Spain: the tough Spain: the tough choices aheadchoices ahead

Dani RodrikDani Rodrik

May 28, 2010May 28, 2010

Widening external Widening external imbalancesimbalances

Current account balance (% of GDP)

-12.00

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

1981

And rapid structural change And rapid structural change away from tradable sectorsaway from tradable sectors

Structure of the economy (%of GDP)

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Tradables

Non-tradables

An international comparisonAn international comparisonGDP per capita (US$ at PPP)

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Spain Germany Finland Israel South Korea

……on industry share of GDPon industry share of GDPIndustry (% of GDP)

10

15

20

25

30

35

40

Spain Germany Finland Israel South Korea

What countries in Spain’s What countries in Spain’s position need to doposition need to do

1.1. Reduce aggregate expendituresReduce aggregate expenditures• Private sector has already retrenched significantlyPrivate sector has already retrenched significantly

2.2. Boost competitiveness of tradable goods and Boost competitiveness of tradable goods and services (exports and import substitutes) services (exports and import substitutes)

• Key: increase labor demand in tradablesKey: increase labor demand in tradables

The second is needed to moderate the adverse The second is needed to moderate the adverse effects of belt-tightening while accomplishing effects of belt-tightening while accomplishing the needed structural change. the needed structural change.

Without it, the recession runs deeper, Without it, the recession runs deeper, unemployment is larger, and the fiscal hole unemployment is larger, and the fiscal hole becomes more difficult to fill.becomes more difficult to fill.

Spain starts from a low point in Spain starts from a low point in terms of competitivenessterms of competitiveness

Source: IMF

What about structural What about structural reforms?reforms?

What may be desirable in the medium- or What may be desirable in the medium- or long-term may not be particularly effective long-term may not be particularly effective in the short-runin the short-run

Structural reform may not be a good Structural reform may not be a good substitute for policies that directly increase substitute for policies that directly increase competitivenesscompetitiveness– Labor-market reformsLabor-market reforms

Reducing cost of firing workers will not increase Reducing cost of firing workers will not increase demand for labor much when no-one wants to hire new demand for labor much when no-one wants to hire new labor to begin withlabor to begin with

Decentralizing wage bargain may have little effect on Decentralizing wage bargain may have little effect on the level of wages the level of wages

And it can eat up lots of political capitalAnd it can eat up lots of political capital

How to boost competitiveness How to boost competitiveness (1)(1)

Increase productivity in tradablesIncrease productivity in tradables– This reduces unit labor costsThis reduces unit labor costs– But: this is a medium- to long-term But: this is a medium- to long-term

strategystrategy It cannot happen quickly enoughIt cannot happen quickly enough

– Recent productivity growth achieved Recent productivity growth achieved through labor sheddingthrough labor shedding Which of course defeats the purpose Which of course defeats the purpose

Spain’s productivity Spain’s productivity performanceperformance

Productivity growth

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

1981

Labour productivity growth (%)

Total factor productivity growth (%)

Source: EIU

How to boost competitiveness How to boost competitiveness (2)(2)

Currency depreciationCurrency depreciation– Gives quick boost to competitiveness, unless Gives quick boost to competitiveness, unless

wages and prices catch upwages and prices catch up– It is the traditional remedy used by countries to It is the traditional remedy used by countries to

extricate themselves from crises of this typeextricate themselves from crises of this type– But Spain doesn’t have its own currencyBut Spain doesn’t have its own currency

even a large depreciation of the Euro would be even a large depreciation of the Euro would be insufficient since 70% of Spain’s exports go to other insufficient since 70% of Spain’s exports go to other EU membersEU members

Leaves exit from the eurozone as the only Leaves exit from the eurozone as the only (unappetizing) option (unappetizing) option

How to boost competitiveness How to boost competitiveness (3)(3)

A “fiscal” devaluation A “fiscal” devaluation – Raise import tariffs and apply export Raise import tariffs and apply export

subsidiessubsidies– In principle, it mimics a currency In principle, it mimics a currency

devaluationdevaluation– But few successful casesBut few successful cases

South Korea and Taiwan during the 1960s and South Korea and Taiwan during the 1960s and 1970s; China in 1990s1970s; China in 1990s

– And would violate EU and WTO rules in And would violate EU and WTO rules in any caseany case

How to boost competitiveness How to boost competitiveness (4)(4)

A cut in nominal wagesA cut in nominal wages – Reduces domestic costs and boosts external Reduces domestic costs and boosts external

competitivenesscompetitiveness– But needs to cover private sectorBut needs to cover private sector

Can’t be limited to public sector wagesCan’t be limited to public sector wages

– And it needs to be accompanied by similar cuts And it needs to be accompanied by similar cuts in the in the pricesprices of other services and non- of other services and non-tradables (e.g. utilities, transport and logistics, tradables (e.g. utilities, transport and logistics, housing, …)housing, …) Otherwise the effect on competitiveness remains Otherwise the effect on competitiveness remains

limitedlimited And workers bear unnecessarily large real wage cutsAnd workers bear unnecessarily large real wage cuts

How to boost competitiveness How to boost competitiveness (5)(5)

Industrial policyIndustrial policy – Targeted promotion of new industriesTargeted promotion of new industries

Through subsidies, public loans, public-private Through subsidies, public loans, public-private collaboration to remove identified bottleneckscollaboration to remove identified bottlenecks

– All successful countries engage in industrial All successful countries engage in industrial policies, even if they do not call it thatpolicies, even if they do not call it that

– But takes time to implement and get resultsBut takes time to implement and get results– And it requires a lot of government capacityAnd it requires a lot of government capacity– Unlikely to be effective on its own in a Unlikely to be effective on its own in a

depressed economic environmentdepressed economic environment– There is no successful example of IP in a high-There is no successful example of IP in a high-

cost environment cost environment

The bottom lineThe bottom line

Two unappetizing optionsTwo unappetizing options– Quit the eurozone and let the currency Quit the eurozone and let the currency

depreciatedepreciate– Engineer an economy-wide reduction in Engineer an economy-wide reduction in

wages and prices of serviceswages and prices of services Requires political leadership and a social Requires political leadership and a social

compactcompact