10 April 2013

Macro-economic Imbalance Procedure in-depth review for Spain

The main observations and findings from this analysis are that the risks and negative economic trends associated to macro-economic imbalances, as identified in the 2012 in-depth-review, are still powerful and have partly materialised.

Negative feedback loops amongst a protracted economic recession, deleveraging and volatile market financing conditions remain a tangible threat. Private sector deleveraging is imparting a significant negative impulse to domestic demand and has plunged the economy into a double-dip recession since end-2011, which may extend into  2014. Efforts to stem the rise in general government debt contribute to compress domestic demand. Structural rigidities and tight financing conditions have been hindering a faster and less costly (in terms of output and employment) adjustment of the real economy to  post-bubble conditions. In turn, the contracting economy and the associated surge in unemployment are feeding back into a more protracted deleveraging process. Hence, while the adjustment of flow imbalances has advanced in 2012, risks to macro-economic and financial stability have not yet dissipated.

Spain has responded to these challenges and to the country-specific recommendations of the Council under the 2012 EU semester with efforts to consolidate public finances and reform product and factor markets. A labour market  reform was adopted by the government in February 2012 and passed into law in July 2012. A comprehensive reform plan was presented in September 2012, covering further reforms to support employment, ensure public finance sustainability, and strengthen the business environment and competition. While measures have been taken or launched in all these areas, the reform agenda remains incomplete, and even reforms already adopted have not always displayed their full effects due to implementation lags. As a result, the adjustment capacity of the economy remains unsatisfactory, with much of the burden of adjustment falling on employment.

High and fast rising general government debt has been the flip side of the ongoing adjustments in the private sector. The general government budget deficit has fallen from the 2009 peak of 11.2 per cent of GDP but remains high at 6.7 per cent of GDP in 2012  (excluding bank recapitalisation costs). In spite of a substantial fiscal effort, a faster reduction in headline balances was hindered by the recessionary environment and shifts in tax revenue elasticitites. General government debt, which has also been affected by the cost of bank recapitalisations, reached 84 per cent of GDP in 2012 and is set to record further substantial increases in the coming years. The unwinding of macro-economic imbalances will only have run its full course once the fall-out on the general government sector has  also been re-absorbed.

The scale and interrelated nature of the policy challenges stemming from these imbalances require a comprehensive and ambitious policy response. Notwithstanding the measures already adopted or proposed by the government, and whose positive effects depend on their swift and full implementation, a number of elements can be considered:

• The rebalancing of the economy and international competitiveness would be helped by greater flexibility in the reallocation of resources. This would be fostered by measures to strengthen competition in product and services markets (including network industries), improve the business environment, support the growth and internationalisation of firms. A review of the growth-friendliness of the tax system could also be considered.
• The adjustment capacity of the economy, the absorption of the large number of unemployed workers and competitiveness rest decisively on a well-functioning labour market. To this end, it would be useful to
  • (i) undertake a comprehensive review of the impact of the 2012 labour market reform against its stated objectives (greater efficiency and reduced labour market duality, higher internal flexibility, a wage bargaining process that ensures a better alignment of wages to economic conditions, greater employability of young workers and greater use of permanent contracts) with a view to ensure its effectiveness and
  • (ii) to enhance active labour market policies (ALMP), public employment services and vocational training, so as to improve employability and raise the quality and effectiveness of training and job matching.
• The stability of the financial system and its capacity to finance the real economy rely on the swift completion of the recapitalisation and restructuring of the banking sector and the strengthening of the regulatory and supervisory frameworks foreseen in the context of the financial sector programme. Increasing the availability of non-bank financing sources and targeted measures for SMEs would also help to alleviate financing constraints on growth and the reallocation of resources. Measures to foster a larger and more efficient rental market could help stabilise the housing sector and promote geographical mobility of workers.

Full review

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