Will Spain continue to outperform the EU?

By: Matilde Mas, Universitat de Valéncia and Ivie

Since joining the European Union in 1986, the performance of the Spanish economy has been quite remarkable. Spain is an example for new entrants of what a nation can accomplish in only two decades of continued high growth performance. Starting well behind, Spain has literally converged in real terms with the average of the EU and very soon its per capita income will be above the average. Can Spain continue to marvel or will the engines of growth finally run out of gas?

 

Many experts pointed out some of the weaknesses of the recent growth process. Spain’s economic growth is based  - almost exclusively - on the additional use of labour with almost no role for productivity increases. Critics warn that this process is not sustainable in the forthcoming years. A radical change in the sources of growth would be required if this growth performance is to continue in the future.

 

Some caveats are appropriate here:

• The current harsh criticism seems to ignore how poor Spain was at its point of departure twenty years ago. The large presence of the primary sector, the low level of labour qualification, the low participation rate of women in the labour market, and the extremely high unemployment rates are still present in today’s Spanish economy;

• Both the accumulation of physical capital and the rapid improvements in labour quality played an important role as sources of growth;

• Industry specialization and not poor companies’ performance were behind the low productivity growth figures;

• The construction and -to a lesser degree- the tourist sectors should neither be blamed nor credited for being a driving force behind Spain’s growth performance. But any gradual change in industry specialization that would raise the role of the knowledge economy as well as those other sectors of fast rising demand is welcome;

• The current high level of capitalization of Spanish firms should be an opportunity and not a burden for switching gradually into new models of growth. More dynamism in industries with higher technological content and value added, more private effort on R&D investment, and a slower pace of employment creation would be part of the new model. Spain’s economic growth would become more intensive and less extensive, with better rather than simply more employment.

 

Spain’s performance in the past

Fortunately, the recent (March 2007) launch of the EU KLEMS database provides us with an excellent opportunity to give support to the claims made above. This analysis puts Spain’s development process in long term perspective compared to the rest of the EU-25, USA and Japan, over a long period of time. The following comments seem suitable:

 

• In the mid-nineties, after a 20 year period of very weak employment creation, Spain did not have a labour productivity problem but an unemployment problem. Ironically, Spain’s labour productivity had been growing at a substantial pace because there was scarcely any new employment created: merely one million jobs. In contrast, since the mid nineties, Spain created 7.2 million jobs. Compared to the previous period this is seven times the former target reached in half the time span. Without any doubts this is a remarkable achievement accomplished at the cost of hardly any growth in labour and multifactor productivity. At first, we don’t think that there is necessarily a trade-off between labour creation and labour productivity (although only a few countries and over given periods of time have been successful in raising both variables simultaneously). But faced with slow growth of its trading partners especially in the EU, Spain pursued instead a growth strategy in its domestic sectors through employment creation. In this respect Spain’s path is different from the one pursued by other EU countries.

• Over the entire period Spain’s unemployment problem was aggravated by the rapidly growing supply of labour due to three main factors: the labour force expelled from the primary sector, the baby boom of the sixties and the growing rate of female participation in the labour market. Since 1970 more than two million agricultural jobs were destroyed. Almost two million people born in the sixties entered the labour force. And the women participation rate raised 18 pp from 27.8 % in 1980 to 45.8% in 2006. The three factors together (with the recent immigration process) created a glut in the labour market that has taken a decade to digest.  

• The starting point for Spain was that of an emigrating country (basically to France, Germany and Switzerland). For the last decade it has become the most preferred destination for EU (and non-EU) immigrants. Since 1995, almost 4 million foreigners have officially arrived in Spain raising their relative share in total population from 0.6% to 9.1% in 2006. 2.4 million of these immigrants are actually working so their share in total employment has gone up to 12.5% from 0.8% only ten years ago. Immigrant jobs concentrate on the following low relative labour productivity sectors: construction, hotels and restaurants, home cleaning and care for the elderly. Consequently, labour productivity is not reinforced by this process. On the contrary, it is fairly weakened.

• Not only labour supply grew at a very fast pace. The quality (education and skills) improved also very rapidly since the mid seventies. The starting point was, again, significantly lagging behind the average level of the rest of the European countries. Since then, the educational progress has been steady and very intensive, closing up a great part of the initial gap.

• Two political factors of no lesser importance should be added: the political transition from a dictatorial regime into a full democracy (1978) and the opening up of the economy -with the final EEC membership 1986- to foreign competition: foreign trade and international capital movements.

 

 

Spain’s performance in the future

Having qualified the merits of the Spanish growth process, it is now time to look at the prospects. Spain is already facing a competitiveness problem. Some of the responsible factors are the following ones: a steady and slightly higher inflation rate, a slow rate of productivity growth, a higher level of foreign competition arising from the new Member States and from other countries of the East, rising internal costs and the diminishing EU Structural and Cohesion Funds. A possible indicator of this reduction in competitiveness is the rising foreign trade deficit, actually reaching almost 9% of the GDP.  

 

Before the introduction of the euro, the national currency would have been adjusted downwards and the competitiveness would have been quickly recovered. Today, the two ways for gaining competitiveness are costs cutting and productivity improvements.

 

A great majority of experts would recognize that Spain is facing a productivity gap with its neighbouring countries. Four reasons explain mainly the poor –even negative- growth in labour productivity observed in recent years:

• First, a still highly significant presence of traditional –labour intensive- manufacturing sectors and an almost inexistent ICT producing sector characterise the Spanish economy. The role of the construction industry, with a tremendous expansion since the mid nineties, can hardly be overstated. Thus, the sectoral composition of output is the first burden for a productivity upsurge in Spain.

•  Secondly, we attribute the poor productivity performance to the service sectors, with the only exception of the “Financial Intermediation” group. The absence of national and foreign competition in particular in the distribution sector –wholesale and retail- one of the main responsible factor for the US recovery of productivity has performed poorly not only in Spain but also in almost all European countries. “Baumol´s disease” has become a “European disease”.

•   The third reason explaining Spain’s poor productivity performance has been the negative contribution of inspiration, measured by Multifactor productivity (MFP) growth. Spanish growth has relied on “transpiration” – plainly hard work – with continuous increases of the traditional factors of production. In fact, the accumulation of the production factors labour, labour skills and capital had to compensate for the persistent negative contribution of MFP. Only a few sectors have escaped from this general rule. They belong to manufacturing and are mainly ICT intensive users sectors. In the service sector, only the financial industry escaped this logic, combining labour creation with MFP growth.

•  Finally, slow ICT capital accumulation was a deterrent to productivity growth. It is true that ICT capital has grown in Spain at higher rates than Non-ICT capital. However, as shown by the EU KLEMS database, this is not specific for Spain but a general case for all countries. In fact, only four countries, Finland, Sweden, Italy and Japan showed lower growth rates.  Moreover the main difficulties do not lie only on accumulating ICT capital. It is the efficient use of the new technologies behind positive and large MFP contributions. In this respect, the negative contribution of MFP growth might be an indication of a still inefficient use of ICT assets that would require additional policy measures to foster ICT capital accumulation.

 

Looking ahead, we believe that the foremost continuity of the Spanish success will require a change in the relative weight of the four classical components of output growth, namely: labour, education and skills, capital and MFP. The needed shift will imply: the maintenance of the capital accumulation rate but giving priority to ICT capital; a slowdown in the intensity of the contributions made by the quantity of labour while allowing for increases in quality, and finally, a much bigger role for the improvements in MFP. However, this would require a structural change in the industry composition of Spanish output, giving way to a much higher presence of high tech sectors at the expense of the weights of the construction and some of the more labour intensive/low value added service industries. In Spain, as in many other European countries, productivity improvements in service industries are clearly needed if closing gap with the US in the evolution of total productivity is going to be a national target for the next decade.

 

 

 

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