06 August 2013

VP Rehn's blog: Can Spain achieve what Ireland and Latvia did?

Rehn writes that the most recent data provided by forward-looking economic indicators point to an improved outlook for Spain. He endorses the IMF's simulation of a broad-based 'social agreement' to lower unemployment.

According to last week’s IMF staff report on Spain, the trade balance adjusted from a deficit of 6 per cent of GDP in 2008 to a surplus of 1 per cent in 2012. As Spain needs to run surpluses over the medium-term to cover its large external debt, import volumes have also fallen. The Spanish export sector has been standing well over time, even though wages in Spain have responded only partially and with a lag. Over the past years, the lack of flexibility and the marked duality in the labour market translated into large employment losses in the economy.

As the Spanish economy needs to reallocate its resources from the non-tradable sectors to more productive uses, we can take a cautiously positive note of recent figures that indicate a better trend in job creation. No doubt this trend may reflect in part a seasonal pattern, related to Spain’s relatively competitive tourism industry, but it could mark the long-awaited turning point.

The momentum to reform, to improve the functioning of the labour market, should be maintained. Social partners traditionally have a central role in Europe. Overcoming the duality between permanent and temporary contracts and giving young people more opportunities are the tasks and responsibility for all the stakeholders involved. IMF staff recently provided a simulation of a broad-based ’social agreement’ between the employers and trade unions on an internal devaluation: employment increases (and price cuts) in return for unions agreeing to significant further wage moderation. Such a rise in employment and lower inflation would boost consumption growth already in the second year.

The comments by authorities that are presented in the IMF report are sceptical as regards the chances of success of such a broad-based social agreement. But a strong sense of political responsibility has been key for the success stories of Ireland and Latvia in terms of economic reform and internal devaluation. The pundits in the eurosceptical commentariat and media have been telling us that this is simply impossible in the light of economic history, due to the money illusion and sticky wages. But if we had trusted them and followed their advice, the euro would have broken up already some years ago.

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