National legislative elections on March 9 could well be a
defining moment for the economic future of Spain. The bombing of
several commuter trains in Madrid transformed the dynamic of the
2004 contest, the last general election between the center-right
People's Party (PP) and the Socialist Party. The murder of 191
innocent train passengers by al-Qaeda terrorists helped to
galvanize the electorate against the government and its pro-U.S.
President, Jose Maria Aznar, propelling to power the socialist
candidate, Jose Luis Rodriguez Zapatero, whose platform called for
Spain's immediate withdrawal from Iraq.
Although terrorism remains an important issue, a different set
of problems could cause a reversal of Spain's political direction
in this year's elections. Spain's economy has started showing signs
of fatigue, pushing economic issues to the forefront of the
electoral debate.
Spain must resume the reform efforts begun under the Aznar
government. The economy is sagging under the restrictive policies
and unfavorable labor conditions that have been aggravated by the
current socialist government. Without a second wave of economic
reforms coupled with decisive political will by the government,
Spain's competitive position in the globalized economy will
continue its gradual decline, putting its citizens' standard of
living at risk.
Spain's Rebirth
Ruled by fascist dictatorships in the decades after World War
II, Spain and Portugal lagged behind the rest of Western Europe in
their economic, political, and social development. Over the past 15
years, however, the Spanish economy has registered impressive
economic growth, due in large part to the country's general
openness, the benefits of membership in the European Union (EU)
common market, and fiscal and structural reforms that were
implemented in the 1990s. Since 1995, Spain has enjoyed a dynamic
economic expansion, registering an average growth rate of over 3.5
percent, which is more than one-and-a-half times the average growth
for the EU as a whole during the same period.[1]
Driven by strong consumer confidence, increased private
consumption, and high investment rates in recent years, Spain's
average annual growth rate has edged up to 3.6 percent. This growth
is reflected in a buoyant construction boom and an upsurge in
employment opportunities. It has also been helped by "the positive
supply-side effects of the strong rise in immigration as Spain
needed more workers to afford the construction boom."[2] The
gap in the standard of living between Spain and the rest of the
euro area has narrowed from 20 percent to less than 12 percent.[3] The
average Spaniard's purchasing power now exceeds that of the average
Italian citizen.[4]
Many reforms were driven by competition between EU member states
to attract investment, create jobs, and increase economic dynamism.
Spain and other countries adopted measures to cut personal income
tax rates and improve their business climates. Spain reduced
corporate taxes considerably under both the Aznar and Zapatero
governments, although the impact on competitiveness has been
greatly offset by the abolition of corporate tax allowances. The
top rate dropped to 30 percent in January 2008, while the effective
corporate tax rate remains mostly unchanged.
The Recent Slowdown
After a remarkable 14 consecutive years of growth, the vitality
of Spain's economy is showing signs of slackening. Inflation is at
a 10-year high of 4.4 percent, while recent unemployment figures
were the highest in eight years.[5] This weakening may be part of
a cyclical trend, but voters should be concerned.
The key to sustainable economic prosperity in today's rapidly
changing global economy is a consistent policy environment that
favors innovation and entrepreneurship. That is the conclusion
reached every year in the Index of Economic Freedom (IEF),an
annual study by The Heritage Foundation and The Wall Street
Journal that examines the economic policies of 157 countries to
measure their level of economic freedom.[6]
With a score of 69.7 in the 2008 Index, Spain's economy is
ranked "moderately free." Its score remains higher than the world
and European averages, but it dipped slightly in 2008 due to
corruption and higher inflation. Although Spain's economic freedom
has grown by 11.2 percent from 1998 to 2008, it has grown by just
1.3 percent over the past five years, which covers the Zapatero
government.
What Reforms Are Needed
The recent slowdown suggests the need for a second wave of
economic reforms. Spain needs to pursue fundamental structural
reforms that can boost productivity and competitiveness over the
long haul.
The primary focus should be the lack of flexibility in Spain's
labor market, one of the main factors holding down the country's
overall economic freedom. Under current Spanish law, permanent
workers are protected by high severance payments, and temporary
workers are not. Despite recent efforts to reduce this
segmentation, a new OECD study found that "structural bottlenecks"
caused by "overuse of short-term contracts" have limited labor
market productivity.[7]
Inflexibility in this area hinders overall productivity growth
and employment opportunities. The non-salary cost of employing a
worker is high, and the rigidity of hiring and firing a worker
makes companies risk-averse with respect to taking on new
employees.
Conclusion
Sustaining Spain's competitiveness and prosperity over the long
term should be the central economic issue in the pre-election
debate. The Spanish economy is in a vulnerable situation and risks
becoming less dynamic if the causes of the current slowdown are not
addressed.
By pursing more profound structural reforms that can boost
economic freedom and long-term competitiveness, a new Spanish
government can continue to build a brighter economic future and go
beyond what the country has achieved so far in catching up. That is
the choice that Spanish voters will face on March 9.
James M. Roberts is
Research Fellow for Economic Freedom and Growth, and Anthony B. Kim is a Policy
Analyst, in the Center for International Trade and Economics at The
Heritage Foundation.