Thursday, 11 February 2010

Spain keeps shrinking

Spain is much in the headlines these days. Markets worry about the PIGS (Portugal, Ireland, Greece, and Spain) not being able to meet their obligations. Paul Krugman has been pointing out that the cases are very different -- that Greece lied and cheated its way into EMU is well-known, as is the fact that its fiscal policies have been utterly irresponsible for as long as anyone can remember. Spain, on the other hand, had a surplus not that long ago, and its overall debt is still less than Germany's. The problem is not fiscal recklessness, but a massive real appreciation following EMU that left the economy largely uncompetitive on world markets. Institutions - labor market institutions in particular - are not up to dealing with this kind of problem, and the time-honored solution of the good old peseta days (devaluation) is no longer on the table. Now, news from the last quarter of 2009 shows that in contrast to almost all other OECD countries, Spain is still shrinking. I was particularly amused to see the folks over at Marketwatch reporting that
"Analysts at Capital Economics said Thursday's GDP data backs up the theory that a return to solid and unsustainable growth in Spain is unlikely anytime soon."
As typos go, this one is just wonderful. I am sure they meant sustainable, but... there is so much that was utterly unsustainable about the boom in the last 10 years that one doesn't even know where to start. Building houses that nobody wants to live in, at prices no-one is willing to pay, is my #1 on the list. It also sums up nicely the problem -- the old growth model post-1999 won't work, and there is not much of an alternative in sight. The government keeps saying R+D will pull Spain out of the crisis, but that is like Greece saying that a closer look at its national accounts show a massive surplus.
This relates to another of this week' highlights: Tim Kehoe was giving here on Tuesday, giving a talk at the Barcelona GSE about lessons from the Great Depressions of the 20th century for the Spanish financial crisis. He compared Chile to Mexico, and (not entirely surprisingly) blamed divergent fortunes on the ill tidings brought by wrong-footed government intervention in the latter. A case that is not in the book that he edited with Prescott, which I think could have provided a more appropriate analogy, is interwar Britain. Britain re-entered the gold standard in 1925 at an overvalued exchange rate, hoping that the currency regime would provide "discipline" for the last 10 percent of factor cost adjustment vis-a-vis the US. Instead, it got sub-par growth while everyone else enjoyed the roaring twenties... By Kehoe's reckoning, Spain's unit labor costs are now about 135% of their 2000 level, while Germany's are at 110%. While unions were powerful in interwar Britain, I am sure they are more powerful in Spain today. There is none of the grim determination to regain competitiveness that I saw in Germany over the last 20 years, after the reunification boom and debt orgy produced a sharp decline in competitiveness. My sense is that a lost decade or two for Spain are beginning to look more likely by the day. And who knows? When Tim Kehoe presents the Catalan edition of his book in a few years (he actually speaks Catalan), there may be a chapter in it on the Spanish depression of 2008-2018.

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