Reasons to be bullish about Spain

<p><em>Viv Davies interviews Albert Marcet for Vox</em></p>
<p><em>February 2011</em></p>
<p><em>Transcription of a VoxEU audio interview [http://www.voxeu.org/index.php?q=node/6170]</em><b><br />
</b></p>
<p><b>Viv Davies</b>: &nbsp;Hello and welcome to Vox talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from the Center for Economic Policy Research. It's the 25th of February, 2011 and I'm speaking to Professor Albert Marcet of the London School of Economics about why he considers recent predictions by the media and many economists of possible Spanish sovereign default, are misguided. Professor Marcet discusses his view of Spain's fiscal sustainability, its unemployment and housing problems and the re‑capitalization of the cajas. He also discusses debt and fiscal coordination in the Euro zone.</p>
<p>I began the interview by asking Professor Marcet to explain why he was of the opinion that much of what is currently written about Spain falls a long way short of the real picture.</p>
<p><b>Albert Marcet</b>: &nbsp;There's been a lot of confusion about how bad the situation is in Spain in the last year, since April or May. And that certainly in the Spanish economy there are some challenges. But I don't see how they are bigger than the challenges of almost any European Union country. I think Spain is pretty average and that the price of CDSs, the sovereign spread, seem to indicate a danger which I don't, I just don't see. There's a number of problems that have been pointed out. So over the course of the last year there's been, the story has been changing. First it was fiscal policy was supposed to be unsustainable. Then it was Social Security. Then it was the deficit. Then it was regional government. And now it's the private banks.</p>
<p>So yeah, so all of these are issues. But I just don't see how they are worse than in many other European countries. And obviously Spain's debt is one of the lowest. Yes the deficit was very high in 2009 but it's coming down very quickly, the government deficit.</p>
<p>The autonomous regions, yeah some of them have a large deficit. But you have to realize, first of all, the autonomous regions, their total debt is 10 percent of GDP. 10 percent of GDP, that's what it is.</p>
<p>The other issue with Spanish autonomies is that they cannot issue debt unless the central government allows them. So it's legally it's much easier for Spanish government to control a regional entity that's not working, that has been spending too much. While in the US, you know, let's talk about California, states are much harder to control from, basically impossible to control from the central government. Sure there are issues but I don't see how they are worse than in many other countries.</p>
<p><b>Viv</b>: &nbsp;What about unemployment? I think no one could deny that severe unemployment is a major problem and concern in Spain. What's your view on what Spain should be doing about its unemployment situation?</p>
<p><b>Albert</b>: &nbsp;Unemployment is no doubt a very bad situation, 20 percent unemployment. For example, Andalucia which is a very large region, has 30 percent unemployment. That's certainly a concern and there's certainly policies that could be improved that would lower unemployment. Unemployment compensation could and should be done, should be given in much more conditionally. Right now there's almost no monitoring of people who get the unemployment compensation. Unemployment compensation should be for those who have been unlucky and are without a job, not for other people. And there's very little monitoring of that.</p>
<p>But the issue is do we get from that 20 percent, the idea that default is almost imminent. Well one feature of Spanish unemployment that is fairly well known is that there is this dual market. There's a very large part of the jobs that are with six-month-long contracts which are very easy to start but they are not costly to stop.</p>
<p><b>Viv</b>: &nbsp;The temporary short-term contracts.</p>
<p><b>Albert</b>: &nbsp;So, yeah the severance pay is very low. They are, they can be simply discontinued because of that, which adds flexibility to the economy, OK. From a macroeconomic view you would expect unemployment to go way up during a crisis, just because you have this large flexibility. Just as you expect it to grow very quickly when things are doing well because of this. The existence of these contracts which makes it easier to start growing quickly when things are going well, but it is well known that most&mdash;a very, very disproportionate part of the recently unemployed&mdash;are coming from these six month contracts. It's not good, especially if you are in that sector of population, it's not a good situation, this dual market. But it doesn't signal any immediate default.</p>
<p>Another very simple calculation that I'm making is now, is just to look at hours worked you know. Because for output, employment doesn't matter. What matters is how many hours are worked.</p>
<p>Consciously or unconsciously what other countries are doing is they are hiding better their unemployment. They are retiring people much earlier. It's obviously very different across countries. And so the way in which unemployment is hidden in each country is very different. In some cases it's hidden through very early retirement. In some countries it's hidden through a huge part of the population with part-time, not temporary but part-time contracts.</p>
<p>But in any case if you count hours worked in Spain, it comes out more or less like many other countries. There has been a dip in 2009 but Spain doesn't come so badly off in terms of hours worked which is what counts, for output and for net revenue for these kinds of things.</p>
<p><b>Viv</b>: &nbsp;And Zapatero's recently increased the retirement age, I believe.</p>
<p><b>Albert</b>: &nbsp;I would say that for a European country, the political system is fairly aware of what it should be doing. We always complain about politicians and we should. But now there was a change in the retirement age from 65 to 67. I don't know, in France they changed it from 60 to 62 and it was a much bigger deal. So there's a lot of room for improvement but there is, you know the way the government, central government and the regional governments are reducing the deficit rapidly is a sign that some things are working well and that there is a certain reputation for doing things well.</p>
<p>And then the other thing that kind of relates perhaps more to my previous work is the fact that Spain was running a surplus or very small deficits during the 2000s. That tells me that there is a system of subsidies, spending, taxes; the whole system is much better balanced actually, than for example the UK which was growing also, but having very large, much larger deficits during the 2000s.</p>
<p>So I think in the UK, we have seen a much stronger cutback, I think, in the last two years, or I think the last year of the Labor government. Obviously with a new government the whole package of everything that has been done to increase taxes and lower spending is much more drastic than what has been done in Spain. And I think it has to be because in the last 10 years here there has been a history of higher deficits. So I'm much less worried than many people seem to be.</p>
<p><b>Viv</b>: &nbsp;You mentioned just a little earlier the autonomous regions in Spain of which there are 17, I believe,13 of which underwent elections this year. Such a composition must be a real challenge of coordination for the government in terms of meeting its budget and austerity targets. Would you agree with that?</p>
<p><b>Albert</b>: &nbsp;Sure, sure but there's several things there. One is that some of the revenue, a big part of the revenue of these regions comes from very volatile taxes. Like in Spain there's a tax on real estate transactions, like a polling tax. It's like seven percent of real estate transaction is taxed, just the whole thing. Now you can imagine that this is incredibly volatile. So it's normal with these taxes that these regions for example experience a bigger deficit when things are going badly. From a fiscal point of view it's not a bad thing that this tax is there because then other times would compensate.</p>
<p>So these big deficits over the last few years, they are something that has to be looked into because it's been probably too much generosity in some social programs or in something. But in part, it's built in the system and it should reverse when things start going well, which they will.</p>
<p>But also there's this issue that autonomous regions are very limited in their ability to issue debt. They can issue debt but if they go above, I think if they go above 1.5 percent of the GDP of the region, they need permission from the government to issue debt. Therefore they are basically forced to cut down.</p>
<p>Obviously it's not as easy as this or some region may resist, but the tools for coordination are there. And they are much, much stricter, for example, than the Growth and Stability Pact. The Growth and Stability Pact, I guess it still is valid, no?</p>
<p>So it's, if you go above three percent they send you a letter but you still keep issuing debt. If a country exceeds three percent, the enforcement of the three percent in the Growth and Stability Pact is basically nonexistent, as we have seen what happened.</p>
<p>The enforcement mechanism within Spanish regions is much stronger. So we'll see what happens. It will be interesting to see what happens but the details are very different.</p>
<p><b>Viv</b>: &nbsp;You're starting to touch on what I was going to ask you next, which is, if we scale this up, I believe some of your work recently has been on fiscal coordination within the Euro zone.</p>
<p><b>Albert</b>: &nbsp;So I've done some work on optimal, on fiscal policy when governments combat a shock so that basically if there is a shock you have to issue debt and you have to try to repay the debt in good times and issue debt in bad times. Now if you look at government in that way, you know, you look at government as a buffer stock which is a good idea to use. If we're in a recession why should we close the hospitals and the schools? No it's better to issue debt.</p>
<p>So that is a buffer stock. You should use it. It should be done. But the issue is if you allow governments to issue debt as a buffer then how do you distinguish between a government that's properly using that as a buffer from a government that's just running an unsustainable fiscal policy?</p>
<p><b>Viv</b>: &nbsp;Is there a good level of debt that a government could hold?</p>
<p><b>Albert</b>: &nbsp;There are good ways of adjusting to that which are not built-in, in the way automatic stabilizers are being set up, and it's not built-in in the way that we usually...we economists usually try to ascertain fiscal sustainability. So we usually think of measuring fiscal sustainability by looking at the discounted sum by present value calculation, a permanent income hypothesis kind of calculation, and try to see if the discounted sum of surpluses discounted at the appropriate interest rate is consistent with the current level of debt given that the current level of debt should be discounted to be equal to this discounted sum of surpluses, right?</p>
<p>So that's true. That's something you should look at, but it's not nearly enough, because when you have fluctuations in the economy, and you have debt that's being used as a buffer stock, something that a sustainable big fiscal policy should have is that it should respond to debt.</p>
<p>So it has to be taxes or unemployment subsidy or government spending. It has to be contingent on that. And in practice it is, no? I mean what we see is that when those are out of hand then governments start drastically cutting.</p>
<p>That is a bit of a dangerous way of doing it because then you have a crisis and things are done in a hurry. What should be the case is that this dependence on debt is built in the automatic stabilizers.</p>
<p>I mean it should be the case that unemployment compensation is linked to debt. And it should be the case that civil servants' wages linked to debt. Because in the end, it is, no? In the end it is.</p>
<p>Now in Spain the wage of civil servants was cut about five percent because debt and deficit were too high. Well, it was cut five percent last year, but the year before it went up by three percent. It 2009 it went up by three percent. Maybe if we would have had an automatic way of adjusting, for example, civil servant&rsquo;s wages to the level of debt, these things would be much more humane and would affect everybody in a much smoother way, and it would be clear that the fiscal policy is sustainable. It would be clear that something would be done when debt gets out of hand.</p>
<p>So I think that should be a part of the system in Europe, no, that there should be a clear statement by the individual countries that their automatic stabilizers will, and their expenses and their budget will, adjust debt before it gets out of hand.</p>
<p><b>Viv</b>: &nbsp;Coming back to Spain for a moment, the country is currently undergoing a rapid and substantial re‑capitalization of its troubled cajas, or savings banks, in an effort to restore international confidence. Are you confident that the re‑capitalization process will succeed in enabling the cajas to raise long‑term money on the finance markets?</p>
<p><b>Albert</b>: &nbsp;I'm confident that it can be done in a way that nothing major will happen. I mean I'm not an expert in banking, but it's obvious that one big difference between Spain and many other countries is that it is the smaller banks that are in trouble. The big banks are fine pretty much. And these smaller institutions they can be made to adjust in many, many ways. They can be absorbed. They could simply sell off their assets and disappear and sell their clients.</p>
<p><b>Viv</b>: &nbsp;A lot of them have merged, actually.</p>
<p><b>Albert</b>: &nbsp;It's some of what's been doing with some success. Some cases there's been a merger of two bad institutions, which is not a good idea, because then you have one bad institution. But most of the mergers have been done quite reasonably, and so there is that possibility. It will depend on the political will and it will depend on many things whether it's done successfully, but there is room for maneuver.</p>
<p>But there are lots of other countries that have big problems in Europe, have big problems with various aspects of their banks' systems. You know, there's lots.</p>
<p>But I guess compared with the U.S. What happened in the U.S. is there was very quickly in this recession, big losses that were realized very quickly throughout the banking system. And the losses are being realized very slowly in Europe. We're still waiting to see what will happen with the Spanish housing boom. We're still waiting to see what will happen with Greek debt, Irish debt. These things are still looming, and I'm sure Spanish banks, but also many other banks, will find that they have to realize some losses in the next few years.</p>
<p>And these problems that we have now with the cajas, similar problems will appear in other parts of the European banking system. And there's no reason it will be the end of anything. We've had banking crisis before. We've had these challenges and we have many tools to deal with them.</p>
<p><b>Viv</b>: &nbsp;So in your opinion despite the fact that Spain is sitting on around one and a half million homes that are yet to be sold, it's not another Ireland and heading for a sort of Irish-style meltdown?</p>
<p><b>Albert</b>: &nbsp;I think pretty much people agree that it's not heading for that. But there is a hole, no, but the size of the hole is practically much lower, and that there's much more room for maneuver. Yes, the stock of housing is a problem because again we still don't who will realize the losses. The construction sector, which used to be huge, and that was bad, is now under its normal level and well, it's also a sector that provides employment.</p>
<p>So until these houses are all finished and lost and sold, there's very little demand for new construction activity. So, yeah, it's a problem, but I don't' think it is nearly a problem as in Ireland. I think pretty much people agree on it.</p>
<p><b>Viv</b>: &nbsp;Do you think the future for Spain is best in the Euro, or do you think there's a case for being independent and being outside of the Eurozone?</p>
<p><b>Albert</b>: &nbsp;Oh, I have no doubt that it's much better to stay in the Euro. I mean you hear a lot of people saying, &quot;Well, it's a problem, because now we cannot devalue,&quot; and my opinion is, Thank God we cannot devalue. Now we really have to face the problem of why we got into this very big deficit in 2009, and we fiscal authorities had to respond and to be clear to the voters and the public about what had been done that was not right, how it had to be reversed. And it's not going to be disguised with a devaluation.</p>
<p>Another problem with devaluation is, I mean I hear American economists talking about devaluations as if they are, I mean some American economists, as if devaluations are such a great thing, and they probably never lived through a country had a huge devaluation.</p>
<p>I mean what happens when you have a big devaluation is that it's very difficult to be competitive in high‑skilled technology, because to export high‑skilled technology you need to import high‑skilled technology.</p>
<p>And you cannot do it if you just...you know devaluation makes you competitive in the low‑skilled labor products, and, if that's what we're going to do then the future is not too bright, no? The future lies in being competitive in a bunch of industries that are now developing in Spain, and for that we need that the devaluation doesn't occur.</p>
<p><b>Viv</b>: &nbsp;And more broadly, are you optimistic that the Eurozone will ride through the crisis and that the European Financial Stability facility will be successful in preventing future bailouts and potential defaults of peripheral countries?</p>
<p><b>Albert</b>: &nbsp;I think it could. So the Europeans move very slowly, you know? It has to be given the way the European Union is organized. But so far it has moved. So far it has reacted to the challenges ahead. It has created the facility. It has responded to the problems that were coming out, so I have faith that in the end people will agree to the doing the right thing. Will the Euro go through, well, it depends on the Euro staying popular in a few countries, but I think Germany, France will realize that their future also lies in the Euro.</p>
<p>And it's very difficult for Germany to be such a leader in technology, in high‑quality cars, high‑quality manufacturing if it doesn't have a stable, if it's not in a broad area with a monetary union. Small countries can&rsquo;t be leaders in technology if they are subjects to huge shocks to the exchange rate. So I think Germany has benefited and will benefit.</p>
<p><b>Viv</b>: &nbsp;One of the things that you've just taken on in fact, Albert, is the chair of the Euro Area Business Cycle Network.&nbsp;How do you see your work on business cycles fitting into your research on fiscal policy in Europe generally and what happens with the business cycle?</p>
<p><b>Albert</b>: &nbsp;Yeah. I think that a lot of work that's been done is actually very irrelevant, and it's a bit frustrating to see that so little of the actual policy discussion in Europe is relying on, let's say, serious economic thinking. There are many very good economists in Europe who have been thinking about issues like fiscal policy sustainability who are criticizing the Growth and Stability Pact for a long time because the question was what would happen at the first crisis with this Pact?</p>
<p>And I guess, again, because the policy discussions in Europe are so politicized by the discussion of what's good for each individual country, there's then little room, perhaps, for thinking about what should be done, and it's much more of a political compromise. But I would hope that all this work that's being done on fiscal policy, on how to facilitate the adjustment of different countries after the recession, that it would help in designing better policies.</p>
<p>I think we have done a lot of progress, and if the purely political discussion would leave room for it, there's a lot of interesting things to be said on how to design better fiscal policy coordination.</p>
<p><b>Viv</b>: &nbsp;Albert Marcet, thanks very much for talking to us today.</p>
<p><b>Albert</b>: &nbsp;Thanks, Viv.</p>
<p>&nbsp;</p>