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[Ferdinando Giugliano] Spain is headed in wrong direction

By Bloomberg

Published : Dec. 10, 2020 - 05:30

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At the end of a terrible 2020, Pedro Sanchez has something to celebrate. Spain’s prime minister has succeeded in passing the country’s first full-year budget since 2016 even though he presides over a minority government. A string of regional parties suddenly warmed to his left-wing coalition of the Socialists and Podemos — and especially to the nearly 140 billion euros ($170 billion) in grants and loans that Spain is set to receive from the European Union to counter the shock of COVID-19.

This political success means Sanchez doesn’t have to fear a new election. But it’s unclear whether such renewed political stability can help Spain’s long-term economic recovery. The government has been busy unpicking many of the structural changes that had contributed to its pre-pandemic economic success. And unfortunately, the EU is unlikely to obtain any commitments to reform in return for the recovery money.

On Thursday, Spain’s lower house passed a classic left-wing budget, which raises taxes on corporations and the rich, while increasing social spending. The measures, which the Senate is widely expected to approve by the end of the year, also include taxes on digital services and financial transactions. Several regional forces, including the Basque and Catalan secessionist parties, backed the budget, which earmarks 27 billion euros in investment spending from the “Next Generation EU” fund in 2021 alone.

Spain had been forced into a cycle of weak governments and snap elections in part because Sanchez hadn’t managed to pass a budget since he became prime minister in June 2018. The pattern looked set to continue after the Socialists cobbled together a feeble alliance with Podemos after the November 2019 general election. But the EU’s 750 billion-euro pandemic recovery fund has proven a game changer. The Spanish government can now draw on unexpected support thanks to the EU cash it can spread around.

There’s no doubt Spain deserves significant solidarity from its European partners. Its economy is set to shrink by 12.4 percent this year, the most in the EU according to the European Commission, and the budget deficit is expected to soar to 12.2 percent of gross domestic product. Spain’s 10-year sovereign bond yields hover around zero, thanks to the European Central Bank’s large-scale asset purchase programs. But the provision of more than 70 billion euros in EU grants will limit the increase in public debt, which is set to rise to 123.9 percent of national income by 2022.

The long-term issue for the EU is whether countries such as Spain will be able to run on their own legs again after receiving help.

In theory, Spain is a model of how this can be achieved. In 2012 and 2013, Madrid obtained 41.3 billion euros in loans from the European Stability Mechanism, the eurozone rescue fund, to support its crumbling banking system. In return, then Prime Minister Mariano Rajoy passed an ambitious structural-reform program that included injecting greater flexibility into the labor market, helping turn Spain into one of the fastest-growing economies in western Europe. Much like in Ireland and Portugal, the exchange of European financial help for measures aimed at improving competitiveness worked.

The European Commission has vowed it will only disburse recovery fund money if countries earmark it for useful investment. But it’s very hard to see countries such as Spain or Italy immediately engaging in efforts to overhaul their economies in order to lift their growth rate in the long run.

In Spain, for example, the government has already begun dismantling Rajoy’s labor market reforms, vowing to go even further. Deputy Prime Minister Pablo Iglesias, also Podemos’s leader, has now floated the idea of introducing a four-day, 32-hour workweek to boost employment. As a study on France’s 35-hour week has shown, there’s no evidence that reducing the number of working days can lead to more jobs.

The Spanish government has the right to make the choices it sees fit with regard to redistribution. If it wants to be a high-tax, high-spend economy, so be it. But the EU should be very careful about what countries are doing with regard to their long-term competitiveness. The recovery fund is meant to be a temporary instrument, but there’s a strong case for having a permanent fiscal tool to help countries in difficulty, at least within the euro region. Such a budget can only work politically if it’s not always the same countries that seek to draw from it. The future of the EU hinges on the long-term success of countries such as Spain.

Ferdinando Giugliano
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. -- Ed.