What Spain needs to do

By: Jaime Pozuelo-Monfort

Spain’s economy and business environment head off towards a widely accepted slowdown before the eyes of the tandem Zapatero-Solbes, who have earned the support of a majority of the population and revalidated a second four-year mandate that faces a sinking economy, a staggering inflation rate, and an increasing unemployment on the verge of a real estate bubble burst that might leave millions of low-skilled inmigrants unemployed. Solbes, now 65, is Zapatero’s most reliable and trusted asset. He agreed to continue, in spite of his age, in a country where older politicians are not as common among the political elite, as in other European countries like Italy or Germany. Zapatero is so confident in Solbes that has left up to him the decision to choose his Deputy Ministers, the so-called “Secretarios de Estado”, a task typically executed by the Premier.

Terrorism played again a role in the days prior to the last-weekend  election, as it was the case in 2004 when the terrorist massacre of March 11 awoke the people’s discontent, who in a swing en masse vote changed the course of history and appointed an unexpected Zapatero as President of the Government. Terrorism might have overshadowed one more time and to a certain extent the concerning evolution of Spain’s economy, that has observed consistent above-average growth for the last 14 years, typically beyond the 3% mark, a level considered economic-miracle in macroeconomic theory. Concerns concentrate along two different dimensions: first the economic growth model based on the increase of mortgage lending to borrowers and credit to real estate developers, that has driven the economic activity to unsustainable levels of household debt and a stock of unsold appartments, with a particular concentration along the Mediterranean cost. Second Spain suffers from a huge trade deficit, only second to that of the United States in the world. Both issues announce a strong correction that might sink Spanish economy in a cycle of economic stagnation similar to that of Japan in the 1990s or Germany in the post-unification years.

Concerns along the issue of a new model of economic growth are shared by some of Spain’s best economists. Emilio Ontiveros, President of AFI, Spain’s finest financial consultancy, argues in favor of the current economic model as long as Spain’s main competitors for unskilled labor in North Africa are perceived as insecure by other European counterparties. Jaime Garcia-Legaz, President of FAES, a right-wing think-tank founded by ex Premier Aznar comments that “we are about to experience and likely lasting crisis”. Garcia-Legaz states that credit restriction at the increasing cost of financing translates into a strong restriction on aggregate demand and consumption. Joaquin Almunia, EU’s Commissioner of Economic Affairs points out that there is a limit to the borrowing capacity of the domestic agents, and adds that “the construction sector seems to be oversized in comparison with both the Eurozone and the historical average in Spain, and an adjustment of the sector towards a size more in line with demographic determinants has started recently.”

A mean-reversion pull towards historical averages is likely to moderate or freeze real estate inflation. As opposed to the United States, Spaniards do not borrow second-liens for consumption and aggregate demand is not likely to suffer based on the decrease in the appreciation of real estate. In a country where most people buy real estate to hold, the stock of unsold appartments that concentrates on the Mediterranean coast impacts real estate developers that have diversified their customer base extensively promoting and selling in Britain and Germany. Britons and Germans who have historically purchased real estate and relocated to Spain as a cheaper destination where their hard-earned pounds and euros are worth more in terms of purchasing power, are now looking to Eastern Europe as an investing destination. So are Spanish real estate companies, that now owe more money in debt than the value of their market capitalization in the stock market, that has performed poorly since the beginning of 2008. Zapatero created a Ministry of Housing in 2004 as a way to cope with and eventually halt real estate inflation, creating a stock of subsidized housing that would enable the worse off to fulfil their dream of owning a house. Zapatero’s most unpopular and ineffective Minister during the first four years was for many the Minister of Housing, Maria Antonia Trujillo, whose interventionist policies were largely ineffective and could not stop market forces of supply and demand that continued pushing appartment prices upward in a two-digit growth that continued until 2007. Trujillo was substituted by Carmen Chacon, the youngest female Minister in Spain’s history. Chacon faces a difficult scenario that fails to grant younger Spaniards to afford buying an appartment. In the meantime the so-called mileuristas (Spaniards making a thousand euros per month) have to buy appartments in couples, devote up to 70% of their incomes to the monthly mortgage payments, and undertake 50-year pay back periods to lessen the price of their monthly obligations.

A majority of international experts have been warning about the likelihood of a sudden correction, advice that has been undermined and underestimated by Spanish realtors, politicians, bankers and investors, because almost every one has stake in this game called real estate appreciation. In a move that announced the end of the cycle Spanish banks Santander and BBVA sold their entire real estate portfolio late in 2007, an action that signaled the insight information Botin and Gonzalez had about the sector. Spain’s model of economic growth is an unsustainable model that needs to focus on productivity, in one of the least productive countries in the Eurozone. Spaniards work on average longer than French and German, for a lower output-per-capita. The import of unskilled labor that has made Spain the second major industrialized country importing immigration, has maintained per-capita wages between 1997 and 2007 in constant dollars, which has helped lower inflation rates, in spite of the recent spikes that bring about concern among Spaniards.

Solbes commented in an interview with Financial Times Madrid correspondent Leslie Crawford that the trade deficit could be brought down gradually over the next four years. The current deficit stands at a concerning 10% of GDP and has been financed by European investors, who have diminished their investment in-flows into Spain’s sunny regions. The belonging to the Eurozone hedges Spain against currency risk and currency depreciation. The years of cheap credit are over and real estate companies are finding more expensive financing terms in the markets, that makes interest payments on their outstanding debt higher, decreases net profits and drags stock prices down. Spain becomes a less attractive marketplace for its historically best performers in the stock market and leaves international investors subject to deinvestment and reconsideration of other more profitable sectors, like banking and energy.

The Socialist renewal of their political mandate announces the consolidation of the energy and banking sectors. The first three years of Zapatero from 2004-2007 showed a fierce competition between Miguel Sebastian, former Chief Economic Advisor of Zapatero, and Solbes. Sebastian’s advice, in favor of cross-regional mergers that aimed at the consolidatoin of national champions in the utility sector, proved interventionist and was opposed by Endesa’s former Chief Executive Officer Pizarro, now with the Popular Party. Sebastian resigned to become candidate to mayor of Madrid, an election he lost against the Popular, well-liked mayor of Madrid Alberto Ruiz-Gallardon, to then return to Universidad Complutense as Economics Professor. The new Chief Economic Advisor of Zapatero is less likely to enter in any fights with Solbes, whose own ruling of the economy might prove more independent and less interventionist. The Socialists are likely to support mergers that keep Iberdrola in national hands, perhaps in combination with some of the construction groups such as ACS or Ferrovial. Spain is more likely to open its banking industry to foreign banks. Santander’s international expansion might trigger the sale of Bankinter and Banesto, headed by Emilio Botin’s brother Jaime Botin and Emilio Botin’s daughter Ana Patricia Botin. Ana Patricia, a graduate of Harvard, is the likely succesor of Botin as CEO of Santander, a bank that has surpassed Citigroup in market capitalisation only last week.

Overall the Spanish economy faces real challenges that will have to be confronted with creative economic policy aimed at the increase in research and development, the improvement of its educational system, the creation of clusters in industries where Spanish companies have proven a competitive advantage over its European counterparties (such as renewable energy, banking, construction or infrastructure management), and a dynamization of the economy through a larger allocation of public spending to infrastructure building and an increase in the supply of public employment.

 

This article was orginated posted on www.5spaniards.com

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