Spain: The Biggest PIG(S) in Europe

Despite having freed itself from the yoke of fascist dictatorship only 35 years ago, Spain is probably Europe’s top economic success story of the past generation. Since then, this country of 45-million people has transformed itself into the world’s second-most-popular tourist destination, the world’s sixth-largest car manufacturer, and eighth-largest economy in the developed world. More recently, Spain has hit the headlines as one of Europe’s PIGS — the continent’s poster children for debt-fueled binges and fiscal profligacy. This negative sentiment has hit Spain hard, and its stock market has been among the worst performing in the world in 2010, close on the heels of China and Greece.

From Economic Boom…

As one of Europe’s best-performing economies over the past 30 years, Spain’s “siesta-and-fiesta” reputation is long outdated. Modern Spain was born with the death of dictator General Franco in 1975, which led to the re-establishment of parliamentary democracy and a new constitution three years later. Over the past 20 years or so, Spain’s economic performance has matched that of the United States — its economy expanding at 3.6% a year between 1994 and 2007. During that same period, unemployment in Spain fell from 24% to 8%, even as some five million immigrants entered its labor force. When Spain joined the forerunner of the European Union (E.U.) in 1986, its per capita income was only 68% of the average. By 2007, this figure rose to 90%. As a result, the average Spaniard now has a higher standard of living than the average Italian. And thanks in part to generous E.U. transfers, Spain soon will boast Europe’s most extensive high-speed rail network.

For all of its economic achievements, mention Spain at a cocktail party in London or Berlin, and the conversation inevitably turns to real estate. A few years ago, it was the real estate boom, when Spain was building more than triple the number of units annually as a much-larger Britain. Today, it’s all about the ensuing real estate bust, as asking prices for apartments along Spain’s Costa del Sol have fallen off of a cliff, and more than 800,000 apartments are awaiting buyers.

To Economic Bust…

Spain’s transformation from Europe’s top economic success story to new “sick man of Europe” happened almost overnight. Although most other E.U. countries climbed out of recession by Q3 of 2009, Spain’s economy never stopped shrinking. The International Monetary Fund (IMF) is forecasting that Spain’s economy will continue to contract in 2010 by 0.4% after a drop of 3.6% last year. Standard & Poor’s projects that real GDP growth in Spain will average an anemic 0.7% annually between now and 2016.

Why the sudden pessimism about Spain? Exacerbated by an over-reliance on the property boom, Spain’s 20% unemployment rate is second only to Latvia’s in the European Union. And close to a million newly unemployed are largely unskilled construction workers, whose jobs may never come back. Spain’s dysfunctional labor system makes things even worse. Half of Spain’s — mostly older — workers are on permanent contracts that make them extremely hard (and costly) to fire. Meanwhile, young workers scrape by on short-term contracts. On the one hand, this gives companies flexibility. On the other, they have no incentive to train younger workers. Throw in the effects of the credit crunch, and many companies are between a rock and hard place. Companies can’t afford to fire workers to cut costs, and they have no access to credit to expand business in an already tepid consumer market.

But Not the Next Greece

Spain’s fall from a poster child for European growth to potentially the “Next Greece” has been swift and sudden. Investor nervousness means Spanish banks and companies are having a harder time raising funds. The spread on yields between Spanish and German sovereign bonds — a key measure of perceived risk — has been rising.

Most Spaniards feel this is eminently unfair. After all, before 2008, Spain was a model of fiscal probity. Nor does Spain have a record of fiscal profligacy like Greece. As recently as 2007, Spain was running a fiscal surplus. And even if Spain’s 2009 fiscal deficit hit a Greece-like 11% of GDP, its overall government debt has hardly hit crisis levels. Spain’s ratio of government debt to GDP of 63% is much lower than either of the other PIGS, Portugal’s 87% or Greece’s 120%. Spain’s debt, in fact, is lower than either that of Germany or France.

Nor is Spain resting on its laurels. Prime Minister Jose Luis Rodriguez Zapatero has moved quickly to cut expenditures to cut the fiscal deficit to 3% of GDP by 2013. These include austerity measures worth a total of €15 billion ($17.88 billion) this year and next year, including a 5% cut in public-sector wages and a freeze in pensions in 2010. The government also recently approved a labor reform bill to make the labor market more flexible. The Spanish central bank also is proposing new rules that aim to force lenders to work out nonperforming loans promptly. A dozen of Spain’s 45 savings banks are racing to restructure before a deadline on bank bailouts set by the European Commission  expires.

Spain’s efforts just might be paying off. Just last week, Spain sold more than $4 billion in bonds in spite of warnings that it was on the verge of losing its triple-A credit rating. Skeptics still worry about the level of Spain’s private-sector debt — estimated at anywhere between 178% and 232%. But Barclays Capital argues that Spain overall is less vulnerable to a debt crisis than rival PIGS, Greece and Portugal, as well as non-PIG Ireland.

Spain’s biggest problem may be the sudden and unpredictable jump in risk aversion, rather than its unwillingness to face the fiscal music.

If the PIGS are ever to fly again, Spain will be among the leaders of the pack.

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