Blog Post

The Spanish conundrum

In this article Bruegel Director Jean Pisani-Ferry puts forward the various options that Spain could use to close its yawning competitiveness gap and turn its economy around. Through competitve deflation, it can impose a wage restraint and increase competitiveness. The other options, such as through deflation or re-entering the euro rea with a devalued exchange […]

By: Date: March 15, 2010 Topic: Macroeconomic policy

In this article Bruegel Director Jean Pisani-Ferry puts forward the various options that Spain could use to close its yawning competitiveness gap and turn its economy around. Through competitve deflation, it can impose a wage restraint and increase competitiveness. The other options, such as through deflation or re-entering the euro rea with a devalued exchange rate, might have more straightforward results, but the repurcussions could be difficult to deal with.

Spanish wages rose by 50 percent between 1998, the last year before the introduction of the euro, and 2008. In the same period, in Germany, the increase was only 25 percent. This would not be remarkable if the wage differential was matched by changes in productivity; there is no obligation for members of a monetary union to proceed at the same pace. But this was not the case. In Spain, where construction and traditional services have driven growth, productivity growth has been less than in Germany, where industry has been completely restructured (seven percent compared to 15 percent). The result has been, in one decade, the opening up of a 30-point competitiveness gap. Even taking into account that Germany entered the euro with an overvalued currency, this gap needs as much as possible to be closed over the next few years. How can it be done?
The first method Spain could use is ‘competitive deflation’, as practiced by France during the 1980s, and Germany since 2000. This means imposing wage restraint and thus gradually closing the competitiveness gap. However, it works desperately slowly, particularly if inflation is low and productivity growth is weak.
The second method is deflation. This does not work through gradually adjusting salaries or prices, but through lowering them as suddenly and as simultaneously as possible. On paper, it looks attractive. If a government can obtain a simultaneous 10 percent cut in wages and prices, the loss of purchasing power will only be felt with imported products, which will become more expensive. The purchasing power loss would be limited to 2.5 percent in Spain’s case, because imports account for a quarter of GDP. However, this method is only really feasible for small, open economies, such as Ireland or Estonia, where cohesion is strong and there are obvious competitiveness concerns. In a large, complex economy marred by disputes over income distribution, deflation is hardly likely to be practical. In France, Laval’s deflation policy in the 1930s ended in economic failure and political disarray.
Some say there is a third way, through which the results of a straightforward deflation could be achieved by less-direct means. US economist Martin Feldstein, in a proposal aimed primarily at Greece, has suggested exit from the euro, followed by re-entry at a devalued exchange rate. But this would soon turn the single currency into an empty shell. The introduction of parallel currencies has been suggested. If it were possible to temporarily denominate contracts in a quasi-currency, say in ‘pesos’, while depreciating the ‘peso’ against the euro, everything would fall into place. But Argentina tried this, and the results were inconclusive. Lastly, VAT can be increased, and social security contributions reduced: in combination such measures tantamount to a devaluation. But there is only a limited margin for a VAT hike (Spanish VAT is 16 percent, soon rising to 18 percent).
The last possibility would be to leave the euro area. However, this would be a step into the unknown, and contracts, in particular public debt obligations, are denominated in euros. Even the announcement by a government of an intention to leave would immediately provoke a financial crisis of great magnitude because of generalised concern about the consequences of such a decision for the solvency of counterparties.
So we are back to the first method: slow and painful steps towards the recovery of competitiveness. Getting there will test the endurance of Spanish society. The European Union’s responsibility is to smooth the path, especially as Spain is not an isolated case. This implies that the European Central Bank should visibly and steadfastly concentrate on increasing inflation to two percent. Currently the risk of too-low inflation is greater than the risk posed by too-high inflation. The implication is also that the German social partners must understand that wage freezes, such as that just negotiated for metalworkers, risk making the Spanish conundrum insoluble. Neither economically nor politically would this be in Germany’s interest.

This Op-Ed was first published in Le Monde.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke and Francesco Papadia Topic: Macroeconomic policy
Read article More by this author
 

Opinion

European governance

Can EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read about event More on this topic
 

Upcoming Event

Nov
9
11:00

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Maria Demertzis and Laurie Mayers Topic: Macroeconomic policy
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Read article More on this topic More by this author
 

Opinion

The pandemic’s uncertain impact on productivity

The pandemic has certainly permanently affected our way of working. Whether this is for the better remains to be seen.

By: Maria Demertzis Topic: Macroeconomic policy Date: September 28, 2021
Load more posts