Spain's Fiscal Fanaticism
It is a well-known maxim that to keep repeating the same action and expect a different result is a symptom of madness. It is hard to find a different way to account for the persistence of Eurozone leaders in inflicting punishing austerity on countries belonging to the common currency, a strategy that has proved both fiscally ineffective and socially destructive.
In recent days, the focus of the crisis has returned to Spain, and for good reason. The country suffers from the highest unemployment rate in Europe: 24 percent, and it’s more than 50 percent among those 15 to 24. Despite this catastrophic state of affairs, the relatively new, conservative Spanish government—elected last November with 46 percent of the vote on a platform of austerity and structural reform—recently unveiled a budget proposal that, in the words of Budget Minister Cristobal Montoro, is the strictest since the death of Franco in 1975. The total fiscal adjustment for 2012 is a massive 27 billion euros. The goal is to bring Spain’s budget deficit down from 8.5 percent of gross domestic product (GDP) to 5.3 percent.
A couple of things stand out. First of all, it’s unlikely Spain will be able to reduce the deficit by this amount given that forecasts indicate a 1.7 contraction in the economy. A host of economists have argued that the austerity measures will only increase the deficit-to-GDP ratio and force the government to pass additional cuts before the year is out. One, Luis Garicano of the London School of Economics, has calculated that bringing the deficit down by 3.2 percent of GDP in 2012 will require an adjustment between 53 billion and 64 billion euros, a task he called “impossible.” It is a vicious cycle that the citizens of Greece are painfully familiar with. Spain is expected to cut with equal abandon in 2013, to get the deficit under 3 percent of GDP at the end of next year.
The second point worth remembering is that even this savage program of cuts and tax hikes was smaller than that which was initially demanded of Madrid by the European Union (EU). The swift economic deterioration of the Eurozone in 2011, as its leaders failed to adequately deal with the debt-and-banking crisis and kept imposing asphyxiating austerity regimes on every country meant that Spain overshot its deficit target for the previous year by 2.5 percentage points of GDP. In a summit in early March, the Spanish prime minister, Marianno Rajoy, shocked his EU peers by announcing that his country would not meet its deficit target of 4.4 percent of GDP for 2012; it would aim for 5.8 percent instead. The 5.3 percent target was the product of a compromise between Rajoy and the European Commission, which balked at the size of Madrid’s unilateral revision.
Since then, Spain’s cost of borrowing has been steadily creeping upward, from 4.91 percent for ten-year bonds on March 2 to 6.07 percent this past Monday. This all makes perfect sense to top officials in Brussels. “Because there was a perception Spain was relaxing its fiscal targets for this year, there has been already a market reaction of several dozen basis points on yields of Spanish bonds,” said Monetary and Financial Affairs Commissioner and commission Vice President Olli Rehn in late March. For the commission, the European Central Bank, and the German government—the main exponents of the doctrine of salvation through unending cuts—the rising yields merely indicate markets’ worries about Spain’s deficient devotion to the doctrine, its doubt about the divinity of the Deficit Target.
There is, of course, another interpretation to the rise in the cost of borrowing. As commentators like Paul Krugman of The New York Times and Wolfgang Münchau of the Financial Times—who have consistently warned of the dangers of a “one size fits all” austerity recipe for Europe’s ills—have highlighted, Spain’s fiscal troubles are a symptom of its malady, not its cause, which was the bursting of the enormous real-estate bubble that drove growth for the most part of the first decade of the 21st century. Both have noted in recent columns that the real reason for the jump in Spanish bond yields is not investors’ lack of confidence in the deficit-crushing credentials of the Rajoy government but rather their fear that the prescription is killing the patient. They are right.
At 1.1 trillion euros, Spanish GDP far outstrips the combined national output of Greece, Portugal, and Ireland, the three countries currently under official economic life-support programs by the International Monetary Fund and the EU. The consequences of a Spanish meltdown, even after the Eurozone’s permanent rescue mechanism, the European Stability Mechanism (ESM), becomes active in July, are incalculable.
Well-informed sources are already stating that Spain may request ESM assistance to recapitalize its banks, battered by the implosion of the housing market. This should be done, and it should be combined with a significant increase in deficit targets for 2012 and 2013, allowing structural reforms in the labor market to take effect and creating breathing room for growth, which will bring down unemployment and improve the fiscal picture over the medium term. If this does not occur, if Berlin, Brussels and Frankfurt (seat of the ECB) remain on their present, mad path, they will lead Spain, and Europe, to the mother of all man-made disasters.
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