July is traditionally the month for sales in Spain, a time when shops throughout the country plaster their windows with rebajas signs and struggle to keep up with the long lines of customers at the cash register. But on Wednesday, Prime Minister Mariano Rajoy threw a bucket of cold water on that season of gleeful bargain hunting when he announced that the value-added tax (VAT) on goods and services would be rising from 18% to 21%. Effective immediately.
The austerity package announced on July 11 is the fourth that Rajoy has approved since taking office in December and the harshest in Spanish history. In addition to raising the VAT, it erases one payment from the 14 that civil servants receive each year, reduces unemployment benefits by 10% after the sixth month and cuts ministry budgets by 30%. Because several of its provisions are reversals of measures that the Prime Minister previously disavowed, the package could undermine Rajoy’s credibility and — as virulent protests held yesterday suggest — increases the possibility of widespread social disturbances. And all this for something that could just as well hurt the economy as help it.
“This is the reality,” the Prime Minister said on Wednesday as he explained the new cuts to parliament. “There is no other. We have to get out of this hole, and we have to do it as soon as possible, and there is no room for fantasies or improvisation.”
The announcement seems tailored to appease the E.U., which, on June 9, approved up to 100 billion euros in bailout funds for Spain’s troubled banks. Spain won some key advantages in the terms of that rescue, recently securing a provision, for example, that will allow European funds to be channeled directly to banks after Jan. 1 (rather than going through the government and thereby adding to the public-debt load). But Rajoy’s insistence that the funds would be given without macroeconomic conditions grows more questionable by the day. A draft memorandum from the European authorities, leaked to the Guardian on July 10, calls on Spain to “present by end-July a multiannual budgetary plan for 2013–14, which fully specifies the structural measures that are necessary to achieve the correction of the excessive deficit.”
It hardly seems coincidental that, one day later, Rajoy did just that. “Spain had no choice,” says Joaquín Maudos, a professor of economics at the University of Valencia. “We’ve been intervened, and this is what Brussels demands.” In the long term, Maudos believes, the move will help calm the market, which even after the rescue package has kept Spain’s risk premium above 7% — a level that many economists believe is unsustainable. “It has to go down because Spain is showing that it’s meeting all its obligations. There’s nothing else we can do after this.”
Earlier this week, Brussels agreed to postpone the date by which Spain must reduce its deficit to 6.3% of GDP until 2014. (In the first five months of 2012, it was already at 3.41%.) The cuts, which Rajoy has said will amount to 65 billion euros, are designed to meet that relaxed goal. Of them, the two most significant — the increase of the VAT and elimination of civil servants’ Christmas payment — will equal an estimated 25 billion euros in government savings. “That’s not peanuts,” says Eduardo Martínez-Abascal, an economist at Barcelona’s IESE Business School, “when you consider that that total deficit is about 90 billion.”
Yet even if that target is met, Spain is hardly out of the woods. In fact, some believe this latest round of austerity is exactly the opposite of what the government should be doing if it hopes to jump-start its ailing economy. Because it belongs to the euro zone, Spain doesn’t have the ability to devalue its own currency to make its exports more competitive. Instead, it looks as though Europe is trying to forcibly increase Spain’s competitiveness through fiscal devaluation — by getting rid of jobs and reducing salaries and benefits that make Spanish exports expensive.
Yet by reducing jobs — in a country where unemployment already stands at 24% — the government is shrinking the number of taxpayers. And by cutting salaries and raising the VAT, it seems certain to reduce consumer spending. “The problem isn’t so much that people won’t buy a particular item because its price goes up a bit,” says Martínez-Abascal. “The problem is that they won’t go shopping at all. When everyone around them is telling them things are getting worse, it creates a kind of generalized panic. People stop spending because they’re worried about what might happen.”
That, in turn, creates a vicious cycle. “What we need to be doing is increasing growth,” says Fernando Luengo, a professor of applied economics at Madrid’s Complutense University and a member of econoNuestra, an organization of academics affiliated with the so-called 15M movement, Spain’s version of Occupy Wall Street. “This just reinforces the loop of recession.”
It also increases the hardship of Spaniards who have already seen prices for medicine and education go up as subsidies decline. “There are plenty of civil servants who are already only making 1,000 euros a month,” says Luengo. “This is going to put whole new swaths of society in a very precarious situation, which it will be almost impossible for them to get out of. And it has a good chance of increasing social unrest.”
Already, this week has witnessed some of the most emotional — and violent — demonstrations since the crisis began. After Rajoy’s announcement, hundreds of civil servants gathered spontaneously outside parliament and attempted to get inside; today, hundreds more have taken to the streets, at one point blocking Madrid’s central artery. A demonstration yesterday by coal miners who had traveled from the northern regions — where the industry is feeling the effects of a drastic reduction in state subsidies — saw protesters attempt to breach police lines, and the police responded by firing rubber bullets.
The unrest is a reminder that reducing the public deficit is hardly Spain’s only issue. “The measures will help alleviate the debt problem,” says Martínez-Abascal. “But that’s not the pressing issue. The pressing issue is reactivating the Spanish economy.”
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