Stuck in the middle of the lost decade

It's the greatest economic crisis in decades, but the figures and the financial forecasts only paint a tentative picture of its real dimensions and impact. And the way out of the hole remains concealed by the fog of Europe's labyrinthine ways, even as an economic relapse has reduced the Spanish government's freedom of action even further, added another million people to the unemployment rolls, and collapsed credit altogether.

The numbers show that Spain has already endured its first five years of crisis: March 2013 data released last week reflect 20 consecutive quarters below the GDP of 2008. And the pundits are forecasting at least five more years until the economy returns to those levels again. The lost decade, an expression that sounded terribly pessimistic at the beginning of the Great Recession, is now something of a best-case scenario.

"I call this Spain's Great Depression," says Francisco Com¨ªn, a professor of economic history. "In terms of duration and decrease in activity, it is only comparable to the Civil War (1936-1939) and the postwar era."

But rather than focus on the drop in GDP, which is nearly seven percent lower than in 2008, Com¨ªn underscores the decline in per capita income, which is now at 2002 levels. "Since the 1970s, no crisis had caused a drop in per capita GDP, and when it did, it was just in 1958 and 1959." Employment figures provide even more conclusive evidence of the true dimensions of the crisis: the 27-percent jobless rate is higher than the US rate during the Great Depression, when joblessness reached 25 percent. And the Spanish government now takes it for granted that it will take over 10 years to recover the four million jobs that will likely be lost by the end of this crisis.

External debt impact

All forecasts about the Spanish economy take into account the crisis' negative impact on consumption and the need, due to high borrowing costs, to reduce debt levels. There was a time, between 1998 and 2007, when the flow of cheap and easy credit fed a real estate bubble and fueled consumption. The result was an explosion of jobs and plenty of tax revenues.

But then the financial markets collapsed, credit dried up, and the Spanish property bubble burst. This led to significant external debt, largely compromising the banking sector. People began to wonder what the new engine of growth would be. It was a lethal combination at a time when investors were running away in droves from anything that smelled of risk.

Spain's foreign debt is around 93 percent of GDP. "In the euro zone, you only find higher debt levels in Greece, Portugal, Ireland and Cyprus," notes Joaqu¨ªn Maudos, a professor at the Valencian Institute of Economic Research (Ivie). "It's the best forecaster of whether a country is going to be bailed out; it's the Gordian knot that needs to be untied so there can be growth again."

I call this Spain's Great Depression, comparable only to the Civil War"

"Being so dependent on the outside exposes us to a relapse at any moment; we are constantly crying out 'ouch'," adds Javier Andr¨¦s, an economics professor at Valencia University. The latest 'ouch,' a capital flight of over 300 billion euros over a period of just a few months last year, only ended when the European Central Bank (ECB) demonstrated a willingness to buy national debt to help struggling states. This was crystal-clear evidence that Europe has a role to play in the end of the Spanish crisis.

Trapped in the euro-maze

Professor Com¨ªn makes a historical comparison: "Just like in Spain under the Hapsburgs, our economic policy is being defined by our creditors." Some experts like Jos¨¦ Carlos D¨ªez, an economics teacher at Icade business school, believe that the political guidelines emanating from Brussels - austerity, structural reforms, wage devaluation to improve competitiveness and so on - are useless against debt.

"The ECB needs to step in, stabilize the public and private debt markets, and contribute to devaluating the euro. That would balance out the economy; after that we need to restructure public debt in Greece, Ireland and Portugal. Spain would require private debt write-offs for businesses and families. Lastly, a powerful fiscal stimulus would be required, to be financed by a eurobond," he says bluntly. "But without ECB intervention, without the eurobond, we are headed for payment defaults and the breakup of the euro."

"It would be desirable for Europe to act differently," agrees Josep Oliver, an economics professor at Barcelona's Aut¨®noma University, who nevertheless points out the positive steps taken so far by Brussels, albeit slowly. "Who would have thought that there was going to be a European rescue fund, or that the ECB was going to buy government bonds?"

Oliver also stresses the mistakes of consecutive Spanish governments. "In 2011 we were recovering, but because of local and regional elections, the Spanish government?¡ª like the Italian one?¡ª relaxed on reforms and adjustments, investors began to hesitate once more, and financing dried up. In 2012, between March and July, the same thing happened again. It was not austerity that caused our relapse; our main responsibility in achieving recovery is not making mistakes again."

Credit stuck in the banks

The risk premium?¡ª the yield spread between Spanish and German benchmark bonds?¡ª has been the defining figure of the European crisis. The ECB, with its liquidity injections into the banking sector (which the latter uses to buy bonds) and its commitment to act if a country should request a bailout, has been acting as a bulwark against a tide of skepticism regarding the future of the euro zone. But now, the enormous difficulties faced by small businesses in southern Europe just to get a loan underscores the fact that financial conditions are still far from normal.

If credit does not start flowing to businesses and families once more, economic recovery is a mission impossible. If credit was growing at an annual rate of 20 percent during the 1998-2007 decade, it is now shrinking at the tune of six percent annually. "We have yet to resolve the issue of the fragmentation of the financial market; Spanish small and midsized businesses have to pay almost twice as much in interest as German ones to access a loan, and that's if they manage to secure one at all," says Professor Maudos.

I predict another bubble in a low-skilled sector"

But the Ivie scholar feels that the credit crunch will not let up so long as questions linger over the situation of some Spanish lenders. After forcing banks to progressively provision funds to cover losses caused by non-performing loans to property developers, the government took a different stance halfway through last year. It suddenly made several savings banks admit to multimillion capital needs, leading to the approval of a European bailout for the Spanish banking sector of up to 100 billion euros and tough new conditions for rescued lenders.

"The restructuring of the financial sector always seems incomplete," says Maudos, who would like the government to use the rescue fund more intensively (only 40 billion euros used so far). This scholar also places his hopes in a greater use of loans from the state's Official Credit Institute, alternative financial markets and new "unconventional" measures announced by the ECB three months ago, all of which might enable a "very gradual" return to lending to small businesses.

A long time coming

Just a few numbers are enough to jog our collective memory as to the role that real estate once played in the Spanish economy: over half of lost jobs are in construction, a sector that used to represent 13 percent of all jobs in Spain; these days that figure is closer to six percent.

"We spent a lot of talent and resources generating a productive capacity that we didn't need, and we are now left with skeletons of buildings and infrastructures. The dismal allocation of resources during the boom years is conditioning us horribly now," says Jos¨¦ Antonio Herce, an economics professor at Madrid's Complutense University and a partner at the financial firm Analistas Financieros Internacionales.

"I am very concerned that we are no longer investing in R&D; the knowledge economy is what will allow us to rebuild our competitive bases," says Herce. "The structural reforms that Brussels is asking us for are the same they've been demanding for years; they need to be undertaken once and for all," he adds.

Josep Oliver highlights the fact that "credit is being re-oriented toward the productive sector," even if only by comparison with the collapse of property lending. "What the government needs to develop as soon as possible is occupational retraining programs," he says.

Juan Jos¨¦ Dolado, a professor of economics at Carlos III University in Madrid, emphasizes the need for a new turn of the screw to labor reform, to include the single contract that will theoretically bridge the growing gap between temporary and permanent employees, an obvious obstacle to productivity gains: businesses have no incentive to train temporary workers and thus improve innovation and productivity.

"Legal changes are a necessary condition; without them, I predict another bubble in another sector that largely employs low-skilled workers," says Dolado, who compares Spain with Finland. Both countries had financing problems in the 1990s, and membership in the EU opened up the cheap credit tap for both.

Companies are using lower wages to self-finance and reduce debt levels"

"We invested in bricks and mortar, while they invested in activities that create added value, because they have a flexible labor model and a great education system in the first levels of schooling," he notes.

Wage devaluation to boost foreign sales

Barring a new European solution to debt repayment, increased demand by countries like Germany, or a decision by the ECB to allow inflation to make repayment easier, then most experts agree that the road to lower debt is steep and full of potholes.

"We need to follow the path of internal devaluation, lower labor costs and increased exports. It will be slow going, and there will be much suffering," warns Maudos.

During the boom years, Spain's imports far exceeded its exports, resulting in a foreign trade deficit of around 10 percent of GDP. In order to reduce foreign debt, even if very progressively, "we need to produce and sell more commerciable goods abroad," says the scholar Javier Andr¨¦s.

Even though labor costs were high and productivity low, Spanish export companies maintained their international market share thanks to competitive factors like design, management and trade aperture, which had less to do with prices.

The collapse of imports has improved the trade balance, but in order to rein in debt the economy needs to be reoriented toward exports in a much more decided manner. The shortcut favored by the government is wage devaluation. "In order to compete in prices, either salaries are adjusted or business margins are adjusted, or both," says Javier Andr¨¦s.

The Valencia University professor underlines that "there's starting to be a wage drop," as reflected in the national accounting data, but business margins are not dropping. "In many cases companies are using it to self-finance and reduce their debt levels," says Javier Andr¨¦s. The result is an uneven adjustment whose cost workers are taking on alone. "It should be an orderly adjustment, coordinated by the unions," adds Andr¨¦s. This adjustment will have a negative impact on consumption that could ultimately cancel out the progress in the foreign sector.

Refloating public finances

"The best way to ease the impact on demand, and to encourage businesses to focus on foreign sales, is through the tax system," says Andr¨¦s. "Revenues have collapsed, fiscal reform is the great pending reform," says Maudos.

The property crash wiped out tax revenues that had allowed the Spanish state to achieve its first surplus in democratic history. But since 2008, the rise in recession-associated expenses (more unemployment benefits, higher borrowing costs) and, in the last year, the financial bailout of banks, has all kept the public deficit at close to 10 percent of GDP. Meanwhile, revenues have barely recovered, even though over the last two years the government has approved the greatest tax hikes in Spain's democratic history.

The tax agency's figures show why fiscal hikes have failed to reach their goal: taxable income, which grew from 800 billion euros in 2000 to 1.3 trillion in 2007, has kept falling with the crisis. The recession will this year keep taxable income barely above a trillion.

More inequality, less welfare

"It will be a comprehensive reform to achieve a fair tax system," said Deputy Prime Minister Soraya S¨¢enz de Santamar¨ªa after being asked about the fiscal reform demanded by the European Commission.

But it remains to be seen whether the new system will serve to temper growing inequality. What is already obvious is that social marginalization will be one result of this lost decade. Again, statistics and forecasts barely serve to sketch out an emerging reality. In 2011, the index that measures income differences among citizens of a country placed Spain as the most unequal country in the euro zone. If we look at the relation between the 20 percent of highest earners and the 20 percent of lowest earners, then Spain has the largest income gap in the EU. And according to a network of non-profits headed by Oxfam, up to 18 million Spaniards will be at risk of social marginalization within a decade.

"After the last great crisis, during the democratic transition, there was an agreement to increase public spending and create the welfare state. Now that is being cut back, and poverty rates are growing," says Com¨ªn. "If history teaches us anything, it is that the most recent depressions did not stop at deterioration of the economic activity. Nobody gets out of one without intense social and political conflict."