The pain in Spain

July 19, 2016


The EU has threatened Spain and Portugal Tuesday with huge fines for failing over many years years to reduce government budget deficits that exceed the limits stipulated by the eurozone treaties and regulations. This is the first time Brussels has formally announced proposals to use its disciplinary powers over member states’ budgets to fine eurozone governments for excessive deficits. Other countries, including France and Italy, have all received warnings in recent years after missing targets on deficit or debt, but no country has so far been sanctioned. Until now.

This year is going to be the eighth consecutive year that Spain has overshot its fiscal target. Originally, the Spanish government was supposed to get its deficit back below the EU’s sacred limit of 3% of GDP by 2013, from a staggering 11% in 2011. When it became clear that the large recession caused in Spain by the financial crisis and the collapse of the property bubble would make it impossible to quickly reduce the deficit the deadline was extended by a year. A year later, Madrid had made so little progress that it got a further two-year extension, to 2016.

Now, with no sign of Spain reducing its defict the EU is threatening to sanction the country, as well as Portugal, with fines of up to 0.2% of GDP for failing to bring their deficit under the targets set by the Commission. If implemented this would be the first time that the EU has adopted such punitive measures.

The ruling comes at a very awkward time, just as the EU is weighing the need to enforce its budget rules against a backdrop of wider calls to rally support for the bloc following the U.K.’s decision last month to leave the EU. Spain’s Acting Economy Minister Luis de Guindos has been adamant that sanctions against his country would be unreasonable as the government is working to fix its economy after the financial crisis. There is also resentment that while Spain and Portugal have been selected for punishment there is no threat of punishment for France which is the biggest repeat offender of excess deficits. The key difference is that the Spanish and the Portugeuse have had their elections and but French elections are not due until next year. The key strategic consideration in Brussels is to avoid anything that will undermine support for pro-EU and pro-austerity parties. If the threat of the National Front can be seen off in next years election then France will come under greatly increased pressure to drastically reduce public spending.

After the threat of fines for Spain and Portugal were announced last week Jeroen Dijsselbloem, the Dutch Finance Minister who leads the group of his euro-area counterparts said “These rules contain some flexibility, but in this case the flexibility has been used up. When I look at the numbers I really have to conclude that Spain and Portugal did too little.” Its worth noting as an indicator of the collapse of European Social Democracy that Dijsselbloem whose is leading the deficit reduction hawks is a member of the Dutch Labour Party.

Complicating matters is Italy which, over the objections of both Merkel and Schauble, is pressing Europe to be allowed to increase spending so it can bailout its banks and overrule the new obligatory EU bank bail-in regulations. Italy has a tricky and very significant refrendum looming in October. Then there is the position of France where the poll ratings of the president are at an all time low, the pro-Frexit National Front are growing in popularity and the French deficit continues to exceed eurozone limits.

Tensions within the eurozone are very high. Years of economic stagnation and high unemployment in the periphery have undermined support for the single currency, deeper union and the EU. The German led block appears to be resisting all attempts to move towards deeper union while insisting that there can be no large scale publicly funded bank recapitalisations and no let up in the drive to hold down deficits.

Spain could end up facing a fine of as much as €2 billion. All will depend on how much and how convincingly the Spanish government commits to reduce its deficit next year. Naturally, the fine will not be paid by the politicians who failed to play by the rules agreed upon in Brussels; it will be paid by the citizenry who are already suffering the consequences of the recession that helped cause the deficits.

The Rajoy government purposefully increased spending last year in a blatant effort to curry favour with voters ahead of the December elections, during which time the Commission’s fiscal hawks were conspicuously silent. In fact, Brussels decided to postpone negative opinion on the Spanish budget for 2016 – a budget that had been drawn up with one basic goal in mind: to buy off voters so as to tilt the electoral balance in the Rajoy government’s favour. Austerity was suspended, spending was hiked, public sector jobs suddenly grew in number, and tax cuts were brought forward. Yet when Europe’s Economic and Taxation Affairs Commissioner Pierre Moscovici told the press that Madrid was at “risk of non- compliance” with the Stability and Growth Pact – not only for 2016 but for 2015 as well — he was quickly silenced by both the European Commission and Germany’s Finance Minister Wolfgang Schaeuble.

Politics trumped the rules it seemed, and nobody in Berlin and Brussels wanted an anti-austerity victory in the Spanish elections. The Commission’s goal was clear: to get Rajoy, a man who can usually be trusted to do “whatever it takes,” reelected. It didn’t work. The results of the December elections, as well as the recent June elections, has been political stalemate with no party capable of building a coalition bloc that can command a majority in parliament.

After seven years of public sector cuts and spending restrictions the deficit still remained too high for eurozone limits, government debt has continued to grow and unemployment remains very,very high. The inevitable result has been the erosion of support for the mainstream Sapanish parties, the fragmentation of politics and the rise of new anti-austerity parties. Just like the rest of the EU it is the mainstream social democratic parties of the centre left that have been the hardest hit.

Now, the Troika has a problem: how to get Spain to adopt (and embrace) yet more fiscal pain, if the new government, assuming there is one, will be the weakest in Spain’s post-Franco history. For Spain’s other major party, the socialist PSOE, supporting a bill that would impose even greater economic suffering on the majority of the population while doing nothing to address the waste, excess, and corruption of the political system would be electoral suicide, as well as a gift to the anti-austerity Podemos party.
Spain has already committed to raise €6 billion in new funds this year from changes to the corporate tax regime. For next year it has pledged to pass a budget that will shrink its deficit from 5.1% of GDP to 3%. If the government actually delivers on this promise — a very sizeable “If” given its performance over the last four years — it will mean roughly €20 billion of savings in a country that is still coming to terms with the brutal, lasting effects of a four-year recession.

In 2008, Spain’s per-capita GDP — an indicator of economic activity per individual, and a close approximation of how individuals experience the economy — was €24,300. By 2015, it had dropped 4.2% to €23,300. During the same period, per-capita GDP of the 28 member EU rose 10.3% from €26,000 to €28,700. In other words, per-capita GDP in Spain went from being 6.5% below the EU average to being nearly 19% below the EU average.

And average household wealth in Spain has plummeted to levels not seen since the mid-1990s. The number of employed (as opposed to unemployed), at 56% of the working age population, is 7.6 percentage points lower than what it was in 2008. The last time it was that low was in 1975, the year Franco died. There has been an explosion in poverty in Spain. According to a recent study by Eurostat, Spain boasts one of the highest risk-of-poverty rates in the EU, only Greece, Cyprus, and Latvia have higher poverty rates.

The demography of the suffering caused by the long post crash depression is also interesting and politically significant. Much of the pain has been borne by people aged between 25-54 (i.e. the working age population) whose risk of falling into poverty and exclusion rose to 32%. By contrast, for those over 55, the risk had declined from 28% in 2006 to 19% in 2014. It’s no coincidence that people over the age of 65 represented almost 40% of voters for Rajoy’s People’s Party (PP), which during the last electoral campaign promised it would not touch the people’s pensions.

Making good on that pension promise may prove very difficult because the PP government has quietly been raiding the governments the Social Security Reserve Fund over the last four years to slow down the rise of Spain’s public debt. The fund has been depleted from a peak of €66 billion in 2011 to €25 billion at last count and is expected to run out completely by the end of 2017, at which point the government — if there is one — will either have to slash pensions, causing significant pain to its biggest voters, or raise even more taxes on workers, to plug the gaping social security deficit, expected to be around €11 billion in 2016 alone.

If Italy can prevent the collapse of its banks then it may be Spain that will prove to be pivotal for the future of the eurozone and the EU. There is no way the country can impose yet more austerity and reduce its deficit, especially with a pension fund black hole looming, without increasing political instability and almost certain continuing growth of the Podemos led anti-austerity bloc.

The EU threat to impose fines on Spain in these circumstances looks wilfully idiotic and only makes sense in the topsy turvey world of the single currency.

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