Spain’s economy was always in line to be particularly hard-hit by the Covid-19 crisis. The Government’s response will not help argues Roger Pike.
In January when we wrote our annual crystal ball-gazing article on business and the economy in Spain, we may already have seen something on the news about a strange new virus in a region of China which we couldn’t place on a map, but we had no inkling of what was around the corner. We did, however, talk about the need for the Sánchez Government to tackle a series of structural problems, and the lack of wriggle room from the high debt-to-GDP ratio of nearly 100%. In the second global crisis in recent history, these imbalances will once again make the Spanish economy more vulnerable than most.
On a May Day without union-led parades, and seven weeks into one of the strictest lockdowns in Europe, the government released economic forecasts predicting a 9.2% fall in GDP this year, with unemployment hitting 19% by year-end, a deficit of 10.3% and public debt of 115.5%. While this is grim reading, the reality will almost certainly be worse. Deutsche Bank expects debt to balloon to 150% of GDP, with Spain facing the need for huge amounts of extra spending just as its tax receipts plummet.
The decision to lockdown was like slamming on the economy’s emergency handbrake. As it came to a near-halt, Pedro Sánchez announced a series of measures aimed at saving jobs and providing workers with a basic income. He beefed up an existing scheme for temporary redundancies (ERTE), under which furloughed workers are paid a special unemployment benefit. At least 3.4m workers, from airlines, retail chains and car manufacturers to bars and hairdressers, were covered under the scheme.
The self-employed forced to shut down their business completely, or whose income was reduced by 75% or more, could apply for a special benefit payment. Over 1 million – 35% of self-employed – applied, although large numbers fell through the net. To help finance small, medium and large companies, €100bn was set aside to provide guarantees to banks to encourage them to lend.
Also in the pipeline is a minimum income for the most needy, although few details have emerged about who will benefit and how much it will cost. The difficulty will be in ensuring it reaches those who need it, while avoiding discouraging people from returning to work.
All this is costing vast sums of money. The challenge for any Government is how to pay for it without wrecking the economy.
Much hope has been placed on the European Union. Sánchez and his ministers have made numerous public appeals to lofty ideals of European solidarity to make a case for establishing a huge European fund, with debt mutualization. This would mean all member states jointly guaranteeing bond issues, with the proceeds being used by those who most need it. Spain prefers grants – which will not need paying back – to loans.
The EU is under no illusions about the need for a massive spending boost to alleviate poverty and kick-start the European economies back into life. Yet some northern countries are not wild about the idea of permanently subsidizing their southern neighbours, or being on the hook for their debt. They would want anything looking like shared debt to come with much stricter control mechanisms, over spending plans and deficits, for example.
The recent joint proposal from Macron and Merkel to establish a 500bn fund for grants goes someway to keeping Sánchez happy, and is additional to the €540bn credits already approved. It’s not completely free money – it will be paid back, some time, out of the member states` budget contributions, and the grants will be based on “a clear commitment from member states to follow sound economic policies and an ambitious reform agenda”. So strings are attached.
Whatever the deal from Europe looks like, Spain’s leaders will have to make some unpalatable decisions to try and reduce the deficit, by upping income and cutting costs. This Government seems to think that increasing income is the easy bit – just put up all the taxes, and think of a few new ones. Even before the Corona crisis, it had prepared a battery of tax increases for income, corporation and inheritance tax, as well as plans to introduce levies known as Tobin and Google taxes. The junior coalition partner Podemos has floated a new wealth tax, which at first sight would hit the comfortably-off with a decent house and few assets more than the really rich.
Spain’s leaders will have to make some unpalatable decisions
There’s a problem with all this. High taxes discourage people from working and from starting businesses. Less economic activity means a lower tax take. The deep recession will already make many companies vulnerable; taxing them further will cause more of them to fold, meaning more job losses. Now is the time to nurture companies, or risk provoking a vicious downward spiral; after all, public spending is ultimately paid for by taxes raised from private sector workers or companies.
Here are some scary numbers: even before the state of emergency, the ratio of private sector workers to the public employers, unemployed and pensioners who their taxes pay for, was less than one. With demographics as they are, that was already unsustainable. Now, with 3.4m receiving benefits through the Temporary Redundancy scheme, there are only about 10 million private sector salaried workers, and some 2 million self-employed still active, many of whom are low earners. Their taxes have to support 19 million people: pensioners, unemployed, public sector workers and those on the temporary redundancy schemes. This needs to change, and quickly.
What should be keeping the Ministers awake at night is thinking of ways to stimulate the private sector, attract investment and create employment. What should keep voters awake at night is that hardly anyone in the government has ever earned a salary in the private sector or seems to understand that without successful companies, there is no money for pensions or healthcare.
No government can replace private incomes indefinitely. The Economist recently ran an article entitled “When lockdown ends, Governments will have to free labour markets”. In Spain they could start by scrapping the obligation for self-employed to pay nearly €300 a month in social security, regardless of whether they earn money or not. That is no way to encourage entrepreneurship. Why not follow countries such as the UK or USA, where self-employed pay Social Security as a percentage of what they earn?
It should also be easier to work part-time, and for it to be compatible with receiving benefits. Payroll taxes are also far too high. They stop companies hiring, and are one of the reasons for Spain’s chronic high unemployment.
Far from freeing the market, the Government has just announced an agreement to tighten labour laws again. The two ministers with responsibility for the economy heard about it on the news, and one of them, Economic Affairs Minister Nadia Calviño, immediately labelled the decision of the Government that she forms a part of, as “absurd and counter-productive”. Such a deep split in the Cabinet does not bode well.
When the Government sees that the tax take after the increases is nowhere near what it expects, and with the EU looking over its shoulder, there will be no choice but to cut spending. And while it would be an exercise in coherence to slim the administrations down, there are really only two areas where big savings can be made – public sector wages, and pensions.
Assuming Sánchez remains in power for the near future, he looks destined to follow in the footsteps of the previous Socialist Prime Minister Jose Luis Zapatero, who was forced to cut public sector pay and freeze pensions. This time freezing them won’t be enough – expect the higher earners and new pensioners entering the system to be targeted for reduced payments. But while pensioners have reasons to be upset, spare a thought for the young, who will once again bear the brunt of poor economic management. Without a dynamic and growing labour market, the hopes of young Spaniards for a decent career and an acceptable level of prosperity will go up in flames. Tens of thousands are likely to try their luck abroad.
No Government of any colour would have avoided the brutal economic downturn caused by the shut-down. But the decisions made now will be critical to determine the speed and strength of the recovery and to avoid lasting damage to the economy. All the signs so far are that the Sánchez administration is getting it wrong.
Photo Credits: Alexander Awerin, Christian Leu