Spain Dragged to the Edge of a Dangerous Italian Economic Trap
Spain spent the years following the global financial crash trying to look a lot less like Italy. Then came the coronavirus.
(Bloomberg) -- Spain spent the years following the global financial crash trying to look a lot less like Italy, the weakest link in the euro-area economy. Then came the coronavirus.
The destruction wrought by the pandemic has plunged Spain into the deepest slump in the euro area and left its public finances in tatters. A piecemeal economic response by the minority government led by Socialist Prime Minister Pedro Sanchez is threatening to push the economy into an Italian trap of sluggish growth and stubbornly-high debt.
“Spain faces a serious risk of Italianization,” said Fernando Fernandez, an economics professor at IE Business School in Madrid. “Last time the crisis hit us dramatically, but we reacted. Now, there’s no serious discussion about the economic reforms that this country needs. The risk of a lost opportunity is very high.”
Across the country, angst about the future is haunting businesses. The share of small firms worried about being able to keep staff and cover loans is higher than in Germany, France and Italy.
Kevin Marquez, who owns a restaurant in the southern Spanish city of Seville, joined hundreds of other owners and workers last week to bang pots and pans, protesting what they say is insufficient financial support from the government.
“Little by little, we’re spending everything we’ve saved in the past four or five years,” Marquez said. He’s had to cut the price of his tapas by around 30%, and daily revenue at his business, El Rincon de Kevin, has fallen to 150 euros from 1,800 euros before Covid-19 hit.
“That’s the way things are in Spain,” Marquez said. “We’re really up or we’re really down.”
Economists say Spain needs to overhaul its troubled labor market, which for years has been plagued by one of Europe’s highest rates of unemployment. They’re calling for changes that will make it easier for companies to grow and hire more employees. Spain has some of the region’s smallest companies, which has left them financially vulnerable and unable to withstand the pandemic shock.
The central bank governor has also weighed in. “There is a pressing need to define an ambitious structural reform agenda,” Pablo Hernandez de Cos, who sits on the European Central Bank’s Governing Council, said last month.
Prime Minister Sanchez leads a weak government that’s struggled with basic things like passing a 2021 budget. That’s raised concern about his ability to deliver on deep-seated changes to fix the broken parts of the economy and prevent the country succumbing to the kind of malaise that turned Italy into a long-term drag on the euro area.
Both Spain and Italy are set to receive a major fiscal boost starting next year, when the the European Union begins to funnel billions of euros in funds to member states as part of a historic aid package agreed this year. The two economies will be the biggest recipients: both were on precarious fiscal footing even before the pandemic hit.
But they also have a track record of not effectively spending EU funds. In Spain, that has prompted economists and business leaders to press officials to draw up detailed plans to ensure the stimulus delivers a meaningful impact in the longer term.
Investors are taking note of the challenging outlook. The gap between Spanish and Italian bond yields has narrowed this year, and Spain’s benchmark stock index has underperformed among major euro countries.
While Sanchez tries to tackle the long-term problems, he also faces the more immediate challenge of pulling the economy out of a deep hole. It’s forecast to shrink 12% this year and regain barely half the loss in 2021. Debt is mounting and unemployment is expected to hover around 20% for at least the next couple of years.
Despite its troubles, Madrid’s medium-term outlook remains less bleak than Rome’s. Italy’s debt-to-GDP ratio is far higher and its economy was barely expanding even before the pandemic. Italy’s per-capita productivity — a crucial driver of growth — is likely to remain below Spain’s in the aftermath of the pandemic, says Ignacio de la Torre, chief economist at Arcano Partners in Madrid.
He’s relatively bullish and expects expansion of almost 11% next year, more than the 9% predicted by the central bank.
Goldman Sachs Group is also more optimistic on Spain than Italy in the medium term, citing the former’s investment plans, as well as potential growth and debt sustainability.
The countries’ “ability to use the Recovery Fund to boost growth will be the crucial factor to watch in the coming months,” economists led by Sven Jari Stehn wrote this week.
Read More
- BBVA in Talks to Buy Sabadell as Spain’s Bank Takeovers Boom
- Which Jobs Are Really Worth Saving? (Podcast)
- SPAIN REACT: GDP Rebound Probably Lags Rest of Euro-Area Rally
But for many in Spain, there’s an unwelcome sense of deja vu being associated again with Italy. A decade ago, both were caught up in the debt crisis that threatened to tear apart the euro area.
When a housing crash threatened to topple Spain’s banking system in 2012, the government requested a bailout and pushed through unpopular reforms in its financial sector and labor market, showing that Madrid could take hard decisions. The transformation helped to stoke more than half a decade of robust economic growth and boosted market confidence.
Italy, in contrast, muddled along and the economy languished. Spain’s GDP reached its pre-crisis level in 2017, a symbolic moment cheered by Spanish political and economic commentators. With a bit of schadenfreude, they noted that Italy was still far off the mark.
Former Prime Minister Mariano Rajoy had the support of a majority of lawmakers in 2012, however, and Sanchez is in a much weaker position. Some ministers are talking about undoing Rajoy’s labor market changes, which aren’t liked by many left-leaning voters.
Some business executives are worried that overturning those reforms could send a message to international investors that Madrid is focused on rehashing past political battles. Economists have called on lawmakers to improve — rather than undo — those job market changes.
“The principles of the reforms have been very important and should stay in place,” Andrea Schaechter, International Monetary Fund mission chief for Spain, told journalists last week. “We think this is an important time to plan ahead and deal with these structural issues to prepare the economy going forward.”
©2020 Bloomberg L.P.