Study of Spain Global Crisis and Austeriity Measure
1. Study of Global Crisis in Spain
and the Recovery Measure
In Completion of Individual Assignment for Monetary & Fiscal
Policy Course – 2011
Submitted by:
Erick Prajogo – GNOV10IT047
2. Not until the financial crisis hits the EU countries, Spain is touted as one of the EU countries
with dynamic economy, fueled by strong growth in real estate (EuroChallenge, 2011). A lot
of people from wealthier European countries, such as Germany and United Kingdom, were
making big business in the real estate field. Not only that, foreign investment are also
flowing in automotive and tourism industry (Economy Watch, n.d.). The tax break given by
the Spain government makes it more attractive for other European countries to invest in
Spain. The economy of Spain on 2006 has been considered as similar to Germany.
When Spain adopted Euro as its currency in 1999, it brought a low interest rate, which leads
to attractive loan for housing and consumerism. This situation keeps on going for few years
and the government did not do much when it comes to fiscal policy. Because of budget
surplus due to prosperous economy, government keeps spending to build the country. All of
this comes to an end when financial crisis hits US on 2008. It is still an argument whether
Spain went because of crisis in US or not. But the fact was credit is contracting all over the
world during that time.
The first occurrence of the crisis happened in 2007, when it first hit the real estate market.
So by 2007, crisis already occurred, on which the credit crisis in US sealed the deal. Year
2007 was opened by a decrease of 10% in real estate market, because people were suddenly
stop purchasing properties (GEAB, 2007). The situation even got worse in 2008, crunching
the real estate sector in Spain as it reverse everywhere across Europe. The immediate effect
3. is felt by the construction workers and housing agencies, that leads to increase in
unemployment as much 8.7% in 2007 (News Spain, 2008). They were not particularly
worried at that time because they still have surplus from the past. But what they did not
know that time was that situation will only get worse.
With the economy crumbling as of 2009, unemployment has risen to a very high level,
nearing the depression level. In 2010, almost 20% of Spanish people are unemployed
(Wachtel, 2010). With that amount of unemployment, you can harness the effect to the
economy, as unemployed people means that they can’t pay taxes. If there are no taxes,
there is no income to the government. Most of these unemployment’s are youth, who
dropped out from school because of the big boom in construction field (Poggioli, 2011).
These youth, because they dropped out from school, will not have the proper intellectual
competence to find a job other than construction. While some of the European countries
such as Germany, UK, and The Netherlands were capitalizing on knowledge, Spain clearly
lacks behind in this area, which leads Spain to lose its competitiveness.
The Spanish government, having seen the high unemployment number, started to think a
way to rectify the situation. The first action that came was raising 41 billion in 2008 to help
banks by buying the toxic asset (Lee and Bond, 2008). Though, most of the economists have
expressed their worry that this financial aid will not help to recover the economy. The
situation behind the screen is already so bad that one of the biggest land developers in
Spain, Martinsa – Fadesa, went bankrupt. And this is later followed by chain of bankruptcy of
other land developers. To protect the real estate industry from further collapse, Spanish
government made a huge investment in infrastructure project, with the amount of 19 billion
euro (Property Showroom, 2008). Spanish also put in effect a program to stimulate the
automotive industry, following example of Germany, by using scrappage scheme. With
scrappage scheme, the Spanish people can trade in their old car, for an amount of subsidy,
to buy a new car with less gas emission. This scrappage scheme is implemented everywhere
in Europe to save the automotive industry from rampant crisis which have hit US automotive
city, Detroit, so bad (Advoco, n.d.).
4. When the financial aid to Spanish bank seems like a blessing came from heaven, it was
actually writing a huge debt on the balance of Spanish government. In order to embark on its
rescue plan, Spanish governments are selling sovereign bonds. With so many debts that
Spain has, in tandem with the slow growth rate of only 0.1% in 2009, the confidence of
investors on Spain are declining. In 2009, the credit rating of Spain has been downgraded
from AA+ to AAA (Kollmeyer, 2009). There were also a huge bias in the market that Spain
will be the most likely to default, after Greece. The story of Greece that gone default has
profound effect on the interest rate of Spain on that time. People have seen that this can
happen in one country in euro-zone, so people began to speculate that this can happen in
Spain and Portugal.
This in turn made investors worry about investing in Spain. To gain the interest from investor
to lend money to Spain, the government has to raise the interest rate. With the increase of
interest rate, lending money becoming very expensive for Spanish government. Spain is in
5. dilemma here, because without borrowing, it cannot spend. Even if they borrowing, but
because of high interest rate, they will have to spend a lot of money only to pay the interest.
The chart below depicts the rise of interest rate in Spain in 2010.
Although situation is very bad, the situation in Spain is still better compared to Greece. Elena
Salgado, Spain Finance Minister, claims that bailout from the European Central Bank is not
necessary for Spain (Brett, 2010). Even, Spain should not take a bailout, because it always
followed by extreme cut on budget spending, which might send the Spain economy to
deflation spiral. Spain has started restructuring effort on 2009, following the government
intervention in revving up the economy in 2008.
In 2009, austerity measure has been taken to cut the budget deficit of 11% of GDP. The first
austerity endeavor taken by the government is to increase the tax of the higher income
people. This effort is followed by budget cut in various front including government spending
in public workers, cut of salary as much as 5% in 2010, and freezing of state-pension in 2011
6. (Legorano, 2010). This austerity measure caused a huge outcry from the Spanish population.
But if this is not done, European Central Bank would not be willing to help Spain by buying
their sovereign bond. All of these efforts are done to reduce the budget deficit of Spain,
which increased dramatically because of big spending in 2008, as shown in the graph below.
Perhaps one of the extreme measures is the labor reform, where not only the salary is being
cut up to 5%, but also changes of policies are being implemented. Government made the
process of firing an employee cheaper in Spain, which is otherwise very high, and makes
company reluctant to take new employee. The government is hoping that this policy will
again make company interested to hire new employees. From the perspective of employees,
they were thinking otherwise, and afraid that this reform will only cause more people to be
fired. All of this is done in order to recover the unemployment rate of 20% (BBC News,
2010).
To further cut the budget deficit, Spain will increase tax on cigarette and invest on clean
energy plan that will generate revenue for coming years. To curb entrepreneurship within
the country, which was rather decline in the past years, the government makes it easier and
cheaper for individual to start a company, and provides benefit on it (Mallet, 2010).
7. To increase investor’s confidence on Spanish bank, the government increases the capital
requirement of Spanish bank from to 8%. With the increase of capital, government wants to
make sure that the bank will be more solvent (News from Spain, 2011). The focus being on
the saving bank is because these banks have lent heavily in construction sector, up to 40%,
which have been hit very hard during the real estate meltdown in 2008. The characteristics
of these saving banks are that they are small and spread everywhere. Overall in Spain, there
are around 45 saving banks, which were forced by the government to merge. The merger of
saving bank has brought the number down to 18 banks. Banks that do not have enough
capital will be helped by the government, in exchange with part-nationalization scheme.
Having seen all the measures taken by the Spanish government, will they recover the
financial crisis? Spain might be in track of recovery, but it will not be speedy recovery. Spain
has to be careful with every step that it will take in the future, as recession still looming, and
unemployment are still at 20% level. Spain can be relieved about its flourishing tourism
sector, which contributes to around 10% of the GDP. (PageRank Studio, 2010)
Because of the economy recession, everything tends to be cheap in Spain, and many people
from other countries are more interested to visit Spain. Saving banks across Spain is also
merged, and the government is helping them by buying their bonds, in exchange for
nationalization and tighter banking policy. This will bring order to saving banks from a rather
politically deformed structure in the past. Other good sign is that the housing market has
begun to see a recovery, although still very slow. One thing that Spain should do is to
eliminate the public view of Spain will default, similar to Greece. Spain in any way cannot be
compared to either Greece or Spain. Somehow, if the government can increase the
confidence of investor, by reducing the budget deficit to 6% on 2011, the future will look
brighter for the economy of Spain.
8. Bibliography
Advoco Spain Scrappage Scheme, [Online], Available: http://www.advoco.es/home/22-
latest/34-spain-scrappage-scheme-plan-2000e.html.
BBC News (2010), 2 June, [Online], Available: http://www.bbc.co.uk/news/10220984.
Brett (2010) An Updated Look at Europe’s Sovereign Debt Woes, 3 December, [Online],
Available: http://contraryinvesting.com/sovereign-debt-trouble/europe/an-updated-look-at-
europes-sovereign-debt-woes/.
Economy Watch Spain Industry Sector, [Online], Available:
http://www.economywatch.com/world_economy/spain/industry-sector-industries.html.
EuroChallenge (2011) An Overview of Spain Economy, [Online], Available: http://www.euro-
challenge.org/doc/Spain.pdf.
GEAB (2007) Burst of Europe's Real Estate Buble, 16 January, [Online], Available:
http://www.leap2020.eu/Burst-of-Europe-s-real-estate-bubble-Spain-comes-first-soon-
followed-by-France-and-UK-an-average-of-10-in-2007_a592.html.
Kollmeyer, B. (2009) SP Cuts Spain's Credit Rating, 19 January, [Online], Available:
http://www.marketwatch.com/story/sp-cuts-spains-credit-rating.
Lee, K. and Bond, P. (2008), 20 October, [Online], Available:
http://www.wsws.org/articles/2008/oct2008/spai-o20.shtml.
Legorano, G. (2010) Spain to freeze state pensions in 2011, 12 May, [Online], Available:
http://www.globalpensions.com/global-pensions/news/1636141/spain-freeze-pensions-2011.
Mallet, V. (2010) Spain seeks to impress with austerity, 3 Deember, [Online], Available:
http://www.ft.com/cms/s/0/32c60f34-fee8-11df-ae87-00144feab49a.html#axzz1KyfsRd2Y.
News from Spain (2011), 25 January, [Online], Available: http://news-
spain.euroresidentes.com/2011/01/reform-of-spanish-savings-banks.html.
News Spain (2008) Unemployment rises in Spain, 25 January, [Online], Available:
http://news-spain.euroresidentes.com/2008/01/unemployment-rises-in-spain.html.
PageRank Studio (2010), 2 March, [Online], Available:
http://pagerankstudio.com/miscellaneous/article_2838.htm.
Poggioli, S. (2011) Spain's Boom To Bust Illustrates Euro Dilemma, 27 April, [Online],
Available: http://www.npr.org/templates/story/story.php?storyId=128514195.
Property Showroom (2008) Spain unveils 'extensive' infrastructure investment, 17 December,
[Online], Available: http://www.propertyshowrooms.com/spain/property/news/spain-unveils-
extensive-infrastructure-investment_112121.html.
Wachtel, C. (2010) Spain, The Next EU Sovereign Debt Crisis, 24 June, [Online], Available:
http://seekingalpha.com/article/211595-spain-the-next-eu-sovereign-debt-crisis-coming-soon.