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Rajoy’s Plan for Spain: Conviction or Necessity?

December 28, 2011

The election of Spain’s new President of Government, Mariano Rajoy, has produced quite a few expectations. His plan seems to go against the tide on some focal points regarding the problems of the European Crisis. Rajoy’s government has been described as the only government in Europe that will not increase taxes to cut the budget deficit. Rajoy summarized his plan in the following 10 points:

  1. More dialogue and transparency.
  2. Deficit reduction.
  3. Financial re-structuring.
  4. Administrative reform.
  5. Pension’s adjustments.
  6. Labor markets reform.
  7. Fiscal measures.
  8. A new model for energy and tourism.
  9. Agriculture and environment.
  10. Education reform.

The first reaction to Rajoy’s points noted the absence of details. The most important announcement was the commitment to reduce deficit to a 4.4% of GDP (16.500 million Euros). But no details on how this will be achieved are known. The ten points, in addition, do not send a clear message of what is going to occur. For instance, financial re-structuring, fiscal measures, and labor markets reform can all mean more or less government intervention.

  1. By “dialogue and transparency,” Rajoy seems to mean nothing more than easier access to public information, and to call things by their names, even if that hurts. It is not at all clear, however, when the new Economic Minister talks about “negative growth” rather than “recession” for the coming quarters in Spain.
  2. “Deficit reduction” was the point that brought most attention. The long-term plan is to take Spain’s debt/GDP to 60% by the year 2020 with a structural deficit of 0.4%. This, of course, does not provide details on how the budget target will be met in 2012.
  3. With the financial re-structuring, financial entities will have to revise their balances for assets mis-priced, as well as achieve higher capital requirements to ensure solvency. Solvency, however, is not just a problem of capital requirements (banks lending too much), but of the quality of the lending as well. An expansionary monetary policy produces at least two effects: (1) lending to unprofitable projects at the equilibrium market rate and (2) lending to more risky ventures (i.e. the sub-prime crisis). If Rajoy wants to ensure the solvency of the financial markets, then he needs to look at the effects of monetary policy by central banks, rather than trying to tell the banks how to run their business.
  4. The “administrative reform” should identify and reduce the duplication of functions among public entities. In addition, with the exception of the military and police forces, there will be no replacement of headcounts in the public administration when a vacancy opens.
  5. “Pensions” are the only expenditure that Rajoy said he is willing to increase by inflation adjustment.
  6. Also without many details, the “labor markets reform” seems to imply more flexibility on labor negotiation. A new geographical and sectorial scope to optimize economic performance should be in place after the reform. The idea of this reform is to allow for a better and faster negotiation according to the particularities of the geographical area or sector. Whether or not the unions will be on board with this reform can affect the extent of the reform and the recovery in Spain’s unemployment rate, the largest in Europe. Also, the reform will try to avoid the use of unemployment benefits as a pre-retirement benefit.
  7. The new “fiscal measures” should benefit new firms by reducing the tax-cost of hiring the first employee, or reforming the VAT tax so that the tax payment should be done, not after the sale of a product, but once the firm has actually cashed-in.
  8. Spain has one of the highest energy costs. This, Rajoy says, should be improved. But no clear identification of why this is the case and how the energy costs will be reduced is clear yet. Is energy expensive due to taxation or due to real factors? Is this cost going to be reduced through more competition or through subsidies?
  9. The Ministry of Agriculture will be reopened. Fishing regulatory framework, for instance, was mentioned as an area that requires revision. Of course, the new ministry will take proper care of the environment.
  10. Without extensive details, there will be education reform that will revise the bachelor format and include the study of a secondary language (English) in the program.

The 10 points may play the role of showing conviction and reducing uncertainty, but the lack of details is where the biggest doubts take gain footing; it is in the details where things can go for better or for worse. The lack of information on how Rajoy plans to achieve the 4.4% deficit in 2012 contributes to the skepticism as to whether this number will be met, especially if 2011’s deficit is higher than expected.

Surely most of these reforms are needed, but are they the result of conviction or necessity? Since the Great Depression and the rise of Keynesian economics, the idea that spending can help to boost the economy has resulted in an increase of government spending as a part of GDP.  Is Spain convinced that the required reforms are in the opposite direction, or is necessity what drives this plan? Will Spain stick to this course of government spending reduction, or will this be revised as soon as the economy starts to recover? When Argentina, after the hyperinflation of 1980’s,, dollarized its economy, cut government spending, and privatized public companies, there was no conviction, but also no other way around. During the 1990s government spending started to increase again, though rather than being paid with inflation it was paid with foreign debt. If conviction was the driver of the reforms in the early 90’s, then fiscal deficits would been under control; it was the financial means, not the underlying behavior, that changed. Spain presents the same question.  Is this message that Rajoy is trying to put out, that Spain is the only European country that will reduce its deficit by cutting expenditure rather than increasing taxes, conviction or necessity?

Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.

image: Stuart Miles/ FreeDigitalPhotos.net