Unproductive Spain

The question of productivity has never been seriously addressed in Spain - not when the economy was miraculously booming and not even now when the country is facing record levels of unemployment, a lack of public funds, and financial markets still prone to hitting the panic button. The need to improve productivity is constantly mentioned in speeches and articles, and efforts are made to analyze it, but this key element of competitiveness is among Europe's worst, and Spain's businesses have little idea, other than reducing wages yet further, on how to improve it.

"Productivity is very important, but people don't find the topic sexy," says Diego Com¨ªn from Harvard Business School. In 2008, that was the answer given to him by Spain's secretary of state for the economy, David Vergara, when he was asked why the issue was so rarely discussed, even though it is clear that this is the Spanish economy's biggest problem - even beyond the property crash and the financial crisis. "We asked business people about it," he explains, "and they would say that when things started to go well again, low productivity wouldn't stop them growing."

Something different is happening in Spain compared to other developed economies: its productivity figures improve during periods of decline. There is, however, a "but" - the improvement comes about due to the destruction of jobs, not by improving production processes or by increasing the value of the goods produced. Productivity by hours worked improved by around two percent in Spain between 2008 and 2012, while in the rest of the euro zone it grew by just 0.56 percent. The trend is the inverse of the previous period of growth. But the gap still remains: Spain's 31.50 euros per hour of value creation is a long way from the 37.30 euros in the rest of the single currency area.

Creating efficiency by creating greater value from resources rather than destroying them is a task that the euro zone's fourth-largest economy still has to tackle. The variable known as Total Factor Productivity (TFP) does not rely on increasing work hours or physical capital. Although the numbers can change depending on the methodology, given that this means adding up heterogeneous concepts, the trend is obstinate, and it even worsened during the boom years. Between 2000 and 2005, productivity shrank by 0.8 percent on average, according to the calculations by economists Juan Jos¨¦ Dolado and Samuel Bentolilla. The Valencian Institute of Economic Research (IVIE), says that between 2005 and 2009, productivity fell slightly, recovering only in 2010, largely driven by the fall in hours worked.

Productivity is very important, but people don't find the topic sexy"

"Improved competitiveness is based on three things: the exchange rate, salaries, and productivity. Spain cannot do anything about the first, and neither would it help much anyway, because just about everything it produces is sold within the EU. Salaries have also been cut, a policy that solves nothing in the long term, meaning that the biggest problem remains productivity," says Com¨ªn.

Salaries have fallen by 7.1 percent in real terms since 2010, and the decline continues: in the first quarter of this year, labor costs in Spain fell by 0.7 percent, while they rose in the euro zone by 1.6 percent overall, and in Germany by 3.9 percent, according to the research department at La Caixa savings bank. "Lower wages, one of the ingredients required by the economy to improve competitiveness, is ongoing. But this needs to be matched by improvements in competitiveness that do not depend on price: in better products and in more efficient production processes," says La Caixa.

A report about Spanish competitiveness from earlier this year, which was compiled by consultants PwC on behalf of German electronics giant Siemens, contains the same message: "Salary costs per employee are significantly lower in Spain than in the 15-member core of the EU," it says. "But they are expensive in comparison with Asia and eastern Europe." Labor costs will always be a factor in competitiveness, but PwC says that they are "not a differential that Spain can use as a competitive advantage in becoming an industrial location over other countries."

This is the same advice Spain was being given more than two decades ago, after the Berlin Wall came down: that the country needed to move toward creating an economy based on skills and that is less dependent on low wages. Since then, India and China have emerged as major economic powers, their dominance built in large part on low wages. In the meantime, there has been a property bubble and the country is now in the midst of its worst recession in decades. What's more, there is no sign of a new productive model anywhere on the horizon, or talk of how to create it: instead, the country is still getting excited about projects such as the Eurovegas casino in Madrid, while Spain continues to perform even worse in terms of creating added value.

The country is still getting excited about projects such as the Eurovegas casino

Spain's low productivity is in large part explained by the dominant role of construction and services in the Spanish economy. But it's not the only factor, says PwC: "Spain has low productivity and has underinvested in R+D, which holds back competitiveness. Overcoming this would add two percentage points to GDP." Investment in new machinery has fallen by between 35 percent and 70 percent between 2000 and 2011 in most sectors of the economy. Spanish industry invests an average of 0.84 percent of the value of production in R+D; in the EU's core-15, that figure is above 1.5 percent.

"Salaries have never been the real reason for low productivity," says Com¨ªn. The OECD says that the purchasing power of the average wage earner fell by four percent between 1995 and 2005 in Spain.

Economist C¨¦sar Molinas highlights the key role of the internal devaluation, along the lines of the German economy. "Labor costs in Germany have fallen significantly, and inequality has increased. The country also needs more and better physical and human capital. We should make our own things," he says. "The root of the problem of productivity is lack of entrepreneurship, although this is changing with the crisis," he adds.

In Germany, when the economy shrank by five percent in 2009, there was very little impact on unemployment; the result largely of a productive fabric that is less dependent on intensive labor practices. "This isn't even about creating new technologies, because very few countries are able to do that," says Com¨ªn. What is needed is to rapidly adopt new technologies that improve productivity and quality. This is what really sets the wealthy countries apart," he adds. "The problem is a lack of human capital trained to work with new technologies, as well as not enough sophisticated small- and medium-sized companies."

Spain's low productivity is partly explained by the role of construction

Spain has also failed to take advantage of the vast accumulation of capital that took place during the boom years. A study by the IVIE and Spanish lender BBVA shows that up until 2007, the accumulation of capital in Spain's economy grew rapidly for 13 years, with levels above four percent some years. That said, the report warns of the need to "improve the productivity of capital by changing its composition and avoid the current infra-utilization."

Jordi Gual, La Caixa's chief economist, adds that there has been investment in R+D and higher education, "but the evidence shows that this investment effort, which has improved in relation to the rest of the EU, has not borne fruit: there is no other way to explain the overall reverse."

Gual continues: "Public sector institutions, in particular, have taken decisions that have produced little, in fact often leading to great efforts that have produced little. The time has come to think about implementing major changes, through the government, that would help better channel the country's efforts to improve education, R+D and infrastructure."

Spain is not the only country where people don't want to talk about productivity. Earlier this year the Davos Forum raised the issue as part of its global ranking on competitiveness by warning that "in Europe, efforts to resolve the problem of public debt and to avoid the collapse of the euro zone have diverted attention away from the issue of competitiveness. The economies of Western Europe will have to continue their efforts to improve the efficiency of the markets, as well as pushing ahead with innovation, and improving financing."

The root of the problem of productivity is lack of entrepreneurship"

Davos also highlighted the growing divergence between European nations, with regards to competitiveness that refers to "significant differences," and with several countries "significantly lower in the ranking" - among them Spain, which places 35th, above Italy, Portugal and Greece, which came in 49th, 51st and 91st respectively. Brussels has also warned Spain about the reduced role of industry in its GDP, which has fallen by four percentage points over the last 12 years.

That said, Spain's exports are at record levels, a phenomenon that seemingly contradicts the bad news emerging about competitiveness. The reality is that there is a huge breach between big companies that invest in innovation and that have found overseas markets, and small and medium enterprises (SMEs), which in most cases face serious challenges.

The figures on R+D spending show this all too clearly, and have been noticed by Pascual Deidos-Pleite, the head of Siemens' industrial division. "The problem of competitiveness lies in the SMEs," he explains. "But Spain has a very competitive industrial sector, it is very innovative in the food sector, for example, and in auto manufacturing; it is Europe's second-largest maker of vehicles."

Spain may be good at making cars, but the problem is that none of those car makers are Spanish companies. There is another problem with exports: they are being used to make up for the fast-shrinking domestic market. "Companies are making a huge effort to export, mainly because they cannot sell any cars in Spain. This phenomenon has become known as deportation, rather than exportation; cars are being sold abroad sometimes at cost prices, simply to reduce losses," says C¨¦sar Molinas. On the up side, he says the knowledge acquired during the crisis about exports will be valuable once the depression lifts.

"The ability of a country to remain competitive in the long term, beyond matching salary growth with improvements in productivity, is based largely on the efficient accumulation of capital in the economy: human, physical, technological and infrastructure. Spain has deficits in human and technological capital, and the challenge it faces is in continuing with the reforms so that investors and businesses have an incentive to accumulate capital, focusing on specialization and technology, which at the end of the day is what it means to invest efficiently," says Gual.

Any discussion about the problem of Spain's limited competiveness always ends up in the same place: education and the need for improved training and skills development, adapted to the needs of the economy. The problem is that right now, growing numbers of engineers and scientists are leaving to work abroad, having failed to find a job here in Spain. It's a vicious circle. And along with productivity and competitiveness, training and skills development are not exactly among the sexiest topics either.