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September 25, 2015

News In Charts: Unpicking Spain’s Growth Miracle

by Fathom Consulting.

This research note is provided by Fathom Consulting. All of the charts below and many many more, covering a range of topics and countries on both the macroeconomy and financial markets are available in the Chartbook to Datastream users at Alternatively you can access Fathom’s Chartbook at

Over the past year, Spain’s economy has expanded at a robust pace, beating the US and most of its European neighbours. There are a number of positive aspects to Spain’s economic performance post 2008, not least of which is the dramatic improvement in its current account position. But deep structural problems remain. Today’s environment of near-zero interest rates has flattered official estimates of non-performing loans. With their balance sheets impaired by a 40% collapse in residential property prices, Spain’s banks are failing to allocate capital efficiently. Bank lending to Spain’s non-financial corporate sector is falling at a rapid pace. In this environment, it is hard to be optimistic about Spain’s labour productivity, and by extension its sustainable rate of growth, beyond the near term.

Among the European economies, Greece has again grabbed most of the headlines this year. And yet, looking beyond the troubled Hellenic Republic, it is clear that one or two members of the single currency bloc have quietly been doing rather well. Take Spain, for example. In the four quarters to 2015 Q2, Spain’s economy expanded at a robust pace of 3.1% – beating the US and the UK, together with all members of the euro club bar Malta (and, of course, the irrepressible Ireland). Here we examine both the background to, and the durability of, Spain’s economic recovery.


Spain suffered more than most

From the outset, it is worth reminding ourselves that Spain was not a passive victim of the fallout from America’s housing market bust. Spain had its own, sizeable bubble in residential property prices. That suggests its banks were hurt at least as much by their domestic, as by their international exposures. Following the onset of the global crisis at the beginning of 2008, Spain experienced little or no growth, quarter by quarter, for five years. By 2015 Q2, output was still some 4% below its pre-crisis peak. In that respect Spain has underperformed the US by 15%, Germany by 9% and France by 6%. Spain, in other words, is starting from a low base.


Deleveraging continues apace

Compared to other advanced economies, the increase in private sector debt in the run-up to, and during the crisis was particularly severe in Spain. Measured as a share of GDP, the debt of households and non-financial corporations (NFCs) doubled from just under 100% in 2000, to just under 200% in 2010.


Since 2010, Spain’s private sector debt as a proportion of its GDP has fallen by around a quarter. At just over 150%, it remains elevated, and it is higher than equivalent measures for both the US and the UK. But at least it is moving in the right direction. And it means that the recent pick-up in growth, driven primarily by a combination of stronger investment and stronger consumption, has not been financed through increased debt. The debt of both households and NFCs has fallen as a proportion of GDP.


Substantial gains in competitiveness

Perhaps the most positive aspect of Spain’s recent economic performance has been the dramatic turnaround in its current account position. Having slipped further into the red over a number of years, by 2008 Q1 Spain’s deficit with the rest of the world stood at a staggering 12% of GDP. Fueled by a dramatic improvement in competitiveness, its deficit has since narrowed sharply, taking the country back into surplus in 2012 Q3. Since that time Spain has run a surplus in all but three quarters.


Spain’s real effective exchange rate, based on relative unit labour costs, has fallen by some 20% since 2008 Q1 – an improvement that, within the euro area, has been matched only by Ireland. Operating in a fixed exchange rate regime, improvements in competitiveness depend largely on movements in relative pay and in relative productivity.


With unemployment in excess of 20%, wage growth in Spain has been modest. In real terms, and by the middle of this year, rates of pay in Spain were more than 10% below levels seen at the start of 2008. But falling real wages have been common to many advanced economies. What is more striking is the surge in Spanish labour productivity. Since the onset of the crisis, it has risen by more than 10%, beating both euro area and OECD averages by some margin.


What has underpinned the dramatic improvement in Spain’s productivity? The next chart offers a clue. The improvement in productivity since 2008 coincided with a substantial increase in unemployment. What we have seen, in short, is not a genuine, structural improvement in productivity, but rather a cyclical upturn driven by widespread job losses among low productivity workers.


Large differences between the degree of employment protection granted to those in temporary and those in permanent employment – the so-called ‘Spanish labour market duality’ – means that the burden of adjustment tends to fall on low-skill, low-productivity workers. Put differently, in times of economic expansion Spain typically creates low-productivity jobs that are then shed when the economy struggles. This phenomenon can be observed in the chart below. The growth of temporary employment has outstripped that of permanent employment over the past two years, causing productivity to level off.


Labour market reforms, and debt write-downs are key

Spain has substantial unemployed resources. But those unemployed resources are likely to be used up only slowly over time, acting as a break on growth, unless the degree of protection offered to permanent staff is reduced.

While the improvement in Spanish labour productivity since 2008 has been impressive, the risk is that it proves to be transitory. In the run up to the crisis, output per worker in Spain stagnated. Spain’s banks lent freely, but the money was used to build new houses, rather than to invest in more productive forms of capital, such as plant and machinery. It is now widely recognised that sustained improvements in productivity depend on a well-functioning banking system. Spain’s is anything but.


On the basis of official, World Bank data, domestic non-performing loans (NPLs) at Spanish banks amount to some 8.5% of assets. Although elevated, and higher than equivalent figures for many developed economies, domestic NPLs at Spanish banks are lower than they were one year previously, and much lower than they are currently in Ireland and Italy. Nevertheless, official NPL data for many European banks are almost certainly flattered by exceptionally low rates of interest, particularly in countries such as Spain that experienced a particularly large housing market boom and bust.


House prices in Spain have fallen some 40% from their peak in 2008. With far more loans taken out in the run up to the peak than in the aftermath, a substantial number of Spanish households will be deep into negative equity. It is likely that concerns about the strength of their mortgage books have prevented Spanish banks from lending to NFCs. In countries such as Spain, where rates of corporate bond issuance are low, banks play a vital role in providing finance, not just for large investment projects, but to small start-ups. Shut off this source of finance, and productivity will suffer.


Spain’s economic recovery, which has gathered pace over the past year, has been supported by a number of encouraging developments. Relative to national income, private sector debt, though still elevated, has fallen by almost a quarter from its peak in 2010. More impressive still is the turnaround in borrowing from abroad. When the crisis hit in at the beginning of 2008, Spain’s current account deficit stood at 12% of its GDP – around twice the size of that recorded by the US two years previously. Spain’s current account is now back in surplus.

But can Spain’s recovery last? Undoubtedly many structural problems remain. In particular, the dramatic improvement in productivity over the past seven years is likely to prove transitory – an arithmetical consequence of the shedding of low skill, low productivity jobs. In the decade leading up to the crisis, output per worker in Spain drifted sideways, as the private sector financed residential construction, rather than more productive forms of investment. According to the official figures, Spain’s non-performing loan problem, though significant, is smaller than that of both Italy and Ireland. Nevertheless, it is likely that data for all three countries are flattered by the ECB’s near-zero interest rate policy. A substantial proportion of Spanish households will be deep into negative equity, and it is likely that this is preventing credit from being extended where it is needed most – namely to the non-financial corporate sector.

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