After the general strike in Spain where 800,000 people (according to the Unions) or 80,000 people (according to the Police) went out onto the streets to express their dissatisfaction with the new labor law of the government, you cannot help but wonder how Spain reached this situation. With 23% of unemployment, Spain is the European country with the largest rate of unemployment and the second country in the world with this gloomy record (only beaten by South Africa, which has 24% unemployment). Critics of the new labor law state that it only fuels the firing of employees and does not support the creation of new job opportunities, as it does not solve the root of the problem that caused Spain to reach this critical stage.
So what is the problem, and how did Spain get itself into such a tangle?
There has been a lot of focus on excessive borrowing by ill-disciplined governments which has led countries such as Greece to turn to their European neighbors for a bailout. Nevertheless, Spain is not one of the countries that has been borrowing and spending too much.
Before the birth of the euro, Germany insisted in a so called “Stability Pact” which would make sure that countries would keep their finances in order. The pact stated that each government had to keep their total borrowing each year to less than 3% of their GDP, and that they were also expected to have debts of less than 60% of their GDP. Most governments over the past decade have been breaking the pact repeatedly and there were never any sanctions made against these countries – Therefore, no reason for them to stop conducting their bad habits. Nevertheless, it has to be said that the Spanish government managed to run a balanced budget on average (no borrowing) every year until the financial crisis in 2008. As Spain's economy grew rapidly, its debt ratio fell to a mere 36% of GDP by 2007. So, given this record, why are market analysts telling us that they fear Spain may not repay its debts?
The reason is the following: when Spain joined the euro; interest rates fell to a much lower level. The Spanish government may not have fallen for the cheap loans, however, most ordinary Spaniards did. The country experienced a long boom period and Spanish households took on bigger and bigger mortgages. House prices rose 44% from 2004 to 2008, at the tail end of a housing boom. Since the property bubble burst, prices have fallen 22% (and they will most probably continue to fall).
During the blossoming boom years, Spaniards earned more and therefore, spent more. That helped to compliment the government's finances. More economic activity means more tax revenues. In addition, it also helped push Spanish wages up to uncompetitive levels. Unit labor costs in Spain rose 36% from 1999 to the end of 2008. In comparison, in Germany unit labor costs rose just 3% over the same period. Now Spanish workers are overpriced compared with German workers now that its construction sector has collapsed.
As a result, households are cutting back on their spending as they struggle to repay their debts, and the unemployment number is growing at an uncontrollable rate. So, even though the Spanish government still has relatively little existing debts, it now has to borrow a vast amount to fill the gap left by the growth in unemployment benefits, as well as the collapse in tax revenues during the downturn. The government may also provide a lot more money to the banks which are not in a good condition either because of the housing collapse resulting in all of the mortgages they have loaned which people are now unable to pay back. All of this results in making financial markets very nervous about lending to Spain.
So how does Spain resolve this situation? How can it regain its competitiveness? By cutting down on wages? By leaving the euro?
Although the reasons of how Spain got into this critical economic situation is now very clear for the experts to evaluate, unfortunately, no one has yet come up with a viable suggestion for an easy way out or to solve it.