- Is The Crisis Now History In Spain?
Mariano Rajoy is a man who is not shy when it comes to being controversial, as the storm surrounding his stance over the recent Greek bailout negotiations clearly illustrates (and here). So it is perhaps not surprising that he did not notably blush when he informed a Madrid audience at the end of last year that "In many ways, the crisis is history." Such was the storm that followed that he was forced to at least partially retract the offending phrase after a meeting with union officials some four days later. "In many ways the crisis is history, but its consequences are not," he clarified.
- Yet when it comes to making "hard to justify" claims about the health of the Spanish economy he is scarcely backward in coming forward, as his statement to the Spanish nation at the end of the last parliamentary session in July illustrates: "Spain has entered a virtuous circle of increasing growth, growing employment, rising incomes and lower taxes," he said, a process which he claimed could lead the country to one of its longest growth periods in recent history. The comparison, it might be thought, would be with the expansion which lasted from 1993 to 2007. No mention here of "secular stagnation", "new normals", or "new mediocres", Spain, it seems, is above such things.
Of course most of this is simply political rhetoric in what is is set to be an election year, but still, it does raise interesting questions. Where exactly is Spain? What is the outlook for the future? There is no doubting the country has been through a severe, even dramatic, crisis. The over reliance on the construction industry and rising property values to boost spending produced a series of imbalances which all came to a head in 2007. Since that time there is no doubt that a major adjustment has taken place. The current account is no longer in deficit, some parts of manufacturing industry (like the automotive sector) have become much more competitive, the fiscal deficit is now falling not rising, etc.
But despite the recent spectacular surge in growth, doubts remain. Is the country still in crisis, or is it, as Rajoy 2.0 suggests simply suffering from the legacy of an earlier one? Will time eventually heal all, or does the economy still suffer from deeper structural problems which will make a "full recovery" from the traumatic shock improbable, and mean the country and its citizens will be poorer than they might have been in the longer run?
These questions are not at all easy to answer, and certainly much less so than they seem at first sight, nonetheless in what follows I will take a shot at examining some of the concerns which still exist over the long term outlook for the Spanish recovery.
This review will be constantly updated, and will contain a summary of all the most relevant current Spanish data. The big issue is whether Spain's government has really done enough by way of reforms to be able to guarantee a secure and prosperous future for its citizens, or whether it has simply done enough to "get by" and meet the requirements of Eurozone officials.
Questions to be discussed below are:
>> has enough been done in terms of international competitiveness to be able to guarantee a "complete" labour market recovery?
>> to what extent is Spain's housing market really going to recover?
>> is the external correction complete, or is there more to do?
>> Spain's population (and especially it's working age population) is in decline, what are the economic implications of this? And what is the long run growth outlook for Spain?
>> the cost of paying pensioners continues to grow more rapidly than income from contributors - does Spain need another pension reform?
>> Spain's economy will grow comparatively quickly in 2015, but the ECB is buying Spain government bonds, ECB interest rates are near zero, and the country is running the largest fiscal deficit in the EU. What would Spanish growth look like without the deficit and with a "normalisation" of interest rates?
>> Spain's sovereign debt is about to pass the 100% of GDP level, will the next government be able to stabilise the debt, or will it continue to grow?
>> Spain's recovery at present is largely a services and domestic consumption based one. Industry and capital expenditure continue to lag behind. Is this profile sustainable in the longer term?
Spain's Recovery Is Real
The most striking and obvious thing about the Spanish recovery is the way in which real (inflation adjusted) GDP growth rates have steadily accelerated across successive quarters. The country's economy - with a quarterly increase of 1% -was one of the fastest growing in the Euro Area in the second quarter of 2015. The annual rate accelerated to 3.1%, while full year 2014 growth rate (as compared to 2013, when it shrank by 1.2%) was 1.4%. Growth in 2015 is likely to be in the 3% range.
- These are good results, but it is worth bearing in mind that everything is relative and that there is still a long hard road to travel. GDP levels still remain around 4% below the pre-crisis level. And while the (possibly optimistic) Bank of Spain forecasts are for robust growth in the near future even their achievement will mean the pre-crisis level will not be attained before 2017, which gives a very concrete and precise meaning to the term "lost decade". But the real debate about Spain's future is not about the crisis years and those of recovery, it is about what happens next. What can we expect during the following decade - the one from 2017 to 2027 - will that one be lost too, as it has been in Japan? Will deflation and secular stagnation steadily take hold in the context of an ageing and declining population (see the latest IMF report on this, and Larry Summers on Secular Stagnation here) . In other words, to what extent is Spain at risk of becoming Japan 2.0?
- Certainly there are many in Spain who would deny that possibility, among them Economy Minister Luis De Guindos, who told the Wall Street Journal earlier this year that he expected growth of between 2.5% and 3% for the next two to three years with the trend simply continuing thereafter. Bank of Spain governor Luis Maria Linde would be another. He told Bloomberg reporters that the recent bout of negative interest rates would be a temporary phenomenon which would disappear as the "recovery takes hold". He added that it was now much easier to "assert there was no deflation risk" in Spain than it had been some months ago (when, incidentally, he was also saying there was no such risk). Assertions like these are hard to either agree with or dispute, since no one really knows the future. Words are easy while economic models simply mindlessly churn out predictions based on past performance, which may, or may not, be relevant. The only thing we can be sure about at this point is that the future will look less like the past than it ever did, so forecasts based on old data have less validity than ever. At the same time simple economic theory suggests that as workforces decline economic growth rates will do so too, which should at least give us all fodd for thought.
Still, were the most optimistic forecasts to be confirmed the resulting growth rates over a sustained period would clearly turn the country into the Euro Area's most efficient and fastest growing economy, and it is hard to see where the basis for such confidence comes from. When Spain's economy grew at rates of 3% or more a decade or so ago it was on the back of excessive and unsustainable debt increases, and that isn't going to happen again, even were it desirable. Spain's economy may well grow by 3% or so this year, but - failing something unexpected like Grexit - it is hard to imagine a more positive growth environment in which to do so. As for when we get to 2016, as they say, it depends.........
Why Nominal GDP Matters
While many deny that deflation risk really exists in Spain, or that deflation is even a negative phenomenon, there no getting away from the role played by the magnitude of the GDP deflator in arriving at the country's headline GDP number in recent quarters. The GDP deflator is the measure that is used to convert nominal (current prices) GDP into real GDP (the one that makes headlines, comparing apples with apples and not with pears), since it is an attempt to remove the impact of price movements (inflation or deflation) from the final benchmark GDP reading. Let's take an example. If nominal GDP grows 5% and inflation is 3% then real GDP has grown by 2%. If inflation is then re-estimated at 2% then real GDP growth turns out to have been 3%, and so on. Compensating for deflation is when things start to get more complicated, and doing so when nominal GDP is either stationary or negative is when the world gets really wonky.
Lets take the case where nominal GDP grows by 2%, and deflation is 1% - then real GDP grows by no less than 3% (you have to add the deflation number, not subtract the inflation one, if in difficulty ask the Japanese for help, they have been doing this for years). Now lets imagine a case where annual nominal GDP growth is zero, but the GDP deflator is estimated at minus 0.5% (the case of Q1 2014 Spain GDP). Then in this case real GDP grows by 0.5%. Supposing that later you revise this estimate to minus 0.25%, then GDP growth is halved at a stroke, since it also becomes 0.25%.
Certainly then the GDP deflator plays a very central role in final Spanish GDP outcomes, and the sensitivity of the early GDP estimates to errors in the deflator value is striking. As I am suggesting here the value attributed for Q1 2014 effectively accounts for 100% of the estimated GDP growth, and the probability of subsequent revision is, going by past experience, large. Indeed in the Spanish context could it be said to be the loop which finally squares any unfortunate circular gaps in the national accounts?
And when I said when nominal GDP is close to zero things get wonky, I meant it. According to data from the Spanish national statistics office, seasonally adjusted nominal quarterly seasonally adjusted GDP didn't shift by much more than a decimal point from 262 billion euros between March 2013 and March 2014.
I was surprised to find this, but then maybe I shouldn't have been since shopkeepers had been telling me for months that the takings in their tills hadn't improved. Now we know why. During the 12 months in question there had been an improvement in output VOLUME and COMPOSITION, since prices have been falling and the economy has reorientated somewhat, but not in overall turnover. Looking at these numbers one of two things are true. Either Spain was sliding steadily into deflation, or there was no recovery. There would seem to be no available third reading. The most probable interpretation of the data we have to date would be the former, that Spain had been sinking steadily into deflation even while government and Bank of Spain representatives were denying it.
Government tax income depends on nominal and not real GDP, so weak nominal GDP growth means higher deficits and rising government debt ratios as a percentage of GDP. Which is just one reason why ongoing deflation is not a desireable thing.
Employment Growth Is Strong As Unemployment Falls
One area where it is possible to see a strong positive side to Spain's recent performance is on the employment front. Spain created 434,000 jobs in 2014 and at the present time is creating them at an annual rate of approximately half a million.
- To put some flesh on these numbers it should be said that many of the new jobs are part time (40% of new indefinite contracts are p-t), while many others are temporary and not well paid (the economy is increasingly becoming a low-value-added-services one, lead by tourism), but still, Spain's economy is once more creating employment, and that is good news.
A similar picture emerges when it comes to unemployment which is now steadily falling back, with the seasonally adjusted rate falling to 22.5% in June. Nonetheless there is still a long, long way to go.
- Affiliations to the country's national insurance system were up 416,000 (or 2.3%) in 2014, and by 568,000 in July when compared with a year earlier. These figures are useful, as they give an idea of the level of employment creation.
- However - as can be seen in the following chart showing numbers of social insurance affiliates - the rate of job creation (which has been very strong) may now have peaked, since the annual change has been more or less constant for the last few months. This is only to be expected, since it is unrealistic for the economy to continue to generate jobs at the same blistering rate indefinitely.
- Naturally, putting all this in perspective, the number of unemployed remains unacceptably high, and the increase in employment needs to be seen in the context of more than 3 million jobs having been lost since the start of the crisis, but still, things are manifestly improving.