Spain, long protesting that it does not deserve to be put in the same category as Greece, has finally realised that this is a distinction markets, not politicians, get to draw. Wednesday’s budget cuts should help convince investors that Madrid’s effort to rein in its deficit has moved from cheap talk to painful actions. But the time wasted resisting the need to prove that public finances are sustainable delayed the task of securing sustainability of a more important kind: that of the Spanish economy.
José Luis Zapatero, Spain’s prime minister, has a point. Public finances were reasonably sober during the boom. The government ran a surplus and owed less than 40 per cent of national income. But the growth that supported this was based on a mirage, as the government rode on the back of a private sector intoxicated by foreign capital. Had the huge private sector deficit been invested to make the economy more productive, it might not have been a bad thing. Instead it financed house-building – which creates jobs and tax revenue, but only so long as the going is good.
The vacuum left behind when the credit flows stopped made both employment and public finances implode. One in five is now without a job. The deficit reached 11.2 per cent of output last year. Spanish real estate, and the banks exposed to it, stand as monuments to a barren economic strategy. Spain’s most urgent task now is to gain credibility with bondholders, without losing sight of the need to reform a rigid labour market that hinders growth from taking root.
Last February, Madrid presented a radical plan for cutting the budget deficit. But it did not rein in the credibility deficit, the most acute contagion which has spread from Greece. Mr Zapatero’s earlier nonchalance made markets doubt his commitment to the plan and the realism of its growth forecasts. The one percentage point spread of Spanish 10-year yields above German ones is nearly double what it was at the start of the year.
Mr Zapatero had no choice but to undergo the welfare-state equivalent of trial by ordeal. He demonstrated he could take the political pain by announcing he would cut civil service pay by 5 per cent. In total, the new measures amount to a cut in public spending of 1.5 per cent of output more than the earlier plan of bringing the deficit to 7.5 per cent of output in 2011.
It is not certain this will work. The last quarter brought the first glimpse of even anaemic growth since the crisis began. Independent forecasts see Spain growing at only 1 per cent next year, just over half the official assumption, and expect a 2011 deficit of nearly 9 per cent. If the new cuts kill off the sickly recovery, the risk is that the deficit will end up wider than hoped.
They are nevertheless indispensable signals of political will. After last week’s market panic and the eurozone’s extraordinary response, Spain had to prove that it would not go the way of Greece. Now that Mr Zapatero has belatedly found his tough core, he should hesitate no further to launch the structural reforms that can bring his country on to a less illusory growth path.
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