The Gain from Pain in Spain

Like no other European country, Spain with its recent history offers Australians valuable object lessons in political economy. 

In 2004, Europe’s arguably most left-wing, most impatient socialist government took over the political reins amidst much criticism of the previous conservative government’s military engagement in Iraq. The new socialist administration of José Luis Zapatero set about modernising the country, whose real per capita income of $33,000 (or 73 per cent of Australia’s in 2012) had by and large caught up with the rest of Europe. The visitor in search of romantic Spain—guitars, bullfights, siestas and the like—is nowadays more likely to be impressed by superhighways, a high-speed rail system more extensive than France’s, breathtaking architecture … and a new class of citizen, who is eager for social liberalisation and consumerist gratification and has jettisoned conservative Catholicism, instead often embracing Europe’s Green pseudo-religion.

The Zapatero government of young, inexperienced politicians set about changing the world with a speed and enthusiasm that outpaced what Australians saw under Whitlam. Political powers were devolved to centripetal provinces and local governments, often run by young activists with radical dreams of creating a welfarist paradise and embarking on grand new public works. Regulatory activism created new bureaucracies—after all, absolutist Spain once contributed the term “burocrata” to the European vocabulary. New trendy causes were the rage: new abortion laws (including for sixteen-year-olds without parental consent), gay marriage, prescriptive Greenery without regard to costs and benefits, and so on.

Unlike the Whitlam experiment, Spain’s exhilarating revolution was not held back by financial gravity. The country had been able to squeeze into the Eurozone (only just), and the new money promised unlimited credit at low interest rates. The new class of reformers grasped the euro opportunities and generous EU subsidies with both hands. When the global financial crisis hit in 2008, the central and provincial governments immediately turned on “the Keynesian hoses”.

Not to be outdone, the people, who had long been disciplined by tight and expensive credit, also went on a borrowing spree. Homes and shops were renovated; new car sales boomed; second houses and apartments by the coast became a must; holidays in faraway places became fashionable. Businesses expanded, never mind prospects for a decent rate of return. The restrictive old monetary morality could be shaken off. Welcome to a brave new world! Only now with hindsight do many curse this era as “the great euro illusion”.

Gravity has caught up with the Spaniards. As the global financial crisis deepened, global bankers realised that public-sector balance sheets were spinning out of control and that local banks were mortgaging more and more assets whose rate of return fell far short of the interest cost. The building boom had produced apartments far in excess of what the market could absorb, and infrastructures often exceeded what was economically justified. Now, the expenditure-and-borrowing fiesta presided over by Zapatero produced a hangover. In 2011, the socialist government was thrown out in a massive swing, despite the fact that the conservatives were promising only blood, sweat and tears.

The new conservative government under avuncular leader Mariano Rajoy spoke firmly and with one determined voice, turning economic reform almost into a moral issue. The top team of gifted conservative reformers acted in the knowledge that an earlier Popular Party government under José Maria Aznar (1996–2004) had successfully managed to sort out a previous overspending mess and the ensuing job destruction left behind by the first socialist government after Franco. On that occasion, a devaluation of the currency and monetary sovereignty had made the task of righting the economy much easier. Now, euro membership prevents such flexibility and deprives national macroeconomic management of its clout.

After the 2012 election victory—and in contrast to, say, Greece or Italy—Spain’s belt-tightening was real, well-thought-out, even heroic. The people were told that the alternative would be unthinkably long misery and a loss of national sovereignty. The leaders appealed to the Spanish character: Spaniards may not be so good at routine tasks, but they excel when confronted with a noble challenge.

The fiscal consolidation of the aggregate public deficit, which had surpassed 11 per cent of GDP in 2009, took time to reflect the results of austerity, not least because the new central government paid the massive arrears of local and provincial governments to local suppliers and contractors. The payment of unpaid government bills did much to ease economic ailments at the local level and helped a hesitant but by now visible recovery. Local savings banks were also bailed out and consolidated, with EU and IMF back-up. During 2012, the public sector deficit still ran at 10 per cent of GDP (6.8 percentage points due to central government overspending). Public debt, at 88 per cent of GDP, is still lower than Germany’s, but it continues to creep up. Deficits can only be expected to drop to promised lower levels when GDP growth resumes in earnest.

The Rajoy government introduced some tax increases to tackle the fiscal deficit, but made it clear that the main thrust would be expenditure pruning and reliance on supply-side reforms to rekindle competitiveness and overall growth. The overblown public sector has since been subjected to drastic slimming. Initially, this of course bloated aggregate employment statistics. A major effort to streamline the administration is now under way, and the liberalisation of enterprise is high on the agenda (after all, post-Napoleonic Spain contributed the term “liberal” to the European vocabulary). Social(ist) activists now also have reason to bemoan the “blood bath of the NGOs”, who have seen their copious subsidies for single-issue programs pruned drastically. But the protestations are dying down, as the public accepts what is inevitable. Many people I met now look relieved that the country is returning to the old, familiar virtues.

The Spanish government sternly rejected offers of summary bailouts by the EU and the IMF. The proud message was: We can manage on our own! Occasional interference from Brussels commissars was met with a proud statement by Mariano Rajoy: “If you can do it better than us, come and stand at the next election!” Such Spanish pride may have contributed to the reluctance of international bureaucrats and the world press to applaud the government’s supply-side policies. This is reminiscent of the dismissive comments Margaret Thatcher’s policies received for a long time. One cannot help but gain the impression that the power-brokers in Brussels and Washington would have preferred Spain to become more dependent on international aid. One also wonders why some EU commissioners criticise the unfortunate social consequences of the fiscal austerity that other EU commissioners are demanding. Maybe these Eurocrats envisage a childish, New Age policy nirvana in which rectifying old mistakes is always painless.

There has been much sobering-up on the work front in the wake of overdue labour market reforms. Despite grandstanding by the central union leadership, many enterprise unions have concluded long-term no-strike deals with employers, accepting present real wages and work conditions in exchange for job security. Thus, the workers at most car assembly plants gained management commitments to new models and job security. The likes of Volkswagen and Renault will make Spain Europe’s biggest car manufacturer from 2014 onwards. In addition, Spain’s big banks are engaging in enterprise rescues, but now with renewed attention to real profitability.

Between March and July 2013, 340,000 new jobs were created, while 100,000 public jobs were liquidated. The sacked public-sector workers of course have more time to protest than the newly employed waiters, factory workers and cleaners, many of whom have admittedly found jobs for relatively poor wages. The notion of a minimum wage has effectively vanished. But a low-paying job is better than none in a country where public handouts are tight and reliance on family has its limits. A job is again widely seen as the best social-welfare measure. In addition, many young people who are officially still registered as unemployed are holding informal jobs. Many of those who protested in the indignados mass movement of 2012 lost their indignation as soon as they were able to pocket tips from tourists. The Spanish government and many workers have realised that downward wage flexibility and a push for higher labour productivity are the only way to return to higher employment, since the exchange rate has been frozen.

Unemployment has also been mitigated by migration. Many recent immigrants from Latin America are returning home, and young Spanish professionals are seeking jobs elsewhere in Europe and the world. Moreover, Spain has implemented a stern policy to control its borders against illegal immigration. Australian officials might study how Spanish governments have gone about the business. They would, however, require a good dose of intestinal fortitude, and the public would have to understand that border protection is about protecting essential shared cultural assets and civilisational traditions from relativistic cultural dilution and welfare opportunism.

Exports are booming. In the first half of 2013, they were running at about one-third above the last year under the Zapatero government (2010). Foreign tourism makes a strong contribution to this recovery, thanks to massive price competitiveness. Daily tourist costs are about half of what one would spend in Australia. Prices are kept low, though many a hotel owner complains that profit margins are slim and workloads high; but at least rooms and restaurants are full again, so that one can re-hire faithful staff. In addition, the Arab Spring has diverted travellers to safe, sunny Spain.

As 2013 progresses, clear signs of recovery are multiplying. The stock market is booming. The risk premium for government debt has dropped markedly. This has come as a relief, for real domestic product per inhabitant had shrunk by nearly 6 per cent since the onset of the global financial crisis in 2008, one of the deepest recessions any major affluent country has suffered over the past two generations. As with a ship at sea, the change of course takes time. Now, every new commercial success is celebrated, whether it is new shipbuilding contracts, the deal by a Spanish consortium to build the high-speed rail link from Mecca to Medina (the “High-Speed Train of the Desert”), or a huge deal to build Riyadh’s new subway system, won by Spanish enterprise against industrial giants such as the Bechtel Corporation and Siemens. Unlike the UK, Spain is certainly not radically de-industrialising. The new export victories are now inspiring the public mood. But they would not resonate as much if there were not also numerous small signs throughout the country that enterprise and a dose of good luck are again on the side of the ambitious and the self-reliant.

Many problems remain unresolved, and the post-socialist hangover will last for some time. Grand road and land developments are already turning into white elephants. While many people have moved into new, better apartments, their old houses and flats remain unsold. This stock will sit around for a long while. Many people now live in residences worth half the original purchase price. Refurbished shops will not earn a sufficient rate of return. Many mortgages are in arrears. Some banks will continue to suffer from anaemic balance sheets. And the top-heavy construction industry will remain on the ropes. Many hasty public investments will do nothing for better capital productivity. And one has to observe signs of real poverty: it is an eternity since I have seen a Spaniard pick up cigarette butts and roll them into new fags. People park their cars chaotically to save the euro for pay parking. Growing vegetables is again in. Grandma’s traditional ways of making ends meet are again appreciated and valued.

Spain’s current pain is going to have lasting psychological effects, just as 1930s unemployment had in the Anglo-Saxon societies. The old morality is back with a vengeance: work, save and invest carefully. Economic gravity can, after all, not be suspended.

To convey the flavour of what seems to be happening after the switch from a New Age socialist to a conservative-realist national government, I cannot do better than relate an episode I came across on my most recent visit to Spain.

Somewhere in the north of the country, two men, one about fifty, the other a bit younger, approach me: “My name is Hernando, this is my cousin Pachi.”

They used to run a specialist undergarment workshop. “We prospered when even fat women cared about their waist. Now it’s all let go! But we still did OK with made-to-measure bras and special glamorous bras for show business divas, till our distributor went bust last year. Then, we lost most of our money.”

Pachi chimes in: “Have you ever had to tell your wife that you will lose the family home to the bank, and that you have to move in with some relatives? Have you ever had to sack people who worked for you for many years?” There was agony on their faces.

“The biggest insult came when our expert handiwork was sold at auction for next to nothing. We bought some of our own bras back, maybe one day to show our grandchildren. That’s when we met a black woman with big lungs,” he grinned sheepishly, “who was hunting for something her size. But there were no bras her size. Even well-endowed Spanish women cannot match such an Africana!”

As she was desperate, the two cousins invited her to their factory, promising to tailor a bra or two for her, although they had not operated cutting and sewing equipment themselves for years. “Her measurements were astounding!” Apparently she was particularly keen on some material with silver thread, even when told that the material would be a bit uncomfortable. She left ecstatic. At least the two bankrupts had done one last good deed!

Then a distressed, buxom African nurse arrived from Madrid, sent by her friend. She ordered five mega-bras and told them that there were lots of friends who just could not fit into those Spanish DD cups. One thing led to another. First, it was word-of-mouth trade with African nurses; soon they were taking more and more orders over the phone. While it normally takes only four measurements to design the perfectly fitting bra, they discovered that the Africanas required six. As their products got bigger and bigger, the two experts had to use special reinforcements to bear the titanic weight. I will spare the reader some of the saucy comment proffered by my new friends.

Before long, the trade went on the internet. New material had to be ordered in. The two entrepreneurs were able to re-hire four employees, then six. One client advised them to do a French version of their website and advertise in nurses’ magazines.

The trade more than doubled and has now become very profitable. They began to resume payments to the bank. The family home was safe. In the process, the two entrepreneurs, who had previously done no marketing of their own, relying instead on a sole distributor, learnt the secrets of marketing and discovered new opportunities.

Mollycoddling by government may have short-term electoral benefits. But they do not last. Credulous electorates end deeply in a quagmire and eventually face material pain. As long as the voters hold up sober values and do not abandon a measure of traditional common sense, adversity—a recession and the threat of bankruptcy—can do much to mobilise new enterprise. It just takes the spirit and skills to be alert to new market opportunities—and a dose of good luck.

At present, Spain’s heroic turnaround consists of thousands upon thousands of such discoveries, big and small, some ending in failure, some in bonanzas. What we observe is no more and no less than another empirical confirmation that work, saving, intelligent use of scarce resources and a bit of luck can—time and again—reopen the path to prosperity and the good feelings that come with material achievement.