Tuesday, December 27, 2011

Things Have To Get Worse Before They Get Really Bad

It seems we were far too optimistic in believing that Mariano Rajoy would finally reveal the details of his economic programme in the parliamentary debate which led to him being formally elected as Spanish prime minister. Instead what we got is a carefully presented misrepresentation of what awaits us, with all the painful details still unrevealed. Supporters of the government will claim this is not true, with the announcement having been made of 16000 million euros in cuts in government spending. But this figure, with the nature of the cuts to be made still unspecified, is simply an unsustainable fraud.

It's true that the cuts figure represents the amount needed for Spain to hit the budget deficit target for 2012. But Rajoy's speech was littered with fiscal presents that make it impossible for Spain to hit the deficit target without making further huge cuts. Unnecessary reductions in corporation tax were promised together with the crazy reintroduction of tax deductions for mortgage holders. The tax on companies is only paid if they are profitable in the first place, and tax officials in Spain have estimated that the real average rate at which this tax is paid is only 10% anyway given that there are so many ways in which to reduce the burden. The mortgage tax deduction is widely credited with having been one of the factors behind the disastrous housing price bubble. If Rajoy sticks to these tax commitments, together with his promise to increase pensions, then most of the promised cuts in spending are already cancelled out by reductions in government income or increased spending elsewhere.

What this all means is cuts in spending way beyond the headline figure, or backtracking on Rajoy's few concrete commitments. A few short weeks ago it was education and health that were untouchable alongside pensions. You won't hear that any more. Despite all the talk of cutting wasteful spending, the reality is that the axe is going to fall on essential services and the employees who work in those services. All the money ripped off in those mega projects of the boom years has been safely stashed away. Usually where the taxman is unlikely to find it should the government surprise us and start to do something about the manifest injustice that leads to so many of those who have the money not being asked to make any contribution towards the cost of the crisis.

The bad news doesn't stop here. Nobody seems very confident about Spain hitting the deficit target for 2011, mostly because of the still unconfirmed deficits in the regional governments. Each 1% of variance above the target is more or less equivalent to another 10000 million euros in cutbacks. Lets assume that 1% variation and a generous estimate of a similar amount on the tax cuts; that's a not very trivial additional 20000 million euros of cuts on top of what Rajoy has already promised. In total well over twice as much as those cuts already made by Zapatero's government, which of course the PP opposed so vehemently when in opposition. Whatever happened to the Madrid PP's petition against the rise in VAT?

The reasons why the PP will not reveal the true scale of the cuts are more to do with political strategy, rather than the economy. Andalucia holds regional elections in March, and the PP has high hopes of winning control of the region after decades of PSOE control. So the full reality of the cuts the PP intend to make has been put back until after these crucial elections, when suddenly we can expect the veil to be lifted and reality will bite hard. The outlook for Spain in 2012 is tremendously grim, unemployment is going to continue to rise well beyond the symbolic figure of 5 million and there is no prospect of economic recovery.

It's wake-up time, particularly for those PP voters who were seduced by the comfortable but cynical illusion that all it would take was a change of government for Spain's economic situation to improve. The recognition yesterday by the new economy minister, Luis de Guindos, that Spain is heading back into recession just makes all this pain for no gain seem even more absurd. This is no natural "business cycle" recession. It's a deliberately provoked recession which will only be made worse by the spending cuts. There are those who will argue that it's a sovereign debt crisis, or even those who still prefer the morality fairy tale of spendthrift Mediterraneans punished for their years of high living. But the Christmas gift of huge amounts of cheap money the other day from the European Central Bank to the banks tells the real story. Those who warned that failure to deal with the causes of the financial crisis would lead to it continuing were right. Those who scoffed at them were disastrously and stupidly wrong. 

There is possibly somewhere a lunatic, safely locked up and restrained, who regards the bombing of Hiroshima as an example of progressive town planning and slum clearance. Those who insist on regarding the deliberate destruction of productive economic capacity as a process of "structural reform" are still walking the streets. You need to have a truly impressive resistance to reality to still believe this kind of interpretation with everything that has happened in the last few years. But then the faith based economics which are so dominant these days accept no examination of the evidence. The coming economic miracle is just kicked repeatedly further into the future. Any other economic model which produced such dismal results would have been binned long ago. 


moscow said...


I didn't vote for the PP so I can't be pitied for being naive (as you suggest). But I wanted the PP to win. I never believed that the PP could or would solve everything. I don't think Spain will get back to growth before 2013 (2014 even). Too much is beyond the PP's own power to get things done.

My hope was always that Rajoy would have the courage to implement the painful and absolutely necessary structural reforms without which Spain will either:
1) be turfed out of the Euro
or 2) become the root-cause of the dissappearance of the Euro.
Unfortunately, I am starting to see the first signs of cowardice. That doesn't bode well for the future.

If I were the labour minister in charge I would carefuly and very attentively listen to everything Candido Mendez had to say, and proceed with the same care but without any hesitation to do exactly the opposite of what CM said. Can't go wrong with that.

Graeme said...

I don't pity PP voters Moscow, those who deliberately close their eyes to the reality of what is happening until after the election has passed don't really deserve pity. Suicide is of course always voluntary, but unfortunately they take the rest of us with them.

What I find difficult to believe is that you really think the future of the euro depends on the labour market reform in Spain. You can't be serious. Given your distance, let me tell you how things look from the inside. For the last 18 months or so we've had to live in Spain with successive waves of market pressure surrounding the euro crisis. On several occasions those of us who have worked and saved have had to ask ourselves whether it was worth doing, as any day could bring potential ruin.

What those of us who are on the inside have seen very clearly is that none of the recipes advocated for those countries with problems have had any effect apart from driving those economies into further depression. In no case has such a move done anything at all to relieve market pressure on the euro, even though all of these countries have carried out the "reforms" which it is claimed the markets demand. Renewed recession has only had the effect of increasing debt together with a bonfire of public services. But of course you know this.

So then the question is why Spain is going to be different? You also know that the reason why Spain's economy is not growing at the moment is not because of labour market restrictions. So why do you always pretend otherwise? The recipe book is failing, and the only advantage for Spain of remaining in the Euro is the absolute chaos that a messy exit would undoubtedly provoke.

If you are concerned about the euro then you would be in favour of a stable international framework for currencies, and in favour of moves to stimulate economic activity in Europe. On the other hand if all you want is for Spain's notoriously short term employers to have even cheaper labour than they already have then clearly the PP may yet satisfy you. Those who want a better future will have to continue looking elsewhere because they won't get decent jobs here.

Then, when the economy finally touches bottom you can unconvincingly try to claim that any feeble recovery is due to the reforms. It's the best you'll be able to do. We've been through this many times before, but as I previously reminded you there is now sufficient evidence to judge these policies on. It's called the UK, is that seriously your model for Spain's future?

Anonymous said...

So what,Graeme, are your sugestions on policy?


Graeme said...

Andrew, the financial system, to use the technical term, is completely fucked. I don't know whether you read, as I did this morning, about how the banks are returning the huge injection of cheap money they were given to the ECB. Things are so bad they're not even using it to speculate on Spanish debt! The banking system simply no longer operates for the real economy, and that is strangling prospects for growth alongside the adoption of deliberately deflationary policies. I tried telling Candido Mendez that it's all his fault but he didn't want to listen.

Put the financial genie back in the bottle, separate the gambling business from the lending business, a euro zone financial transactions tax to be used for investment in productive economic activities. Force the break up of the larger banks so they can't bankrupt governments. Those that don't want to play by the rules can operate from the remaining tax haven that we´ll leave open as a token gesture - although they can't take their assets with them or operate in the euro zone markets.

Instead of giving money to the banks in an endless spiral we can then use it to promote genuine economic activity which in turn would be the only thing that enables countries to break out of the vicious circle of recession just increasing their debt. Work on creating a new international framework for currency management. Recovery from the Second World War would have been simply impossible if it occurred with the current economic model, so eliminate the impediments to managed recovery instead of subsidising them.

In Spain a thorough and long overdue fiscal reform which will eliminate unfair provisions which only encourage the underground economy for people like autonomos on the clear understanding that they will then only have a certain amount of time to regulate their situation or face heavy fines. An additional team of tax inspectors who will pay their salaries many times over by being told to go for the headline fraudsters. Change the colour of the 200 and 500 euro notes to flush them out. All those changing them, regardless of the sum involved, have to make a declaration on the origin of the money. That seems like a start.

ejh said...

It's a funny thing about "structural reform". It's always "absolutely necessary".

Graeme said...

But not as necessary as the subsequent reform of the reform!