The Spanish Economy is one of extremes. At one point a focus of the Eurozone Crisis, at another the largest contributor of growth, and more recently, suffering the greatest economic hit of any Advanced Economy in 2020.
Spain’s Economic problems are often confused. In the years leading up to the Great Recession it posted consistent budget surpluses.
However, a huge real estate bubble was lying in wait.
The question ... is why?
Why did Spain go from a seemingly safe level of debt to one larger than its Economy?
How was the housing bubble encouraged?
And since then, has Spain’s Economy ever truly recovered? Or in what ways?
This is Spain The Spanish economy is one of extremes. As one point a focus of the Eurozone crisis. At another the largest contributor of growth. and more recently the worst performing advanced economy in 2020. Spain’s economic problems are often misunderstood. In the years leading up to the Great Recession its government expenditure was relatively stable. However, a huge real estate bubble was lying in wait. The question... is why?
The link to which is in the description below. Now back to the video. At the end of the Spanish civil war in 1939 the nation lay in ruins. Seeing the emergence of an incredibly isolated Spain. A far cry from the country today, which routinely ranks second in the world for tourist arrivals. Because of isolation and poor policies under the early years of General Franco’s Dictatorship. Recovery and development was slow.
For example, the nation was excluded from the USs Marshall Plan for European recovery. Not reaching its pre-civil war peak in GDP per capita until 1955, Five years after most other Western economies did despite World War 2. In general, the economic policies under Franco’s rule weren’t fixed, but varied during his time in power.
However, there was a trend from self-reliance to liberalization. A key trigger of this change was a dire shortage of foreign exchange reserves by the late 1950s. A consequence of failed self-reliance and isolationism. Being a large factor in Spain’s pivot to adopting pro market policies. Through the so called plan of stabilization and liberalization Creative I know (dry humor XD) What followed was termed the Spanish economic miracle. Creating a sort of Iberian economic tiger
Costa Del Sol style!
Though make no mistake Spain was a dictatorship without the freedoms it enjoys today. An estimated three million people or about 10% of the population moved to urban areas in the 1960s With many moving abroad. Often providing valuable remittances in return. This wave of liberalization coincided with Spain joining international organizations like the GATT A predecessor of the WTO. Economic progress continued to gain pace after Franco With well-known Spanish brands starting to gain international attention . The transition to democracy also paved the way for Spain to join the EU. Or European Economic Community as it was called then in 1986.
However, it’s important to note that despite the great growth Spain’s official unemployment rate was stubbornly high in the 80s and 90s.. Now despite only joining the EU in the mid-80s Spain decided to take the plunge and be amongst the first to adopt the euro in 1999. Intending to demonstrate to the entire world not only how far it had come but how integrated and open the economy had to be. Or so people thought!
Adopting the euro was a trade-off. On the one hand, it traded in its monetary sovereignty, the ability to devalue its currency and set its own interest rate. On the other hand, trade with its neighbors became a lot easier as did paying for imports through a stronger currency. And most importantly perhaps, it gained access to cheaper credit. Whilst this was a time of great change there were a couple of striking things about this period. The flow of goods, services and the transfer of money otherwise known as the current account, took a downturn. Notably, the country already had a negative current account before adopting the euro. Though this worsened. Reaching its lowest level just before the Great Recession. Something which isn’t unusual as recessions often cause imports to drop and international credit to dry up. The massive buildup of credit was a fundamental part of Spain’s economic bubble. You see, credit became cheaper Adopting the euro led many investors to believe that the likes of Spain, Greece and Italy’s credit was as good as Germanys. With increasing demand causing interest rate differences to narrow.
However, there is a common misconception that Spain’s central government was the one doing the borrowing. This was certainly true for Greece but for Spain, this really wasn’t the case at all. Spain’s debt was low and even posted budget surpluses in the lead up to the crisis. Begging the question, who was borrowing?
Well, this was largely done by firms especially ones in construction. But, who lent them money? A large portion came from Spain’s regional savings banks through the international market. Regional economics plays a large role in Spain The country is split into 17 regions with a very high level of fiscal decentralization.
For example, a lot of tax collection, education and health expenditure, is dealt with by local and regional authorities. Likewise, Spain possessed some 45 regional savings banks before the crisis. A lot of whom had gone all in on lending money to speculative real estate. To be fair though, Spain kind of anticipated some type of debt problem when they joined the euro.
According to the EUs own official report they were the first country in the world to require banks to set aside additional money for non-performing loans in the good times. Which may sound strange in a post financial crisis world. But remember this was pre crisis Setting aside an estimated 35 billion euros something we found surprising.
So check out the link in the description below for some light bedtime reading.
However as were about to find out the money saved up was far from sufficient In the early part of the 2000s the average house price sky rocketed. Which to be fair, was a common trend in many economies But the dependency in construction led growth really set Spain apart.
For example, credit for the real estate sector far outstripped credit for the economy overall By the time the crisis hit, triggered across the Atlantic by rising mortgage defaults, Spain’s real estate debts equated to almost half of GDP. And make no mistake. Spain was heavily reliant on construction related employment. In 2007, more than 1/8 workers were employed in construction. Delivering more housing starts than Germany, France, the UK and Italy combined.
This can be attributed to three core factors The first being the cheaper credit we mentioned earlier. The second being the tax breaks and investment incentives the government gave to the real estate sector. Whilst the third, was the general economic growth model. The model favored construction activity because of the sectors labor intensive nature. Helping to drive down unemployment. Politically speaking, pro real estate policies also helped spur on higher prices.
Great news for the 80% of Spanish voters who were home owners at the time. However, just like all bubbles at some point it had to burst! From their peak, average house prices declined by 45%. Pushing many, way into negative equity. Where the value of their asset was worth less than the debt. Now as the credit dried up and panic took over the world, people started to realize that building all these houses assuming ever higher prices just didn’t make much sense.
Speculative developers who borrowed heavily quickly turned into non-performing loans. On a scale, which far exceeded the provisions we mentioned earlier. And remember, if you borrow a hundred thousand from the bank and cant repay then you have a problem but borrow a hundred million and cant repay and then the bank has a problem. And Spain’s lenders certainly did. Spain’s response can be split into two periods: the first part, involved the country trying to send its way out spending more as a percentage of GDP on stimulus than any country in Europe. Not a problem, given their low debt.
However, as the Greek crisis evolved attention quickly turned to who was next. Sure Spain started with low debt but its economic model was fundamentally flawed. Real concerns were raised over whether Spain would be able to borrow enough for long enough to get its house in order. Ultimately this led to the bailout of Spain’s banks and massive reform. With only two of the forty five savings banks we mentioned earlier escaping the crisis unchanged.
By simplifying things a lot numerous banks were merged to create one giant bad bank. Using financial wizardry to separate the bad apples from whatever was left. It’s important to highlight just how much the crisis impacted Spain’s economy. A point w discussed in much more detail in our video on Greece. A big problem, is that by being tied to the euro Spain couldn’t just depreciate its exchange rate.
It had to undertake painful structural reforms to raise competitiveness. A tough love approach which saw unemployment rise to an eye-watering one in four and millions leave in a brain drain of epic proportions. So, it’s fair to ask Well, yes and no. If you were to look at the pure stats in isolation Spain’s GDP overtook its pre-crisis peak in 2017 Not only that, but in recent years pre-2020 at least it has become an engine room of the Eurozone economy. At times accounting for more than its fair share of overall growth. A lot of this growth has been on increases in its exports. Which has grown as a share of GDP. One reason for this, is that after a decade of painful reforms average labor costs either declined or were typically lower than other larger European economies.
Though to be fair, productivity still lags some way behind. On a more positive but related note, its current account entered a surplus in 2016 for the first time since 1986. And consistently has been there since. Pointing towards a more sustainable growth trajectory. Yet at the same time it’s only fair to point out that the nation has lingering issues. Which make a full recovery less likely. One is its stubbornly high unemployment.
Which is related to how expensive it can be to hire workers. Redundancy costs are extremely high. This has led to a large number of short term temporary contracts Possessing much less job security. Because of this Spain’s historically high unemployment has been suggested to be slightly misleading. Some of the officially unemployed work or at least did before 2020 in the black market to avoid the red tape. Now, Spain’s persistent unemployment issue is also a product in part of having the highest rate of in the whole of Europe from education and training.
Helping to shine a light on its notoriously high youth unemployment. With all of these points coming to haunt the nation during the Great Lockdown. Which according to the IMF Saw Spain record the highest contraction of any advanced economy. Much of this can be of course linked to the hit to tourism. Though this loses a little bit of weight when you consider France; the most visited nation on earth. Experienced less of an impact. Crucially as mentioned earlier Spain has the highest proportion of temporary workers.
Comprising over a quarter of the work force. Whereas in France, they account for roughly sixteen percent. With the layoff of these short term workers helping to understand at least some of the difference between the two nations. What this also highlights is that the Spanish economy is still grappling with the legacy of its economic bubble and most likely will for years to come We’ve seen that Spain made incredible progress from a dictatorship to one of the largest economies in Europe. Its entry to the euro was controversial in more ways than one. Which undoubtedly influenced its housing bubble. Unlike other Mediterranean countries though Spain’s government debt was surprisingly low before the crisis.
However, its economic growth model one based on rising current account deficits and a disproportionate reliance on construction, was not. Private debts quickly became a public issue. But since undertaking reforms, its economy has improved. In some cases dramatically, yet in others not so much. We can’t help but think that Spain’s poor performance during the Great Lockdown, was at least in part a result of its unresolved problems.
The real question is whether they’re likely to be solved anytime soon. And now it’s over to you Do you think Spain suffered the world’s greatest housing bubble? Or do you think that title belongs somewhere else? To a country like Ireland which has done considerably better in recent years. What do you think lies in Spain’s future? A population crisis? Given its incredibly low fertility rate? Something we mentioned in soon many other videos.
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