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Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Spain related comment. He also maintains a collection of constantly updated Spain charts with short updates on a Storify dedicated page Spain's Economic Recovery - Glass Half Full or Glass Half Empty?

Saturday, October 05, 2013

Can demography explain Portugal's growth slump before the crash?

The above still comes from a recent Financial Times video entitled "Portugal's Brain Drain", which can be found here, and which I encourage everyone to watch. The issue being raised revolves around the current acceleration of emigration from countries on the EU periphery, largely towards the EU core. Typically the emigrants are young educated people who can't find work. There is nothing especially surprising in this, since the tendency has long existed for people to move from more depressed areas to economically more dynamic ones. The exodus from Detroit in the United States immediately comes to mind. Or Scottish people getting on the bus to make the fateful journey from Edinburgh or Glasgow to London. The Schengen accord simply extends this process which used to take place within nation states to single market zones, or currency unions. But does this extension have consequences for the participating states which were not anticipated at the outset, and are these consequences all benign?

In addition, this time round in an important sense something is different since these movements are occurring in the context of a long and difficult economic adjustment, indeed one could almost argue that the people leaving form part of that adjustment. What's more it is hard to accept that this is the kind of adjustment that countries like Spain and Portugal really need. Renovation in these countries implies these people and their talent are injected into the local economy to dynamise it, and not shot out the side like water from a high pressure hose with holes in it. So the big question I want to ask here is whether the economic programs which are being implemented in these countries take sufficient account of the demographic impacts they are inducing, and of the fact that the population loss involved - which most likely will become permanent - is going to cast a long shadow over the history of the countries concerned.

In earlier generations, migrants used to leave behind them what were comparatively high fertility societies. There were more children being born than the local economy could absorb.  We can still see this phenomenon in the world around us, as highlighted by the recent tragedy near Lampedusa, Italy. But the EU periphery case is rather different becuase - as the article I publish below indicates - the countries people are leaving are going to be short of working age population in a not too distant future.  Again, as blogger Valter Martins argues, maybe the impact of stagnating working age populations was already being felt before the global crisis broke out. Certainly, as I argue here, a case can be made that in Latvia it was the labour force limitation which lead to the excessive overheating and then the roller coaster landing that hit the country in 2008.

True, all these countries are suffering excessive levels of unemployment. But unlike the case of, say, Nigeria or Ecuador, this is not because there are too many young people for the economy to absorb, it is because the economy is stuck in a bad place and can't grow. Structural reforms are needed, but some of the reforms simply don't make sense. What is the point, for example, in lengthening the working life of older, less productive, workers while going to the airport to wave goodbye to their innovative and educated grandchildren who are forced to leave as a result. Surely a better solution would be sustainability in the pensions system - what goes out in total can be no greater than what comes in - and no reduction in the retirement age in the short term. Yes, this will mean lower pensions, but if the young leave the lower pensions will be even lower in the long run. There's a problem of priorities somewhere, and a generational imbalance in how the adjustment is being implemented which is not only unfair, it will lead to far from optimal outcomes in the longer run.

As it happens, just a couple of weeks ago three IMF economists (including chief economist Olivier Blanchard) presented  a paper to the Brookings Institute which  reviewed the performance of the Latvian economy since the EU-IMF intervention. It was a kind of informal post program evaluation. Interestingly enough, during the course of that paper they raise the very point I am raising here. “The question," they say, "is whether this emigration [from Latvia, EH] is, in some sense, a failure of the adjustment program."

They are right. This is exactly the question we should be asking ourselves. And in Portugal, Spain and Greece too. Their answer -  from an economic point of view emigration raises overall welfare:

 "In the United States, migration rather than unemployment is the major margin of adjustment to state specific shocks ….. These adjustments are typically seen as good, indeed as the main reason why the United States functions well as a common currency area: If there are jobs in other states, and if moving costs are low, it is better for workers to move to those jobs than to remain unemployed.”

This is the typical "non answer" we keep getting to this issue in the EU context. Obviously, from the point of view of optimal output, and the maximizing resources across a continent,  most probably such movements are beneficial. But to whom are they beneficial? Which "collective" community is it whose overall welfare is being raised here? Arguably not those in Latvia and Portugal. EU countries are not US states, and a United States of Europe does not exist. Again, this point is obvious, and agreed on by all, but when the problem this raises in terms of emigration from countries who have been running birthrates well below the replacement level  is put on the table all we get is silence.

Now assuming policymakers are not simply stupid this silence suggests that the whole issue touches on some very fundamental raw nerve. There is no answer in terms of sustainability for those countries who are net losers unless there are reverse direction transfers, as under the US Federal system, and that no one wants to talk about, at least in public. As the IMF economists admit in their paper - “the largely permanent departure of the younger and more educated workers may indeed be costly for those who stay”. So the question they pose - could things be done differently? - remains, at least from the demographic point of view, unanswered.

Portugal isn't Latvia, but it does have a very serious demographic problem. In Latvia  the total population declined by about 14 percent (340 thousand people) between 2000 and 2011. Emigration was responsible for about two thirds of this decline while low fertility accounted for the remainder. An estimated 200–215 thousand people left, mainly young people - roughly 9 percent of the population. Obviously Latvian emigration long predates the crisis. The average net emigration rate was 0.5% from 2000-2007. It increased to an average 1.3% from 2008 to 2011, but by 2012, was roughly back to its pre-crisis average. So emigration isn’t a product of the crisis, it was simply made worse by it. But the basic underlying reality is - given the ongoing fertility shortfall - even with the pre-crisis rate of emigration the population pyramid isn't sustainable.

Portugal's case is not so severe, but the pattern is similar. Between 1998 and 2008  about 700,000 Portuguese nationals left their home country according to research carried out by the former Economy and Employment Minister Álvaro Santos Pereira. In the pre-crisis years the outpouring was to some extent offset by an inflow of immigrants from other countries, but now the migrants are leaving too so the country's working age and total population are both declining.

Which conveniently brings me to the second guest post I would like to present from the Portuguese blogger Valter Martins. As Martin's coherently argues below, the drying up of Portugal's labour supply was already affecting sustainable trend output before the crisis set, so what I am suggesting we might like to ask ourselves is one very simple question  - how is an adjustment which accelerates the longer term decline in the country's workforce, and leads some of its younger and abler members to abandon the country, possibly for good, going to help raise the country's long term growth rate? Instead of alleviating this problem it seems to me it is likely to make the long term situation worse.

Can demography explain Portugal's slump before the crash? 
Is the Eurozone suffering from a “Shortage of Japanese”? 

Guest post by Valter Martins

In Portugal, unlike other countries now experiencing economic difficulties in the Eurozone - Spain, Greece and Ireland, for example - anemic economic growth was all too evident well before the financial crisis of 2007-08.  Accession to the Euro club brought a significant reduction in interest rates in those countries that had experienced historically high ones, triggering real estate bubbles (in Ireland and Spain), and public overspending (in Greece) this cheap money allowed these countries to maintain rates of economic growth above their long term potential and also above the European average. Portugal, on the other hand, suffered a mild housing bubble and government overspending,  yet growth was much weaker and more in line with countries that  have had fairly lackluster performances in the European context:, like Germany or Italy. (See chart below)

So what lies behind the relatively low growth that took place in Portugal when compared with other  countries that are now in the same situation? To put it another way, what’s the factor that differentiated Portugal from the other countries before the crisis of 2007-08? A number of recent papers and articles have attempted to explain the causes of this relative weak performance, but although some of the factors mentioned  surely contributed to the weak Portuguese growth  they do not fully explain it since many of them  were also present in the other - higher growth - countries before the crisis.

So we need to look a bit deeper. Essentially, long term economic growth can be split into labor force growth and productivity growth.  Invariably, the main cause cited for the Portuguese low growth has been productivity growth, or the lack of it, but although this certainly has been a problem in the last decade, it was not so much of a problem before, and it hardly appears sufficient on its own  to explain the relative weak performance. The differences in productivity gains don't seem large enough to justify the sizable difference in GDP growth, even in the cases of Ireland and Greece (where productivity growth was higher than Portugal), and certainly not vis a vis Spain since productivity growth there was lower than Portugal, as can be seen in the chart below. In the last decade, productivity growth in Portugal was threefold that of Spain but its growth was less than half.

As such, we can safely conclude, that productivity on its own cannot explain the differences in economic growth between Portugal and the other group of countries. On the other hand, the stagnation and decline of the working-age population can not only help explain the weak economic growth that afflicted Portugal, but also the GDP growth differences between several countries in the Eurozone before the crises.

As explained in the previous post, between 2003 and 2008, working-age population growth in Portugal was negligible and as such the “workforce effect” - contribution of labor force growth to GDP growth - was non-existent, as can be seen in the chart above.  Starting in 2008, working-age population growth became negative and thus the “workforce effect” began to act as a drag on the economy. To maintain a strong rate of  economic growth Portugal needed to gradually increase its productivity growth, and/or alternatively increase its labor participation rates - to compensate for the declining workforce - but given that this is not easily attainable trend growth will surely steadily fall. Therefore, when the labor force starts to stagnate or decline it is likely that economic growth begins to stall. This phenomenon may well explain the relatively weak economic growth seen in a number of  European countries over the last decade. In particular, it explains why Portugal and Spain had very different economic performances before the 2007-08 financial crises and how the two began to converge subsequently. 

Population change is comprised of natural growth, the difference between births and deaths, and net migration, the difference between immigration and emigration. Natural growth, both for Portugal and Spain, had been barely edging positive at the turn of the century since in both countries the total fertility rate fell below replacement level in the early 80’s. In Portugal, natural growth turned negative in 2007, the year that for the first time there were more deaths than births. On the contrary, Spain experienced a slight recover of its natural growth in recent years, as a result of an increase in its total fertility rate, as can be seen in the chart below, although this is due almost exclusively to foreigners, who have a higher fertility rate than the native-born.

As a result, both in Portugal and Spain, population growth in the last decades depended almost exclusively on having a positive net migration, and this resulted in a large influx of immigrants. But while in Portugal this growth started to slow down beginning in 2002, in Spain immigration exploded until the boom burst in  2007, as can be seen in the chart below. "No modern country on Earth experienced such a massive increase in its immigrant population as Spain. In 1990, one in 50 people in Spain was an immigrant. Today, it's one in seven."

Portugal not only received fewer emigrants from 2000 onwards, but also witnessed a massive exodus of its nationals.  As Edward Hugh pointed out, the entry in the European Union was accompanied by steady emigration flows, which clearly sets Portugal apart from the other countries, Spain in particular (see map on page 11), and resembles more the path that would be later trodden by Eastern Europeans countries when of their accession to the European Union.  Consequently, and according to the Instituto Nacional de Estatística (Statistics Portugal), during the inter-census period, the resident population of Portugal increased by only 1.9% while in Spain, the increase was 12.9%. (Chart below)

With the accession to the European Monetary System and later the Euro, interest rates declined significantly for both Portugal and Spain and as a result the two increased their debt levels. According to the McKinsey report, Debt and deleveraging (see page 14), in the second quarter of 2011 Portugal and Spain had total debt of 356 and 363 (as % of GDP), respectively. The consequence of cheap and easy credit was to create a housing bubble, both in Portugal and in Spain, but while the Portuguese began to deflate in 2002, the Spanish continued to inflate until 2008. This outcome was the result of the substantial increase in Spain’s population as a result of immigration, many of them Portuguese, while the increase in immigration in Portugal was just enough to replace the ones who were leaving. This population growth allowed the housing bubble to continue for much longer in Spain, while in Portugal there were no longer enough people to buy the excess homes being built, and so prices didn't skyrocket; but the housing units were built regardless. As such, rather than a classical bubble with inflated house prices, in Portugal, it was more a case of oversupply, given that 800,000 homes were built in the last decade while the population only grew by 200,000. On the contrary, in Spain, in addition to the excess construction, prices went through the roof, with migration pressures making a substantial contribution to both. It is estimated that the immigration inflow increased house prices by about 52% and was responsible for 37% of the total construction of new housing units between 1998 and 2008. Between 2002 and the 2007-08 financial crises the growth of the Portuguese economy started to fall more in line with the growth of economies where the labor force was stagnant or declining, namely Italy and Germany, as can be seen in the chart below.

The chart above is easier to understand if we group countries into two groups: countries with weak economic growth – Portugal, Germany and Italy-, and countries with more healthy growth - Spain, Ireland and Greece.  With the exception of Greece, countries with sound economic growth before the recession were also the countries with higher labor force growth in the same period, as shown in the graph below.  By contrast, in countries where economic growth was weaker, the labor force growth was also more moderate or even negative, as in Germany. (Chart below)

However, the dynamics changed completely with the onset of the 2007-08 recession. In Spain, where working-age population growth depended exclusively on immigration, the rates of labor growth collapsed, only matched by the plunge of its GDP growth, and its workforce has actually started to shrink. In Ireland, despite a more abrupt fall, growth nonetheless remained positive, this was due to the fact that its population growth did not depend only on net migration but had an important natural component as well.  In fact, Ireland has the highest fertility rate amongst European countries and therefore, unless emigration returns to numbers only seen in previous centuries, growth of its working-age population should stabilize in positive territory, although at a level well below the pre-crisis one.

In Portugal and Greece, even before the 2007-08 recession, labor force growth already showed clear signs of a slowdown, as growth came to a standstill in 2005, and despite a slight recovery after, more pronounced in Greece than Portugal, working-age population went into decline with the onset of the recession.  Italy, which had reversed the decline of its working-age population initiated in the 90’s, appears to have once again slid back into negative territory. On the other hand, in Germany, the workforce began to grow for the first time since 1998 due to an increase in immigration, many of them Portuguese, Spanish, Italian and Greek.

As explained by Daniel Gros, when comparing economic growth performance between countries with very different rates of population growth, the best indicator is undoubtedly GDP per Working Age Person (GDP/WAP).

Hence, if we compare the per working-age person GDP growth between the various countries in the last decade, as such taking working-age population growth out of the equation, it can be said that growth in Spain and Ireland was not so spectacular as it looked on paper, nor was growth in Portugal, Germany and Italy so dire when taken in comparison. In fact, only Greece seems to have had a spectacular growth, which would be in line with its productivity growth before the recession, but Greece’s population statistics might be underestimated, as Greece has not only a large population of illegal immigrants but some weakness in data collection that have also been highlighted. Anyway, a part of Greek growth was probably due to other - unrepeatable - factors, like the Olympic Games. It also should be highlighted the economic growth which was achieved in Germany despite the decline of its workforce, proving that growth is possible with a declining population.

Despite some regional variation as a result of internal migration, the reality is that working-age population in the Eurozone as a whole has now initiated a long downward trend that will have major repercussions in terms of its economic growth, as explained in the previous post, and therefore, we can also conclude that Europe is starting to suffer from a "shortage of Japanese" as shown in the graph below.

As such we cannot fully comprehend the situation that Portugal, Spain and Greece face at the moment without looking into their adverse demographics.  This already exerted an disproportional role in the last decade, namely in Spain,  whose migration-induced working-age population growth  goes a long way explaining its outstanding economic growth, while for Portugal the contrary it’s true, as the lack of population growth made its economy  lose steam  as it joined the Euro. More worryingly tough, is that working-age population in Europe as a whole has started a long, perhaps irreversible, path of decline that will act as a drag on its economic growth, making the economic recovery for these countries even more difficult.

Wednesday, September 11, 2013

Is The Perfect Always And Everywhere The Enemy Of The Good?

Against a backdrop which offers an eerie parallel with events which took place somewhat to the North more than 30 years ago, Catalonia is now threatening to separate from Spain. In so doing the region seems to be putting at risk both the future of the host country and beyond that the outlook for the Euro currency and the process of European unification.

The parallel is of course with the drive for Baltic independence and its impact on Mikhail Gorbachev’s ill-fated attempt to peacefully reform the disintegrating Soviet Union. In the words of Aleksandr Yakovlev, one of his closest associates at the time, the ideas of those seeking independence were ''out of touch with reality'' and any expectation that the Baltic republics could regain the independent status they had before Soviet annexation in 1940 was ''simply unrealistic.'' As late as February 1991 Gorbachov himself was still describing the Lithuanian vote – described by the countries leaders as simply a non-binding opinion poll - as illegal, and this a matter of days before it was actually held.

Sound familiar? It should do, since these very same arguments are now being played out in another pole of Europe. Not only is the Spanish administration taking precisely the view that any vote in Catalonia on whether or not to separate from Spain would be illegal, the attitudes of those outside the country are largely being conditioned, not by the merits or otherwise of the Catalan case, but by the fear of what might happen to Spain if Catalonia left.

While Catalans busy themselves assuring each other that any new state would be economically viable, few on the outside doubt that this would be the case. To give but one example, former chief economist at the IMF Kenneth Rogoff recently commented that Catalonia taken on its own constitutes one of the richest regions in Europe. This is simply stating the obvious. What has external observers really worried is the subsequent viability of Spain, and with it the future of the Euro. If Spain is too big to be allowed to fail, then Catalonia is too small to have inalienable rights the argument seems to run.

It is for this reason, I feel, that the Catalan cause is attracting little sympathy beyond the confines of what is often called “The Principate”.

Many feel that Catalonia is being selfish – just as they felt in their day that the citizens of the Baltics were - in putting their own particularist interests (a better fiscal distribution, the right to a national football team) before those of the collective (economic recovery, closer political union in Europe, etc.). But this way of looking at things is essentially flawed, just as it was in Estonia, Latvia and Lithuania. The movement for Catalan independence is primarily, and at its core, a democratic one. So what should matter to the outside world is not whether the vote will be considered legal by the central government in Madrid, or whether the Catalans have a good case. If the Catalans vote peacefully and democratically, and by a significant majority, that they want to form a separate state, then it is clear that the region's days inside the frontiers of the Kingdom of Spain are numbered. Unless that is the Catalans be retained within those frontiers by the use of force, in which case some of the fundamental principles of the Treaty of Europe will be put in question. Hence the fundamental dilemma which the Catalan independence drive presents to the whole European Union.

Under these circumstances what outside observers should focus on is what the result of the vote, when it does finally take place, will be. After all what the Catalans are demanding at the moment is “the right to decide”, and at the end of the day it is they who will decide. My country, as the saying goes, right or wrong.

Nothing here is either unavoidable or inevitable. As in the case of Greek Euro exit, beyond the expedient there are no ex ante juridical limits to the bounds of the possible. What is important for everyone is that the eventual solution be an orderly one. In this context messages that the new country, should one be created, would need to apply for membership of the European Union constitute nothing more than mere hot air, just as the suggestions from the Spanish administration that any such application would be met with a veto on their part is no more than an empty threat. Such talk is not in the realm of the real, or the realistic. It is simply an attempt to alter the outcome of the vote, and a bad and ineffective one at that. Not for nothing does Catalonia’s President Mas describe the speechwriters of the Partido Popular as running a production line for manufacturing separatists.

If Spain’s sovereign debt is already on an unsustainable path, then how much less sustainable would it become if the country suddenly had its GDP reduced by 20%? Common sense dictates that negotiations would be held, negotiations in which Catalonia would be asked to accept a proportion of the legacy debt, just as common sense suggests that Catalonia’s financial system, which has assets of around 500 billion Euros (i.e. it is much larger than the Greek equivalent) would be allowed to remain in the Eurosystem. The alternatives – and their consequences well beyond the frontiers of Europe – are simply unthinkable. Naturally sometimes the unthinkable happens, especially when a majority of the key players assume it won’t. Catalonia has now decided to hold some sort of “consultation” or “opinion poll” during 2014. As in the Lithuanian case the outcome may not be binding, but few should draw comfort from that single fact and assume that the result will not be significant and even decisive for the short term future of Europe.

As I say, nothing here is inevitable, or foretold in advance. But avoiding predestination involves facing up to the facts, and not, as the IMF director general Christine Lagarde recently put it in the Greek context, engaging in wishful thinking. And the facts in this case are that dialogue between Catalonia and the rest of Spain has now broken down. Catalans feel themselves to be tired of not being listened to, while the rest of Spain feels itself tired of the Catalans and their constant demands for more autonomy. At one pole there is “Spain weariness” and at the other “Catalonia exhaustion”. Matters have now past the point where orderly solutions will be sought out and found internally.

Most external observers expected some sort of offer to be made by the central government after the last Catalan elections, but reading the result as a setback and defeat for President Mas the only “offer” which has been sent in the direction of Barcelona is one which involves “Hispanicising” children via the reform of the Catalan education system, a move which has effectively united the Catalans behind their new government. That is why a decisive intervention on the part of Europe’s political leaders is now crucial. Whether they like it or not they have no alternative but to become intermediaries in the search for viable solutions, if not neglect will only produce the result everyone seeks to avoid.

It is no accident that the Baltics saw their chance just in the moment of maximum Russian weakness, and that Catalans see their only realistic possibility of achieving their objective of having their own state just when Spain is effectively on the ropes, and possibly in terminal decline. Some, comforted perhaps by the writings of Francis Fukuyama, feel that what is happening to Spain is simply an unfortunate setback on the bumpy road to becoming a mature democracy, but darker readings are possible. The current economic crisis is not simply cyclical or conjunctural and there is a real possibility that the country’s problems are so complex that it will become impossible for Spain’s leaders to fix them without recourse to an Argentina style default. It is precisely the loss of confidence in the capacity of the Spanish political class to resolve the country’s dire economic situation, and the mounting frustration with their perpetual insistence that all will be well starting tomorrow that has the Catalans running for the exit door. If the building is about to burn down they don’t want to be trapped inside when it happens. As Janice Joplin once put it freedom is sometimes “just another word for having nothing left to lose”.

In the critical weeks and months that are to come, I think it important that all participants bear in mind that once the Baltic vote was taken, and once the demise of Gorbatchev became inevitable, attitudes towards the new countries rapidly changed. All three are now consolidated members of the European Union, and the past is simply that, what is over. Many Catalans tell me they are doing what they are doing, not for themselves but for their children and their grandchildren. Measured on such a timescale a few years of economic turbulence seem as nothing. In the interest of the common good solutions need to be found - solutions which are able to both satisfy the aspirations of the Catalans and guarantee stability in Europe. If this search is not initiated soon, then time will ineluctably run out and the likely will steadily become the inevitable, simple application of the rules of game theory tell us that. There isn’t a day to lose. You know it makes sense.

The above is a short chapter I wrote for the book "What's Up With Catalonia" published earlier this year by the Catalan Press.

Q&A: The Catalan Way explained

Why are Catalans taking part in a human chain this Wednesday? The Catalan newspaper Ara has produced a series of questions and answers in English which should explain everything you want to know about why the human chain is taking place today.

What is the 'Via Catalana'?

The 'Via Catalana' (The Catalan Way) is a political demonstration which will take place this September the 11th. Inspired by the Baltic Way — a human chain formed by up to two million people on August 23 1989 across Estonia, Latvia and Lithuania — its aim is to create a 400 km long chain which will cross Catalonia from north to south. 400.000 people have signed up to take part in the human chain, although organizers hope that the actual turnout will be at least twice that figure. People will be asked to join hands at exactly 17:14 (15:14 GMT). The chain, which runs along highways, roads and city streets, will come to an end at 18:00 (16:00 GMT). If successful, it will be one of Europe's largest ever demonstrations, following in the footsteps of last year's march in Barcelona, when up to 1,5 million people walked through the streets of the capital asking for independence, the country's most massive rally ever.

What is Catalonia?

With more than 7,2 million inhabitants Catalonia is a country in the northeastern corner of the Iberian Peninsula. At a crossroads between different cultures and civilisations, it once formed part of the old Crown of Aragon, which merged with the Crown of Castile to create what later became Spain. What in medieval times was a powerful nation which extended its influence across and beyond the Mediterranean, is now an autonomous region within the Spanish State posessing restricted powers, devolved as seen fit by the central state. It has its own language, Catalan, and institutions, amongst them one of Europe's oldest Governments and Parliaments.

Why is the Catalan Way taking place today?

Catalonia was a party in the War of Spanish Succession (1701-1714), where the old crowns of Castile and Aragon fought, alongside their European allies, over who should be crowned as king of Spain following the death of Charles II. Catalonia, which favoured archduke Charles as successor, lost a war which ended with Europe recognising Philip V as the new king of Spain. The long war ended with a prolonged siege of Barcelona, Catalonia's capital, which was systematically bombarded by Spanish troops fighting for the Bourbon candidate, Philip V. After months of resistance Barcelona finally surrendered on September 11 1714. Modern Spain was born, but Catalonia was to pay a heavy price for its support for the Austrian candidate: Catalan language was forbidden and Catalan institutions abolished. Every year, on September 11, Catalans commemorate the day on which Barcelona fell, honouring those killed defending the country's laws and institutions [See video: A trip to Barcelona].

Why do many 21st century Catalans want independence?

Since the defeat of 1714 Catalonia has never been allowed to rule itself again [a Catalan history of Spain]. The old nation was forcefully transformed into a mere Spanish province. This state of affairs did not change until 1931, when the proclamation of the Spanish Republic gave Catalans the freedom to regain their old institutions. Catalan was taught in schools, the Parliament reopened, the Government was once more established... Unfortunately the situation was not to last. The end of the Civil War, with the subsequent establishment of the Franco dictatorship, meant a new blow for the country, crushed once again by a centralist state, administered directly from Madrid.

Following Franco's death, and with a new democratic regime in place, Catalonia regained its old institutions, and it was once more allowed to rule its own affairs in a number of key areas. But the centralist inertia of the Spanish state, always resisting to the last all devolved powers and continually meddling in matters which are close to the heart of all Catalans — like respect for the Catalan language — has left Catalonia’s citizens with a deep sense of frustration. This frustration was brought to a head in 2010 when an appeal by the Partido Popular over some of the clauses in the newly approved Catalan Statute (which won majority votes in both the Catalan and Spanish Parliaments) lead the Spanish Constitutional Tribunal to rule it was unconstitutional to use the term “nation” to refer to Catalonia in the document’s preamble.

Since that time the feeling of alienation from Spain has only grown, with many previously apathetic citizens suddenly becoming separatists. More fuel has been added by the economic crisis, and the gross incompetence which has been demonstrated by Spain’s political and financial leaders. This, along with the record levels of unemployment with no end in sight, has given a new impulse to Catalonia's demands, since it has left the Catalan Government in a critical financial situation, unable to access the international financial markets and totally dependent on the such funds as the Spanish Government to forward to it. This unjust situation reached its most bizarre moment when the Spanish government raised the VAT rate last year to help improve funding. The Catalan government actually lost out, since it had to pay the new rate to all its suppliers but received no refund or additional funding from the central government which was, of course, much better off.

This, in a country which contributes to Spain far more than it gets in return: figures vary, but it is reasonable to suggest that Catalonia loses between 10,000 to 16,000 million euros per year, because of this fiscal deficit. The accumulated deficit between Catalonia and Spain for the period 1986-2010 reaches a total of 213,933 million euros, five times Catalonia's current debt. The economic imbalance between what Catalans pay in taxes to the Spanish state and what they get in return, is a major contributing factor to the sense of anger and frustration felt by many [opinion: Spanish Prisoners]. It has been very hard for Catalans see their school and hospital services deteriorate under the sever cuts that have been administered while those in other regions which are arguably subsidized from Catalan taxes go virtually unscathed. [See NYT OP-ED: Spanish Prisoners]

What do the Catalan political parties say?

Since the death of Franco all Catalonia's main parties have argued for a theoretical right to self-determination, but have never taken steps towards achieving that goal. Following slow and painstaking negotiations with Madrid, only a fragile, unstable compromise has been reached: the Spanish state has devolved powers in some key areas, from education to health or police, but it still is unable to recognise Catalonia as a nation. This has left Catalan parties divided on the issue of which course of action to take. Traditionally, Catalan parties have asked for more powers to be devolved from Madrid to Catalonia, but the recent rise in strength of the pro-independence movement — which originates in social, rather than political organizations — has taken some aback [See video: Catalonia push for economic independence].

Centre Right Nationalist CiU, Catalonia's current governing political coalition, has evolved from a pro-autonomy stance to being more clearly inclined towards independence. It is, though, a coalition of parties with different views; officially, it wants a referendum on independence, but stresses the need to reach agreement on this with the Spanish Government. The once powerful Socialist party PSC, which has strong ties with the Spanish Socialist PSOE, is torn too between conflicting approaches. In theory, it recognizes Catalans the right to self-determination, but rather than asking for independence, it wants Spain to move towards a more federal political structure. The left republicans ERC, for years the only party actively seeking independence, are the rising star in the current Parliament and, according to some surveys, could become the country's main party if elections were to take place now; they want to hold a referendum as early as 2014.

Left-wing ICV, political successors of the old communist party, support the idea of a referendum, although their views on independence are not so clear. Finally, the Popular Party, which is now in power and Spain, and Ciutadans, are both opposed not only to independence but even to an eventual referendum on the issue. However, they are a minority in the Catalan political landscape: the Catalan Parliament has passed a declaration which states that Catalonia is a country with the right to decide its own future. The declaration was passed with 104 votes in favour of a referendum, for only 27 against [See video: Will Catalonia say adios to Spain?].

What does the Spanish Government say?

The Spanish Government bitterly opposes the organization of a referendum in which Catalans can choose whether they are in favour or against an independent Catalonia. The official position is that the government has to abide by the Spanish Constitution, which states that there is only one nation, the Spanish one, and that sovereignty is exclusively held by the Spanish people in its entirety; this means that what is seen as being simply one part of the Spanish nation cannot on its own decide on matters which affect all, effectively denying the principle of the right of peoples to self determination. Since, according to the Constitution, only the Spanish Government can organize a referendum, the Catalan demand faces an insurmountable barrier. Spanish main parties — PP, now in power, and the socialists, the main party in opposition — do not want Catalans to express their views on a referendum [See video: Should Catalonia seek independence?].

What is the position of the EU?

The official position of the EU is that it is not for the institution to take into consideration hypothetical declarations of independence following the possible breakaway of part of an existing member state. The official line of the EU Commission is that Catalonia's independence demand is a Spanish internal affair and, as such, they cannot comment on the issue. This has proved to be a controversial idea, though, since the Spanish Government has tried to influence the debate by assuring that an independent Catalonia would be automatically expelled from the EU, and should start from scratch new negotiations with Brussels to rejoin the institution. Some commissioners have denied this, stating that there is no precedent for a situation like this, and that Europe could not possibly deny membership to 7,2 million people who are now EU's citizens.

Why is Scotland holding a referendum, while Catalonia is not?

Because they are both nations without a state Scotland and Catalonia have often been compared, and the fact that both countries are engaging in an open debate about their possible future as sovereign states has only increased the parallels being drawn between them. Yes, they are both old European nations, with institutions of their own, but the similarities end here. It was not until recently that Westminster Parliament devolved some of its powers to Scotland, but the UK has a tradition of decentralised power in many areas. Citizens are used to the fact that laws — from smoking to gay marriage to university taxes — are different on both sides of the border. This is not the case of Spain, which for most of its history has been a heavily centralized state. However the main and most glaring difference is to be found in the very different approach to recognizing a separate identity: whereas the UK – as a plurinational society - has no real problem in acknowledging that Scotland is a nation, Spain as a whole has been unable to move beyond the idea that Catalonia is simply just one more autonomous region. Unlike Scotland, Catalonia cannot take part in official sports competitions around the world, which leaves Barcelona football club as the unofficial national symbol [See Video: cry for Catalan independence during the 'classic' Barça – Real Madrid]. The consequence of this different approach is that, while the British Government is allowing the Scottish government to organize a referendum on independence, the Spanish government is completely opposed to allowing the Catalans to be consulted about an eventual secession and has promised to fight any move by the Catalan government to organize a referendum [Catalonia and Scotland: how they compare to EU nations and Europe's other separatists]

What is Catalonia's level of autonomy?

Catalonia has a restricted autonomy. The Catalan Parliament has the power to pass laws on all sort of issues, from education to housing, but this theoretical autonomy has many strings attached. To begin with, the Spanish Government is unwilling to hand over some key powers, from allocating student grants to administering pensions, and tries to legislate on areas of devolved power, a situation which leads to constant conflicts between the governments in Barcelona and Madrid, with the Spanish Constitutional Court deciding which of the two is entitled to legislate the disputed area. Crucially, all main taxes are collected by the Spanish Government, which is then responsible for distributing the money raised between the various receiving institutions. In practice, Catalonia's Parliament is legislating on affairs without having the money to implement its laws.

How strong is the popular support for independence?

Surveys vary significantly, but they show two consistent trends. First, support for independence has been growing year after year. Second, from being the option favoured by a minority of Catalonia's citizens, independence is now supported by the majority of the population. The latest official figures show that, in an eventual referendum, 55,6% of Catalans would vote in favour of an independent state, with those against being 23,4% and roughly a 20% showing no clear preference or saying that they are not interested. When asked which form of relationship with Spain do they prefer, 47% favour an independent state, 22% want to maintain the current status quo, and 21% would like Spain to become a federal state.

What happens next?

A Council for the National Transition, with academics and experts from a number different fields, is working on the establishment of a timeline for an eventual referendum. Catalonia's main political force, CiU, which governs thanks to the support in Parliament of pro-independent ERC, argues that a referendum should take place before the end of 2014. The problem is that, according to the Spanish Constitution, only the Spanish Government can authorize the referendum, something the ruling PP party is firmly opposing. Other options include organizing a referendum without Spanish Government consent — which would make it technically illegal — or dissolving the Catalan Parliament and organizing new elections, with pro-independent parties sharing part of their manifestos. After months of bitter disputes, the Catalan president, Artur Mas [profile], is holding discrete talks with his Spanish counterpart, Mariano Rajoy, to try to find a way out of the current deadlock.

Could an independent Catalonia become a viable state?

As with all the other aspects of the argument, the viability of a future state is a contested issue. Those opposing independence argue that a Catalan state would inherit a huge deficit which would make it very difficult to pay pensions or salaries. Besides, they take for granted that Catalonia would be expelled from the European Union, depriving Catalan companies from the benefits of a single market. On the other side of the debate, those in favour of independence argue that, without the burden of the huge deficit which results from the difference between what Catalans pay in taxes to Spain, and what they get in return, Catalonia — Spain's most vibrant economy — would have a GDP level in line with some of Europe's wealthiest nations, and its government could reduce the current debt and improve the quality of public services. In addition they doubt that Catalonia would find itself outside the frontiers of the EU, pointing among other precedents to the fact that the EU Treaty held that national bailouts of member states were illegal, until in fact one was urgently needed. [Keys on the independence of Catalonia].

Tuesday, September 10, 2013

Doing Nothing Is Not An Option!

The recent IMF proposals to help stimulate growth and job creation in Spain at least deserve serious consideration.

In a blog post which sought to defend the recent IMF proposal to for a social compact involving a 10% reduction in Spanish wages and salaries, the EU Economy and Finance Commissioner Olli Rehn cited a line from Bob Dylan - "Something is happening here, but you don't know what it is".

He was talking about the evident uncertainty surrounding the kind of economic recovery Spain might be having. But the line could equally be applied to the across-the-board response of Spanish society to those very Fund proposals he was defending. From employers to unions to government and opposition the country has spoken with one voice, “something is going on here and we don’t want to know what it is”.

I say “don’t want to” since most of the comments appearing in the Spanish press have had little to do with the arguments that are being advanced or even with trying to understand them. Some journalists simply focused their attention on the salaries received by the Fund’s own economists (which recently went up).

Others argue, citing the example of the Brazilian representative who refused to sign-off on the latest payment to Greece, that the institution is not democratic, since the emerging countries are not adequately represented. Little does it matter that what these countries are in fact complaining about is too much European influence on Fund policy and too much simplistic optimism. The prize for irrelevance though must surely go to the La Razon writer who thought it worth dedicating a whole article to the fact that German wages have risen 20% more than Spanish ones during the crisis.

What this latter point has to do with anything I’m not sure, but all these arguments do share one feature, they fail to take notice of the fact that Spain is in deep crisis. They ignore the fact that unemployment, and especially youth unemployment, is unacceptably high, that the country’s future is leaving by the day on planes, boats and trains, that the economic growth outlook is pathetically weak, and that, en fin, something most definitely needs to be done.

As Spain IMF Mission Head James Daniel puts it, “we see a recovery, but only a weak one”.

What the IMF are saying is that if you leave the situation as it is then growth will not be sufficient to make any significant change in the unemployment rate. Thus they estimate that on the basis of present policies the rate will still be 25% in 2018.

In addition they draw attention to the way the impact of the crisis has been so unfairly distributed, with those aged under 30, who surely have little responsibility for what actually happened, being asked to carry the biggest part of the burden. Given this, is it really so surprising that many of them are now leaving to seek a brighter future elsewhere? Still being unemployed in 2025 is hardly an enticing prospect!

Much has been done to protect those members of our society who, like me, are over 60, but we need to remember that it isn’t the increase in life expectancy that represents a threat to future pensions, the real threat is not having enough young people left around to pay them!

To avoid this catastrophe, as James Daniel says, “Growth needs to be stronger and needs to become more job rich”. This, he argues, is something that requires action in many areas, among which he includes “increasing wage flexibility so that growth produces more jobs” and creates “a more even playing field between those with permanent jobs and those with temporary jobs”. Does any of this ring any bells?

By chance this week I spoke with a journalist from Estonia, a country whose recent progress many in Spain would like to identify with. What he explained to me was that in his country the highest average wages go to those in the 30 to 35 age group, while in Spain the top paid workers are aged between 50 and 59. This situation doesn't make any economic sense whatever and something is seriously wrong here if we want a country which is open to initiative, creativity, entrepreneurship and imagination.

The Fund’s proposal is effectively for a new set of “Pactos de la  Moncloa”, a series of agreements between all parties and social agents arrived at during the transition from dictatorship to democracy in the 1970s, to agree not only wage reductions, but for employers at the same time to make employment commitments while measures are also agreed which could bring down prices.

This is the so called “internal devaluation” that macroeconomists like Paul Krugman, Dani Rodrik and myself have been advocating for some 6 years now. It isn’t a perfect plan, having the Euro doesn’t make things easy, but it is a damn sight better than doing nothing and watching and waiting while things get worse. Certainly it is a proposal worth studying and discussing and not simply dismissing out of hand.

The above is an adapted version of an article that originally appeared in the Catalan newspaper Ara.

Monday, September 09, 2013

The Recession May Be Ending But The Crisis Continues

What follows is an interview I did over the summer with the Madrid based publication The Local.

Let's start with the basics: what are Spain's current economic problems?

Spain's economic problems are a knock-on effect of the end of Spain's property boom. The collapse of the property market led to a drop in incomes, depressed demand for goods and — slightly — lower wages.

At the same time, apart from property prices haven't come down.

In addition over one adult in four isn't working.

So consumption is steadily falling.

On top of that we have a debt overhang — which means it is difficult for Spain to borrow. Larger companies are struggling to get credit so they are delaying payments to smaller suppliers, which means smaller companies are finding it harder to get money. It's a vicious cycle.

We are also seeing imbalances within Europe with the Germans doing 'well' and young Spaniards leaving the country to work elsewhere.

And how has the Popular Party (PP) government led by Prime Minister Mariano Rajoy tackled these problems?

One of the main objectives has been to avoid a financial rescue from the European Union. This was important for a number of reasons.

National pride was definitely one factor. Also, it is unlikely any Spanish government could have survived a bailout. Then there is the fact that Europe would have had a greater say in how the Spanish economy operated if a bailout had taken place. The EU would have been telling Spain which taxes to raise or lower, for example, or how to go about pension reform.

How do you rate the government's attempts to cut spending?

At the end of the day, this government is made up of 'middle of the road politicians' and they are basically economically liberal. Which means they would like to see less government. So if the deficit hasn't come down very far it hasn't been for want of trying.

I would probably have to say their least recognized achievement has been their attempt to reform the public administration. This hasn't been easy for the PP as some of the areas where the party has a lot of support are also places where there is not a lot of industry, and where government is a big employer. This being said Spain still had the biggest deficit in the EU last year (government spending exceeded tax revenue by 10.6 percent).

In addition, reform of the financial sector still has a long way to go as well because while there is increased liquidity in the system, more recapitalization is constantly required as the high unemployment and low demand for products means more bad loans are created with each passing day.

Recently, Spain's Economy Minister Luis de Guindos asserted the recession may be over. He didn't mention the crisis though.

That's an important distinction. Luis de Guindos is an intelligent man and recognizes that while the crisis is ongoing, recessions are a normal part of the business cycle. Spain's second recession since the crisis began could well be over.

And yes, we could well see two, or three, or even four quarters of weak economic growth but this is just part of the cycle. Indeed, our double-dip recession could eventually turn into a triple-dip one. This is because none of the underlying problems have been adequately addressed.

We were told house prices would bottom out with the creation of a bad bank, but they are still falling. There is probably some way to go still, maybe two or three more years of falling prices. The organization charged with handling failed banks' property assets, the "bad bank" Sareb, isn't operating very well either. Sales are very low and the costs for potential buyers from Sareb is too expensive as the organization doesn't have depositors and has to make deals with other banks to give mortgages which end up making interest costs too expensive to make the purchase attractive.

And even while some of the old imbalances are adjusting new ones are being created since young people are now leaving Spain to work elsewhere in ever greater numbers. We don't know exactly how many are leaving because Spain's electoral roll doesn't keep accurate track of where native Spaniards are living and working. What we do know is that last year Spain's population fell for the first time in modern history, and that it will continue to fall as far ahead as the eye can see. A turning point of some kind has been passed.

What do you make of the spate of claims the crisis is over?

I believe these predictions play to two audiences. The first issue is a confidence issue. Politicians would like to give the impression to the Spanish people that the crisis is ending  to encourage them to spend.

At the same time, Prime Minister Rajoy is fighting for his political survival. One of the likely consequences of the current lack of government credibility, in my opinion, is that Spain could - in time – become effectively ungovernable in a way which has become common in other southern European countries. Fresh elections are unlikely in the short run, but when they do come there is unlikely to be a clear majority party, the outcome is likely to be fragmented, and indeed the Catalans want a vote on whether to leave.

The (opposition socialist) PSOE party continues to have a huge credibility problem following the fiasco of the Zapatero government. They are currently  polling at very low levels (21.6 percent according to a July poll run by Metroscopia).

It's also very hard to imagine a political party in Spain making an alliance with Catalonia's ruling CiU party given there is an independence referendum in the pipeline.

So what does the term crisis actually mean after five years?

My feeling is that it's totally unrealistic to expect a 'return to the old reality'. We are now in a change of paradigm process.

We all need to change our expectations and find ways to live with the new situation, since whether we like it or not we will have to. There is no quick fix - these have all been tried and failed - and Spain is now condemned  to going through a painful long-term shift. The country will have to deal with its legacy debt.

Personally, I think the International Monetary Fund could have played a more important role. It could have acted as a kind of  referee between Spain and the European Central Bank (ECB) and the EU, coaxing the country into adopting more fundamental changes. It could have pushed for the  "front loading"  of the deep reforms the country needs (especially the much needed internal devaluation) coaxing the country into making changes at a time when the population was still receptive. But unfortunately even though the Fund is now trying to recover lost ground, most of the principal social actors turn a deaf ear. No one wants to hear more about harsh sacrifices, they only want "sweet words" about a looming recovery and regeneration.

In addition I believe the IMF is now increasingly trying to distance instance from Europe because it has become tired of playing the part of public relations officer for what are effectively EU-lead programmes. It is clear from the Greek case - and the recent IMF "mea culpa" - that this way of doing things doesn't work. Further, non-European members of the Fund like Brazil, China and India are now increasingly pressuring the organisation to stop molly coddling Europe's leaders. Look, for example, at how little money is being offered to Egypt and how much has been spent on Greece.

But what this means is that the organisation is now unlikely to play the role it once could have.

To what extent is Spain responsible for its crisis, and to to what degree are international circumstances to blame?

When the Euro was rolled out, the single currency idea clearly wasn't thought through well enough. The EU leaders didn't envisage the problems that have arisen.

Another part of the problem lies in an idea that existed in Europe before the crisis — this was the idea that all countries all had equal levels of risk. And this clearly wasn't true.  So to some extent the EU itself needs to assume responsibility.

But on the Spanish side, it's obvious the political parties were up to their necks in fomenting the boom by letting regional savings banks keep lending money, and by allowing builders to keep building.

During the building boom, many Spaniards also became property speculators in their own right, buying more houses than they really needed.  As the saying goes,  "When the music plays you have to dance".

Sunday, April 28, 2013

Beyond Their Ken?

Spain's economic problems now form part of such a complex web of cause and effect, action and reaction, that it is getting increasingly difficult for laymen, journalists and politicians alike to get to the core of what is actually happening.

To a herd of rams, the ram the herdsman drives each evening into a special enclosure to feed and that becomes twice as fat as the others must seem to be a genius. And it must appear an astonishing conjunction of genius with a whole series of extraordinary chances that this ram, who instead of getting into the general fold every evening goes into a special enclosure where there are oats- that this very ram, swelling with fat, is killed for meat”. – Tolstoy, ‘War and Peace’.

After so many false dawns, the recent announcement by Spain’s Prime Minister Mariano Rajoy that the government was revising down its 2013 economic forecast hardly caused a blink among a citizenry that is now completely inured to deception and ready to believe the worst about the intentions of any politician willing to come forward with either good or bad news. The long announced recovery has once more been delayed, and will now be noted not in the last three months of this year, but during the first six of 2014. Naturally, a public which is now totally accustomed to such postponements will not be surprised if this one is far from being the last.

In fact, the latest institution to throw a bucket of cold water over the Spanish government’s rose-tinted promises is the IMF. In their latest five-year forecast for Spain they paint a pretty bleak picture of low growth and high unemployment lasting at least all through what is left of the present decade. Mariano Rajoy has already jumped into the fray to take issue with their outlook for 2013, but it is their longer-term forecast which is most interesting and preoccupying. Growth between 2015 and 2018 is now only expected to average around 1.5 percent annually. This would seem to be what the IMF now consider longer-term trend growth to be for Spain, and the most notable thing about the number is that it represents a significant downward revision from their earlier optimism. Even this comparatively low number may still be overly optimistic and may yet come down again – I personally expect NO noticeable recovery as cumulative negative developments more or less cancel out positive ones – but it is certainly much more realistic than anything we have seen from the Fund before. There is no question here of any “V” shaped bounce. That is just a fiction of Finance Minister Cristóbal Montoro’s imagination.

Naturally, the other side of the coin on this is the consequence for unemployment. With growth so low there will be little in the way of job creation (watch out, pension system sustainability) and unemployment will linger over 20 percent for many years to come – indeed the IMF have 2018 unemployment at 22.9 percent, meaning they don’t expect it to fall below 20 percent come 2020.

And there’s another highly interesting detail from the IMF Spain forecast. Even to get that rather low level growth of 1.5 percent a year, the Fund pencil in Spain’s running a fiscal deficit of 5 percent a year all the way through to 2018, with the natural consequence that the debt-to-GDP ratio is expected to reach 110 percent by that point, and that isn’t making allowance for any further bank recapitalisation that will be needed. As I have been arguing since 2008 now, Spain’s sovereign debt simply is not on a sustainable path, and what 1.5-percent growth supported by a 5-percent fiscal deficit means is that there is no structurally adjusted growth going on in the economy at all. As a country you are getting more into debt than any increase in output you generate with the borrowing.

A well-oiled crisis

As I have argued in an earlier post, it may well be that the Spanish contraction machine is now so well-greased that it simply continues winding the economy down and down in such a way that things may never recover, in the classic sense of that term. The only argument which stands in the way of reaching this conclusion is the near religious belief now so often heard in policy circles that, well, “economies always recover, don’t they?”

As it happens, they don’t, as a quick look at what happened in Argentina in the 20th century would confirm. But Argentina is arguably an isolated case, and the current economic malaise (I hesitate to use the word “crisis” due to the duration of what is so evidently an ongoing process) seems to be far more general. What people seem to find hard is asking themselves one simple question, “but what if this time really is different?” Which is strange, since reasons for thinking that things may well not return to what was previously considered “normal” are not in short supply.

Populations in developed economies are all now ageing rapidly, generating a phenomenon never before seen in the entire history of known human societies – systematically falling numbers of under-15s coupled with an ever growing population in the over-80s group. The sheer novelty of this phenomenon, coupled with the manifest feeling of unsustainability it generates about our current welfare arrangements should at least give policy makers food for thought, yet evidence that it actually is doing so is in very short supply. Plough on regardless seems to be the watchword.

The current round of cuts to health and education spending are described as “painful but necessary” in order to facilitate a return to growth which will make further adjustments in the future unnecessary. Unfortunately nothing could be farther from the truth. The credit ratings agency Standard & Poor’s, which has been one of the global leaders in highlighting the likely impact of “first world” demographic changes, argues in its latest report on the subject that despite some recent progress, without ongoing and continuous changes in provision entitlement, deficits and debt in developed economies will spiral out of control as the century advances.

I think everyone who stops and thinks for five minutes about the situation will recognize the obviousness of this point, yet scarcely a single politician is willing to come out from behind the curtain and explain to voters the longer-term implications of having shrinking and ageing workforces at the same time as the size of retirement age populations explodes.

Ignoring the obvious

By the middle of this century, and without policy changes, average deficits for developed countries will rise to 15.1 percent of GDP as the interest cost of the increasing debt burden exacerbates the budgetary impact of demographic spending. Median general government NET (not gross) debt (as a percentage of GDP) is expected to increase to 71 percent by the mid-2020s (from around 40 percent today) – and would then accelerate to 216 percent of GDP by 2050. Government spending would rise to about 57 percent of GDP in 2050, from some 49 percent today.

Naturally, these numbers are just very rough and ready estimates, and such levels are unlikely to be reached since markets will surely not fund them, and policy changes will happen. The problem is that many policy makers are still stuck in denial about the need to make them, and where they are willing to do so it is largely linen washing conducted in private and not in the public space provided by election manifestos. Spain’s leaders, for example, continue to insist that no major changes in either pension contributions or entitlement are in the offing even though the need for one or the other is evident, as the structural deficit in the system continues to grow.

Worse, the more frequently they say in public that there is nothing to worry about and all is well, the lower their credibility falls, since few people continue to believe them. At the same time they insist and insist that the current level of health provision will be maintained no matter what, when obviously this is something the country simply cannot afford to do.

But more than the simple impact on government spending possibilities, it is the impact of these demographic changes on growth which seems to be the least widely appreciated part of the story. This is not an oversight of which Standard and Poor’s is guilty. According to the agency:
For several sovereigns in the Eurozone (European Economic and Monetary Union), the financial strains caused by shifting demographics are being compounded by the current economic and financial troubles, which are both strangling growth and increasing the need for social safety net spending. This environment can result in tighter financing conditions amid private-sector deleveraging, plus cuts in public investment leading to a reduction in total investment and consequently the stock of capital. At the same time, the decline in investment activity will likely hurt total factor productivity (a measure of an economy’s technological innovation). Adding to these adverse trends, low employment and net emigration from several sovereigns implies a smaller contribution of labor to future economic growth, a continuing threat if unemployment becomes structurally high.
As can be seen, Standard and Poor’s mention a number of other factors which contribute to what they call the current “strangling” of economic growth in countries like Spain (tighter financial conditions, private sector deleveraging, cutbacks in public sector infrastructure spending, net emigration).

They could also have cited the mere existence of the euro. It is evident that participation in the common currency has had the perfectly foreseeable effect on Spain of making it simple to get into trouble and a lot harder to get out of it. Borrowing was cheap and easy of access during the boom years, now lending to Spain’s banks has all but dried up, and what there is available remains burdensomely expensive.

Divergences in interest rates paid by businesses on bank loans across the Eurozone have recently reached record highs, despite ECB attempts to achieve the opposite result. While the spread between yields on Spanish 10-year bonds and their German equivalent has narrowed significantly the Goldman Sachs interest rate divergence indicator – a measure of cross-border variations in rates charged by Eurozone banks on a selection of business loans – has once more risen and reached 3.7 percentage points in January. This means that companies in southern Europe continue to pay significantly higher interest rates than their northern rivals, leading to the conclusion that while ECB measures may well have been effective in avoiding short term Eurozone break-up, they have still failed to address the problem posed by such inhibitive credit conditions along the southern periphery.

The lessons learned from inaction

So not only does Spain have uncompetitive productivity levels, and a damaged brand image, it also has a high cost of new capital making investment in the country’s economy both unattractive and prohibitively expensive. With unemployment at over 26 percent, non-performing bank loans remain on their upward path, meaning that more companies are facing potential insolvency. The recent bankruptcy of food multi-national Pescanova has renewed rumours in financial circles that the Bank of Spain is preparing another round of provisioning increases – this time for loans to large corporates and small and medium companies – is an indication of how severely the crisis is now hitting the entire business sector. The Spanish problem is now no longer simply one of a construction collapse, since the ensuing impact on overall economic activity has now spread right across the board. A stitch in time saves nine, as the saying goes, but in the Spanish case there was no stitch (since according to policymakers there was no deep-seated issue to address) and the garment simply unravelled. Lesson – it is a lot easier to make things worse by inaction than it is to make them better using the same approach.

But backtracking a bit, the euro makes correcting Spain’s present situation difficult due to the absence of a national central bank able to conduct a full range of monetary policy operations, a limited access to fiscal policy and the fact the country has no currency of its own to devalue. But that does not mean, as Wolfgang Munchau recently suggested, that it is becoming more and more rational to think about euro exit as the cost-of-leaving threshold gets lower and lower. Countries may well one day leave the euro, but if they do it will be because the cost of trying to hold it together has driven them all but mad, not because they have made some back-of-the-envelope calculation showing that the benefits outweigh the costs. Leaving the euro would be a huge leap into the unknown, leaving one side of the calculation sheet simply beyond our ken. As I argued in a post for the CNN blog, the currency bares an uncanny resemblance to Dr Strangelove’s doomsday machine, designed so that one day it would almost inevitably blow up the global financial system, but constructed so that any attempt to dismantle it would also produce the same outcome.

Yet, despite the risks, as Gideon Rachman puts it in the Financial Times, in today’s Spain people are slowly but surely losing their faith in both national and EU institutions, and are slowly being driven towards ever more radical “solutions” which far from being rational bear a pretty strong resemblance to the exact opposite:
The “European dream” that Spaniards embraced promised a middle-class lifestyle for most people. But with little prospect of secure jobs for the young and a threat to the future of the welfare state, the fear now is that the Spain of the future will look more like Argentina than Germany. An Argentine future would involve the constant fear of financial crises – and a widening gap between the social classes, as many continue to enjoy a first-world lifestyle, while a growing underclass becomes detached from prosperity. Above all, Argentine public life is characterised by deep cynicism about national institutions and leaders.
Leaving the euro would be an incredibly costly decision for Spain, and becoming yet another Argentina would surely be no panacea, but that doesn’’t mean it won’t happen.

Following in the Footsteps of Japan?

Meanwhile Mariano Rajoy struggles on. Since it is quite obvious that the current policy mix isn’t working, and with one eye on the growing number of “platforms” out there desperately seeking his scalp (those affected by the mortgage crisis, those affected by the preference share haircut) he is desperately thrashing around for a fig leaf policy to stop the nightmare. Last week he found one – in Japan. “I think in Europe we must all ask ourselves whether the ECB should have the same powers as other central banks around the world,” he told a press conference. In particular he seemed to be thinking about what he described as the “very important” shift in monetary stance that had just been undertaken by the Bank of Japan. Now here is not the place to go into the background to the Japan crisis (see my arguments here if you are really interested), but one thing I am sure about is that neither Rajoy nor his main policy advisers have any real idea about what lies behind Japan’s long lingering deflation problem. What he does know is that Japan is able to run a 10-percent fiscal deficit and a 235-percent government debt-to-GDP level with what Nobel economist Paul Krugman calls “no evident ill-effects”. Sounds good to Rajoy. Will it work in the long run? “No idea”, could be his response. In the long run, as is well known, we are all dead, and “anyway I won’t be in the Moncloa” might easily be his reply.

In fact, as billionaire investor George Soros recently warned, systematically debasing a currency (ie not just conducting a one-off devaluation) is an extraordinarily dangerous move. The Bank of Japan has, in Krugman’s words, committed itself “to credibly promise to be irresponsible”. What this “irresponsibility” means is devaluing the currency sufficiently every year to generate sufficient price rises to comply with the central bank’s recently announced 2 percent annual inflation target. This is one promise it will be hard for the bank to keep since Japan’s deflation is being caused not by a poor adjustment in the economic system by structural demand deficiencies produced by the country’s ageing and shrinking population.

The best case scenario would be that the country’s policy makers realize in time that the experiment won’t work, and come to recognize that they have to learn to live with deflation – in which case the only big headache they will have will be what to do with all that debt (you know, the debt that many thought presented no evident problem). Far worse would be success, since if the Bank of Japan succeed in changing expectations (not in the why, but in the how) and lead people to believe that the currency will be debased every year ad infinitum (even assuming the rest of the G20 could ever agree to this), just to guarantee that 2-percent inflation, then they may well end up forgetting their supposedly innate “home bias” and start converting as many yen as they can get their hands on into dollars or some other convenient monetary unit, in the process creating a run on the currency which will make what happened in Argentina look like child’s play.

Such details are doubtless lost on Mr Rajoy and his advisers, which is just my point. The current crisis – which is arguably no longer a crisis but rather a way of life – has all now gotten so complex that the issues involved are almost certainly, and in principle, “beyond their ken.” Spain’s economy will continue to march boldly forward towards what now seems almost guaranteed to be long term decline, while from within the captain’s tower, far from an acceptance that what is happening really is happening, we will continue to hear yet one more crazy and implausible story after another telling us “if only this”, or “if only that” even as representatives of the Plataforma de afectados por las hipotecas (or equivalents) start to assemble outside the local version of the winter palace looking for their hides.


I have recently established a dedicated Facebook page to campaign for the EU to take the issue of the Euro Area accelerating population imbalances more seriously, in particular by insisting member states measure movements of their own national populations more adequately and also by having Eurostat incorporate population migrations as an indicator in the Macroeconomic Imbalance Procedure Scoreboard in just the same way current account balances are. If you agree with me that this is a significant problem that needs to be given more importance then please take the time to click "like" on the page. I realize it is a tiny initiative in the face of what could become a huge problem, but sometimes great things from little seeds to grow.

This is a revised version of an article which originally appeared on the Iberosphere website.