Austerity Bites: How the Remedy May Just Make Things Worse for Spain

The Rajoy government's stringent new measures to bring down the country's deficit may just suppress the economic forces that might propel growth

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Manu Fernandez / AP

A woman protests against evictions and banks in front of a Barclays office in Barcelona on July 12, 2012

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.

(MORE: Beyond Soccer: The Poignance and Royalty of Spain’s Soft Power)

“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.

(MORE: European Stock Markets and the Flight from Reality)

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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10 comments
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Firozali A.Mulla
Firozali A.Mulla

Made-in-China US Olympic uniforms spark political row. If Ralph Lauren does

stop outsourcing their manufacturing jobs to China in the near future, they

likely will not return to the U.S either. Ralph Lauren and their other fashion

counterparts will eventually move on to some other cheaper manufacturing

locations such as Bangladesh, Vietnam or Indonesia like Gap and Izod has. Those

senators can cry all they want but in 2014, 2016 and the Olympics following

those; American athletes will still be wearing foreign made uniforms because

the wages of the average American is too expensive to pay and will cut into the

greedy corporation's profits. It is important for India to set some

quality criteria on importing Chinese goods to India. I can give a typical

example of what happens. We started importing cheap Chines toys made of

recycled plastics and cheap wood. Since these were cheaper than made in India,

consumers started buying only Chines items. Indian toy manufacturers could not

compete because the environmental compliance requirements in India did not

allow them to make such cheap quality toys. Eventually Indian manufacturers

could not find market for their products and they shut their plants and looked

for other jobs. The net result is we are now stuck with only the cheap Chinese

toys or very expensive ones imported from other countries. This way we are

killing our own industries and forcing consumers to buy either the low quality

or toxic products or shell out exorbitant amounts to by quality products. We

should set quality pre-requisites for imported goods just like US or Europe, or

even the Gulf countries do. I thank you Firozali A.Mulla DBA

 

Pablo Sánchez Río
Pablo Sánchez Río

15M IS NOT a Spanish version of Occupy Wall Street, in fact it is the movement in which Occupy Wall Street was inspired.

David 10
David 10

There are bad politicians in Spain

spaniard? spanish!

jkaravidas
jkaravidas

the story of Greece all over again. cuts that is supposed to promote growth and competitivity but that also might lead into in a downward spiral of the real economy that is imossible to stop if it happens. can't the economists in Brussells understand that? or they just ignore it because this austerity policy is just a part of a hidden agenda?  

Scotty_A
Scotty_A

I am skeptical that the Euro currency is worth the amount of austerity needed to make a common currency work. People do not need many of the possessions they have, but they do need to be able to have some way to make a living. American and Chinese policy makers seem to understand this much better than their European counterparts. It is not clear to me how other European countries will avoid the same tragic fate that Greece has had recently. Europe spent too much money and went into debt because it envied the economic success of America and Asia.

mamaotis
mamaotis

A good number here in the US are living in different degrees of austerity. Like Spain, there was easy credit and a housing bubble that burst, as well as all the bailout business. Same story. The people take the cuts and the banks get the money.

DED_Follower
DED_Follower

When it comes to housing bubble Spain and USA are kinda similar. Yet the situation in Spain is actually different and way worse than in the USA since in Spain there´s a problem of structure. The Spanish State/Administration does not work anymore. Spain is at a turning point so the current structure must be torn down in order to start over, from scratch, doing something else, something better. For that,politicians are not willing to as they put all the burden upon people´s shoulders and the shit hits all over the fan^^

bcfred
bcfred

"May suppress economic forces that might propel growth" versus "will otherwise, with absolute certainty and in short order, run out of money."  I fail to see how this is even a question.

0megapart1cle
0megapart1cle

The situation is nowhere near that cut and dry.  Spain, and most European countries, have already enacted multiple series of austerity measures.  All it's doing is further hurting the economy.  It needs to stop.  They only way to dig themselves out of the fiscal hole is to encourage growth.

Firozali A.Mulla
Firozali A.Mulla

Let us wait for Friday may be we will be

able to hear better news. Daily it is the same story. We have the gloom and

doom. No one says anything ta=hat may cheer us up. Well if that be so let us

take it for now. European shares fell on Thursday, taking their cue from poor

overnight showings by Wall Streetand Asia

after minutes of the US Federal Reserve's June meeting dampened hopes for more

risk-asset-boosting stimulus in the near term. The FTSEurofirst 300 was

off 0.4 percent at 1,034.82 by 0825 GMT, having closed flat on

Wednesday. The Fed minutes showed the world's biggest economy would have

to worsen before the central bank eased monetary policy further. A few

officials thought more stimulus was justified, but the majority were

unconvinced. "It doesn't change my overall view that QE3 is going to happen

later this year or the beginning of next year. But in the short term this was a

disappointment," Philippe Gijsels, head of research at BNP Paribas Fortis

Global Markets, said. "There is not much to expect from economic

data, there is not much to expect from earnings, so the only thing markets hope

for is more quantitative easing, more stimulus from Europe - more U.S. officials are looking into the British financial scandal

involving a key global interest rate. A House Financial Services subcommittee

and the Senate Banking Committee want to know what American regulators knew

about charges that the British bank Barclays was manipulating the London

Interbank Offered Rate, or LIBOR. The international interest rate helps set

short-term rates around the world, and it influences mortgages and other loans

in the United States and abroad. "I am concerned by the growing

allegations of potential widespread manipulation of LIBOR and similar interbank

rates by some financial firms," Senate Banking Committee Chairman Tim

Johnson, D-S.D., said in a statement. "At my direction, the Committee

staff has begun to schedule bipartisan briefings with relevant parties to learn

more about these allegations and related enforcement actions," he added. "It

is important that we understand how any manipulation may impact American

consumers and the U.S. financial system," he said. British and U.S.

authorities have already fined Barclays $453 million for providing false

information to the people who calculate LIBOR stimulus from

everywhere." In a broad-based fall, basic resources came under

pressure, down 1.2 percent, as the copper price dipped on the back of the Fed

minutes, and ahead of China GDP data, set for release on Friday. I thank

you Firozali A.Mulla DBA