How Spain fixed its econ­omy

The Pak Banker - - OPINION - David Ship­ley

So eco­nomic stag­na­tion is the new Euro­pean nor­mal, and the south­ern pe­riph­ery the euro area's Achilles' heel? Spain just posted its strong­est quar­terly growth in eight years and pre­dicts 3.3 per­cent growth for the year as a whole. Maybe there's a les­son here.

There is, but it's a bit more com­pli­cated than "aus­ter­ity works" -- the mes­sage that Europe's fi­nance min­is­ters and the In­ter­na­tional Mon­e­tary Fund might choose to em­pha­size. Fis­cal con­trol has been part of the mix, but only part. Luck had a hand, too. Most im­por­tant, Spain made some brave, un­pop­u­lar choices that seem to be work­ing out.

The econ­omy suf­fered a crip­pling down­turn in the fi­nan­cial cri­sis, then hob­bled along un­til 2012 with­out any­body do­ing much about it. At that point, the gov­ern­ment ap­plied for a 100bil­lion-euro res­cue pack­age from the Euro­pean Union. The sit­u­a­tion was grim. Spain's real-es­tate bub­ble had burst, un­em­ploy­ment (a blight on Spain for years) had climbed above 25 per­cent, and cas­cad­ing bank­rupt­cies fur­ther un­der­mined con­fi­dence. The yield on 10-year Span­ish bonds in July 2012 ran more than five per­cent­age points over Ger­many's, prompt­ing the Euro­pean Cen­tral Bank to step in to save Spain from spec­u­la­tive runs on its sov­er­eign debt.

The gov­ern­ment of Prime Min­is­ter Mar­i­ano Ra­joy bowed to aus­ter­ity de­mands, cut public-sec­tor wages and ben­e­fits, and in­creased VAT to 21 per­cent (with ex­emp­tions) from 18 per­cent. Had he stopped there, Spain might have bumped along the bot­tom for a good while longer, rather than see­ing the re­cov­ery it's now en­joy­ing. Low in­fla­tion, a cheap euro, the fall in energy prices and re­newed fi­nan­cial sta­bil­ity in Europe have sup­ported con­sumer spend­ing and lifted Spain's be­lea­guered re­tail­ers. Hol­i­day­mak­ers have fa­vored Spain this sea­son, too -- in part be­cause vis­it­ing Greece with­out bun­dles of cash has pre­sented dif­fi­cul­ties. Put much of all that down to luck. But Spain's re­cov­ery to­day also owes a lot to hard re­form aimed at par­tic­u­lar fail­ings in the econ­omy. The Ra­joy gov­ern­ment braved street protests and the rise of an anti-re­form left-wing op­po­si­tion and per­sisted in a de­lib­er­ate rewiring of the Span­ish econ­omy, with an em­pha­sis on far-reach­ing la­bor-mar­ket and tax re­forms. In 2014, the gov­ern­ment said it would grad­u­ally lower the cor­po­rate tax rate to 25 per­cent from 30 per­cent. The top mar­ginal rate on per­sonal in­come will fall to 45 per­cent from 52 per­cent. The gov­ern­ment is lim­it­ing de­duc­tions, broad­en­ing the tax base and mak­ing a se­ri­ous ef­fort to curb eva­sion. Com­pa­nies have been given more flex­i­bil­ity to set wages and work­ing con­di­tions.

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