Thursday, March 31, 2011

Reasons Not to Fear a Spanish Default

Another interesting viewpoint on Spain and the economic crisis from the Guardian via Kyero

Reasons Not to Fear a Spanish Default

With all the uncertainty surrounding Portugal’s economy, many people are asking if Spain could be next to develop problems. I am uneasy about comparisons: the economic systems and the recent evolution of the two countries are very different. Why should Spain be compared to Portugal instead of, say, to the Netherlands?

The truth is Spain does not have a history of defaults. It did become a “serial defaulter” in the 16th century, after failing to invade England. But there are no plans for another invasion, so I do not see the danger for a default. Neither did Spain default in peacetime in the 20th century, as the US did in 1933, or seek a bailout, as the UK did in 1976.

More important, Spain has recently demonstrated a great deal of fiscal responsibility. From 2000 to 2008 it often ran budget surpluses. The moderate public debt went down from 66% to 47% of GDP in this period. Other countries that were also growing saw their debt increase during the same period, for instance the United States (54% to 71%) and the UK (from 45% to 57%), or they maintained debt at very high levels, as Greece did (from 115% to 105%).

This record was blemished in 2009, when the deficit climbed to 11%. Two factors played into this: first, the contagion from the bailout epidemic that swept the world that same year; and, second, it was a post-election year. But austerity measures were taken in 2010 and they appear to have brought back fiscal stability.

Most of the austerity measures just reversed tax cuts or spending hikes that had only been in effect for a year or two. For instance, civil servants’ salaries were cut by 5% but they had gone up by 3% the previous year, so the fall in purchasing power during the crisis was small. Another example: capital gains tax went up by 2%, and income tax for the top pay bracket by 1%-4%. But wealth tax was abolished in 2008, and inheritance tax has all but disappeared. Therefore total taxation on capital and income is roughly where it used to be.

This is one reason why the social backlash has been muted. The Spanish government has even undertaken some long-term reforms, such as postponing the retirement age from 65 to 67 and improving flexibility in the labour market. Compare this with the austerity measures in the UK, or with the inability of the American political system to lower the deficit this year.

The doomsayers have spread a huge amount of misinformation. I have read reports in the press that Spain cannot export, that it cannot compete, cannot employ its workers, run its fiscal policy, pay its pensions … I do not have the space to counter all these claims, but any comparison of actual data about deficit and debt, exports, growth, average retirement age, and cost of rescue packages with other countries, will reveal the true picture.

In fact Spain’s output is quite high: even in 2009 GDP per capita in Spain was essentially the same as Italy’s, very close to France’s, and only about 10% lower than Germany or the UK.

Certainly there are problems, as in almost every other country. The banking system has to be reformed; but the amount needed to recapitalise the system will be quite small as a percentage of GDP, much smaller than in many other countries. There is no need for the government to pick up the tab, and there is no indication that it will.

As is well known, the unemployment rate of 20% is very high relative to Europe in normal times, but this is in part because other countries are better at hiding joblessness, either by retiring workers from the labour force or by using part-time work. However, the high unemployment is an unavoidable temporary shock, since a large part of the workforce has to be reallocated away from construction. Once growth begins, employment usually grows quickly.

So please do not be deluded: there are no fundamental reasons to fear a Spanish sovereign debt crisis.

Story from Guardian

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