Chewing Gum And Chicken Wire Will Not Be Enough To Save Spain - Part 2 Featured
In part 2 of this exclusive interview, Edward Hugh cuts through the political obfuscation to explain the latest developments in the economic crisis and the possible consequences.
Editor's note: Edward is a respected macro economist whose focus is on the effects of democratic changes on economies. He is regularly quoted in international publications such as the Financial Times, the New York Times, the Wall Street Journal and Time magazine. Edward has spoken to BcnIn before including this in-depth look at the crisis from November 2011. He contributes to a number of economics blogs as well as overseeing a lively Facebook community page which you can find here.
For part 1 of this interview click here.
Despite the measures announced in the budget, markets still seem to lack confidence in Rajoy's ability to carry them out. What, if anything, should he be doing differently?
Mariano Rajoy's leadership is obviously wobbling. This was always coming, but I hadn't seen it coming so quickly. But then I hadn't forseen the mediocrity of the present Spanish administration, and the difficulty they would have speaking with one voice. Manuel Arias Maldonado, politics professor at the University of Málaga, summed the situation up in a quote in a Financial Times article last Friday, "There's no single voice explaining clearly to the citizens what's going on," he told Spain correspondent Victor Mallet, "I think Rajoy lacks the qualities needed for this job -- to be self-possessed and clear, and to transmit the confidence that is needed now."
Basically this administration has easily excelled the last one in its ability to contradict itself. Perhaps the best recent example was Jaime Garcia-Lehaz, Secretary of State at the Economy Ministry calling for ECB intervention with bond purchases almost exactly the same time as Mariano Rajoy was in Poland arguing that Spain could manage on its own. "Talking about a rescue makes no sense", he told his audience, "Spain is not going to be rescued, Spain can't be rescued. There's no intention, and no need and so Spain will not be rescued."
The bickering between PP aparatchick and Finance Minister Cristobal and the far more independent Luis de Guindos has been constant, and the big fear investors have is that the Economy Minister is not able to carry through the sort of financial reform he must be able to see Spain needs due to his being overruled by the Finance Minister. Also, members of the PP are evident stakeholders in the troubled savings bank Bankia, and again it is not clear that Rodrigo Rato doesn't pack more clout than de Guindos via his direct acces to Prime Minister Rajoy. So the worry is not only that the financial reform may be bothched, but that it may be botched to suit the needs of one particular interest group. The different treatment meeted out to Novacaixagalicia which is based in the PP stronghold of Galicia when compared with equivalents in Catalonia or Valencia only adds to the doubts.
Again arguing in public about the actual size of last years deficit didn't help. But surely the turning point came when Mariano Rajoy went to Brussels to give press conference asserting his country's sovereignty and his ability to decide his country's budget for himself. The irony, of course, was that was in the EU capital to sign an agreement for greater cooperation between Euro Area member states, and he completely omitted to inform his peers of his intentions, thus highlighting the ineffectiveness of the measures being agreed to. The end result was to put in question both his abilities and judgement and the capacity of his country to fulfil its deficit targets. Since that day he has been fighting hard to recover lost ground.
To what extent to you think Spanish decentralisation is responsible for the deficit situation?
Well obviously everyone has their favourite unnecessary airport story, so it is clear there was massive and irresponsible overspending. But it is important not to get carried away with all this. In a way I don't consider either the regions or the town halls to be the big culprits here. They are victims in the same way many ordinary Spaniards are. That is to say they are the victims of their own ability to borrow and spend during the good times without thinking about the future.
But they are not the big players in the Spanish story, and the issue in Spain is mainly in the private and not the public sector. Public debt is rising uncontrollably because the economy is bust, which is very different from, say, Greece, where the economy is bust because government debt is rising uncontrollably.
On the other hand I do think the way the PP are leveraging the regions' situation is interesting, along with the growing power-elbowing inside the PP. President of the Madrid Region and Mariano Rajoy's rival for the PP leadership Esperança Aguirre was out during last week campaigning for more centralisation. Now this was not surprising, what was surprising was what she wanted to centralise -- education, health and justice. What she didn't want to do was abolish 15 of the 17 regional parliaments. The UK has a decentralised health service without so many parliaments, and it seems strange to me that someone wants to leave the parliaments and centralise health. Does anyone else smell a political agenda being advanced here?
Same thing goes for many of Finamce Minister Montoro's proposals. Most of them are perfectly reasonable as techniques for getting spending in hand, but in sum total they do mean the average Spaniard is going to be much more controlled. We are even hearing that demonstrators against cuts could be considered "low level terrorists". I am worried about where all this is leading, especially if Spain eventually has to default on its debts.
Spain's regions have a spending problem due to the competences they have -- like heath, education and care of the elderly -- which account for over 50% of their budgets. It isn't simply a question of them being spendthrift in these areas, but rather it is Spain's demography that is working against them. A growing elderly dependent population -- ten years from now Spain could be the oldest country on the planet -- means the health budget rises every year just to offer the same level of care, while the recent influx of immigrants pushed up the birth rate and lead to more demand for education. This latter phenomenon, while being one of the keys to the solution in the long run, only adds to the country's problems in the short term since the dependent population is rising at both ends. The crisis has reversed the birth trend, and new intake at the infant level fell last year for the first time in a decade, but it will still be another decade before the knock-on effect works its way through. Leads and lags in demography are much longer than in normal economics.
So the problem is not the regional structure -- arguably this is a much better way to organise service provision -- but entitlement at the national level, which is derived through rights guaranteed via the country's constitution. Central government passes laws, which underfunded regions then have to pay to implement. Take the new Care Law, which S&Ps warned in 2010 would lead to growing pressure on regional finances. This provides entitlement to assistance in the care of an elderly dependent relative or disabled person, it provides entitlement but it does not provide funding, which the regions have to find from their already overstrained budgets.
Spaniards have been lead to expect world class health care, and while this was possible during the boom years, it isn't now, given the economic slump and the growing demographic headwinds. Getting regional spending under control isn't so hard, and indeed measures are now being put in place which can make this job a lot easier.
But someone has to tell Spain's voters that their pensions, health support and aid for their elderly relative is going to be reduced, and since no one has the courage to come forward and do this we have the "regional issue" on the table.
What is preoccupying here is that under the guise of economic reform Spain's hard right -- lead by Esperança Aguirre but aided and abetted by former Prime Minister José Maria Aznar -- may well be seeking to force the country's evolving plurality back into one common identitarian mould based on marriage, heterosexuality, motherhood and speaking Castillian Spanish. Of course, there is nothing wrong with being married, or being a mum (far from it, Spain needs more of them) and certainly not with speaking Spanish, what is wrong is to try to force everyone into the same compressed identity. Such a move may win votes, but it surely won't aid economic recovery.
According to PWC, Q1 business bankruptcies in Spain are up 21% on the same period in 2011. Unemployment continues to rise, as does the emigration rate for young and qualified people. Do you think the case for austerity measures has been made and generally accepted in Spain or are they still (correctly or incorrectly) perceived as an external sanction? And indeed, does public sentiment really have any bearing at all on the situation?
I think austerity and why it is necessary is largely misunderstood in Spain. No one likes pain, and it is nice to think that there is a way out of all this that is relatively painless. The fact that the insistence on austerity comes from Germany only adds to the problem, since it only serves to highlight a religious fault line that has long divided Europe.
Part of the problem is that this situation has all become so complex that it is hard for people to understand. There are arguments and countearguments -- would, for example, Eurobonds help? Some say they would, while other experts are totally against them. The dividing line between political opinion and technical expertise has become totally blurred. The layman or woman has no way of making a decision over many of the issues presented. What we do know, however, is that popular sentiment will eventually tire of making sacrifices and seeing no progress. This is another factor which makes me fear demagogic outcomes.
The situation in the United States is often contrasted with that in Europe, but it is far from clear that the US economy has actually recovered. This is an election year, and double digit deficits are still permitted, but what about next year? Somehow I doubt even the United States will be able to avoid its own share of austerity.
The recent general strike was understandable on the one hand -- people are feeling frustrated, and sense that austerity alone won't work -- but on the other the idea that the answer is more government spending also isn't too convincing. Japan has had expansionary fiscal policy for over a decade now, we have seen little in the way of economic recovery there, but we have seen a huge explosion in government debt. Is that an advisable path to go down? Is Japan stable in the longer run? There are too many questions lurking here to buy the simplistic solutions. Once you strip the anti-austerity arguments down, they are based on an idealisation of the US and Japanese experiences.
Your assessment in November was that the three likely outcomes of the crisis would be a common European fiscal treasury, a divided Eurozone or a disorderly collapse of the whole system. Are these still your predictions and, if so, which do you now consider most likely?
Well, my opinions here haven't changed that much. I think there are no perfect solutions; we are in the midst of a huge demographic transition which compounds the debt crisis due to its impact on population pyramids and on what is sustainable and stable in terms of public spending. We could do much better than we are. A common fiscal treasury and joint and several Eurobonds alone won't work due to the existence of the competitiveness and growth problem. A structural change in the Eurozone is needed -- dividing the Euro in two, for example.
But while the attitude to Eurobonds could change following elections in France and Germany this year and next, I am not optimistic that the changes will move fast enough and deep enough to bring relief. I think democracy is coming under threat along the periphery as people become steadily more and more frustrated and search for alternative "unorthodox" policies. The crisis in Greece is still far from over, so I think, as I argued in the essay I submitted to the Wolfson prize, that unfortuately disorderly disintegration is all too possible, indeed I consider this outcome more probable now than the last time we spoke. Naturally this does not make me happy at all, but this is where we are. As Paul Krugman said in a New York Times Op-ed this week, "The question then was whether this brave and effective action (the ECB LTROs) would be the start of a broader rethink, whether European leaders would use the breathing space the bank had created to reconsider the policies that brought matters to a head in the first place. But they didn't. Instead, they doubled down on their failed policies and ideas. And it's getting harder and harder to believe that anything will get them to change course".
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