are deducted from the amount of taxable income. When hiring women - 3,600 euros, and for permanently unemployed people over 45 years old - 3,900 euros;
• overtime work is permitted for persons employed part-time in order to increase employment and income of workers;

Although some of these innovations will help increase the flexibility of the labor market, the implementation of the fiscal results set in the current budget remains questionable. It seems that Rajoy has set himself the goal of eradicating the scourge of high unemployment. However, markets remain skeptical about the implementation of the revenue side of the budget, which is why demand for Spanish bonds has fallen and their price has fallen. Interest rates have risen sharply in the last few days, with the yield on 10-year bonds reaching 5.7% on April 6, 2012. Many of the reforms introduced are a step in the right direction. However, the cherished goal remains far away.

Did you like it? Take a minute to support the EKIP on Patreon!